Trade, employment and development: Back on track?

Richard Kozul-Wright

In today’s world of increased economic and political interdependence achieving a broad-based, rapid and sustained growth in incomes and employment involves even more complex policy challenges than in the past. This was the case before the recent crisis, but it is even more so as policy makers in both developed and developing countries look for ways to mitigate the damage from that crisis and build a more sustainable recovery.

The International Labour Organisation (ILO) worries that the kind of integrated policy framework and the accompanying degree of policy coherence required to respond effectively to the crisis within and across countries is still not in place. In particular, the kind of mutually supporting links between macroeconomic policies, social protection systems and active labour market measures are still not established to ensure both an inclusive (job-rich) recovery and to realize the Millennium Development Goals (MDGs) within an acceptable time frame.

This worry is very much shared by United Nations Conference on Trade and Development (UNCTAD). Indeed, when the development agenda is expanded beyond the MDGs to include the traditional issues of catch-up productivity growth, economic diversification and technological upgrading, then our worries tend to be amplified.

At the G20 and other meetings, like the recent one in Oslo co-hosted by the ILO and the International Monetary Fund (IMF), there have been signs that the stranglehold on policy design by the financial institutions has begun to loosen. There have been some important steps away from policy orthodoxy, particularly by the IMF, on issues such as inflation targeting, capital controls and countercyclical policy measures.

These are welcome developments but at the end of the day actions speak louder than words. The kind of programmes put together by the Washington institutions since the crisis have continued to carry much of the damaging policy baggage of the recent past, particularly with respect to procyclical adjustments and targets and squeezing public investment programmes, including in Least Developed Countries (LDCs).

Despite the recognition that the growth in global interdependence poses greater problems today, the mechanisms and institutions put in place over the past three decades have not only fallen short on surveillance and the policy coordination challenge but have in many respects contributed to the dissonance and tensions that eventually culminated in the financial crisis that hit in 2008. The failure to make reforms now runs the very serious risk of retuning to “business as usual” and the danger of repeating the boom bust cycles of the recent past.

The kind of institutional changes needed for financial stability - and the “global public good” which the IMF promises to deliver - have made little headway in recent discussions. These include larger, more predictable and less conditioned flows of development finance; adequate international liquidity to support countercyclical macroeconomic policymaking at the domestic level; the management, through some kind of orderly workout mechanism, of sovereign debt crises; a stable exchange rate system; and more representative form of international governance (though small steps have recently been agreed on this).

The problem in achieving progress on these fronts has in one sense not been too little coherence but too much; namely an almost blind faith, particularly at the international level, in freely functioning markets to generate prosperity and stability at the national, regional and global levels.

That is a debate which has not closed though there is a good deal more realism than a few years ago). But what seems not open to question is the fact that by focusing exclusively on a narrow definition of fundamentals (efficient markets, rational expectations, balanced budgets, price stability, and so on) the Washington institutions have consistently missed every single one of the major economic crises that have occurred over the past 25 years, from the savings and loans collapse in the US in the late 1980s, through the Asian financial crisis of 1997, to the sub-prime meltdown and the collapse of the Icelandic economy in 2008.

These institutions have also missed (or worse neglected) one of the most persistent trends in the global economy over the past three decades, namely the massive increase in income inequality which has occurred, albeit to varying degrees, in almost all countries. This trend is closely linked to the rise of unregulated financial markets and institutions, a trend strongly promoted by these same institutions, and which is the characteristic feature of globalization in our era. This is certainly one of the reasons why rising inequality has been accompanied by such a volatile mixture of shocks, imbalances, asset cycles and generally sub-standard economic performance.

The key imbalances in this regard are, on the one hand, the falling wage share and the rising level of household indebtedness and, on the other, the rising profit share and the declining (or stagnant) levels of productive investment. Failure to address these imbalances has made for a weak and uneven recovery and a persistent state of labour market distress even when growth has picked up.

These are trends which UNCTAD also identified in its latest Trade and Development Report as lying behind the jobs crisis in many developing countries even prior to the recent crisis.

Unsatisfactory labour market outcomes, in developing countries as much as developed countries, are also due to unfavourable macroeconomic conditions that inhibit investment and productivity growth, along with inadequate wage growth which continues to repress domestic demand. External demand can compensate up to a point but there are dangers with this strategy which can reinforce wage repression and limit capital formation.

