The field of macroeconomics was born in the aftermath of the Great Depression of the 1930s, when average incomes fell by 25 percent in some countries. Avoiding such a decline by using monetary and fiscal policies became the main concern of macroeconomists. In the 1980s, understanding why average incomes differed across countries became a second important topic of investigation. Over the past three decades, a consensus has emerged that a triad of policies—consisting of (1) macroeconomic discipline, (2) structural reforms to free up markets, and (3) the global spread of markets through free trade and movement of capital and labor—can deliver growth in average incomes and help the poorer countries catch up with the richer ones.
There is much to cheer about the substantial benefits generated by these policies. Global growth has increased in the 1990s and before the onset of the Great Recession was fairly robust, in particular in many populous countries such as China and India. As a result, between-country inequality has declined and millions have been rescued from abject poverty. The Millennium Development Goal of reduction in absolute poverty was met five years ahead of schedule. Inflation has been tamed in advanced economies and in many developing economies as well.
These substantial benefits, however, have not been equally shared. Median incomes have stagnated in the United States and in many other advanced economies, the labor share of income has steadily declined in many countries, and within-country inequality has increased in almost all advanced economies and in several emerging markets. The evidence in this book suggests that greater attention to these distributional consequences of many economic policies is needed. The reasons are three-fold.
First, excessive levels of inequality are bad not only for social and moral reasons but also for growth and efficiency: although the relation between inequality and growth can be complex, higher levels of inequality are associated, on average, with lower and less durable growth (Ostry 2015; Berg and Ostry 2017). Hence, even from the perspective of the goal of fostering growth, attention to inequality is necessary. Moreover, high levels of inequality may lead to latent social conflicts that ultimately translate into political backlash against the pursuit of free market policies, including globalization.
Second, the fear that redistribution will have an adverse impact on growth turns out to find little support in the data—implementing policies to reduce excessive inequality tends on average to support growth rather than to retard it: “sharing wealth more equally may actually produce more wealth overall” (Ostry 2014).
Third, many adverse distributional developments arise from policy choices made by governments. Hence, they are not—as sometimes argued—exclusively due to technological developments and other global trends beyond the control of any one government.
For these reasons, we suggest a course correction in the rules of the road that have governed economic policy making across much of the world. While the pursuit of market-friendly policies is needed and desirable to ensure an increase in average living standards, the distributional consequences of these policies should be recognized and addressed ex-ante through better policy design—with aggregate and distributional effects in mind—and ex-post through redistribution (Ostry, Furceri and Loungani, 2018).
Happily, there is evidence that governments are paying greater attention to the efficiency–equity trade-offs posed by economic policies. So rather than just “going for growth”—as the consensus view and organizations like the OECD advocated as a goal—governments are opting for inclusive growth (Loungani 2017). Inclusion is important, but so of course is growth: “a larger slice of the pie for everyone calls for a bigger pie” (Lipton 2016). Hence, the advocates of inclusive growth do not have in mind as role models either the former Soviet Union or present-day North Korea—those are examples of inclusive misery, not inclusive growth.
The change in goal is reflected in the policy choices countries make and in the advice they get from institutions such as the IMF. For instance, on fiscal policy, the IMF’s then-chief economist Olivier Blanchard said “what is needed in many advanced economies is a credible medium-term fiscal consolidation, not a fiscal noose today” (IMF Survey 2010). In October 2013, the IMF’s managing director Christine Lagarde applauded the decision by the U.S. Congress to raise the country’s debt ceiling. On the pace of U.S. fiscal consolidation, Lagarde advised: “we say slow down because the point is not to contract the economy by slashing spending brutally now as recovery is picking up” (Howell 2013). For the euro area, the IMF advocated that “those with fiscal space should use it to support investment” (IMF 2015).
Attitudes toward unfettered flows of foreign capital are also changing. The mounting evidence that some flows generate large costs but little benefit led the IMF’s former first deputy managing director Stanley Fischer to exclaim: “What useful purpose is served by short-term international capital flows?” Among policymakers today, there is increased acceptance of using a variety of tools to mitigate the risks to financial stability and to the economy associated with capital flows, especially short-term carry trade flows (Ostry 2012). Greater exchange rate flexibility offers some insulation against the risks of volatile capital flows (Obstfeld, Ostry, and Qureshi 2018). But so do capital controls and prudential measures to restrain the financial sector (Ostry, Ghosh, Chamon, and Qureshi 2011, 2012). Capital controls may be the best option when it is borrowing from abroad that is the source of an unsustainable credit boom (Ostry, Ghosh, and Qureshi 2015).
The IMF also recognizes that opening up to foreign capital flows is generally more beneficial and less risky if countries have reached certain thresholds of financial and institutional development, and that full liberalization may not be the appropriate end goal for many countries (Ghosh, Ostry, and Qureshi 2017).
Events over the past few years have prompted concerns about a reversal of globalization. That would only serve to negate the great benefits that freer trade has engendered, as we noted earlier. At the same time, not acknowledging some of the shortcomings of globalization is wrong. The problems with questionable efficiency benefits and sizable equity costs from some policies will not go away if we do not acknowledge them. Rather than shy away from inconvenient truths, designing policies so they deliver inclusive growth will be a more durable response than leaving matters to the trickle-down effects of growth (Guriev, Leipziger, Ostry 2017).
Trampolines and safety nets: Policies such as job counseling and retraining allow workers to bounce back from job loss: they help people adjust faster when economic shocks occur, reduce long unemployment spells, and hence keep the skills of workers from depreciating. While such programs already exist in many advanced economies, they deserve further study so that all can benefit from best practice. Safety-net programs have a role to play too. Governments can offer wage insurance for workers displaced into lower-paying jobs and offer employers wage subsidies for hiring displaced workers. Programs such as the U.S. earned income tax credit should be extended to further narrow income gaps while encouraging people to work (Obstfeld 2016).
Broader sharing of the benefits of the financial sector and financial globalization: We need “a financial system that is both more ethical and oriented more to the needs of the real economy—a financial system that serves society and not the other way round” (Lagarde 2015). Policies that broaden access to finance for the poor and middle class are needed to help them garner the benefits of foreign flows of capital. Increased capital mobility across borders has often fueled international tax competition and deprived governments of revenues: a “race to the bottom leaves everyone at the bottom” (Lagarde 2014). The lower revenue makes it harder for governments to finance trampoline policies and safety nets without inordinately high taxes on labor or regressive consumption taxes. Hence, we need international coordination against tax avoidance to prevent the bulk of globalization gains from accruing disproportionately to capital (Obstfeld 2016).
“Predistribution”and redistribution: Over the long haul, policies that improve access to good education and health care for all classes of society are needed to provide better equality of opportunity, as argued forcefully by former IMF chief economist Raghuram Rajan in his 2011 book Fault Lines. Of course, improving access is neither easy nor an overnight fix. Hence, in the interim, such “predistribution” policies need to be complemented by redistribution: “more progressive tax and transfer policies must play a role in spreading globalization’s economic benefits more broadly” (Obstfeld 2016).
Since the Great Recession, much attention has been given to macro-financial linkages and, more recently, to fears of secular stagnation in growth. Broadly speaking, our book makes the point that just as much attention needs to be devoted to macro-distributional linkages and to the secular exclusion of large parts of the population from the benefits of increased growth.