The Broadbent Blog


Roy Culpeper: Inequality and economic liberalization

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Increased inequality is a phenomenon that has affected many countries since the 1980s—industrial, emerging market and developing. At the same time, some countries have become more unequal than others. Thus, it is important to try to distinguish factors that have been at work universally from factors that have served either to retard or to exacerbate inequality at the national level. The latter category comprises, among others, income transfers, progressive income taxation and active labour market policies aimed at generating decent jobs and full employment. However, this note focuses on the former—the universal factors.

Among the universal factors associated with rising inequality, it is evident that policies of economic liberalization have played a key role. In particular, financial and trade liberalization policies have been key contributors to increasing inequality, and have been in the ascendant since the 1980s around the world—at first, in the OECD countries, but ultimately in all countries that wish to be seen as bona fide participants in the global economy by the IMF, World Bank, WTO and the G20.

With regard to the financial sector, policies of liberalization and deregulation have led to enormous growth in the incomes of both corporations (i.e. profits of banks and other private financial institutions such as hedge funds) and individuals (financial traders and executives of financial corporations). Increased incomes of the latter have typically taken the form of bonuses and stock options rather than a growth in their salaries. For this reason, the impact on inequality isn’t wholly captured by increased incomes for this group, but is reflected in their increase in wealth.  The distribution of wealth is even more unequal than that of income, and it is harder to corroborate since data are less available. Moreover, the impact on incomes in the financial sector is highly concentrated—traders and executives only account for a tiny proportion of the workforce of banks and financial corporations. The majority of employees—e.g. bank tellers, clerks, and support staff—have seen job cuts and little in the way of wage and salary increases.

Financial deregulation has also led to moral hazard. Financial innovation and increasingly risky behaviour on the part of banks and financial traders has been a one-way bet. As long as the financial bubble was expanding, banks and traders enjoyed enormous benefits. When the bubble burst, and the entire financial system was faced with a possible meltdown, governments had to intervene at stupendous cost. (Unlike the US and the UK, the story has not so far played out in this way in Canada, where there have been no bank bailouts. However, it is clearly the case that the major Canadian banks are all “too big to fail”, and if any were threatened with insolvency, they would be bailed out by the government in short order. The underlying moral hazard is the same: bankers and traders can continue to take risks and enjoy their enormous windfalls, in the knowledge that in a worst-case scenario the Canadian government would come to their rescue.)

Finally financial crises, like the present one, are typically followed by deep recessions, and when recovery occurs, it is often a “jobless recovery”. Hence the adverse distributional impact of financial liberalization must take into account not only the income gains of a tiny minority in the financial sector, but also income and employment losses suffered by a large number of middle- and lower-income workers in the aftermath of financial crises.

These considerations would lend support to the imposition of financial transactions taxes (FTTs). The egregious private rate of return to a great many financial transactions (for example, high-frequency trading) adds little social value while creating huge potential social liabilities. Taxing away some of the windfall benefits would contribute both to redistribution and lower inequality, as well as generating revenues to buffer the public against possible financial meltdowns. There is increasing traction for the idea of FTTs, for example in Europe.

At the end of the day, however, it would be better to reduce the scope for speculative and risk-taking behaviour in the financial sector through increased regulation, than to continue business as usual with contingency planning and financial transactions taxes. The financial sector should be regarded as a utility serving the “real” economy—as some have put it, finance ought to be a “good servant instead of a bad master”. Such an approach would tackle rising inequality at one of its key sources, rather than accepting the status quo and looking for remedies and backstops.

Turning to trade liberalization, there are questions of the process by which liberalization is negotiated, as well as how its impacts are managed. First it should be acknowledged that trade liberalization can be important to employment and income-creating opportunities for all parties involved in trade agreements. However, the devil is always in the details. More typically, trade deals create both winners and losers. The winners—businesses and their workers—find new opportunities in foreign markets that were previously inaccessible or restricted. The losers find that their sources of income and employment are suddenly undercut by foreign competition. Trade agreements can sometimes be good news for consumers who enjoy lower prices from foreign producers, and sometimes bad if prices go up, for example on account of rights claimed by foreign producers.

Trade agreements are typically negotiated more with potential domestic winners than losers in mind. Nonetheless, if the negotiators do their work well, the benefits accruing to winners (whether producers or consumers) should significantly outweigh the costs suffered by the losers. In theory, this should enable the winners to compensate the losers. In practice, compensation is rarely undertaken or even contemplated (see Rodrik 2010, chapter 3). The assumption is typically that the spinoffs from new trade opportunities will create new jobs that will become available to those who are unfortunately displaced and have the initiative to find them.

As a result, trade liberalization can contribute to increasing inequality. The winners enjoy higher incomes and the losers must endure lower incomes or lost jobs unless they are able to capitalize on opportunities created by trade agreements.

The problem with the trade negotiation process is that it is almost always undertaken outside of public view. Because of the hidden nature of trade negotiations, it follows that they typically work in favour of the potential winners, and leave potential losers out of the process. A current example is the Comprehensive Economic and Trade Agreement (CETA) being negotiated between Canada and the European Union. When the parties agree to the final deal, it will be tabled in Parliament for approval. Typically, the agreement is presented by the government of the day as the best possible deal for Canada. By then it is too late for parliamentarians or the public to have any impact.

It would be far more democratic if the Government of Canada were more transparent and open about trade negotiations either contemplated or under way. The government should state clearly what it aims to achieve, which sectors and regions may be at risk, and how these may be compensated after the agreement goes into effect. This would no doubt be resisted by a trade bureaucracy that exists principally to help those expanding their market horizons abroad, rather than those in domestic industries who must adjust to new competitors and rules, or perish. But it is crucial to make government more transparent and accountable for international trade decisions they make, presumably with the best interests of all Canadians in mind.

Roy Culpeper is the former President of the North-South Institute.