II. Toward an Actionable Framework
Strong economic growth is the sine qua non of improved living standards. While a growing national economic pie does not guarantee that the size of every household’s piece will be larger, such an outcome is arithmetically impossible unless the overall pie does indeed expand. Growth creates the possibility of a positive-sum game for society, even if it does not assure it.22
The extent to which economic growth broadens improvements in economic opportunity and living standards is influenced by an interdisciplinary 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. Appreciation of the crucial role of institutions – particularly legal frameworks and public agencies that administer rules and incentives – in the development process has expanded in recent decades, supported by an accumulating body of research and practical experience. This includes seminal research by Nobel Laureate Douglass North, who explored the important role of institutions in providing the incentive structure of an economy, shaping the direction of change and influencing its performance.23 Other scholars have since built upon these insights, including by documenting a significant empirical relationship between institutional development and economic performance.24
The World Bank’s landmark 1993 study, The East Asian Miracle,25examined how eight economies in the region succeeded in achieving a remarkable record of “high growth with equity” from 1960 to 1990. In a chapter entitled “An Institutional Basis for Shared Growth,” its distinguished research team concluded: “Of course, few political leaders anywhere would reject, on principle, either the desirability of growth or that the benefits of growth should be shared. What distinguished the High-Performing Asian Economies’ leadership was the extent to which they adopted specific institutional mechanisms tailored to these goals, and that worked.” They then documented the institutional approaches taken in these economies across such areas as education, land reform, small and medium-sized business support, housing, labor-management relations, insulation of policymaking from rent seeking behavior, integrity in public administration and business-government relations.
The international blue-ribbon Commission on Growth and Development chaired by Nobel Laureate Michael Spence drew a similar conclusion in its 2008 report entitled, The Growth Report: Strategies for Sustained Growth and Inclusive Development:
“In recent decades governments were advised to “stabilize, privatize and liberalize.” There is merit in what lies behind this injunction—governments should not try to do too much, replacing markets or closing the economy off from the rest of the world. But we believe this prescription defines the role of government too narrowly . . . On the contrary, as the economy grows and develops, active, pragmatic governments have crucial roles to play . . . (M)ature markets rely on deep institutional underpinnings, institutions that define property rights, enforce contracts, convey prices, and bridge informational gaps between buyers and sellers. Developing countries often lack these market and regulatory institutions. Indeed, an important part of development is precisely the creation of these institutionalized capabilities.26“
In fact, economic institution building has been a crucial part of the development path of essentially every country that has industrialized and achieved high living standards. Because development is a complex and multidisciplinary process – many conditions need to be fulfilled in order for widespread poverty to be replaced by ever-rising middle-class prosperity – this process of institutional deepening occurs across a wide spectrum of domains. But the process is not automatic. Although rising national income generates additional resources and policy space to establish and effectively implement such institutions as public education systems, independent judiciaries, labor markets and protections, and competition, investment climate and social protection frameworks, they do not guarantee it. The pace and pattern of economic institution building is a choice, a function of policy decisions and public-private cooperation. Like other aspects of a country’s growth model, it is shaped by the prevailing political economy. It is endogenous to the development process. As a result, so to a considerable extent is the payoff to broad living standards from economic growth.
