Keywords

Since the publication by Adam Smith of The Wealth of Nations nearly 250 years ago, humanity has made tremendous economic and social progress. Most of the world’s population have become more affluent and are living healthier, longer and more productive lives in no small part owing to the insights and tools of liberal economics. Nevertheless, Chap. 2 presented evidence of significant shortcomings in its track record on inclusion, sustainability and resilience. Deficits in these three areas are serious and persistent, and they have been fuelling a decline in social cohesion and a rise in political polarization in many countries and regions.

Chapter 3 investigated whether these deficits can be traced to the discipline’s original conceptualization. It concluded that, to the contrary, the field’s most influential founding theorists and codifiers explicitly contextualized their insights about the power of market-based resource allocation in a larger perspective and complementary set of prescriptions. These emphasized the important role of institutions—legal and other norms, policy incentives and public administrative capacity in multiple domains—in helping to translate the increased economic growth enabled by market-based resource allocation into broad improvement in social welfare. Smith, John Stuart Mill and Alfred Marshall considered increased production and national income, the wealth of a nation, as a means and not an end in itself. The ultimate purpose of an economy, they each emphasized, was to advance the material well-being, or standard of living, of society as a whole.

Nevertheless, during the twentieth century the discipline grew far more focused on production than on distribution, drawn by the pressing need to boost output during the Great Depression and Second World War and the related advent of Keynesian demand management techniques and national income accounting. These achievements made and are continuing to make an enormous contribution to human welfare. However, the parts of the economics profession ostensibly dedicated to the study of social welfare—e.g., welfare and social choice economics—came to be narrowly focused on modelling utility-maximizing behaviour by individuals and organizations within markets and extrapolating these micro-level insights into highly abstract “social utility functions” based on simplified normative assumptions, e.g., equal distribution of utility gains, weighted distribution or Rawlsian distribution (initial fulfilment of minimum thresholds). These models have little to say about well-being or societal welfare in the macroeconomic sense emphasized by Smith, Mill and Marshall. They mirror the ongoing emphasis of most of the rest of the profession on the drivers of allocative efficiency within markets and the role that these play in optimizing the overall size of the economic pie, as opposed to the drivers of socioeconomic inclusion, sustainability and resilience and the role that these play in optimizing the pie’s distribution and contribution to the material well-being of society as a whole.

From time to time, scholars and polities have pushed back against this imbalance in the theory and practice of capitalism, notably in the form of rights- and capabilities-based critiques and labour and social protection legislation, as summarized in Chap. 3. More often than not, the latter has been triggered not by theory and pedagogy but by social and political pressures arising from economic crises. The actions taken by many countries during the COVID-19 crisis to expand their social protection programmes and occupational safety and health (OSH) requirements are a recent case in point. Nevertheless, this imbalance in the standard liberal growth model—its disproportionate emphasis on increasing allocative efficiency through markets relative to improving distributional equity and sustainability through institutions—persists.

In effect, inclusion, sustainability and resilience were lost in translation during the evolution of eighteenth- and nineteenth-century political economy into twentieth-century economic science. These important priorities and the range of institutions that facilitate their implementation have yet to meaningfully penetrate the dominant production cum capital accumulation mental model of growth and development. This is despite the increasingly insistent pleadings of political leaders, who have repeatedly committed to pursue fundamental reform of their economies in these three respects, beginning at the 1972 United Nations Conference on the Human Environment in Stockholm and continuing with the 1992 Rio Summit on Environment and Development, 2008 and 2009 G20 Summits, 2015 UN Paris climate agreement and 2030 Agenda, 2019 ILO Centenary Declaration and, most recently, the 2022 Kunming-Montreal Global Biodiversity Framework. Taken literally, each of the outcome documents of these historic summits is an unfulfilled promise of deep economic reform.

Smith, Mill and Marshall established the theoretical foundations of a more balanced growth and development model long ago through their explicit distinction between social welfare and economic efficiency and their corresponding explicit emphasis on institutions as well as markets. The principles they articulated in this respect have been refined and extended by the likes of Veblen, Commons, Sen, North, Acemoglu, Rodrik and others. However, the standard model remains largely unreformed by these insights; in economic theory and policy practice, growth and production remain largely disconnected from living standards and distribution.

Institutions are the underexploited link. They play a vitally important role both in production and distribution and in capturing synergies between the two. Rebalancing liberal economics by elevating and formalizing the role of institutions in core economic theory and practice is an increasingly urgent priority. The prospect of a twenty-first-century version of Polanyi’s Great Transformation cannot be discounted, as algorithmic automation, net-zero regulation, population ageing and geopolitical and geoeconomic fragmentation gather force.

