Human-Centred National Economic Policy: Institutionalizing Inclusion, Sustainability and Resilience in Domestic Economic Governance

Abstract

This chapter elaborates on many of the domestic policies and institutional features that are most relevant to the task of strengthening an economy’s aggregate distribution function—its underlying ecosystem of legal and other norms, policy incentives and public administrative capacities that strongly influence the extent to which it grows in an inclusive, sustainable and resilient manner. Countries should devote at least as much policy attention and effort to strengthening the distribution function as production function of their economies by investing on an ongoing basis in policy incentives and institutional capacity relating to the five “factors of distribution” of household employment and entrepreneurial opportunity; disposable income; availability and affordability of material necessities; economic security; and environmental security. This is a structural way of improving the social quality as well as quantity of economic growth—that is to say, median household living standards as well as productive output or GDP. Extensive comparative data are presented in each of these policy domains demonstrating that nearly every country has a substantial social “welfare gap”—underperformance on one or more aspects of median household living standards relative to the frontier of outcomes and enabling policy practices in peer countries. Like output gaps, these can be narrowed by examining what works well in peer countries and how it can be adapted to national circumstances through policy innovation and investment.

In Chap. 4, I posited that countries should devote at least as much attention to strengthening the aggregate distribution function as the aggregate production function of their economies, irrespective of their level of economic development. This is the golden rule of human-centred economics. It is the key to rebalancing modern market economies so that they deliver the more inclusive, sustainable and resilient pattern of growth and development which their populations have been demanding and leaders have been promising.

In practical terms, this means governments should place as big a priority on strengthening and investing in the policies and institutions corresponding to the five factors of distribution represented in the aggregate distribution function as on those related to the factors of production in the aggregate production function. This is the key to increasing not only the wealth (national income or GDP) of their nation but also its median standard of living, which is the bottom-line measure of national economic performance for individual households and society at large. The former is but a means to achieve the latter, and median living standards are influenced by more than the rate, or quantity, of economic growth. The pattern, or quality, of growth matters as well, and this is shaped to a considerable extent by institutional design and capacity in the five domains outlined in Chap. 4 and summarized again in Box 5.1 below.

The practice of human-centred economics begins with a recognition that the construction and ongoing refinement of this policy and institutional ecosystem are an integral part of the development process, equal in importance to the traditional strategy of seeking to boost GDP through measures that increase allocative efficiency and capital accumulation. This is a different approach to structural economic reform. Since the 1980s, structural economic reform has been synonymous with short-term packages of austerity and efficiency measures intended to stabilize public finances and currencies in the context of a crisis. These administer a concentrated dose of the general neoliberal prescription of fiscal and monetary belt-tightening combined with supply-side measures that liberalize labour, product and capital markets. By contrast, a sustained strategy to progressively invest in the policy incentives and institutions that more directly support household employment opportunity, disposable income, availability and affordability of material necessities, and economic and environmental security is a formula for improving both demand and supply—for increasing both the living standards and the growth potential of an economy.

In simple terms, an economy’s growth potential is its maximum sustainable rate of economic growth. Its output gap is the difference between its actual GDP and the level implied by this potential rate. Macroeconomists often think in terms of how to narrow this gap through policy, particularly during recessions or periods of stagnation. They generally consider a country’s long-run growth potential to be primarily a function of the size and productivity of its active labour force, whereas its near-term output gap is more related to business cycle conditions and the restrictive or stimulative posture of macroeconomic policy with respect to aggregate demand.

Economies with roughly the same level of national income per capita can have a higher or lower growth potential than each other depending upon the characteristics of their policy and institutional ecosystem that influence the size and productivity of the workforce (e.g., those affecting capital investment, technological development and diffusion, skills, immigration, gender discrimination). In other words, a country’s output gap can vary depending on the policy choices it makes in these and other policy areas (and, in the near term, the phase in which its economy is situated in the business cycle).

The practice of human-centred economics requires governments and economists to think in analogous terms about median living standards. Countries at roughly the same level of national income per capita can have quite different levels of median household living standards. This difference is influenced significantly by the relative robustness of their policy and institutional ecosystem in the five dimensions of household living standards represented in the aggregate distribution function.

