Inclusive growth in the 4th industrial revolution — the challenge of our era

By Stephen Easton

Monday April 23, 2018

Governments are being asked to explain why majorities feel the next generation will be worse off. Canada’s top finance official tells Australian counterparts it is in significant part due to the inability to enforce the ‘rules of the game’.

It is easy to draw similarities between Australia and Canada and talk fondly of our close ties, as public officials from both countries often do, but in terms of economic policy we have been growing apart lately.

Improving equality through inclusive growth and building “a strong middle class” is the mantra in Ottawa, while arguments around inequality in Australia are centred on whether it is even a problem at all.

There was obviously a lot more ideological alignment under prime ministers John Howard and Stephen Harper, who were in office when the Canada-Australia Public Policy Initiative was launched. The most recent CAPPI public lecture, delivered by Canadian Department of Finance boss Paul Rochon in Canberra, illustrated how divergent the Trudeau and Turnbull governments are in terms of domestic policy responses to modern economic challenges.

Canadian policies include increasing the annual immigration target, rather than recasting it as a “ceiling” and cutting it by stealth, and more generous support for university student and parents of young children from low and moderate income backgrounds, including incentives to makes use of early childhood education.

The Trudeau government is putting more money in the pockets of low-income workers transitioning from welfare to work, as part of efforts to increase labour force participation, while Turnbull’s team focus on policing welfare more strictly and getting money back that might have been claimed incorrectly.

Canada is also seeing “the largest increase in science and research funding since the 1970s” including a 25% boost to funding for basic research over three years, Rochon said, accompanied by “a major restructuring and simplification” of innovation policy that is consolidating about 90 innovation programs into 30.

Other economic policies include industry-specific regulatory reviews and “an aggressive trade agenda” centred on multi-lateral trade agreements.

Wealth inequality vs income inequality

Introducing Rochon, economist and head of the Australian Public Service Martin Parkinson noted the close working relationships between public servants in the two Commonwealth settler-colonial nations. In his experience, “we are natural allies in multi-lateral fora” like the IMF, World Bank, G20 and APEC.

In terms of income inequality, Australia’s phenomenal 27 consecutive years of growth have been fairly inclusive. Each income quintile has grown by a “broadly similar” amount, Parkinson explained, unlike in the USA, where nearly all growth has been near the top. This is acknowledged in last week’s CEDA report on the issue.

At the same time, the PM&C secretary acknowledged, the value of property has skyrocketed so those who own it are asset-rich, which means overall “wealth inequality” has grown.

Rochon pointed out that this extraordinary boom in property values, which has taken place in Canadian cities as well, increases inequality when those assets are sold. Each purchase by a first home buyer transfers a big chunk of their income to sellers who are mostly older and wealthier, via the banks.

The “financial vulnerabilities” associated with rising household debt and high house prices are mostly felt by young and moderate to low income earners, he said. “And so, ensuring that this system remains stable is one of our more important responsibilities as public servants.”

Canada is trying to put the brakes on the housing market with policies to boost supply and reduce demand. Borrowers must pass a “stress test” to see if they could afford their home loan with an interest rate 2 per cent higher than the actual rate. New taxes are designed to discourage at least some wealthy foreign buyers.

There is no reason to assume Australia’s economic growth should continue, either, said Parkinson. “So how we manage this 4th industrial revolution doesn’t just affect us an individuals, it’s going to impact on the heart of our democracy,” said the Prime Minister and Cabinet secretary.

“Disaffection with economic outcomes is a core driver of the loss of confidence in institutions that we’re seeing around the world.

“We’ve seen it in Brexit; we’ve seen it with the election of political outsider Donald Trump in the US. So the way we manage economic change brought about by technology is going to have a really significant, if not defining impact on what our future looks like.

“It’s up to us as citizens to decide how our society distributes the new wealth that technology will deliver, but neither the creation of that wealth nor its redistribution will be easy, so how we respond to those changes goes to the heart of our political and social future.”

Going back to ‘Bretton Woods’

Rochon, whose role is comparable to our Treasury secretary with some of the Finance secretary’s job thrown in, agrees that Australia has not suffered the same rising income inequality that has affected other parts of the world.

“But I think it is fair to say the emergence of these issues has coincided with widespread, and potentially growing, dissatisfaction with economic outcomes, as well as a loss in confidence in the institutions and the approaches to economic policy that most Western countries – including Canada and Australia – followed from about the 1980s to the present,” he added.

More than a third of Canadians “feel their quality of life is worse than that of their parents” and nearly two-thirds believe things will be worse for the next generation, Rochon said in the lecture, hosted by the Institute of Public Administration Australia at the National Gallery.

He did not, however, advocate a “wholesale change in direction” from the economic ideas and international financial institutions that have reigned supreme since the wash-up after WW2.

“In fact, part of my thesis here today is that many of the ills that plague the politics and economics of advanced economies today have resulted precisely because some of the basic tenets of traditional post-war neoclassical approach were not followed.”