Many countries have learned this lesson the hard way, with economic growth contributing to a build-up of social discontent over unduly skewed opportunities and outcomes, forcing governments to play economic strategy catch-up even when politically painful. The most common response is a burst of measures aimed at deepening institutions and strengthening the enabling environment, for example through the creation or expansion of social insurance systems, anti-corruption laws, worker training and protection programs, and infrastructure improvements. There are many examples of this since the crisis, in developed and developing countries alike.27
Indeed, the importance of economic institution building for balanced and inclusive growth was a central lesson of the economic and financial crises of the early 20th century. Beginning at the turn of the century and gathering force in the decades following the Great Depression, most of today’s advanced industrialized countries underwent a sustained process of institutional deepening to broaden the base and strengthen the resilience of their economies. Labor, financial, social insurance, competition, infrastructure and other reforms were deliberately aimed at engineering a more inclusive and sustainable growth model. They played a critical role in supporting the dramatic expansion of the middle class, eliminating poverty, and reducing economic insecurity in these societies during the latter half of the century.28
If an economy can be thought of as a garden or arboretum, its macroeconomic and competitive environment sets the climate (basic conditions of moisture, sunlight, and temperature), while its institutions represent nutrients in the soil. Improvements in soil fertility can have a pronounced effect on the pace and consistency of plant growth, a process that takes years to get right and requires regular monitoring and modulation. Similarly, the essential fecundity of an economy – its yield of broad-based advancement of living standards – is shaped by the health of its macro-competitive environment as well as strength of its institutions and policy-based incentives in areas particularly important for social inclusion. Like both weather conditions and soil quality, these factors require equal and ongoing attention. This fundamental lesson – and the rebalancing of emphasis in national policy that it implies – is where the journey toward a new, more socially inclusive, growth paradigm begins.29
The practice of inclusive growth and development requires widening the lens through which priorities are set in national economic strategies. Macroeconomic, trade and regulatory policies remain critically important as they establish the conditions necessary for improvements in productivity that help drive growth. However, other areas are just as vital to the overriding purpose of economic policy: strong, sustained increases in broad living standards. Rising living standards, not economic growth per se, is what societies expect their economic leaders, both public and private, to deliver.
What are the areas of policy and institutional strength that have a particularly strong bearing on social participation in the process (productive employment) and outcomes (median household income) of economic growth? This Report presents a Framework and a corresponding set of indicators of performance and enabling environment conditions in seven principal policy domains (pillars) and fifteen sub-domains (sub-pillars). Societies that have had particular success in building a robust middle class and reducing poverty and social marginalization have tended to create effective economic institutions and incentives in many of these areas, while supporting growth through sound macroeconomic policies and efficiency-enhancing reforms.
These pillars and sub-pillars describe the structural and institutional features of a modern economy that particularly matter for achieving broad-based improvement in living standards. Structural reform usually refers to measures aimed at boosting economic growth by sharpening the functioning of markets and restoring the health of public finances, often in response to fiscal or balance-of-payments crises; they frequently have the effect of squeezing living standards in the short term. But a serious effort to strengthen institutions in some or all of these fifteen domains also constitutes an exercise in “structural adjustment” – in this case, for the purpose of boosting living standards while reinforcing the rate and resilience of growth. This sort of structural reform is best pursued as a long-term strategy forming an integral part of the development process, rather than as a crash effort to preempt or recover from a crisis.30
The essential measure of the inclusiveness of a society’s growth model is the extent to which it produces broad gains in living standards before fiscal transfers are taken into account. For this reason, six of the Framework’s seven pillars relate to policy and institutional factors that influence the composition of private-sector activity and the distribution of opportunity and outcomes within the market itself. In particular, because wages and returns to self-employment and small-business ownership constitute a very high percentage of the income of all but the wealthiest households, factors that shape these elements of national income figure prominently in the indicators that have been assembled.
At the same time, since the focus of this exercise is inclusive growth and development rather than social inclusion per se, the set of policies and institutions it highlights and the specific benchmarking indicators it chooses must be consistent with the deepening of economic dynamism and growth. An inclusive growth strategy can only be effective if it reinforces, or at least does not undermine, incentives to work, save, and invest. This is a further reason why the Framework concentrates in large part, though by no means exclusively, on policy levers that influence relative incentives within the private sector rather than those that effect direct transfers through the public sector.
A database of cross-country statistical indicators has been compiled in each sub-pillar, permitting comparison at the pillar, sub-pillar, or individual indicator level within peer groups. Out of this benchmarking exercise emerges a distinct profile of the institutional strength of countries relative to their peers in areas that particularly help support broad-based progress in living standards. These comparative Country Profiles are like diagnostic scans of each country’s institutional enabling environment as it relates to encouraging socially inclusive growth. The results are presented in four peer groups of countries based on level of economic development as measured by national income.