The place to begin is a recognition that production of goods and services (GDP) is just a top-line measure of national economic performance, analogous to the way that revenues (sales) are commonly considered the top-line measure of business performance and profits are considered the desired bottom-line result.Footnote 1 The bottom-line way that societies—people—judge their economy’s success is progress in the living standard of their household and community, i.e., in the lived experience of ordinary families. And yet, like in a business, it is very difficult to grow the bottom line over time without increasing the top line. GDP growth remains vitally important to progress in living standards for the simple reason that it is easier for everyone to receive a larger piece of pie if the entire pie, in this case the national economy, is expanding.

To be certain, the correlation between economic growth, or change in real GDP per capita, and broad progress in living standards is strongly positive, particularly with respect to poverty alleviation.Footnote 2 However, it is far from lockstep. The evidence suggests that this relationship can be closer in poorer countries than more affluent ones, which is intuitive given that economies dominated by subsistence agriculture and having little industrial production and service sector activity are starting from a low base. The superior labour productivity associated with more specialized and industrial uses of labour is the sine qua non of economic growth, as Smith famously argued. A very poor economy cannot become significantly richer, at least not durably so, without such a structural transformation of its economy and the more productive and remunerative deployment of its workforce that this enables. Over the medium to long term, labour productivity growth is also the main driver of living standards in wealthier countries. But the incremental payoff from additional economic growth for poverty reduction and living standards tends to decline as countries become rich.Footnote 3 In these countries, the challenge is more about inclusion and distribution—involving more of the population in their already substantial industrial and other productive economic activity.

In fact, production and distribution both matter greatly—in poor and rich countries alike. And institutions matter greatly for both production and distribution, as emphasized by the original principles of liberal political economy. Many of the world’s least developed countries remain mired in extreme poverty, despite large infusions of foreign aid over decades, in no small part because they have struggled to assimilate the lessons of the East Asian miracle; for a variety of reasons they have failed to develop an enabling environment of rules and institutional systems and administrative capacities conducive to productive investment, job creation and human development—the cornerstones of economic growth. At the same time, many of the world’s middle- and high-income countries have failed during the course of their development to sufficiently upgrade aspects of their institutional enabling environment which promote inclusion, sustainability and resilience. Regulations, policy incentives and public investments and administrative capacity in certain areas of economic policy help to diffuse the benefits of national income across society as a country develops, often in ways that further increase labour productivity and economic growth.

Thus, achieving strong bottom-line national economic performance—broad progress in household living standards—requires policymakers to adopt an explicit twin focus, as Smith, Mill and Marshall taught. Their work—as well as that of a number of leading twentieth-century figures in the field of institutional economics, such as Veblen, Commons, Polanyi and Sen—strongly suggests that governments at all levels of economic development should formally adopt a dual economic policy anchor or strategic focus—GDP and median household living standards—in order to capture the material well-being or lived experience of people much more directly in their conceptualization, pursuit and measurement of economic progress. This is particularly true when markets are undergoing substantial liberalization, integration or technological or environmental disruption, since these impose increased human costs in the form of dislocation, insecurity and income dispersion. Each of these two policy anchors requires deliberate policy effort and performance measurement in its own right. Moreover, there is an important feedback loop between them, a circle that can be either vicious or virtuous depending upon circumstance and policy.

Like a person who can only see through one eye, standard liberal economics suffers from limited depth perception and peripheral vision in managing the performance of economies because it neither conceptualizes nor sets policy priorities, nor measures national economic performance explicitly and simultaneously through these two lenses. Rebalancing capitalism in the twenty-first century—reclaiming it from its late-twentieth-century neoliberal diversion—begins with reconstituting economics, both scholarship and policy practice, so that it is focused on cultivating the median living standards at least as much as the aggregate wealth of nations. This in turn requires a better understanding of the mix of policies and public and private sector institutional features that can best activate the latent synergy between the two.

This new principle—that GDP growth and broad progress in living standards deserve equally explicit and direct policy effort—is also an old one, to judge from the writings of the eighteenth- and nineteenth-century founders of market economics. But instrumentalizing it in the twenty-first century will require countries, and especially capitalist democracies, to revise the mental model, policy toolbox and progress metric they have relied upon to develop their economies.

An elaborate canon of theory and policy tools for conceptualizing and influencing GDP growth has accumulated over many decades of scholarship and practice. But comparatively little has developed in this respect regarding living standards and their relationship with economic growth. As a result, the tree of accumulated economics knowledge is lopsided and at risk of toppling over and taking the rest of the Enlightenment’s precious legacy of individual liberty and empowerment with it. What should have been one of its major branches of enquiry is severely stunted, whether owing to lack of imagination, path dependency or the natural tendency of analysts to go where the data are, which happened to be GDP after the establishment of national income accounting in the 1930s and 1940s.

