Around the globe, leaders of governments and other stakeholder institutions enter 2017 facing a set of difficult and increasingly urgent questions:
- With fiscal space limited, interest rates near zero, and demographic trends unfavorable in many countries, does the world economy face a protracted period of relatively low growth? Will macroeconomics and demography determine the world economy’s destiny for the foreseeable future?
- Can rising in-country inequality be satisfactorily redressed within the prevailing liberal international economic order? Can those who argue that modern capitalist economies face inherent limitations in this regard – that their internal “income distribution system” is broken and likely beyond repair – be proven wrong?
- As technological disruption accelerates in the Fourth Industrial Revolution, how can societies organize themselves better to respond to the potential employment and other distributional effects? Are expanded transfer payments the only or primary solution, or can market mechanisms be developed to widen social participation in new forms of economic value-creation?
These questions beg the more fundamental one of whether a secular correction is required in the existing economic growth model in order to counteract secular stagnation and dispersion (chronic low growth and rising inequality). Does the mental map of how policymakers conceptualize and enable national economic performance need to be redrawn? Is there a structural way, beyond the temporary monetary and fiscal measures of recent years, to cut the Gordian knot of slow growth and rising inequality, to turn the current vicious cycle of stagnation and dispersion into a virtuous one in which greater social inclusion and stronger and more sustainable growth reinforce each other?
This is precisely what government, business, and other leaders from every region have been calling for. Over the past several years, a worldwide consensus has emerged on the need for a more inclusive growth and development model; however, this consensus is mainly directional. Inclusive growth remains more a discussion topic than an action agenda. This Report seeks to help countries and the wider international community practice inclusive growth and development by offering a new policy framework and corresponding set of policy and performance indicators for this purpose.
Policy Framework and Metrics
The ultimate objective of national economic performance is broad-based and sustained progress in living standards, a concept that encompasses wage and non-wage income (e.g., pension benefits) as well as economic opportunity, security and quality of life. This is the bottom-line basis on which a society evaluates the economic dimension of its country’s leadership. Many countries have had difficulty in satisfying social expectations in this regard. For example, in the last five years, annual median incomes declined by 2.4% in advanced economies, while GDP per capita growth averaged less than 1%.
To borrow from a business concept, growth can be thought of as the top-line measure of national economic performance, with broad-based or median progress in living standards representing the bottom-line. Inclusive growth can be thought of as a strategy to increase the extent to which the economy’s top-line performance is translated into the bottom-line result society is seeking, i.e., broad-based expansion of economic opportunity and prosperity.
However, inclusive growth is more than that. An economy is not a business, and history and scholarship have shown that there is a feedback loop between the bottom- and top-lines (growth and equity) in a national economy. This feedback loop can run in either a positive or a negative direction. The extent to which it is a virtuous circle is influenced by a diverse mix of structural and institutional aspects of economic policy, going well beyond the two areas most commonly featured in discussions about inequality: education and redistribution.
This Report presents a policy framework encompassing seven principal domains (pillars) and 15 sub-domains (sub-pillars) which describe the spectrum of structural factors that particularly influence the breadth of social participation in the process and benefits of economic growth. Societies that have had success in building a robust middle class and reducing poverty and social marginalization have tended to create effective economic institutions and policy incentives in many of these areas, while also pursuing sound macroeconomic policies and efficiency-enhancing reforms over time.
Framework: The Policy and Institutional Ecosystem Underpinning Inclusive Growth
The policy and institutional domains portrayed in this Framework represent the ecosystem of structural policy incentives and institutions that together and as part of the growth process help to diffuse widely the benefits of an expanding national economy in terms of household income, opportunity, economic security, and quality of life. This ecosystem constitutes the implicit income distribution system – or, more precisely, living-standards diffusion mechanism – underpinning modern market economies. When functioning properly, it operates in a self-reinforcing cycle in which economic growth and social inclusion feed each other.