To provide added context, a Dashboard of National Key Performance Indicators is shown for each country in the areas of Economic Growth and Competitiveness; Income-related Equity; and Intergenerational Equity. In the first category are indicators providing a measure of whether the fundamentals are in place in terms of competitiveness, labor productivity performance, and sustained economic growth. The second illustrates how widely income is distributed (pre- and post-transfer inequality), the progress of median living standards (in terms of median household income growth), poverty rates, the labor share of income in advanced countries and proportion of middle-class households in upper-middle, lower-middle and low-income countries. Lastly, the Dashboard provides an inter-temporal look at equity from both an environmental (natural capital depletion) and fiscal (public debt) perspective in order to illustrate whether economic performance is being pursued at the expense of future generations.
This Dashboard of National KPIs provides an integrated view of the contours of a country’s overall performance on inclusive growth and development. It complements the more detailed Country Profiles, which benchmark performance and institutional enabling environment conditions in the fifteen policy areas of the Framework. Together, these three elements are intended to help policymakers and other stakeholders translate an aspiration for a more inclusive model of economic growth and development in their country into a practical national strategy.
Description of Framework Pillars
This section describes the types of indicators contained in each pillar and their importance for delivering inclusive outcomes from growth. A full description of indicators and sources can be found in the appendix.
Pillar 1: Education and Skills Development
- To what extent does the country create an enabling environment which provides high quality educational opportunity for all members of society including vulnerable or marginalized groups (e.g. low-income individuals and women)?
- To what extent is education at all levels accessible, of high quality, and inclusive in terms of attainment and learning outcomes?
Labor is the primary, and in most cases, exclusive, source of income for citizens of rich and poor countries alike. Strong and rising labor productivity across different sectors and geographies is therefore an important cornerstone of any strategy to strengthen broad-based progress in living standards and reduce social marginalization. This is all the more important in the presence of rapid technological change that is automating, dis-intermediating, and enabling remote performance of many functions (see Box 5). Such change both disrupts existing jobs and creates new opportunities for labor income at every stage of economic development, in both cases favoring workers who are able to acquire and adapt skills. The challenge to societies is to create an enabling environment for widespread access to, and steady improvement in, skills acquisition.
As such, the Framework includes indicators that gauge the breadth of enrollment in early, basic, vocational, and tertiary education as well as the availability of training services (Access Sub-pillar). It includes measures of educational system quality such as the proficiency of secondary students, pupil-teacher ratio, internet access, public expenditure levels, and employer perceptions (Quality Sub-pillar). It also incorporates information on preprimary, primary, and secondary completion rates, basic reading and math proficiency by quintile of parental income, as well as other measures of the equity of educational opportunity in a society, reflecting a view that education is the main vehicle for disrupting the transmission of inequality in life chances from one generation to the next (Equity Sub-pillar).31
Pillar 2: Employment and Labor Compensation
- Productive Employment
- Wage and Non-wage Labor Compensation
- To what extent is the country succeeding in fostering widespread economic opportunity in the form of robust job creation, broad labor force participation, and decent working conditions?
- How well does its enabling environment support a close correlation between growth in the productivity and compensation of labor, helping to ensure that a rising tide lifts all boats?
This pillar continues the theme that productive employment is central to achieving inclusive growth (see Box 4). It includes indicators measuring the extent of labor force participation (including for women) and unemployment (including for youth); underemployment and vulnerable, temporary, and informal sector employment; employer perceptions of the ease of retaining skilled employees; measures of social mobility; and strictness of employment protection. Other indicators capture the quality of working conditions, for example regarding occupational injuries and excessive working hours (Employment Sub-pillar).
Pillar 2 also measures enabling environment factors that can influence the pace and distribution of wage and non-wage labor compensation (Wage and Non-wage Labor Compensation Sub-pillar). For example, it includes indicators measuring wage dispersion (ratio of median to minimum wages), low pay (below two-thirds of the median), trade union density, collective bargaining coverage, cooperation in labor-employer relations, gender pay gap, and agricultural productivity. Finally, it incorporates measures of key aspects of non-wage compensation such as childcare costs and maternal and parental leave.32
Pillar 3: Asset Building and Entrepreneurship
- Small Business Ownership
- Home and Financial Asset Ownership
- To what extent is the enabling environment conducive to broad-based asset accumulation and employment- and productivity-enhancing entrepreneurship?