At the centre of the prevailing mental model of economic progress, familiar to everyone who has studied university macroeconomics, is the aggregate production function. This is an analytical framework that deconstructs the growth process into its main building blocks or “factors of production”. It typically takes the form of an equation in which an economy’s output or overall production of goods and services (Y) is represented as a function of available production technology (A) and the quantity of capital (K), labour (L) and sometimes other factors such as natural resources (R), human capital, etc. Thus:

$$ \mathrm{Y}=\mathrm{A}\times \mathrm{f}\left(\mathrm{K},\mathrm{L},\mathrm{R}\dots \right) $$

The aggregate production function provides a cognitive roadmap for addressing the challenge of raising the level of production in an economy (GDP). It has been the focus of extensive theoretical and empirical enquiry. Great effort has gone into developing policies to optimize this equation by strengthening these individual factor inputs through better policy and understanding of how they relate to each other.

Policymakers need an analogous mental map for enabling the broad diffusion of material well-being—an aggregate distribution function—in order to fully operationalize the principle that an economy’s production (GDP) and median living standards deserve equal and parallel emphasis. On the inspiration of its production function counterpart, such an aggregate distribution function should deconstruct the main drivers or channels by which gains in a country’s standard of living manifest in distributed fashion across society. By modelling such factors of distribution, we can better understand the full range of policy levers available to promote this process of diffusion—that is to say, to render the economic development process more socially inclusive, environmentally sustainable, and resilient.

There is no single, generally accepted definition of “standard of living” or “material well-being” within any social science let alone across all of the relevant ones. However, employment and entrepreneurial opportunity—the availability of decent work and livelihoods—certainly lies at that heart of the concept inasmuch as the great majority of the income of median households in rich and poor countries alike is derived from labour compensation of some form. In addition, work confers skills that can help to improve the resilience of workers and their households to economic and social change. Finally, decent work also confers a certain purpose and dignity upon one’s everyday existence. This may be more of an intangible than material aspect of well-being, but for many people it is just as important as the money they earn.

Disposable income—financial resources available to spend after taxes and debt service—is obviously fundamental to one’s standard of living. It is the principal enabler of consumption, that is, purchases ranging from life’s immediate necessities to its more ephemeral pleasures. Whether one is well or poorly paid for productive services rendered and whether equal work is equally remunerated are key determinants in the material well-being of workers and their households. A household’s disposable income also determines its ability to invest in future well-being, for example in the acquisition of skills and competencies that lead to greater employment opportunity or in self-insurance against risks or unforeseen developments.

The availability and affordability of material necessities, such as housing, food, shelter and energy, also have a major influence on a household’s standard of living. Indeed, in all but the wealthiest households, such expenses account for a large proportion of the use of disposable income. They therefore tend to represent a major variable in the typical household’s perception of its standard of living.

Basic economic security—a reasonable degree of protection against major risks to a household’s ability to provide for itself—is another vital element of its standard of living. Such risks include loss of employment, serious illness, disability and old age. In the absence of basic social protection in these areas, households remain in constant, if underlying, anxiety about the prospect of downward mobility, i.e., a sudden, sharp drop in their standard of living.

Meanwhile, basic environmental security—a reasonable degree of protection against risks of disruption to the household’s natural environment—is a rising preoccupation and important element of material well-being for many families. This applies not only to disruptions related to the climate and global warming, such as droughts, floods and heat stress, all of which can seriously and rapidly impair livelihoods, property and labour productivity, but also to threats to the same from air, water and soil pollution and collapsing natural habitats and species populations. The viability and quality of the natural environment is an integral part of material well-being for a wide spectrum of households, from those depending on it directly for their livelihoods, to those whose health is threatened directly or indirectly by its degradation, to those relying on it for a significant share of their leisure and recreation.

Thus, an economy’s aggregate distribution function can be represented as follows:

$$ \mathrm{Z}=\mathrm{f}\ \left(\mathrm{O},\, \mathrm{I},\, \mathrm{N},\, \mathrm{EcS},\, \mathrm{EnS}\right) $$

where Z represents the median household’s standard of living, O is its employment and entrepreneurial opportunity, I is its disposable income, N is the affordability and availability of its material necessities, EcS is its economic security or capacity to withstand adverse shocks, and EnS is its environmental security.

These five “factors of distribution” represent the core components of family or household material well-being. They are the main channels through which a country’s standard of living is expressed in the lived experience of ordinary people, defined for these purposes as households earning the median level of income.

Combining the two functions enables us to represent the drivers of a nation’s material well-being more completely:

$$ \mathrm{W}=\mathrm{A}\times \mathrm{f}\left(\mathrm{K},\mathrm{L},\mathrm{R}\right)+\mathrm{f}\left(\mathrm{O},\mathrm{I},\mathrm{N},\mathrm{EcS},\mathrm{EnS}\right) $$

This is an economy’s aggregate social welfare function. It comprises both an aggregate production function and an aggregate distribution function, reflecting the crucial importance for a nation’s socioeconomic progress of both its overall level of national income (the size of the pie) and the everyday lived experience or material well-being and security of its people (the breadth of social participation in its benefits).

