Since 2008, a pattern has emerged. Across developed countries, growth has slowed while inequality has ballooned. This has led to exclusion, poverty, and social unrest that is threatening to boil over.
Government and business now recognise the existential threat of this trajectory. If they want to stay in power and ahead in the global economy, they need to address inequality and spread the rewards of the economy more evenly.
For many, that means turning to inclusive growth.
At its simplest, inclusive growth is about enabling the widest range of people and places to contribute to, and benefit from, economic success. The purpose is to achieve more prosperity and greater equity at the same time.
But inclusive growth is much more than just ramped up redistribution. It stands on the assertion that reducing exclusion and inequality, rather than being an afterthought, can itself drive growth. This is a radical challenge to the economic orthodoxies of recent decades.
The values-based case for inclusive growth is clear, but now a strong economic case has emerged too. And the economic case is something that no one can afford to ignore.
Inequality is putting the brakes on growth
Today, the top 10% of the income distribution in OECD countries takes home more than ten times the income of the bottom 10%—up from seven times in the mid-1980s.
Those at the very top have done better still. Over the last three decades, the top 1% captured a staggering 47% of total growth in pre-tax incomes in the US. In the majority of OECD countries, there is a similar pattern: those at the top have pulled away from those at the bottom.
What does this mean for growth?
Up to a point, inequality may be a good thing. Economists think that some inequality is needed to propel growth, because without the carrot of huge financial rewards, risky entrepreneurship and innovation would grind to a halt.
But recent research has put the emphasis on “up to a point”.
A 2014 report from the IMF showed just how mainstream the idea of toxic inequality has become. They found that economic growth was slower and periods of growth were shorter in developed countries with higher inequality.
What’s more, they observed that higher inequality appears to make growth more volatile and liable to abrupt slowdowns.
This may be because inequality contributes to the world’s “savings glut”, since the rich are less likely to spend an additional dollar than the poor. As savings stack up, interest rates drop, thus boosting asset prices, encouraging borrowing and making it harder for central banks to manage the economy.
Either way, it looks like inequality, in excess, starts to choke growth. But even as growth stumbles, inequality continues to perpetuate itself, hurtling towards crisis level.
The trend is clear, but the question remains: why is inequality now harming growth?
There are several hypotheses. One is that when inequality is too great, those at the bottom cannot fulfil their potential to become the leaders and innovators that drive growth.
A study by the OECD looked at inequality and growth in its 34 member countries. They found that income inequality was leading to educational disadvantages that stifled social mobility. Put simply, the poor were struggling to finance investments in education.
More broadly, though, excessive inequality may be the root of the poor productivity gains across developed economies.
Dissect the productivity problem and a pattern emerges: the leading “global frontier” firms have actually continued to register strong productivity gains, but their poorer, far more numerous counterparts have been left behind.
The global firms are typically larger, more profitable, have better access to financial leverage, and are better placed to apply for patents and to adopt cutting-edge ideas, technologies and business models. As global companies, they are best placed to take advantage of the benefits of globalisation.
The smaller firms, by contrast, have lagged behind. Their productivity has flat-lined—and thus so have the wages of their employees. In the past, one might have expected productivity gains to diffuse from the larger companies to the smaller ones—but the differences between the two have become so chasmic that this is no longer happening.
Inequality, which in small doses may help propel growth, has become systemic and toxic. Now, the politics of the situation is now harming the economy further still. Take globalisation and free trade. From the perspective of GDP alone, they’re a fine thing. But rightly or wrongly, they’ve become a scapegoat for inequality. And now it’s almost politically impossible to support them.
Inclusion can drive growth
If inequality is no longer propelling growth, perhaps something in the other direction will: inclusion.
Inclusiveness is a concept that encompasses equity, equality of opportunity, and protection in market and employment transitions. In the long run, as we are starting to see, it’s a key component of any sustainable growth strategy.
From the economist’s perspective, it can both raise the pace of growth and make it more sustainable by bringing workers into the growth process and getting more out of those trapped in low-productivity activities.
That’s likely part of the reason why recent research has found that it is social progressiveness, not GDP, that correlates best with competitiveness.
There are surely many mechanisms behind this. But there are clear reasons why including women and ethnic minorities and keeping poorer citizens in a position to contribute should be good for the economy.
To start with women, the first thing to state is something obvious and incontrovertible: they make up half the world’s total talent pool. Their development has a massive bearing on the growth and competitiveness of economies worldwide.
Some recent estimates have suggested that gender parity could add $1.75 trillion to the GDP of the US. Another report found that global GDP could rise by $5.3 trillion by 2025 if it closed its gender gap in economic participation by 25% over the same period.
Clearly, this would lead to a surge in global tax revenues, perhaps fuelling a virtuous cycle of investment in inclusion and greater tax receipts.
When it comes to leadership positions, companies with top quartile representation of women in executive committees perform better than companies with no women at the top—some estimate by as much as a 47% premium on average return on equity.
Increasing workforce diversity more generally is also a boon to growth. Research looking at firms across the US found that those with more diverse leadership were much more likely to grow their market share and capture new markets. But those firms were a minority—and they need not be.
Finally, it’s worth stating the obvious: exclusion increases poverty, and poverty is bad for growth. When people are unemployed, they clearly aren’t working productively and they may require more from the welfare state. From the perspective of GDP, which is admittedly rather limited, they don’t contribute to growth and they are a burden on government budgets.
Helping those people into the workforce should be a win-win: they’ll take less and give more.
The Apolitical View
The pace of growth is important, but so is the pattern. Growth and inclusion are connected, and they should be treated as such.
The last decade has shown us that excessive inequality drags on growth, whereas inclusion accelerates it. Policies that pursue inclusive growth will thus take the foot off the brake and press on the gas.
But the bigger question is about the kind of growth and economy we need. Governments don’t exist to pursue growth; they exist to serve their citizens. GDP growth at any cost is not in the interests of their citizens. Inclusive growth is.
(Picture credit: Pixabay)