Small business entrepreneurship and home ownership are typically the first means by which working families accumulate wealth beyond savings from wages and pension contributions. For many, they provide the primary ladder to the middle class and beyond. This pillar includes a range of indicators assessing the ease of starting and running a business with respect to regulatory and cultural factors. These include the number of new business registrations and patent applications; attitudes toward entrepreneurial failure; cost and time required to start a business, resolve insolvency, and enforce a contract; and the time required to prepare and pay taxes (Small Business Sub-pillar). Several additional indicators measure the extent of and enabling environment for for home ownership and private savings. These include the perceived strength of property rights protection, home ownership rate, house price-to-income ratio, housing loan penetration and, for advanced countries, employee stock ownership, profit sharing, and private pension asset accumulation (Home and Financial Asset Ownership Sub-pillar).
Pillar 4: Financial Intermediation of Real Economy Investment
- Financial System Inclusion
- Intermediation of Business Investment
- How well does the financial system deploy private savings for productive purposes and enable new capital formation in the real economy?
Access to credit is a key link between economic opportunity and outcomes. By empowering individuals to cultivate opportunity, financial inclusion can be a powerful agent for inclusive growth. This sub-pillar measures access and affordability of financial services with particular emphasis on banking for the poorest and most marginalized (the bottom 40%). An account at a formal financial institution generally reduces the cost of engaging in financial transactions, provides a ready vehicle for savings and access to funds, and serves as a reference for individuals wishing to obtain credit for small business development. With improved financial access, families can smooth out consumption and increase investment, including in education and health. They can also insure against unfavorable events, and therefore avoid falling deeper into poverty. Indicators are also included on prevalence of accounts used for business purposes, ease of access to credit, and depth of credit information (Financial Inclusion Sub-pillar).
Another important factor that influences employment and wage levels is the extent to which a country’s financial system efficiently intermediates the flow of private savings to businesses in the real economy, as opposed to financial assets or real estate which result in little net new capital formation. Such business investment typically requires a medium- to long-term investment horizon to support investment in infrastructure, equipment, workforce skills, and innovation, which are crucial for firm competitiveness and growth. Accordingly, this sub-pillar includes indicators illustrating the extent to which the financial system fosters non-residential private investment and business capital formation. These include the extent of local equity market access, venture capital availability, domestic credit to firms by banks, private investment in infrastructure, non-residential private investment, private R&D expenditures, share turnover, bank lending to non-financial corporations, IPO issuances for both small- and large-cap firms, follow-on equity issuances, and share buybacks. These latter indicators are expected to be replaced by a single measure of net equity issuance in the near future in order to provide an integrated picture of how well the financial system mobilizes risk capital (Intermediation of Business Investment Sub-pillar).
Pillar 5: Corruption and Rents
- Business and Political Ethics
- Concentration of Rents
- How well do the country’s policies and institutions support broad-based economic opportunity and efficient allocation of resources through zero tolerance of bribery and corruption, low barriers to entry, and fair competition in
product and capital markets?
Corruption has a chilling effect on personal initiative and entrepreneurship, and hence, on investment, job creation, and purchasing power. Its effects, both direct and indirect, are borne most heavily by ordinary citizens. It is corrosive, even antithetical, to social inclusion and economic growth as it represents the exploitation of power by the haves against the have-nots. This sub-pillar gauges perceptions of the ethical behavior of firms, efficacy of measures to combat corruption and bribery, diversion of public funds, irregular payments in tax collection, and public trust in politicians (Business and Political Ethics Sub-pillar). Undue concentration of wealth and market power and high barriers to entry discourage entrepreneurial initiative and the recycling of resources toward uses that have the most potential to contribute to productivity gains. As such, they also suppress economic growth and progress in living standards. This sub-pillar includes indicators measuring perceptions of the extent of market dominance, intensity of local competition, regulatory protection of incumbents as well as the concentration of land ownership, wealth, and banking-sector assets (Concentration of Rents Sub-pillar).33
Pillar 6: Basic Services and Infrastructure
- Basic and Digital Infrastructure
- Health-related Services and Infrastructure
- To what extent does the country provide its citizens with a core, common endowment of infrastructure and other basic services that enable productive engagement in the economy and provide often budget-relieving and quality-of-life-enhancing contributions to their standard of living?