The ILO argues that the rebalancing of labour market conditions will require improving wage determination mechanisms; measures to promote productivity growth; and the narrowing of income inequalities. This is very much supported by UNCTAD’s analysis. We would also put a very strong emphasis on strategies to enhance domestic demand as an engine of employment creation. The mixture of employment friendly monetary, financial and fiscal policies will have to be tailored to particular local conditions and constraints. Industrial policies will also need to be added to the policy mix; this is already happening in a number of middle-income developing countries

A critical role in moving to a jobs-rich development path must be ceded to a developmental state which aims to create and manage rents in line with the objectives of inclusive growth.

A key question for us is whether we have global arrangements capable of providing the financial and monetary stability to help these states pursue development strategies that sustain the expansion of employment and output and encourage the structural diversification that are necessary for their own long-term success and their effective insertion into the international trading system?

It should be clear to all by now that the question of stability and appropriate alignment of exchange rates (particularly among the G-3 currencies) remains unresolved, and large swings have posed a persistent threat to global financial stability, the international trading system, and to exchange-rate policy and other aspects of external financial management in developing countries. The daily volatility in these rates can often offset annual gains in domestic productivity and drastically alter international competitiveness. This problem has been recognized in recent discussions (though the language of "currency wars" is unhelpful and misleading) but ignored in current global arrangements which are based on a false dichotomy between trade and finance.

Moreover, the international division of labour is still greatly influenced by commercial policies which favour products and markets in which more advanced countries have a dominant position and a competitive edge. High tariffs, tariff escalation, and subsidies in agriculture and fisheries are applied extensively to products that offer the greatest potential for export diversification in developing countries. The panorama of protectionism is no better for industrial products including footwear, clothing and textiles where many developing countries have competitive advantages. The abuse of anti-dumping procedures and product standards against successful developing-country exporters creates further obstacles. Given the adjustment that developed countries will be required to take in the coming years, it is not difficult to imagine a worsening of this situation, unless these countries can make the appropriate expansionary responses which allow their citizens to adjust as living standards rise.

It is also widely believed that the existing arrangements do not allow sufficient policy space to developing countries to overcome their longer-term payments constraint by pursuing targeted trade, industrial and technology policies and thus increasing their export capacity in more dynamic sectors. There are increasing concerns that persistent policy orthodoxy and global arrangements have the result of kicking away the ladder by which today’s advanced countries attained their present levels of economic development, denying developing countries many of the policy instruments that were widely and successfully used in the past.

The need for a more effective multilateral trade and financial system cannot be ignored; indeed developing countries continue to have a stake in building such a system. Controlling finance remains the place to begin this task as it was back in the 1945. As Keynes noted at that time: “It is very difficult while you have monetary chaos to have order of any kind in other directions… “

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Richard Kozul-Wright is a senior UN economist heading the unit on Economic Integration and Cooperation Among Developing Countries in UNCTAD. He was previously in charge of the World Economic and Social Survey in UNDESA, New York. He holds a Ph.D in economics from the University of Cambridge, UK, and has published papers on economic history and development issues.

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Talking about an Energy and Jobs Revolution

Kumi Naidoo
© Jeremy Sutton-Hibbert / Greenpeace

Creating decent new jobs, fighting poverty and curbing catastrophic climate change have historically been seen as three distinctive challenges, pursued by a trio of different movements: trade unions, development organizations and environmentalists. This should no longer be the case. In the past few years, as climate change has become ever more of a pressing issue and the international financial institutions have once again proved incapable of creating employment or fighting poverty, people and organizations have realized that it is in our collective interest as citizens of the world to pursue a green industrial policy. This should start with a re-evaluation of the way we produce and distribute energy.

Greenpeace's Energy [R]evolution, developed in conjunction with over 30 scientists and engineers worldwide, proposes a radical shift in the way the world produces, distributes, and ultimately consumes energy. It is a roadmap for moving energy production closer to the point of use. Under the current system, we produce large amounts of energy at a few centralised locations and send that energy over very long distances to where it is consumed. This system is inflexible, often wasteful, and leaves large swathes of the world’s population unserved and without access to any energy.

In addition to being centralized geographically, energy production is also centralised in terms of influence with control lying in the hands of a few very powerful energy companies. All too often, these companies operate as monopolies, dictating availability, prices and access. Because energy corporations do not cater to the poor, about a third of the world's population (over 2 billion people) lives with little or no access to reliable energy services. For cooking and heating, many people must depend almost exclusively on burning biomass, a labour-intensive process often detrimental to health and a scourge for the environment.

Bringing energy to these parts of the developing world would not only help us address the ongoing issue of poverty but, if done in the right way, we would also be a big step closer to a fairer and more sustainable future. Such a move would also help curb global warming and create millions of new jobs along the way.

