Governments have come to recognize that income inequality hinders economic growth. How policy-makers will support inclusive growth remains to be seen.

Conventional wisdom on the relationship between economic growth and inequality has been turned on its head in recent years. The world’s leading economic institutions — the OECD, the World Economic Forum, the International Monetary Fund and the European Commission — no longer conceive of growth and social inclusion as unrelated policy goals. Indeed, each of them has endorsed in one form or another an inclusive growth agenda that “can create opportunities for all segments of the population and distribute the dividends of increased material prosperity fairly across society.”

It would appear that the economic policy paradigm of the past several decades has run its course. In a context of rapid globalization and technological change, governments have long relied on trade liberalization, financial deregulation, tax cuts and more “flexible” labour markets to promote growth. The prevailing attitude was to first focus on growth and assume the rest would (more or less) take care of itself. This period, however, has coincided with a substantial rise in income inequality in most OECD countries, marked by wage stagnation, a polarization of jobs and earnings, precarious employment and the rise of the 1 percent.

These broad and sustained trends prompted more research on the impact of inequality, which shows it is associated with lower social mobility, weaker educational achievements of children born into poorer families, worse health outcomes and higher unemployment.

Although the evidence on long-term growth effects is somewhat mixed, there are indications that inequality dampens the pace of medium-term growth and shortens the duration of growth spells. Greater inequality may also have contributed to the 2008 financial crisis as households took on ever more debt to maintain their standard of living, which created greater economic vulnerability.

More broadly, some time ago the OECD started raising concerns about the potentially detrimental effects of inequality on social cohesion, political stability and support for trade. Brexit and Donald Trump’s election last year have provided pretty compelling evidence for that line of argument.

Together these events may explain the current sea change in governments’ approach to economic policy. Policy prescriptions for growth still rest on trade, productivity and innovation. But the notion that, to be sustainable, the benefits of growth have to be more broadly shared and that harmful inequality effects need to be prevented or mitigated is increasingly part of the equation in many countries. Moreover, the long-standing presumption that policies to reduce inequality hamper growth has not held up to scrutiny — au contraire.

By Shutterstock/Joseph Sohm

The Canadian context

The discourse on inclusive growth in Canada emerged quite suddenly with the election of the Liberal government under Justin Trudeau in 2015. Before this, there was still a vigorous public debate as to whether income inequality was really a problem for this country and what (if anything) should be done about it. In fact, the competing narratives on this question prompted the IRPP to undertake a major research initiative to examine the Canadian story on inequality.

We found that inequality trends in Canada reflect the same dramatic shifts in the distribution of income that have occurred in other countries over the past four decades. As elsewhere, market income (labour and capital income) inequality increased considerably in the 1980s and 1990s but in Canada it stabilized after 2000 in good part due to the natural resources boom, which boosted the labour demand for and wages of low- and middle-skilled workers.

Four trends stand out as particularly meaningful:

  • The rise of the 1 percent: The main contributor to rising inequality has been the large and rapid concentration of income among those at the very top of the distribution as a result of markedly skewed income growth rates (see figure 1).

  • The decline of the middle class: Between 1970 and 2005, the proportion of male workers earning “middle-class wages” fell by 10 percentage points, and their share of total earnings fell even more.
  • Wage stagnation: Since 1980, median hourly earnings have stagnated or declined even as output per hour worked increased (see figure 2). After-inflation earnings growth, which had been on a downward track since the last recession, has remained sluggish in 2016, despite the fact that unemployment fell to 6.3 percent (its lowest level in nearly a decade).

  • The decline in the labour share of income: There has been a prolonged decline in the share of national income allocated to wages relative to profits, which is even more pronounced for the bottom 99 percent of earners (see figure 3).

These trends are at the heart of the issue of how the benefits of growth are shared.