A few important caveats are in order. This is not a mathematical function; it is a representation of a social science system—a mental model or heuristic. Not only do its two component functions represent different things (output of goods and services at the national level versus material well-being at the household level), but some of the latter’s factor inputs are also less quantifiably measurable than those of the former. That said, the aggregate production function itself has been demonstrated to have limited, if any, meaningful mathematical validity, despite its ambitions in this regard when it was originally developed and empirically tested in the mid twentieth century.Footnote 4 The aggregate social welfare function described here has no such pretension. It is simply a cognitive roadmap—an expanded and thus more balanced and complete way of thinking about how to mobilize economic progress in the modern world, in which inequality or relative poverty and insecurity is at least as big a problem as absolute poverty for many countries and their citizens.

This rebalanced mental model of national economic progress resurrects the lapsed first principle of Smith, Mill and Marshall that growth through greater allocative efficiency is a necessary but not sufficient condition for the ultimate measure of a nation’s economic performance: improvement in its general standard of living. It does so by formally integrating the critical role of institutions—particularly those that promote inclusion, sustainability and resilience—into the standard “neoclassical synthesis” growth and development model, restructuring it to explicitly cover both the productive quantity and social quality of growth—that is, both the wealth and the living standards of nations.

Such a reformulation of the standard growth and development model has a key policy implication for both developed and developing countries: the production and distribution functions of their economies require equal and ongoing cultivation. Like the supply of capital and labour and the pace of technical change reflected in the aggregate production function, the strength of each of the aggregate distribution function’s factor inputs is heavily influenced by policy rules and incentives as well as public and private institutional capacities.

Box 4.1 is a representation of this institutional ecosystem, a summary of the primary domains of policy and institutional strength corresponding to each of the aggregate distribution function’s five factor inputs.

FormalPara Box 4.1 Aggregate Distribution Function: Policy and Institutional Ecosystem

Employment and entrepreneurial opportunity (O)

Competition and rents

  • Anti-trust

  • Anti-corruption

  • Property rights and land tenure rules and enforcement capacity

  • Technology governance, e.g., intellectual property rights, data ownership and access

Investment in real-economy productive capacity

  • Corporate governance rules and protections

  • Financial system governance rules and protections

  • Public investment in infrastructure, R&D, key industries, public works

Labour force skills, transitions and participation

  • Skills, e.g., basic K-12 education,Footnote 5 school-to-work, tertiary education, lifelong education

  • Active labour market policies, e.g., employment services, training, skills matching, income maintenance, credentialing

  • Rights: elimination of forced and child labour; non-discrimination, e.g., gender, race and ethnicity, disabilities, age, etc.

  • Formalization of work arrangements

Disposable income (I)

Wage compensation

  • Minimum/living wage regulations

  • Rights, e.g., freedom of association and collective bargaining

  • Social dialogue rules, institutions, practices

  • Taxation of wage income and relative treatment of earned and unearned income

Non-wage compensation

  • Health insurance rules, policy incentives

  • Pension rules, policy incentives

  • Dependent care rights, benefits, incentives

  • Working hours, annual leave, work–life balance regulations

  • Profit-sharing and employee, community ownership regulations, incentives

Availability and affordability of material necessities (N)

Regulation, policy incentives, and subsidies

  • Water and sanitation

  • Food

  • Housing

  • Energy

  • Transport

  • Telecommunications

  • Recreation

Economic security (EcS)

Social protection—coverage and adequacy of benefits

  • Health care

  • Pension

  • Unemployment insurance

  • Disability

  • Anti-poverty

Worker protection regulation and enforcement capacity

  • Occupational safety and health

  • Arbitrary dismissal

  • Consumer protection

Asset-building/wealth accumulation policies and incentives

  • Homeownership

  • Private pensions

  • Business ownership

  • Small saver protection

Environmental security (EnS)

Climate change policies

  • Mitigation

  • Adaptation

Other natural capital regulation

  • Water

  • Air

  • Soil

  • Natural habitat and biodiversity

These are the primary areas of policy and institutional design that influence the nature and extent to which a country’s rising prosperity (traditionally understood as GDP growth) takes expression in a general improvement in its standard of living. As discussed in greater depth in Chap. 5, this process is far from automatic within countries or uniform across them. Policy choices within and across these policy domains make a big difference, resulting in considerable variation in median household living standards among countries with similar levels of GDP per capita.

In short, this policy and institutional ecosystem is the de facto income distribution system—or, more precisely, living standards diffusion mechanism—of modern market economies. It is the practical manifestation of their social contracts—how they apply their society’s values with respect to inclusion, sustainability and resilience to the rules of the game within their economies.