However, in many advanced countries, this policy and institutional ecosystem has deteriorated or has been inert over the past two decades as the forces propelling secular dispersion – technological change, global integration, domestic deregulation, and increased immigration – have intensified. Many developing countries, meanwhile, have lagged in creating the basic elements of such an ecosystem as they have industrialized and integrated into the global economy, missing an opportunity to include more of their populations in their development process and rendering their economies more vulnerable to fluctuations in exports and commodity prices.
The Framework represents an alternative way of thinking about structural economic reform and its role in the development process. Structural reform usually refers to measures aimed at boosting economic efficiency and macroeconomic stability by sharpening market signals and improving the health of public finances, often in response to a recent or looming fiscal or balance-of-payments crisis. In such circumstances, it tends to have the effect of squeezing living standards in the short term. But a systematic, sustained effort to strengthen institutions and policy incentives across the Framework’s 15 sub-domains – or within the weakest areas – also constitutes an exercise in structural reform, albeit one that mixes demand- and supply-side measures for the express purpose of boosting broad living standards while reinforcing the rate and resilience of growth.
To help governments and stakeholders assess their countries’ relative strengths and weaknesses within this ecosystem, this Report contains a cross-country database of 140 statistical indicators that enables comparison at the pillar, sub-pillar, and individual indicator level for each of the 109 countries for which the relevant data is available. These Policy and Institutional Indicators (PIIs) yield a distinct profile of each country’s relative institutional strength and utilization of policy space. They are like diagnostic scans of the structural underpinnings of an economy’s capacity to capture the synergies between growth and social inclusion. The results are presented in four groups of countries based on their level of economic development as measured by national income.
The following patterns emerge from this data:
- Given the breadth and complexity of this policy ecosystem as well as the important role each country’s particular political economy plays in shaping it, there is no single ideal policy mix for the pursuit of inclusive growth. It is most important to view the entire spectrum of the Framework as an integrated system that merits deliberate cultivation as an integral part of the growth and development process with periodic upgrading to address weaknesses revealed in one part or another.
- Larger fiscal transfers are not necessarily incompatible with long-term growth and competitiveness, but neither are they always the primary or most effective available option for broadening socioeconomic inclusion. Many of the world’s most competitive economies have high levels of social protection and the significant tax burdens these imply. However, other countries achieve moderate or low Gini ratios mainly because their pre-transfer levels of inequality are comparatively modest to begin with rather than due to the significance of their transfers.
- Policies and institutions supporting social inclusion are not solely a luxury of high-income countries. There is extensive overlap in absolute scores across at least three of the four income groups of countries in the sub-pillars of Business and Political Ethics, Tax Code, Financial System Inclusion, Intermediation of Business Investment, Productive Employment, Concentration of Rents, and Educational Quality and Equity.
- A robust inclusive-growth strategy is both pro-labor and pro-business, an agenda to boost both social inclusion and economic efficiency through a stronger focus on institutions. The inequality debate focuses almost exclusively on up-skilling of labor and redistribution – when it moves beyond problem identification. For many countries, these may be among the most appropriate responses to widening dispersion of incomes. But the enabling environment for real-economy business investment and entrepreneurship can be just as critical to a country’s success in expanding employment, boosting wages, and widening asset ownership, which are central drivers of progress in broad living standards.
In addition to the Policy and Institutional Indicators (PIIs) described above, a set of performance metrics, or National Key Performance Indicators (KPIs), is presented below in the form of a dashboard for each country. This set of KPIs provides a more complete picture of national economic performance than that provided by GDP alone, particularly if the ultimate objective of development is understood to be sustained, broad-based advancement of living standards rather than increased production of goods and services, per se.