The good news is that an Energy [R]evolution is well within our grasp. If we make the right changes over the next ten years or so, we will be able to redesign the outmoded energy system we rely on in most parts of the world – and move to a future powered in most part by the sun, the wind and the natural forces of the Earth. This would create benefits not just for the environment, but for workers as well.

The Energy (R)evolution calls for decentralized energy, which comes wherever possible from renewable sources such as wind or solar energy and is connected to a local distribution network system. This local “micro-grid” supplies homes and offices, rather than the high voltage transmission system. The scenario would see a huge proportion of global energy produced by such decentralized energy sources – supplemented, as needed, by large offshore wind farms, concentrating solar power (CSP) plants in the sunbelt regions of the world, and other renewable sources of energy by 2050. Creating a closer proximity of electricity-generating plants to consumers will allow any waste heat from combustion processes to be piped to nearby buildings, a system known as cogeneration or combined heat and power. This means that nearly all the input energy is finally put to use.

The Energy [R]evolution is a win not just for the environment, but also for local people. Towns, villages and local communities will be empowered to produce, monitor and profit from their own energy thus by-passing major monopolies.

Properly implemented, the Energy (R)evolution would also create millions of new jobs starting with the global power supply sector which could create up to 12.5 million jobs by 2015 (4.5 million more than the current projection). A significantly increased uptake of renewable energy would create over 8 million jobs by 2020 in that sector alone, four times more than today.

The potential boost in employment can only occur with aggressive renewable energy policy and targets. Greenpeace calls for a range of measures from governments to safeguard against detrimental changes to the employment balance by providing jobs and retraining in communities affected by this transition. Doing nothing means we will see significant losses in employment in the fossil fuel sector, and there will not be an expansion in clean energy production to compensate. With renewable energy investment it is possible to provide more replacement jobs to counteract the losses, in areas like wind turbine and solar PV manufacturing, geothermal drilling, solar thermal plant constructions, wave energy installations, energy efficiency, and many other cleaner employment alternatives.

If we look at the power sector as a whole, the picture is equally encouraging: if we radically redesign our energy systems as outlined above there will be 3.2 million (or over 33 percent) more jobs by 2030 in the global power supply sector. In Asia, we would see 650,000 power sector jobs by 2015, compared to 610,000 under a business-as-usual scenario. In India, we would see around 1 million power sector jobs – compared to 710,000 under a business-as-usual scenario.

In addition to quantity, the quality of many of these new jobs is impressive. Employment in the sectors that would come to exist, or would considerably expand, through an Energy [R]evolution will often be of a much higher standard than those created by the oil industry for example. They will be a world away from the risks and dangers emanating from the 19th century technology so much of the world still relies on for its energy production. By shifting away from dirty, deadly energy sources such as fossil fuels and nuclear energy, we will create many new jobs that are clean, safe and healthy.

For developing countries this presents a great opportunity to catch up both financially and technologically with the more developed world. By implementing new forms of energy, these countries could leapfrog the era of dirty energy that the world’s developed countries are just emerging from – and move straight to clean and sustainable energy thereby avoiding rising oil prices, dwindling fossil fuel reserves and the ongoing dangers that come with these types of energy. By embracing the technologies of the 21st century, they would not only be able to reduce their CO2 emissions drastically and play an important part in the global fight against climate change; they could also set themselves on a pathway of economic growth, decoupled from a dependence on fossil fuels and respecting the natural limits of the planet we all share.

The timing couldn’t be better: many power plants in industrialized countries, such as the USA, Japan and the European Union, are nearing the end of their proposed life-span, with more than half of all operating power plants already over 20 years old. At the same time countries such as China, India and Brazil are looking to satisfy the growing energy demand created by their expanding economies.

But the Energy [R]evolution won’t happen by itself. We need governments and industry around the world to implement the right policies to make substantial structural changes in the energy and power sector. Unfortunately, few of our current leaders - political or business - have seen any advantages for themselves in promoting a revolution in the way we treat the planet.

Given that change is in the interest of the people and the planet and not necessarily of Big Business, it is going to take the will of millions of us around the globe to force those in power to create the political infrastructure for change. We are going to need an international movement of honest men and women that encompasses environmental organizations, trade unions, development organizations and many others who haven’t actively thought about how the environment touches all of our lives.