This institutional infrastructure tends to be constructed over time in an ad hoc and piecemeal manner. In many countries, it remains poorly or unevenly developed or has been left to wither on the vine because policymakers have not been trained to think of it as a system (a “function” in economics parlance) that has an important bearing on bottom-line national economic performance and therefore requires deliberate, ongoing construction. Most top policymakers as well as the economists who advise them tend to be macroeconomists or financial market specialists who have been conditioned by modern economic science to treat living standards mainly as a residual—a trickle-down outcome of more efficient and better capitalized production. They therefore concentrate on policies (macroeconomic, financial stability, trade) that boost the economy’s top-line performance as measured by GDP, asset prices and trade flows, rather than on domains like these which are particularly important in shaping its bottom-line intended outcome: broad-based progress in household living standards.

This policy framework and the aggregate distribution function to which it corresponds are tools to help modify these reflexes, to rebalance liberal economics away from patterns of thought and behaviour which have developed over the past century and especially the last four decades. They are vehicles to help restore the explicit dual focus of classical political economy on markets, production and national income, on the one hand, and institutions, distribution and broad social welfare, on the other. Ours is a century that badly needs economies—and economists—to establish a better balance and stronger synergy between the two.

Towards Human-Centred Economics

Economics and capitalism are ripe for fundamental reform. And while it is important not to throw the baby out with the bathwater (markets, production and economic growth remain important challenges about which modern economics has much to contribute), it is also important not to underestimate the current degree of stasis within the field relative to the transformation underway in economies, business and politics.

Frustration regarding inclusion, sustainability and resilience has been building within many societies and appears to be close to the boiling point in some. The gap between the promises of political leaders and the facts on the ground in these respects has reached uncomfortably stark levels. Social patience appears to be running thin at precisely the moment when a major cyclical challenge (the unwinding of over a decade of unsustainable macroeconomic stimulus) is coinciding with three extraordinary shocks (the break in US–China economic relations, COVID-19 pandemic and Russia–Ukraine war) and increased disruption from climate change and automation.

We appear to have arrived at another hinge point of history when the liberal tradition is being challenged to evolve, to summon the imagination and will necessary to pre-empt a gathering storm of economic, social and political disruption that has the potential to rip it asunder. It nearly missed the boat in this regard a century ago, as it descended into financial panic, depression, industrial unrest and political extremism in the 1920s and 1930s. Can it respond more proactively this time around? Can economists find a better way to help the world’s political leaders deliver what they have promised in multiple international declarations—a growth and development model that is stronger for being more inclusive, sustainable and resilient?

That is the spirit in which this conceptual model and policy framework are presented. The aggregate social welfare and distribution functions formally integrate important institutionally enabled dimensions of social welfare into the standard mental model of economic growth and development. They define the social contract in practical terms and insert it into the core of macroeconomic theory. In so doing, they provide a formula for better reconciling the rights-based and economic-utility-based conceptions of economic progress, which have been like two ships passing in the night for a very long time.

In other words, these are concepts and tools for re-embedding economics in society, to use Polanyi’s terminology. Placing institutions that matter for distribution and social welfare at the heart of liberal economics in this manner would go a long way towards overcoming its long-standing blind spot with respect to inclusion, sustainability and resilience—that is to say, the weakness of its implied assumption that these matters are ultimately sorted out through the indirect, trickle-down effects of growth. It would help to make market economies—and the intellectual discipline of economics—more human-centred, that is, more focused on living standards and the lived experience of people and less on GDP and financial markets.

The aggregate distribution function looks at national economic strategy and performance through the other end of the telescope—from the bottom-up perspective of the material well-being and security of households as opposed to the top-down, abstract statistical construct of national income. Its vantage point is the kitchen rather than boardroom table or financial trading desk. It adds a missing practical macroeconomic dimension to welfare economics, which has been a highly abstract, microeconomically oriented subdiscipline for too long.

In effect, the aggregate distribution function describes the larger social welfare policy “switch” at which many economic policymakers have fallen asleep over the past few decades as inequality and insecurity mounted while digital disruption, economic integration and environmental degradation accelerated. The aggregate distribution function of an economy extends well beyond transfer payments and education and skilling, the two most commonly proposed responses to the centrifugal forces of technological disruption and globalization upon societies. It provides a wider view of the playing field for policymakers—the full range of pre- and post-transfer policy responses available to shift an economy from a socially polarizing trickle-down mode to a levelling-up, lifting-all-boats dynamic.

Countries wishing to make faster progress on social inclusion, environmental sustainability, and resilience should be investing in strengthening the distribution function at least as much as the production function of their economies. Some have managed to forge a more perfect union than others between individual economic liberty and shared socioeconomic progress by taking a more direct and systematic approach to managing this side of their economies—the social quality of economic growth. They have maintained competitiveness while achieving greater inclusion through a mixture of sharper policy incentives and stronger public and private institutions designed for this purpose.Footnote 6 Governments should not be too proud to learn from their peers in this regard, no matter how particular they perceive their own history, culture and political institutions to be.