The Report also derives a composite index that ranks countries based on their combined KPI scores, the Inclusive Development Index (IDI).This new global index conveys a more integrated sense of the relative state of economic development – and recent performance – than conventional rankings based on GDP per capita alone. Some countries score significantly better on the IDI than on the basis of GDP per capita, suggesting they have done a relatively good job of making their growth processes more inclusive: they include countries at very different stages of economic development such as Cambodia, the Czech Republic, New Zealand, South Korea, and Vietnam. By contrast, other countries have significantly lower IDI rankings than GDP per capita rankings, indicating that their growth has not translated as well into social inclusion; these include Brazil, Ireland, Japan, Mexico, Nigeria, South Africa, and the United States.
Significantly, 51% of the 103 countries for which these data are available saw their IDI scores decline over the past five years, attesting to the legitimacy of public concern and challenge facing policymakers regarding the difficulty of translating economic growth into broad social progress. In 42% of countries, IDI decreased even as GDP per capita increased. In over 75% of economies,wealth inequality was a chief culprit. It rose 6.3% on average during this period.
Implications for National Policy
Many countries have significant unexploited potential to simultaneously increase economic growth and social equity. But activating the virtuous circle of inclusive growth more fully will require them to change their approach to structural reform, reimagining it as an ongoing process of continuous improvement within a diverse ecosystem of demand- and supply-side policies and institutions, the combined effect of which is to diffuse opportunity, income, security, and quality of life as part of the growth process. The construction and maintenance of this policy and institutional ecosystem deserves equal and parallel emphasis with the traditional focus of top economic policymakers: macroeconomic, trade, and financial supervision policies. Rebalancing policy priorities in this manner would imply a profound change for many countries and indeed for the “growth model” that has been posited for a generation by much of the economic policy establishment, including key international organizations.
For many countries, a reimagined process of structural reform aimed at broadening the base and benefits of growth may also be the best hope for accelerating its rate in the current context. For example, in advanced countries experiencing diminishing returns from extraordinary monetary policy measures, limited fiscal space, and unfavorable demographic trends (e.g., Japan, the United States, and the European Union, to various degrees), a mixture of demand- and supply-side structural reforms could boost consumption and job creation in the short term while raising the economy’s longer-term growth potential through lasting improvements in labor productivity, household finances, real-economy investment, and innovation. In middle-income countries experiencing weak exports and commodity prices, monetary policy constrained by the risk of currency depreciation and capital flight, and limited fiscal space (e.g., most of the BRICS – Brazil, Russia, India, China, and South Africa), a structural reform agenda of this nature is precisely what could rebalance their growth model toward more robust domestic consumption.Similarly, for lower-income countries with extensive social marginalization due to poor resourcing of and inequitable access to basic services, education, and infrastructure as well as weak legal, tax, and investment climate institutions, a reform strategy with a sharper focus on these basic building blocks could help boost growth and social equity simultaneously.
Countries seeking to keep pace with the labor-market challenges accompanying the Fourth Industrial Revolution should set a discrete national investment target and public-private implementation strategy across the following five areas of human capital formation:
- Active labor-market policies
- Equity of access to quality basic education
- Gender parity
- Non-standard work benefits and protections
- Effective school-to-work transition
PII data indicate that few, if any, of even the most advanced economies are well positioned for the change that is coming. A universal basic income is no substitute for these five crucial institutional underpinnings of a well-functioning labor market. It may serve as a useful complement at some point, but countries seeking to prepare their workforces for the Fourth Industrial Revolution would do well to invest in and level up performance across these areas. Here again, a systemic rather than silver-bullet approach is likely to be most effective.
Implications for International Economic Cooperation
Major economies should undertake a coordinated effort to boost global growth by identifying and implementing the demand- and supply-side structural reforms that are most needed to activate more fully the virtuous circle of inclusive growth in their economies. Governments should examine whether based on peer comparison they have
unutilized policy space in one or more of the Framework’s 15 sub-domains and then draw upon the structural policy analyses of other international economic organizations, particularly the Organisation for Economic Co-operation and Development (OECD) which has a wealth of analysis and prescriptions in these domains, as well as the World Bank, International Labour Organization (ILO), and others, to develop an action agenda tailored to their circumstances. The World Economic Forum and these organizations could provide further support by facilitating public-private, interdisciplinary input into and support for the agendas that emerge. Such a global effort in 2017 to reinvigorate global growth by broadening its base and strengthening its long-term foundations – making it less dependent on short-term macroeconomic measures and export demand – is precisely what the world economy needs to combat the cyclical and secular pressures weighing on growth. The G20 Enhanced Structural Reform Agenda, launched during China’s recent presidency, provides an opening for such a coordinated international initiative.
