Income Inequality and Employment Revisited: Can One Make Sense of Economic Policy?

Abstract

This article discusses growing inequalities in the context of employment and labour market policies and how the latter can contribute to lowering inequalities. It discusses what is meant by income inequality, why it is remains important to focus on income inequality, which measures of income inequality are relevant and how we have arrived at growing income inequality. A last section reviews what can be done about growing inequality. The current situation is dominated by globalization, which has influenced the functioning and outcome of various aspects of the labour market. Greater attention to labour market institutions and greater coherence between economic and labour market policies is therefore necessary to stem growing inequality. Past examples of combining growth with equitable income distribution are often examples of restrained capitalism. Either social pacts or government bureaucrats and political elites provided the restraint. The current crisis and the public concern for improved income equality might engender renewed political will to make employment creation and income distribution important objectives for economic policy‐making.

Key words:

• Employment
• Inequality
• Globalization
• Development
• Economic policy

Acknowledgments

This article is a revised version of an inaugural address at the Institute of Social Studies, September 2008. I would like to thank the editors of the Journal of Human Development and Capabilities and an anonymous referee for useful comments.

Notes

1 During the 1980s and 1990s income inequality before taxes and subsidies was more or less the same in Finland and the UK, rising in both countries; but while income inequality after taxes and subsidies rose in the UK, it declined in Finland! (Atkinson, 2004).

2 The Spirit Level by Richard Wilkinson and Kate Pickett (2009) shows that this finding applies to many areas of social problems beyond health — levels of trust, mental illness, life expectancy, children’s educational performance, teenage births, obesity, homicides, imprisonment rates, social mobility.

3 This observation is actually based on an economic concept that was made famous by the Italian economist Pareto, who argued that any outcome of a policy is optimal if at least one member of society sees his position improved by that policy and no one is worse off. This so‐called Pareto optimality has guided neoclassical policy making for a long time.

4 Kuznetz’s curve was based on the very limited amount of data as was then available — mostly from developed countries. The much greater quantity of data now available has discredited the Kuznetz’s curve.

5 Their results correspond well with the observations made above that part of growing inequality can be explained by the policies undertaken during the process of liberalization and adjustment, including policies to make the labour market more efficient in order for a country to grow faster. van der Hoeven and Taylor (2000) have argued that the notion of efficient labour markets in most adjustment programmes was mainly based on considering the allocative efficiency of these markets, but that dynamic and redistributive efficiency were neglected during the adjustment programmes, leading to greater inequality.

6 A recent experiment is the so‐called ultimatum game between two players, where the first player proposes to divide a cake or a sum of money in two, while the second player, the receiver, can only take or leave the proposition by the first player. Economic theory would posit that the receiver accepts all offers of various divisions made by the first player since each offer is greater than zero. But experiments show that most people reject an offer that is below 20% of the initial cake and are thus arbiters of fairness. However, experiments with chimpanzees showed that chimpanzees acted more as a homo economicus than the Homo sapiens (The Economist, 6 October 2007).

7 For example, in the case of China, research from the IMF argues that making the quasi‐fixed exchange rate more flexible would allow the country to pursue a more independent monetary policy. The same paper also argues for a cautious approach to capital account liberalization, given the institutional weaknesses of China’s financial system (see Prasad et al., 2005). The argument could be extended to many other developing countries. Rather than abandoning capital controls altogether, they should remain a policy tool that can be used selectively.

8 ‘Millions of dollars are spent studying every aspect of inflation, but few aspects of unemployment; thousands of hours of the time of highly scarce, skilled economists are spent pouring over complex models designed to show how to get inflation down from 8 to 4 per cent, but not on how to create more and better jobs; and if other government officials or those in civil society ask the central bank to do something about employment creation, the central banks can respond, “that’s not our job”. More than anything else, the cost of inflation‐focused monetary regimes is to divert the attention of the some of the most highly trained and skilled economists and policy makers in developing countries away from the tasks that previous generations of central bankers took for granted as being their main job: to help their countries develop, to create jobs, and to foster socially productive economic growth’ (Epstein, 2007, pp. 92–122).

9 It has been argued that the existence of minimum wages results in greater informal employment. ILO (1997) shows, however, that minimum wages up to two‐thirds of the level of wages of unskilled workers will not produce substantial increases in informality.