Fuller activation of an economy’s aggregate distribution function is fundamentally a strategy to increase investment in people—their capabilities, purchasing power, fair employment and entrepreneurial opportunity, and material well-being and security. The standard of living of working people and their households overwhelmingly depends on employment-related compensation and publicly enabled (but not necessarily publicly delivered) services and protections in such areas as education, consumer safety, asset-building, social insurance, and infrastructure. Investing in these translates much more directly into people’s lived experience than do the blunter instruments of general fiscal and monetary stimulus and cuts in business regulation.

Business and political leaders commonly describe people as an economy’s most important resource, but they have perennially failed to walk this talk by investing adequately in them and their standard of living and economic security. The trickle-down frame of reference of liberal economics with its emphasis on boosting investment in physical and financial capital, often through huge, untargeted expenditure of public resources (e.g., across-the-board personal and corporate tax cuts), has at best an indirect and blunt effect on jobs and living standards. Optimizing an economy’s aggregate distribution function, by contrast, focuses on increasing public and private investment in multiple aspects of the lived experience of households. It aims more directly and structurally (as part and parcel of the growth process itself) to improve the capacity of market economies to democratize participation and diffuse the benefits of growth in economic activity, thereby bringing more of society along on a nation’s upward development journey.

This more comprehensive and direct human investment and security agenda also happens to be what is most needed at this juncture to strengthen the growth prospects of many economies. There are three big prevailing and vexing challenges here. First, economists were debating for several years before the COVID-19 pandemic whether the United States and other advanced economies are characterized by a chronic underlying deficit of demand—so-called “secular stagnation”—owing to technology, globalization, population ageing and other structural factors. The recent sharp rise in inflation related to the COVID-19 pandemic and war in Ukraine has transformed this concern into open fear of a prolonged period of stagflation. Second, despite the technological innovation in our midst, productivity growth has been very slow for the past decade—about 1% per year—and this phenomenon has spread to major emerging economies.Footnote 7 And third, with interest rates rising to combat inflation and balance sheets still bloated from two rounds of extraordinary monetary stimulus in the past 15 years, many central banks have limited policy space to fight the next downturn, even before it has begun. They may need to work more closely with fiscal authorities to devise more direct and effective methods of transmitting stimulus into the economy in the event monetary policy is severely constrained during a future major downturn.

The aggregate distribution function offers policymakers an additional way of addressing each of these growth conundrums. First, its fuller activation would have the effect of adding a bottom-up, structural dimension to Keynesian demand management, in contrast to the top-down, indirect and transitory nature of traditional macroeconomic stimulus packages. A full-court press of structural policy and institutional reforms that reinforce household disposable income, purchasing power, economic security and labour market participation and transitions would support aggregate demand and consumer and investor confidence on an ongoing basis. Other things being equal, this would raise the labour share of national income and level of consumption within an economy—Keynes’s key preoccupation as discussed in Chap. 3—and so help it to escape the grip of secular forces weighing it down, whether the after-shocks of recent crises or the income- and opportunity-dispersing effects of automation and the climate transition.

Second, fuller activation of an economy’s aggregate distribution function would also address slow productivity growth more directly and effectively by prioritizing investment in skills development, research and development, sustainable infrastructure and anti-trust and anti-corruption protection, placing these at the centre of national economic policy rather than at the periphery where they too often have languished. Finally, the function represents a menu of potential channels to transmit stimulus more directly into the economy, particularly in the event that central bankers find themselves in the monetary black hole of a liquidity-trap or stagflationary recession. During such a crisis, an extraordinary increase in financing corresponding to one or more of these factors of distribution (such as disposable income or material necessities), through either conventional government borrowing or direct central bank financing, would help to stabilize the economy in the near term while advancing its structural rebalancing and reform over the longer term.

Thus, strengthening an economy’s aggregate distribution function represents a growth as well as social justice strategy—a way to render its growth model more dynamic, resilient and sustainable by making it more inclusive. Finding such a way to add a sustained bottom-up impetus to growth could scarcely come at a better time for many economies around the world that are struggling to wean themselves from a decade and a half of unsustainable and decreasingly effective monetary and fiscal stimulus. While such stimulus was crucial to stabilizing their economies in the aftermath of the 2007–08 financial crisis, this strategy has run its course. So has the other approach many economies have relied upon over the past generation—trade surpluses. Trade volumes are growing again after the pandemic, but they are not likely to return soon to the rates experienced earlier in the century given the geopolitical and other forces of global economic fragmentation at work.