For more information about Greenpeace's proposal for an Energy (R)evolution go to:

www.greenpeace.org/energyrevolution

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Kumi Naidoo is the Executive Director of Greenpeace International. He began his career as an activist as a youth leader in South Africa’s battle against Apartheid. He then became founding executive director of the South African National NGO Coalition (SANGOCO), before heading CIVICUS: World Alliance for Citizen Participation, from 1998 to 2008. He was the founding Chair of the Global Call to Action Against Poverty (GCAP), served as Chair of the civil society alliance ‘Global Campaign for Climate Action’ (GCCA) of which Greenpeace was a founding member, and also served as a board member of the Association for Women’s Rights in Development.

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Social forces drive financial insecurity

Seeraj Mohamed

The frequency of financial crises has increased and we are concerned about how soon to expect the next one. The liberalisation of cross border capital flows has increased the possibility not only of contagion from crises elsewhere but that financial profligacy in one country is easily exported to another. Economic policymakers have a duty to protect their country from contagion, global financial volatility and the domestic adoption of profligate financial practices by asserting policy sovereignty. The global trade union movement can play an important role by fighting for policies that limit the power of finance.

Civil society, including trade unions should campaign for economic policies that protect countries from financial crises and contagion. Global trade unions are well placed to co-ordinate these campaigns across countries. Widespread financial liberalisation leads to increased socio-economic insecurity and loss of jobs, factors which weaken the social fabric and create increased hardship for the poor. The rich are able to diversify their investment portfolios and move their wealth abroad if necessary. They can weather the storms of financial instability and crises while the poor are stuck in the eye of the storm.

Many countries are pondering changes to the regulation of financial institutions and markets. However, one should not expect huge changes. James Carville, American political commentator and strategist for former President Clinton’s 1992 election campaign, was quoted in the Wall Street Journal (25 February 1993) as saying, “I used to think if there was reincarnation, I wanted to come back as the president or the pope or a .400 baseball hitter. But now I want to come back as the bond market. You can intimidate everybody.”

The political and economic power of financial institutions, including many that are ‘too large to fail’ is enormous. Large private corporations and governments are expected to make their policies and practices palatable to the few hundred people operating global financial markets and the major credit ratings agencies. Furthermore, economic policymakers and central bank leaders of many countries are drawn from the large financial institutions or expect to work for one of those institutions in the future. The large and very powerful financial institutions have the ability to capture and intimidate policymakers and regulators. They are able to direct how they are regulated by government and, as the recent crisis shows, they are able to acquire bailouts when they have driven their financial systems into crises.

One would expect that the global financial crisis would have undermined the economic and political power of financial institutions. It is necessary to understand the social forces driving the power of financial institutions to understand why they have proved so resilient to financial crises and popular political outcry. The reversal of welfare programmes and state provision and support for pensions, health insurance, unemployment benefits, housing and other necessities drives the power and influence of finance. Demographic factors in many developed countries have a huge impact on global financial markets. Their populations are ageing and want to ensure that they have sufficient investment for their retirement years. They also invest more in health and other insurance products because they are less able to depend on the state. Most of these investments are through institutional investors that have put pressure on large corporations to focus on high short-term returns.

As a result, the approach in many of the largest global corporations to investment and employment has changed. There is increasing evidence that economies that are more financialised have had reduced levels of investment in manufacturing. Institutional investors can capture rents and profits in developing countries and they do not have to support long-term investments and decent jobs in their home countries. Furthermore, the ageing populations in developed countries are politically important and influential, particularly during election years. Policymakers in these countries are usually older and share the interests of those who support institutional investors.

We live in a world where many states will not increase their spending on social security and welfare services. As sovereign debt problems mount, the rhetoric is to cut fiscal spending, further reduce social services and to increase the retirement age. Financial institutions have profited from the inadequacy of social services and from the insecurity of the aged in the recent past. Widespread programmes to reduce fiscal spending will drive even more people to find private providers for social services and to invest more in private pension funds. Finance, particularly institutional investors, will profit from this increased insecurity.

The power of institutional investors stems from the allocation of the capital people pay for social services, retirement investments and risk insurance. They have global financial markets as their playground. Therefore, we cannot expect major changes or ample regulation in these markets unless the social forces that drive the power of finance are addressed. The agenda of the international trade union movement should be more than ever to reverse the reduction of social services and retirement provision by governments. They must fight programmes that cut social spending and increase the insecurity of the poor.

Ultimately, the fight should be to decommodify education, health and other social services, as well as pensions, and to make the state the primary provider of these services. Global trade unions should act to counter the ability of financial institutions to capture and intimidate economic policymakers and regulators. They have to convince their members to use their power as consumers of private social services, health insurance and retirement policies to campaign against the destructive behaviour of the institutional investors that sell these services.