The common availability of basic services and infrastructure underpins equality of economic opportunity. For example, a well-developed transport infrastructure network is a prerequisite for less-developed communities to access core economic activities and services. Investment in the provision of health services, clean water, and sanitation is critical economically as well as morally. A healthy workforce is vital to a country’s competitiveness, productivity, and inclusivity, as workers who are ill cannot function to their full potential. Exclusion from physical networks (water, power, telecommunications, transportation, logistics, solid waste disposal, etc.) constrains productivity and keeps people poor. Markets often do not naturally extend these networks to encompass the entire population, as it may not be cost-effective to connect poor people because the fixed costs cannot be recouped. The Basic and Digital Infrastructure Sub-pillar includes indicators that gauge the quality of overall infrastructure and domestic transport network, transport infrastructure investment as a proportion of GDP, overall access to electricity, inequality in access to electricity, proportion of urban population living in slums, dwellings without basic facilities, and several measures of access to and affordability of information and communications technology (ICT).
The Basic Health Services Sub-pillar gauges perceptions of the quality and accessibility of healthcare services, extent of out-of-pocket health expenses, access to improved drinking water and sanitation, inequality in access to safe drinking water and sanitation, undernourishment, particulate matter concentration, as well as gender-gap health measures including sex ratio at birth, female healthy-life expectancy as compared to male, and, finally, inequality-adjusted life expectancy.
Pillar 7: Fiscal Transfers
- Tax Code
- Social Protection
- To what extent does the country’s tax system seek to countervail income inequality without undermining economic growth? How much of its tax burden falls on labor, capital, and consumption relative to its peers?
- To what extent are a country’s public social protection systems engaged in mitigating poverty, vulnerability, and marginalization?
A nation’s fiscal policy – the way governments collect and spend public resources – can play a major role in reducing poverty and inequality. Taxation is an important source of revenue to fund social protection programs and provides a means of directly redressing market inequalities. However, taxes must be designed well to minimize loopholes and ensure progressivity (that they are levied more strongly on those best able to afford them), and transfers must be targeted well to adequately reach those most in need without dampening incentives to work, save, and invest. This sub-pillar includes indicators measuring total tax revenue, total tax wedge as a percentage of labor costs, the incidence of taxes on capital, property,inheritance, and consumption, as well as the overall progressivity of the tax system and perceptions of its impact on incentives to work and invest (Tax Code Sub-pillar).
Social safety nets of various sorts can help societies mitigate the effects of external and transitory livelihood shocks as well as to meet the minimum needs of the chronically poor so that they too can participate in and benefit from growth. These include policies and programs to reduce the risks of unemployment, underemployment, or low wages resulting from inappropriate skills or poorly functioning labor markets. Other social insurance programs are designed to cushion risks associated with ill health, disability, work-related injuries, and old age. Social assistance and welfare schemes such as cash or in-kind transfers are intended for the most vulnerable groups that have no other means of adequate support. This sub-pillar includes indicators that comparatively assess: the total fiscal effort on coverage of public disability and health insurance; coverage and adequacy of public pension, unemployment, disability and health benefits; progressivity of pension benefits and perceived government spending; and adequacy of social assistance and insurance (Social Protection Sub-pillar).
Box 4: The International Labor Organization’s Examination of Wages and Income Inequality
Debates about the economic role of wages have intensified in recent years. The ILO’s Global Wage Report 2014-2015 presents both the latest trends in average wages and an analysis of the role of wages in income inequality.1-4
Global wage growth has been driven almost entirely by emerging and developing economies, where real wages have been rising – sometimes rapidly – since 2007, albeit with major regional variations. In 2013, for example, real wage growth reached 6 per cent in Asia but was less than 1 per cent in Latin America and Africa, and China alone accounted for almost half of the world’s global wage growth. Comparing the purchasing power of their wages, an average American worker is still earning three times as much as a Chinese worker, but the gap is declining fast.
In developed economies, by contrast, wage growth has fluctuated within a narrow range since 2006 (plus or minus one per cent), and in some countries wages remain below their 2007 levels. In countries where labor productivity growth has exceeded real wage growth, higher wages would be desirable, to avoid widening inequality and slower economic growth.