The world economy also requires a new growth paradigm because of the very real prospect that artificial intelligence and machine learning will hollow out employment, purchasing power and aggregate demand over the next ten to twenty years as much as or more than digitalization and globalization did over the previous two decades. If projections about the speed of this disruption are anywhere near accurate, then shifting the economic strategy from pushing-on-a-string, trickle-down mode to a lifting-all-boats, level-up dynamic becomes a long-term macroeconomic imperative as much as a sociopolitical one. Direct, systematic action to strengthen the living-standards diffusion mechanism of economies may prove to be an indispensable tool in countervailing a technology-driven erosion of demand within them as automation spreads.

Enabling Country Practice

Thus, a country can improve not only the inclusiveness and sustainability of its economy but also the dynamism and resilience of its growth by systematically strengthening its aggregate distribution function. That is the larger significance of this theoretical construct and policy framework. They point towards a new type of structural economic reform that is pro-growth as well as pro-equity, sustainability and resilience. Indeed, it is pro-growth because it is pro-equity, pro-sustainability and pro-resilience.

The principles and framework presented here can help to fundamentally reform and rebalance capitalism while correcting its neoliberal blind spot regarding the human costs of technological change, policy liberalization and environmental externalities. By more directly and systematically activating the broad spectrum of rules, policy incentives and institutional frameworks that support the equitable diffusion of employment and entrepreneurial opportunity, disposable income, affordable material necessities and economic and environmental security, they provide a comprehensive roadmap for practising and not just preaching the mantra of inclusive, sustainable and resilient growth at the country level.

However, developing a specific strategy to strengthen an economy’s aggregate distribution function is necessarily a bespoke, rather than cookie-cutter, exercise. Each country has its own institutional strengths and weaknesses, fiscal constraints and political mandates conferred through elections and other channels. But each also has an interest in understanding how this institutional ecosystem functions as a system and in basing decisions regarding priorities for its improvement on better data and evidence. This is no small challenge given the complex, interdisciplinary scope of this important dimension of economic policy and its underemphasis for so long by mainstream economics.

In fact, this challenge presents an enormous opportunity for economics as an applied social science—a chance to renew its relevance to society and government on some of the biggest challenges humanity confronts this century. The fact that the aggregate social welfare and distribution functions presented here are not mathematical functions does not mean they are impervious to sophisticated quantitative analysis. Better data and analysis on both policy effort and efficacy in each of these five domains can support better, evidence-based decision-making by political leaders and technocrats.

In other words, a big empirical research agenda beckons. Comparable and comprehensive data are needed to help countries benchmark policy effort and institutional strength and assess their remaining policy space for improved design and increased investment in each of the five domains of the aggregate distribution function. These data could ultimately be used to construct cross-country indices of policy inputs and outcomes within these domains and perhaps across them as well.

Some important cross-country data sets and analytics of this nature exist, but most benchmarking of policy effort and investment in these domains has limited country coverage (mainly OECD countries). The most recognized indices comparing performance across multiple policy domains measure outcomes rather than these kinds of inputs. Examples include the UNDP’s HDI,Footnote 8 the OECD’s Better Life Index,Footnote 9 the Genuine Progress Indicator/Index of Sustainable Economic WelfareFootnote 10 and the Oxford Global Multidimensional Poverty Index.Footnote 11 These hint at but do not directly measure the nature and extent of policy effort and institutional strength contributing to such outcomes. The first priority of this new macro-welfare economics research agenda therefore should be to develop data and tools to help countries gauge the strength of their policy design and institutional capacity across the aggregate distribution function in relation to the experience of other countries. Comparable global databases of such information would help governments to better understand where the development of their economy’s distribution function stands relative to that of peer countries, and why, and thus to take better decisions about the priorities for further investment in it.

A handful of major data sets exist on these topics, and these could be the building blocks of such an effort. For example, the OECD tracks fiscal expenditures by major category of social spending; the ILO compiles decent work indicators, which measure various dimensions of labour protection; and the ILO also has an extensive database on social protection systems, including with respect to their coverage, benefit levels, and financing. These and other databases corresponding to the aggregate distribution function’s five factor inputs are explored in greater depth in Chap. 5 as part of a more extensive examination of what these concepts and tools imply for national policymaking.

A second research priority should be to establish a generally accepted outcome index, or composite panel of indicators, corresponding to the aggregate social welfare function. Such a multidimensional measure of a country’s progress in advancing its standard of living would include GDP, insofar as this is part of the production function component of the aggregate social welfare function; however, as a more complete measure of bottom-line national performance, the entire composite should replace GDP per capita as the main international metric of annual performance and overall level of economic development. Considerable effort would be required to select an appropriate handful of indicators corresponding to outcomes related to the aggregate distribution function as well as to assign a combined weight to these relative to GDP.