States with a developmental economic programme should put in place measures to curb the power of financial institutions in their domestic economies and to protect their economies from speculation, turbulence, crises and contagion from the rest of the world. Trade unions have to partner with other social movements to fight for changes in economic policies and for more developmental programmes. As a political constituency, they have to push much harder for more effective regulation of finance. Unless we can wage a global campaign against the uncontrolled power of finance, we face the threat of more financial crises in the future. If the past few decades point to what we can expect, there could be more regular and increasingly severe crises. The workers and the poor will bear a disproportionate amount of the pain associated with them.

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Seeraj Mohamed is director of the Corporate Strategy and Industrial Development Research Programme (CSID) in the School of Economics and Business Sciences at the University of the Witwatersrand (Wits University). He also teaches at Wits University in the Economics Department and the Global Labour University Masters Programme. His work is in economic policy research, analysis and development. He has worked on economic and industrial policy for 2 decades.

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On the urgency of stopping global warming

Willi Semmler

Christian Schoder

Parts of the labour movement still have strong reservations towards measures aimed at reducing the carbon intensity of production in order to mitigate global warming. The public debate is dominated by fears that environmental policies harm the working population in the North as well as in the South by increasing unemployment. In line with this public opinion, governments are reluctant to implement mitigation policies on the national or international level. They impose market-based abatement regimes which are in line with orthodox economic theory but ineffective in practice. In this article, we want to rebut these concerns by pointing out that global warming may follow a self-enforcing pattern which is increasingly costly to reverse, thus harming the world's population more and more. Moreover, we argue that mitigation policies may have a positive impact on employment if done properly. After discussing different mitigation policies, we conclude with the policy recommendation of immediate and ambitious action.

Understanding the pattern of global warming

Despite many uncertainties, two stylised facts appear to have elicited consensus among geo-scientists. First, the extent of global warming observed since the age of industrialisation is not natural, but caused by humans. Hence, a reduction of the emission of greenhouse gases is likely to have a decelerating effect on climate change. Second, there are tipping points in the climate pattern. These can be understood as thresholds beyond which climate change turns into a self-enforcing process. Once reached, enormous efforts would be required to move below the threshold again. In order to minimise costs, one should mitigate global warming while it is “cheap”, i.e. before the dynamics of the system accelerate global warming. However, if we are already beyond the tipping point, ambitious mitigation policies are of the highest urgency.

The positive employment effects of abatement

Policy makers justify their reluctance to implement ambitious mitigation policies by referring to the danger of losing jobs to competitors and increasing unemployment. As argued by Mittnik et al. (2010), this fear is not justified. The analysis of a number of countries suggests that budget-neutral green policies which tax carbon-intensive sectors and subsidise carbon-saving sectors or fund research in “green” technology generally have positive net effects on employment. Reasonable mitigation policies may thus imply a “double dividend”: reducing carbon emission while increasing employment. Hence, from the labour movement's point of view, there is not necessarily a trade-off between ecological sustainability and high levels of employment.

The responsibility of the West for global warming

The US and the rest of the industrialised world should take a lead role in the struggle against climate change. As Posner and Weisbach (2010) report, in 2005, the US and China produced roughly the same amount of millions of tons of CO2 (7,219 for the US and 6,964 for China). Yet, if measured per capita, China produced only one quarter of US emissions (5.5 vs. 28.5 tons). This relation becomes even more disproportionate if one considers the cumulative CO2 emissions per capita that have been released into the atmosphere since the beginning of industrialisation (623.3 tons for the US vs. 82.9 tons for China). Even if the US does not take on a leading role, the rest of the world should still engage in ambitious mitigation policies. Europe's role is particularly important in this context. Tipping points exist for adopting climate policies. If there is a critical mass of countries adopting internationally coordinated mitigation policies, the incentive for the US to avoid such policies (competitiveness) will lessen. Moreover, it is not implausible that those countries investing most in green technology will be rewarded by high green economic growth in the future, even though they may not be as competitive in the short run.

How can carbon emissions be reduced?

To establish effective economic incentives, the producers/consumers of carbon intensive products must bear the costs of carbon emission. Two concepts to achieve this have been put forward: (a) cap-and-trade and (b) carbon tax. The former is a decentralised market system for carbon trading. It imposes limits on total allowable carbon emissions. These allowances are then distributed to emitters or other stakeholders and firms trade the allowances for pollution on a market. The carbon tax is a proportional tax on carbon emission.