In the speech (on video below), Rochon argues “a significant part of the rise in inequality in advanced economies is due to our inability to enforce some of the ‘rules of the game’ that were established in the post-WW2 period” — and that national governments need to “bolster and evolve” the Bretton Woods system of international governance.

“This includes, for example, the need for flexible exchange rate mechanisms, the enforcement of rules at the World Trade Organisation and a new focus, I think, on emerging international issues, primarily related to digitisation and the role of data more generally in the global and all of our domestic economies.”

Later, Rochon suggested developed nations were caught napping when rapid structural change occurred in the global economy over a few decades from the 1990s, as global trade expanded and lots of manufacturing jobs essentially moved to developing countries, including China in particular.

“One of the reasons for this rapid change is that exchange rates did not adjust as required,” he argued. “As a result, the burden of adjustment was borne excessively through wage compression and employment loss in advanced economies.

“And so, a critical lesson of the past 25 years is that properly functioning balance of payments adjustments are critical to global stability. This is because they serve to smooth shocks and allow businesses and employees time to adjust to changing circumstances.”

The big future challenges on Rochon’s mind are not related to “further integration of massive amounts of labour into the global economy over the medium term, as was experienced with the rise of the Chinese economy over the last two decades” but more about technological advances.

“Advances in artificial intelligence and the rise of data more generally raise questions of privacy, security and intellectual property. They also require competitive conditions that will allow firms and countries to compete on a level playing field.

“And so, solving these questions will not only require policy responses within our own domestic economies, but reinforce the importance of international institutions and multilateral cooperation.”

He has faith in the alphabet soup of international bodies — the IMF, WTO and World Bank, as well as the OECD and the UN — as the best available mechanisms to make sure the benefits of economic growth from technological change are shared somewhat equally.

Sound financial management

Rochon also argues that “sound management of our financial systems is paramount” and places Australia among the countries that have done well in this regard, despite some worrying signs of loose lending practices growing in Australia’s banking sector and ineffective regulation emerging from the current Royal Commission.

“One of the reasons that Australia and Canada fared so well in the last financial crisis is that we practised much stricter financial regulation than other countries, particularly with respect to our banks,” Rochon said.

“And so, continuing prudent financial sector regulation and attending to the increase in household indebtedness in both of our economies is going to be critical to both our economic performance and broad public confidence in government and in the institutions of government.”

While the GFC was caused by massive regulatory failures in the United States, he sees the international response as an example of effective international co-operation that is cause to be optimistic about international institutions.

“Canada and Australia can play important roles in the international fora on these questions. Working together, we can make significant progress.”

Following the GFC, he said, government agencies like Australia’s Treasury were overly optimistic and should have expected the slow growth that followed.

“That low global growth is exactly what the students of financial crises told us would happen. I remember looking at the studies that had been done and then we went through a period of about eight years where we consistently overestimated growth and asked ourselves why we were off.

“Well, we knew why we were off. We just found it hard to come to terms with it.”

Neoliberalism, and beyond

Rochon still backs the neoliberal policies that became popular from the 1980s — cutting top income tax rates and company taxes, deregulation, cuts to unemployment benefits, trade liberalisation and balanced budgets — but believes they make inequality worse.

“Many of the measures were, and still are, the right thing to do to create prosperity. But I think it is fair to say that we policymakers did not pay enough attention to the distributional impacts of these reforms.”

More recently, he noted “mainstream economists led by the IMF and the OECD” had begun to notice that “higher inequality is associated with lower and less durable growth” and said the reasons for this are not exactly complex.

“In short, excessive inequality can be harmful to growth because it locks in privilege and exclusion.”

Governments need to think more carefully about whether their policies do enough to support “equality of opportunity and, where appropriate, equality of outcomes” in Rochon’s view.

Even though Australia and Canada have both fared reasonably well in challenging times in the new millennium, their policymakers have “underestimated the speed and depth of globalisation and technological change, while overestimating our ability to adapt to those changes, particularly as they affected our workforces” in Rochon’s view.

A “broader way of thinking” is required to make sure that we all move forward together, rather than splintering apart into a dystopian future where technological advances only widen the divide between the haves and have-nots.

“The bottom line is that we need to pay more attention to policies that generate greater participation in the economy, promote equality of opportunity, and lead to more equal sharing of the benefits of growth,” Rochon said.

“The trick, though, is to do so in ways that do not introduce the disincentives to work and risk-taking that crept into some of our social and economic programs in the 1960s and 1970s.

“It also entails moving forward in parallel with what we might think of as conventional pro-growth policies like open, flexible and competitive markets, and ensuring that tax systems are competitive and conducive to wealth creation.”

Watch the full speech below, courtesy of the IPAA ACT Branch, which has also published the presentation slides.

Top image, L-R: Martin Parkinson, IPAA ACT council member Dawn Casey, Paul Rochon, Finance secretary Rosemary Huxtable. All images: RLDI.

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