Data shows that inequality often starts in the labor market. Changes in the distribution of wages and job losses accounted for 90 per cent of the sharp increase in inequality in Spain from 2006 to 2010, and 140 per cent of the increase in the United States in the same period. Conversely, when inequality fell considerably in Argentina (2003 to 2012) and Brazil (2001 to 2012), changes in the distribution of wages and paid employment accounted for 87 and 72 per cent of the change, respectively. This highlights the importance of coherent labor-market policies, including minimum wages and collective bargaining, alongside employment and social protection policies.
In developed economies where social transfers are an important source of income for the lowest-income groups, policies need to raise the quality and compensation levels of available work and help individuals in these households to move into employment. In emerging and developing economies, raising the income of low-income groups has been achieved through both direct employment programs (as in India and South Africa) and cash transfers (as in Brazil and Mexico, among many other countries). Although some of this inequality can be corrected with taxes and transfers, current trends in the labor market often place too heavy a burden on fiscal redistribution.
In the end, the most effective and sustainable route out of poverty for the working-age population is a productive, fairly paid job. Policies should be geared toward this objective.
Box 5: Technology and Inclusive Growth
Technological change can be an important driver of economic growth: in developing countries, a 10 percent increase in high-speed internet connections is associated with an increase in growth by an average of 1.4 percent.1-5 Yet, whether it tends to create inclusive growth in the absence of supportive public policies is hotly debated. The technological progress of recent decades has been linked to the increasingly unequal global distribution of income: it has increased the premium commanded by high-skilled workers while enabling previously medium-skilled tasks to be performed by lower-skilled workers or off-shored to lower-wage economies.2-2
History suggests that any technology which displaces jobs also creates new kinds of jobs, which often require higher skills and pay better. However, it is unclear whether this trend will hold as rapid progress in artificial intelligence and robotics promises to diminish the range of tasks at which humans can outperform machines. Even if enough new categories of jobs emerge, managing the transition will become ever more challenging. Already, as more of our lives are lived online, individuals without access to technology are getting increasingly excluded from creating value and participating in social structures.
Nonetheless, there is ample evidence that technological advancement has strong potential to foster inclusive growth and job creation, notably by empowering the self-employed and small enterprises.3-5 One study in Niger found that farmers increased their income by 29% when ICT gave them better access to information.4-5 Online work offers opportunities for people who face barriers to working outside the home, whether due to geographical remoteness, physical disability, or cultural barriers (such as those against women’s work in patriarchal cultures).
Technology is also fostering more inclusive growth by democratizing access to education. Open educational resources – publicly-shared teaching, learning, and research materials – are revolutionizing the management of education systems and the design of curriculums.5-5 The growing penetration of connectivity and increasing affordability of devices are bringing high-quality learning to some of the poorest parts of the world. Bridge International Academies in Kenya, for example, uses modern technology to inform teaching methods in schools aimed at families living in slums on less than $2 a day.6-5
Likewise, innovations in mobile payment systems and peer-to-peer lending platforms are democratizing access to financial services and credit. Mobile money apps such as Kenya’s M-PESA are giving small-scale entrepreneurs and low-income households access to a range of financial services, enabling them to grow their businesses and make financial transactions effortlessly.7-5 Mobile money can also reduce low-level corruption – minibuses in Nairobi are switching to contactless payment systems, which will reduce the scope for traffic police to solicit cash bribes.8-5
Technology has the potential to improve governance in other ways too: by enabling governments to share information more widely with citizens, and granting citizens the knowledge, tools, networks, and means for proactively bringing change to their communities. The growing capacity to capture and analyze data should also increasingly help organizations and leaders to better tackle social problems such as crime and disease through early identification of anomalous patterns. On the other hand, technological progress may also increasingly enable repressive governments to shut down controversial or challenging voices and shrink the space for civil society.
New technologies will always have the potential to be used in positive and negative ways. Technological change is the result of conscious decisions taken by scientists, investors, governments, and consumers, and its nature and direction can be influenced by public policies and market incentives. There is a role for public-private collaboration in mitigating the social and economic risks presented by technological change, and for maximizing benefits to produce more widespread stability and prosperity.