International organizations should embrace this reformulation and reprioritization of structural economic policy in their public signaling, country advice, and development cooperation programs. By virtue of their public profile and intimate relationship with the economic ministries of governments, the major international economic organizations have a vital role to play in the establishment and scaled application of this new and more inclusive growth model.
The international community should buttress national efforts by:
- funding a major increase in institution-building assistance for developing countries in the corresponding policy domains.
- reforming development finance institutions (DFIs) to support a scaling of blended, public-private financing of sustainable infrastructure to promote worldwide implementation of the Paris Agreement of the 21st Conference of Parties of the United Nations Framework Convention on Climate Change and progress toward the Sustainable Development Goals (SDGs). The infrastructure intensity of the SDG and climate agendas (and the employment intensity of infrastructure investment) suggests that they could provide much of the impetus for global growth over the coming 10-15 years, especially if combined with a broader structural shift of economies toward inclusive growth as outlined above. Most of the leaders of DFIs recognize the need for a strategic shift in their role from direct lending (usually to sovereigns) to catalyzing much larger multiples of domestic and international private investment through greatly expanded emphasis on co-investment, risk mitigation, aggregation, and project development technical assistance. However, their boards and staff are not yet fully supportive of or equipped for this shift. Shareholder governments and the business community must mobilize to seize this opportunity by engaging in collective work to surmount these impediments.
- resetting the priorities of trade and investment cooperation to scale trade-related small-business activity and employment; reduce barriers to trade in services (which are often labor-intensive) and investments in industrial value chains (in which relatively few developing countries participate extensively); catalyze a leveling up of social and environmental practices within such value chains so as to maximize their payoff for sustainable development in developing countries while minimizing the fear in developed countries of a global race to the bottom in social protections; and modernize and align international investment and regional trade agreements in order to strength their contribution to sustainable development, simplify the conduct of business across multiple jurisdictions, and reduce discrimination, particularly against small countries that are not part of major regional agreements.
Efficient markets and macroeconomic stability are essential for economic growth. But how well growth benefits society as a whole depends on the framework of rules, incentives, and institutional capacities that shape the quality and equity of human capital formation; level and patience of real-economy investment; pace and breadth of innovation; effectiveness and flexibility of worker protections; coverage and adequacy of social insurance systems; quality and breadth of access to infrastructure and basic services; probity of business and political ethics; and breadth and depth of household asset-building.
This recognition and the rebalancing of policy priorities it implies is what is required for governments to respond more effectively to decelerating growth and rising inequality – to take seriously the social frustrations increasingly being expressed through the ballot box and on the street. Such frustrations have an essential validity. The implicit income distribution system within many countries is in fact severely underperforming or relatively underdeveloped, but this is due to a lack of attention rather than an iron law of capitalism. Inequality is largely an endogenous rather than exogenous challenge for policymakers and needs to be recognized and prioritized as such in order to sustain public confidence in the capacity of technological progress and international economic integration to support rising living standards for all.
A coordinated global initiative along these lines is what is required to transform inclusive growth from aspiration into action – into a new global growth agenda that places people and living standards at the center of national economic policy and international economic integration. Such an effort to reshape the assumptions and priorities of the way modern market economies organize themselves to generate socioeconomic progress can only be realized with the engagement of all stakeholders. This calls for a collective commitment to greater responsiveness and responsibility in economic leadership by government and business leaders alike. The Forum’s System Initiative on Economic Growth and Social Inclusion is intended to serve the international community as a platform for such public-private cooperation.