Despite its flexibility, the cap-and-trade system is not advisable due to its deficiency in effectively reducing carbon emission. First, emission prices exhibit disproportionate volatility due to uncertainty regarding the overall quota and to financial speculation. According to an estimate by Nell et al. (2009), the carbon price is even ten times more volatile than stock prices. The high price volatility of emission rights increases uncertainty and triggers speculative booms and busts. Second, as has been demonstrated by Uzawa (2003), the global market-based system unfairly burdens developing countries. The dollar price of a carbon ton will mean a much bigger percentage penalty for low-income economies than for the industrialised world.

A carbon tax has some considerable advantages over the cap-and-trade system as has been argued by Nell et al. Because there would be one “metric” for all, it allows for a globalised standard. The carbon tax’s clear price trajectory would drive long-term investment. Other advantages include universal applicability, better efficacy, and lower set-up costs due to existing administrative institutions. Uzawa proposes a global carbon tax system under which the tax rate applied in a country is proportional to the country's per capita income. Moreover, he proposes to establish an International Fund for Atmospheric Stabilization funded by income from the carbon tax. The aim of the fund should be to enhance the development of green technology as well as to narrow the growing income gap between developed and developing countries. These aims could be achieved by redistributing tax revenues across countries according to a scheme that provides incentives to develop environmentally-friendly technology and takes per capita income into consideration.

“Green recovery” policies – an insufficient step in the right direction

Since economic wealth is empirically correlated with carbon emission, countries are reluctant to reduce emissions sufficiently. By adopting environmentally friendly technology, this relation could be weakened or reversed. To reduce the carbon intensity of GDP, government action is needed as market forces provide insufficient incentives for the development and diffusion of environmentally friendly technologies. Although the current economic crisis provides an opportunity for implementing ambitious environmental policies through deficit spending, so far it has been left out vastly. From September 2008 to December 2009, the US spent only 12% of its fiscal stimulus on a “green recovery”; on a global level, the corresponding number is less than 16% (Barbier 2010).

Where are we headed?

The 2009 United Nations Climate Change Conference in Copenhagen was a huge failure. The high expectations associated with the conference turned out to be inconsistent with the national interests of the participating countries. According to scientists, carbon emissions must be reduced by 2020 by 25 to 40% of their 1990 level to avoid the worst consequences of global warming. The Kyoto Protocol, agreed upon in 1997, committed the participating countries to reducing the emission of greenhouse gases on average by 5.2% of their 1990 level by 2012. In contrast, the planned reductions agreed by governments in Copenhagen are less ambitious and, most importantly, not binding: countries agreed to reduce carbon emissions by 13 to 19% of their 1990 level by 2020.(1) Given the experience with the Kyoto Protocol, which failed to reduce carbon emissions to the extent agreed upon, one can make an educated guess that the vague and non-binding outcome of Copenhagen is far from sufficient to prevent temperature increases beyond 2°C. Current fiscal stimulus packages do not take into consideration environmental goals sufficiently. Since the current public debate is dominated by misinformation and corporate interests, the future of our climate depends on the social movements, trade unions and critical academics around the world. The pressure put on policy makers has to be increased substantially in order to get them to implement ambitious mitigation policies.

(1) The EU promised to reduce its carbon emission by 20-30% of 1990 levels by 2020, the US by 4% of 1990 levels by 2020 and China by 40-45% until 2020, however of 2005 levels and measured per GDP (Source: Copenhagen Accord, http://unfccc.int/resource/docs/2009/cop15/eng/11a01.pdf).

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Willi Semmler is a Professor at the Department of Economics at the The New School, New York. He is member of the New York Academy of Sciences and has been a visitor at Columbia, Stanford and the Cepremap in Paris. The second edition of his book "Asset Prices, Booms and Recessions" (Springer Publishing House) was recently published.
Christian Schoder is a PhD candidate and research assistant at the Department of Economics at The New School. He holds MA degrees in Economics and Political Science from the University of Vienna.

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References

• Barbier, E. B. (2010), ‘Green Stimulus, Green Recovery and Global Imbalances’, World Economics, 11(2)
• Mittnik, S., Semmler, W., Kato, M., Samaan, D. (2010), ‘Climate Policies and Structural Change – Employment and Output Effects of Sustainable Growth’, CEM Working Paper, Comparative Empirical Macroeconomics, New York, available from: www.newschool.edu/nssr/cem
• Nell, E., Semmler, W., Rezai, A. (2009), ‘Economic Growth and Climate Change: Cap-and-Trade or Emission Tax?’, SCEPA Working Papers 2009-4, Schwartz Center of Economic Policy Analysis, New York: The New School
• Posner E. A., Weisbach, D. (2010), Climate Change Justice, Princeton: Princeton University Press
• Uzawa, H. (2003), Economic Theory and Global Warming, Cambridge: Cambridge University Press