We concluded that Canada had so far avoided the worst excesses of income inequality, but more by luck than by virtue. Indeed, most of the increase in market income inequality in the 1980s and up to the mid-1990s was offset by the tax-and-transfer system; and the post-2000 resource boom reduced the burden on weakened income support programs.

What does this mean for the future? Although the economy continues to recover from the collapse in energy prices, our longer-term growth prospects may rest elsewhere. How we pull through the NAFTA renegotiation, diversify trade and address our chronic underperformance in productivity and innovation will be determining.

The federal government’s current economic policy agenda reflects these priorities but seems inclined to take an “inclusive growth” approach to tackle these challenges. How talk of “inclusive innovation” and “progressive trade” will translate in practical terms, however, is not yet clear.

Our research suggests that incremental changes in existing policies are likely to have little impact on underlying inequality trends.

As we know, the Liberals campaigned on promises to help the middle class. And early on in their mandate, they followed through by implementing several measures to make the income tax system more progressive, to enhance and better target child benefits and public pensions, and to improve access to post-secondary education. These measures aim to make taxes and transfers more progressive, which is important. But our research suggests that incremental changes in existing policies are likely to have little impact on underlying inequality trends. Indeed, we argue that it would be unrealistic to rely exclusively on the tax-and-transfer system to mitigate what is the inherent product of forces operating throughout the economy. Moreover, in Canada (as in many other countries), tax-and-transfer policies have become less effective in reducing inequality than they were 20 years ago.

This is where the concept of inclusive economic growth comes in. It moves us beyond the “first grow and then redistribute” approach to policy, and proposes two equally important societal goals of economic growth: first, to create opportunity for all segments of the population; and second, to distribute the dividends of increased prosperity fairly across society. To do so, however, requires both fundamentally rethinking the way the benefits of growth are distributed and having a broader conception of “social policy.”

Fundamentally, inequality trends result from major shifts in bargaining power over wages over time. Part of the solution, therefore, lies in measures to redress the balance of power across the income distribution. For instance, we suggest that tax regulations, CEO compensation and other corporate governance practices should be thoroughly reviewed and adjusted to reduce the ability of top earners to extract earnings and profits in excess of market fundamentals. The federal government is presently reviewing tax measures favouring top earners, but so far corporate governance practices do not appear to be on the radar.

In effect, laws and regulations governing unionization have increasingly failed to provide workers sufficient voice and bargaining power to share equitably in the benefits of growth.

We also know that the decline of unionization, to now well below 20 percent in the private sector, contributed significantly to growing wage inequality in Canada. In effect, laws and regulations governing unionization have increasingly failed to provide workers sufficient voice and bargaining power to share equitably in the benefits of growth. Research shows deunionization has also had negative spillover effects on nonunionized workers. More broadly, the quality of employment is deteriorating, as evidenced by trends in earnings and nonwage benefits and the rise of nonstandard jobs. These trends become even more of a concern when we consider the potential labour market impacts of technological advances in automation and the digital revolution.

It may be time to move beyond the traditional union framework. There appears to be cultural resistance in North America to European-style social partnership models, so perhaps granting stronger rights and protections to all workers holds more promise. This idea may seem controversial, but let’s remember that policies such as equal pay for women and the minimum wage, which were once considered extremely controversial, are now widely accepted as part of a fair and efficient labour market. We tend not to think of such measures as social policy, but in effect they are.

Toronto women’s march, January 2017. Shutterstock/by J. Louis Bryson

In the same vein, minimum-wage policies can be viewed as governments bargaining on behalf of the lowest-paid workers. The increase in minimum wages in all provinces since the early 2000s (after years of status quo) has reduced wage inequality, but not enough to reduce household income inequality. The reality is that implementing further minimum-wage increases of the same magnitude as in the past would still leave many full-time/full-year minimum-wage workers living below the poverty line (as defined by the low-income cut-off or LICO).