An existing example of such a composite index is the Inclusive Development Index, which I helped to create and publish at the World Economic Forum in 2017–18.Footnote 12 It placed equal weights on its three pillars of Growth, Inclusion, and Intergenerational Equity and Sustainability and their 12 constituent indicators but invited users to vary these according to their preference via an online tool. Other examples of multidimensional indices and databases related to living standards include the HDI, including its inequality-adjusted income componentFootnote 13; the Social Progress Index (SPI)Footnote 14; and the Environmental Performance Index published by the Yale Center for Environmental Law and Policy and the Center for International Earth Science Information Network at Columbia University’s Earth Institute. Footnote 15 These are somewhat less representative measures of median progress in living standards and material well-being, because they either cover only a subset of the function’s five factors of distribution or, in the case of the SPI, additional topics. The ILO has published a composite set of indicators for gauging country progress on Sustainable Development Goal 8: “promoting sustained, inclusive and sustainable economic growth, full and productive employment and decent work for all”.Footnote 16 These 12 indicators are displayed in “rosebud” charts to provide a more holistic perspective on national economic progress than do traditional GDP-based measures.

A third important area of research would be to examine the historical evidence regarding the correlation between the aggregate production and distribution functions—between GDP growth and median living standards and their constituent factors. As Chap. 5 will illustrate, some evidence suggests there is a weak and inconsistent correlation between growth and key dimensions of living standards.

An integrated research agenda of this nature could add substantially to our understanding of the institutional infrastructure that underpins modern market economies and how it can be upgraded to deliver the better user experience that leaders have been promising for decades in terms of inclusion, sustainability and resilience. Economists could make a major contribution to both scholarship and society by greatly expanding quantitative work on the qualitative dimension of economic growth and development—applying empirical analysis in ways that give policymakers the tools they need to fulfil the distinctly heterodox principles and vision of liberal political economy’s founders. Such work would have the effect of revitalizing two important subdisciplines of economics which have been in semi-hibernation for the past generation: welfare and institutional economics. It could also help economics to transcend its long-standing reputation as the “dismal science”, focused on scarcity and narrow, economic-utility maximization, by rendering it more relevant to and enabling of the economic, social and environmental possibilities of our time.

In particular, this reformulated growth and development model would go a long way towards reconnecting liberal economics with the foundational principles articulated in the 1944 Philadelphia Declaration of the ILO. The Declaration stated that “all national and international policies and measures, in particular those of an economic and financial character”, should have as their “central aim” and “be judged . . . and accepted only in so far as they may be held to promote and not hinder” the attainment of the conditions in which “all human beings, irrespective of race, creed or sex, have the right to pursue both their material well-being and their spiritual development in conditions of freedom and dignity, of economic security and equal opportunity.”

This multilateral statement of the bottom-line social purpose of economic policy strongly evokes the explicit two-lens, growth-and-living-standards, markets-and-institutions framework of analysis of Smith, Mill and Marshall as reflected in the aggregate social welfare function presented above. The Philadelphia Declaration was agreed only a few months before the Bretton Woods conference creating the IMF and World Bank, providing important context for their design as well as that of the General Agreement on Tariffs and Trade and Havana Charter of 1947-1948 and the Universal Declaration of Human Rights of 1948. The initial articles of the charters of the IMF, World Bank, GATT and WTO all reflect the logical policy hierarchy set out in the Declaration, stating that the ultimate purpose of each institution is to advance employment, standards of living and sustainable development. All of these texts embody Roosevelt’s conviction, expressed in his State of the Union message to Congress and the American people a few months before ILO delegates arrived in the “City of Brotherly Love,” that a Second Bill of Rights of an economic and social character was needed because “true individual freedom cannot exist without economic security and independence” and “people who are hungry and out of a job are the stuff of which dictatorships are made.”Footnote 17 The aggregate distribution function is a device for systematizing this sense of solidarity—this appreciation of the ultimate social purpose of economies—within a country’s economic policy through the ongoing institutional development of its social contract, that is to say, through acts of political economy mediated optimally through representative democratic processes including social dialogue.

Chapters 5 and 6 apply this rebalanced and re-embedded model of economic growth and development to contemporary domestic and international economic governance, respectively. Chapter 5 derives several important lessons for its application in national economic policy from existing cross-country data. These demonstrate that nearly every country has ample scope to make substantial progress on inclusion, sustainability and/or resilience by working to strengthen correspondingly weak areas of its aggregate distribution function, its social contract, relative to the experience and practices of peer countries. One size cannot fit all in this regard, since social contracts are highly context-specific in a cultural, historical and political sense. Because they are so polity-specific, the discussion refrains from prescribing a single policy mix. Rather, it provides a methodology—a set of tools, frameworks and comparative data—that can be applied by governments in a wide range of political and economic contexts to integrate priorities regarding inclusion, sustainability and resilience systematically into the design and implementation of their economic policy.