Paying for Inequality: The Costs of NAIRU-based Macroeconomics

Servaas Storm

C.W.M. Naastepad

Mainstream macroeconomics is in a deep crisis in the wake of the financial collapse of mid-2007 and the ensuing Great Recession. What the crisis has revealed is that the remarkable macroeconomic performance of the US and the UK from 1995 to 2006 was just a façade. Hiding behind it, a mountain of unsecured credit and housing debt was accumulating, as a constantly expanding network of secondary markets seemed to be sharing the risk created by such debt, apparently diminishing the risk exposure of individual holders. How that debt mountain collapsed is well known. Mainstream economists did not in any way foresee the crisis, bringing out the failure of the orthodoxy of an entire era in economic thought, teaching, practice and policy advice. As Citigroup’s chief economist Willem Buiter writes (in the Financial Times): “the typical graduate macroeconomics and monetary economics training received at Anglo-American universities, during the past 30 years or so, may have set back by decades serious investigations of aggregate economic behaviour and economic policy-relevant understanding. It was a privately and socially costly waste of resources.” We believe that the theory of the non-accelerating-inflation rate of unemployment (NAIRU), which belongs to the core of graduate macroeconomics and monetary economics, is seriously implicated in creating the crisis. NAIRU theory helped shape the broader macroeconomic conditions within which the spectacular macroeconomic imbalances could build up and eventually lead to collapse. The NAIRU approach must be discarded to provide the space for “serious investigations of aggregate economic behaviour”.

The NAIRU is the equilibrium unemployment rate; it bears a strong resemblance to Marx’s reserve army of (unemployed) labour. Equilibrium unemployment is the outcome of the conflict over income distribution between workers (unions) and firms. Workers negotiate money wages designed to give them a certain standard of living, while firms set prices as a profit mark-up on labour costs. Wage setting is assumed to depend on the expected price level and exogenous wage-push factors (including employment protection legislation, social security and minimum wages) and negatively on the unemployment rate. Competing claims by workers and firms are made consistent by means of variations in unemployment. If workers demand “excessive” wage increases (i.e. exceeding productivity growth), equilibrium unemployment will increase, forcing workers to reduce their wage claims. NAIRU theory holds lessons for both macroeconomic policy and labour market policy. Its key macro policy implication is that governments and central banks should not try to promote full employment, because efforts to push the unemployment rate permanently below the critical threshold (the NAIRU) will fail, as doing so will generate only accelerating inflation (not growth). Fiscal and monetary policies are ineffective as unemployment is regarded as structural or “voluntary”; workers supposedly either lack the required skills or prefer social transfers to employment. The key employment policy lesson of the NAIRU doctrine is that labour markets should be deregulated, welfare states trimmed down, and the institutional wage bargaining position of unions weakened, so as to reduce real wages (relative to productivity) and improve firms’ profitability. This would, according to the doctrine, lead to increased investment, reduced unemployment (especially of the lower-skilled) and improved overall macroeconomic performance. It follows that there exists a conflict, or trade-off, between growth and equity. In other words the price to pay for higher employment is a low-pay sector.

Why and how is the NAIRU model implicated in the current crisis? As Gabriel Palma (2009) compellingly argues, the process of financial deepening in the US (and globally) has been closely related to the huge sustained increase in income inequality after 1980, in a process of simultaneous causation. NAIRU-based economics has created the deregulated labour markets and scaled-down welfare states, within which the very sharp rise in inequality, especially in the US, has occurred, while at the same time legitimising high inequality as the unavoidable by-product of a low-unemployment economy enmeshed in global competition. These huge inequalities have in turn destabilised the system by making it more prone to financial instability. This last fact is easily explained.

One side of the increasing inequality in the US has been stagnant average real incomes for the bottom 90% of US households. This has led not only to a decline in personal savings but it has also created a “captive market” for bank loans and sharp increases in household indebtedness (to sustain the “American Dream” on credit). The flip side of the coin has been a dramatic rise in real income and wealth of the top 10% (and especially 1%) of households, which created superabundant liquidity in US financial markets, transforming them into unstable institutions incapable of self-correcting. High Net Worth Individuals (HNWIs) were the leading providers of finance to hedge funds, which in turn were the leading buyers of securitised mortgages. The HNWIs demanded above-average returns on their investments from the hedge funds, as they were also paying hedge fund managers above-average fees and bonuses.