In recent years as many as 18 large American cities have either implemented a new minimum wage or significantly increased its level, with several of them adopting a $15/hour target. The evidence so far shows that the employment effects of these policies have been modest. They have also led to family incomes rising at the bottom and sizable reductions in labour turnover, as employers try to reduce recruiting and training costs.

We are also seeing major changes in Canada on that front. Alberta’s minimum wage is fast approaching the $15 mark (a year from now); Ontario has announced it will be moving to $14/hour in 2018 and to $15/hour in 2019; and BC’s new government has established a fair wages commission to move in that direction as well. It will be important to monitor the full distributional impact of these major changes on jobs and wages. But given that the cost of living and labour market conditions in Canada’s large urban centres are markedly different from those elsewhere in their provinces, it may be that maintaining uniform provincial rates is not optimal.

Notwithstanding my earlier comments on taxes and transfers, we should not underestimate their importance as part of an inclusive growth agenda. According to the OECD, income taxes and cash benefits reduce income inequality among the working-age population by 22 percent in Canada, compared with 26 percent on average in the OECD and much higher rates in Sweden, France and the Netherlands (see figure 4). A recent review of evidence for the European Commission also shows that countries vary greatly in terms of the effectiveness of their social spending in reducing inequality and poverty per dollar spent. Of course, the institutional and economic context in which policies are implemented is a factor, but policy mix and design matter a great deal as well. There appears to be ample room for improvement in Canada.

Our research showed that the greatly diminished redistributive capacity of the tax-and-transfer system in Canada in the mid-1990s was principally due to large cuts to EI and social assistance. These two programs, which remain the pillars of the Canadian income security system, have long been the object of criticism for not fulfilling their core mission and allowing too many needy individuals to fall through the cracks. There is also a broad consensus that both need to be seriously revamped to adapt to rapidly changing needs.

The very concept of employment insurance is being increasingly challenged by the growing incidence of nonstandard work and displaced workers. As for social assistance, we have seen poverty rates decline, but the real problem remains how to help those vulnerable individuals most at risk of recurring and persistent poverty. The good news is that there now seems to be some impetus to move beyond more program tinkering and even perhaps go back to the drawing board.

For instance, the old idea of a guaranteed annual income (GAI) is again being seriously considered as a means to simplify and rationalize the complex web of overlapping income support programs. It could be a better way to provide integrated and stable long-term income support for people with severe disabilities and those unable to work. The full implications of implementing a more broadly based GAI, however, need to be carefully assessed, especially in its potential interactions with other programs, including underused instruments that have proved to be effective elsewhere, such as earnings supplements and wage insurance.

We must also remember that cuts to EI and social assistance in the 1990s were not just a cost-cutting exercise but also part of a policy shift away from “passive” income support measures. The idea was to make way for greater social investment in education, training and “active” labour market programs to facilitate job search and employment.

As figure 5 shows, Canadian governments have never fully or effectively delivered on this important half of the equation. The problems with EI are well known and most don’t need repeating. However, some — like the failure to provide timely access to effective re-employment support to displaced workers; restricting this access to recipients of EI benefits when a growing proportion of unemployed workers fail to qualify; and the inadequate income support provided to older and long-tenure displaced workers — are particularly problematic for an economy looking to diversify beyond its resource base and make the most of new advances in technology.

As we know, education and training have a direct bearing on equality of opportunity and social mobility, in both the short and long terms. This is why much more should be done to enhance “second chance” education and training options for working-age adults.

It is encouraging to see that many of these issues are addressed in the 2017 federal budget. The government has announced a wide array of measures to broaden opportunities and enhance support for workers to develop and upgrade their skills — both within and beyond EI, and in cooperation with the provinces. Of course, as always, the devil is in the details. A lot will depend on how the proposed measures are implemented, but they can and should be a central component of Canada’s evolving policy agenda for “inclusive growth.”

This article is part of the special feature Inclusive Growth in an Age of Disruption

Photo: Shutterstock, by Radachynskyi Serhii.

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