12/05/2014 12:15 pm ET Updated Feb 04, 2015

5 Ways to Lessen Inequality as Demand for Labor Decreases Worldwide

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Wages, incomes and wealth in most countries have become more unequally distributed in recent decades. Most of us understand that this is politically dangerous. There is much less unanimity regarding how national governments should go about addressing this. I argue here that one key source of growing inequality is a softening of the demand for labor and that this changes policy debates significantly.

The connections between soft labor demand and inequality are clear. First, labor's share in many countries' national incomes has been shrinking since at least the 1980s. Second, in some developed economies, median real wages have stagnated despite economic growth. And those who derive their income predominantly from capital tend to be richer than those who get theirs from labor. Both trends increase inequality.

To better understand how to deal with softening demand for people, we must understand its causes and structure. In which economies and sectors has labor demand gone soft?

Let's begin with economies. Labor demand has softened in the West partly because poorer countries have built rival industrial capacities of their own. But labor-saving technological change (automation) probably plays an even bigger role in these economies. In developing countries, workers are being squeezed out of agriculture, but countries that grow faster (e.g., China, India and Vietnam) still find compensating increases in labor demand in other sectors. However, technology-driven trends in developed-country labor markets do tend to be replicated eventually. When this happens, the slowdown in Western labor demand could become a global phenomenon. There are already signs of it in the high rates of youth unemployment around the world.

Next, consider sectors. Perhaps surprisingly, globalization seems to have led to softer labor demand in internationally tradable sectors of the economy. Employment in most developing countries is shifting rapidly out of agriculture and manufacturing, the two most tradable sectors, and into mostly non-tradable services. Trends in developed economies are similar, except that there are already very few jobs in agriculture. It has been estimated that 98 percent of net U.S. job creation between 1990 and 2008 occurred in non-tradable sectors of the economy. This matters because the second thing that globalization seems to have done is to make jobs producing tradable goods and services much more footloose. When wages rise, the jobs move. This undercuts countries' ability to combat inequality by raising mandated wages, or introducing other pro-labor policies in tradable sectors. The tradeoff between jobs and wages should be less pronounced in non-tradable sectors.

Finally, for whom has demand gone soft? Most obviously, for less educated workers. Globally, the wages of workers with higher education have risen relative to those of high school graduates. However, in some highly-educated countries (e.g. the U.K. and U.S.), this college premium has increased more because high school graduates' wages have fallen than because college graduates' wages have risen. Certainly, real wages for college graduates in these countries are growing more slowly than student debts. Meanwhile, in many developing economies, the returns to secondary education have declined as governments increased access to it. Beyond a point, more debt-financed higher education is not an antidote to inequality.

"As demand for labor decreases, we may need a guaranteed minimum income for all people, regardless of employment status."

Given these structural roots to inequality, what types of policies make sense? Solutions will have to be context-appropriate. However, to be effective and politically sustainable, they will require the support of those they benefit directly, and of those who fund them or think they might. In other words, they will need to be compromise solutions that appeal to left and right alike by achieving the most redistribution for the least bureaucracy and inefficiency. In that spirit, here are five ideas that might be useful for combating inequality in a world of softening labor demand.

1. Shift the tax burden off labor.
Rule one of sensible taxation is to tax most the things we need least, and to tax least those we need most. We need more jobs and fewer carbon emissions. Reducing labor income taxes while making up the lost revenue through large carbon taxes is a no-brainer. Some will complain that this is regressive and that carbon taxes are job killers. However, if cuts in labor income taxes do spur labor demand, this need not be the case. Rule two is to devise taxes that are unlikely to alter our behavior very much (unless it is bad behavior). Inheritance taxes, while not perfect, are much better than the labor income taxes they could replace in this regard. Similarly, higher capital gains taxes would probably cost fewer jobs than labor income taxes currently do, especially in countries where capital gains rates are zero.

2. Design policies that can augment incomes when many people don't have stable jobs.
Time-bound unemployment insurance becomes increasingly unwieldy as employment becomes a fluid proposition. A negative income tax or guaranteed income would offer all persons, regardless of their income or employment status, a transfer payment. Those whose tax liabilities are less than this payment would receive a tax rebate check, while those whose liabilities were more than this payment would pay their taxes net of the transfer. The beauty of such a system is that it often requires no additional bureaucracy, and it only reduces recipients' incentives to work for a living insofar as it reduces desperation (which is exactly its purpose) and does so equally for all citizens. It has long been politically popular -- Milton Friedman promoted it and Martin Luther King Jr. endorsed some version of it. And, it should work best in societies where other safety nets are the least developed -- precisely the places where soft labor demand exacts the greatest toll.

3. Redirect efforts to protect working conditions and wages at non-tradable sectors.
Protections for household servants, security guards, cleaners, gardeners and elevator operators should cost fewer jobs than protections for factory workers, whose jobs can now be off-shored. These non-tradable services will usually be demanded even at higher prices. Employees in these occupations are also amongst those most severely affected by stagnant wages and temporary employment. One can already see efforts to protect labor shifting to non-traded sectors, such as U.S. fast food workers attempting to unionize and push for higher minimum wages.

4. Make competition policy more robust.
A growing number of the world's rich, from bankers to real-estate moguls to mobile phone magnates, derive their wealth from controlling markets for goods, services and assets. Better competition policy becomes important as markets grow and cornering them becomes more lucrative. It also usually becomes more politically sellable as the numbers of consumers and smaller businesses hurt by anti-competitive practices grow.

5. Think about education policy differently.
As the stakes in the job lottery grow, priorities for education policy shift. Churning out more graduates often will not solve the unemployment problem, as even fast-growing economies like India and China are failing to generate enough jobs for all their graduates. Pursuing equality of opportunity and restoring the social contract will come to be more central objectives of education policy. Exactly what that entails and the role of the private sector in educational delivery will vary across societies, but controls on college costs, scholarships and dramatically enhancing the quality of basic education received by poorer children will clearly be important.

None of these policy suggestions are novel, and all have downsides. Recognizing that inequality has structural roots in low-labor demand does not necessarily change the menu of policy options to consider. It alters the tradeoffs between these options. Clearly, these tradeoffs are changing.

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