Rising inequality is at the root of the (financial) crisis. On the one hand, increased inequality depressed aggregate demand and prompted monetary policy to react by maintaining low interest rates, which itself allowed private debt to increase beyond sustainable levels. On the other hand, the search for high-return investments by the HNWIs led to a process of “virtual wealth creation” on an unprecedented scale, based on financial innovations which could go on and on in effectively unregulated financial markets. Net wealth became overvalued and high asset (house) prices gave the false impression that high levels of debt were sustainable. The crisis revealed itself when the “financial weapons of mass destruction” exploded. Crucially, superabundant credit “was not used to finance new [technical] inventions” as in earlier boom periods; as Robert Skidelsky (2009) explains, “it was the invention. It was called securitized mortgages. It left no monuments to human invention, only piles of financial ruin.” Financial markets collapsed once inequality-driven imbalances and instability became too large. So although the crisis may have emerged in the financial sector, its roots are much deeper and lie in a structural change in income distribution that has been going on for almost 30 years.

NAIRUvian macro and labour market policies must take a large part of the blame for unleashing and at the same time legitimising an unequal, unstable and unsustainable profit-led growth process. To prevent financial fragility and crisis, the key issue for macro policy is to impose “compulsions” and “restrictions” on the capitalist system, to discipline firms, investors and financial markets. Labour market regulation could be one such systemic compulsion, in addition to stricter financial regulation and firm-level co-determination, aimed at discouraging non-productive, speculative activity. More egalitarian wage-led growth and low unemployment are crucial to avoid the build-up of excess liquidity which triggered the current crisis. This is why a serious rethinking of the NAIRU approach to macroeconomics is needed. The present crisis offers a historical opportunity for progressive change: given the loss of credibility of financial laissez-faire (Anglo-Saxon style), the legitimacy crisis of stock-market capitalism and the cynicism of Wall Street and the City, the global crisis could force a return of the democratic state, of regulation and of more egalitarian full-employment policies―provided there is a viable alternative to NAIRU macroeconomics. The urgent need is therefore a reconstruction of macroeconomics in which the various positive contributions which labour and labour market regulation make to macroeconomic performance are given their rightful place.

Wages, for instance, are not merely a cost to firms (as the NAIRU model assumes), but higher wages also provide macro benefits in terms of higher demand and faster productivity growth. Higher wages mean higher (consumption) demand, higher capacity utilisation for firms, and hence higher profits. Capital accumulation, in turn, will increase in response to the growth in demand and profit and this will result in higher productivity because investment in new equipment embodies the most advanced technologies and also due to more rapid learning-by-doing in firms. Higher wages and labour market regulation (offering strong legal protection to workers and giving them an effective say and stake in how they do their jobs and how firms are run) will motivate workers to commit to firms through higher productivity. Higher wages and pro-worker regulation will also motivate firms (and make it easier for them) to step up investment in labour-saving technological progress, thus raising productivity growth. And finally, central wage setting is good for overall productivity, as it rewards highly productive enterprises and forces the relatively unproductive ones out of business.

If these positive contributions by labour and labour market regulation are taken into account, it can be shown (Storm and Naastepad, 2011) that there is no conflict between growth and equality. The main reason is that more regulated and co-ordinated industrial relations systems are associated with higher labour productivity growth. Higher productivity growth and stronger technological dynamism in turn allow higher real wage growth (while maintaining firms’ profits and investment), thus creating the conditions for high and egalitarian growth with relatively low unemployment. The mainstream NAIRU approach rules out any possibility for egalitarian growth. Hence, the first step in creating progressive change is to expand the academic space and the public visibility of alternative macroeconomic approaches (beyond the NAIRU approach) that do address the deep economic problems of our time.

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Servaas Storm and C.W.M. Naastepad are both Senior Lecturers in Economics at the faculty of Technology, Policy and Management at Delft University of Technology, The Netherlands. Servaas works on macroeconomics, globalization, agricultural development and the economics of climate change. He is one of the editors of the journal Development and Change. C.W.M. works on macroeconomics, (un-)employment, and technological change.

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References

• Palma, Gabriel (2009), The revenge of the market on the rentiers, Why neo-liberal reports of the end of history turned out to be premature, Cambridge Journal of Economics Vol. 33, No. 5.


• Skidelsky, R. (2009), The myth of the business cycle, available at: http://www.realclearmarkets.com/articles/2009/01/the_myth_of_the_business_cycle.html


• Storm, Servaas and C.W.M. Naastepad (2011), Macroeconomics Without the NAIRU, forthcoming.