In this sense, an economy can be conceived of as having not only an output gap but also a living standards gap or social welfare gap. In conceptual terms, this is the difference between its current median household living standard relative to the level that would obtain if its government more fully activated the policy and institutional ecosystem underpinning its aggregate distribution function. In practical terms, this welfare gap can be represented by comparing the current state of the country’s median household standard of living (or major component thereof) with that of the best-performing countries at a similar level of development, be they high, upper-middle, lower-middle or low income.

In other words, just as national economies can have a higher or lower growth potential and corresponding gap in output (GDP) relative to this potential, so they can have a higher or lower potential median standard of living and corresponding social welfare gap depending on the extent to which they have exploited the possibilities for activating the aggregate social welfare function of their economy and, in particular, its aggregate distribution function component (its social contract).

Estimating Welfare Gaps

Four cross-country indices of multidimensional living standards help to illustrate in quantitative terms the social welfare gaps of countries, that is, differences between actual and potential median household living standards, as well as the considerable potential for variation in such gaps among countries with similar GDP per capita. First, the Inclusive Development Index (IDI) is a composite measure of 12 indicators, four each in the areas of Growth and Employment; Inclusion; and Intergenerational Equity and Sustainability.¹ IDI data for 103 economies published in 2018 suggest that that GDP per capita correlates somewhat weakly with performance on indicators other than labour productivity and healthy life expectancy (and poverty rates in advanced economies). For example, all but three of 29 advanced economies experienced GDP growth over the preceding five years, but only 10 registered clear progress in the IDI’s Inclusion pillar (median household income; poverty rate; income Gini and wealth Gini). A majority, 16 of 29, saw their Inclusion score deteriorate, and the remaining three were stable. A majority of countries with the best GDP growth performance failed to improve on Inclusion.

This pattern was repeated in the relationship between GDP growth and performance on Intergenerational Equity and Sustainability, with 11 of 29 showing clear progress and 18 of 29 deteriorating. This pillar includes indicators on public indebtedness relative to GDP; the dependency ratio (active workforce relative to retiree population); carbon intensity of GDP; and adjusted net savings, which measures the rate of savings in an economy more holistically, that is, after taking into account investment in human capital, depletion of natural resources, and damage caused by pollution.

Developing country data showed a similar weakness in the relationship between GDP growth and Inclusion. Of the 30 such economies with the highest GDP per capita growth over the preceding five years, only six scored similarly well on a majority of the Inclusion indicators, while 13 registered mediocre performance and 11 outright poor performance. With respect to Intergenerational Equity and Sustainability, only eight scored similarly well on a majority of indicators, while 12 were no better than mediocre and 10 registered outright poor performance. Most developing economies recorded a deteriorating performance on this pillar. Notable exceptions included Brazil, China and India, which reported strong levels of human capital investment that offset high levels of natural resource depletion.

In sum, over 40% of developing countries had IDI scores that were more than nine places different from their GDP per capita scores, suggesting that policy and institutional factors can make a considerable difference in a country’s broader socioeconomic performance. Among the 30 advanced economies for which comparable data was available, the United States had an IDI score that was 14 places lower than its GDP per capita ranking, suggesting that it has substantial room for improvement in many of the policy domains corresponding to its aggregate distribution function.

Second, on the narrower question of the relationship between poverty reduction and economic growth in poor countries, there is considerable evidence that growth is strongly correlated with reduction in income poverty (e.g., number of people living on less than US$1.90 per day in 2011 prices on a PPP basis). However, its relationship with country performance in multidimensional poverty reduction (on broader measures of living standards such as employment, education and health) is more nuanced and significantly weaker, albeit still positive, particularly for poorer developing countries. The authors of one of the few existing studies on this question concluded,

The elasticity of income-based poverty to growth is between five to eight times higher than that of multidimensional poverty, depending on the specific measure of poverty used … our results indicate that economic growth is an important instrument to alleviate multidimensional poverty, but its effect is substantially lower than that on monetary poverty. Therefore, countries aiming for progress in SDG 1, Target 1.2—or specifically, to “reduce at least by half the proportion of men, women, and children of all ages living in poverty in all its dimensions”—must identify other policies or interventions to reduce poverty in these other dimensions. This is particularly urgent in the present day given the already emerging and forecasted impacts of the COVID-19 pandemic on both income and multidimensional poverty. For these reasons, future researchers should focus on an investigation of other factors and policies, starting from social policies that could have a substantial impact on multidimensional poverty.²

Third, GDP per capita and environmental performance are positively related in a general sense. For example, the Environmental Performance Index (EPI)³ has a strong overall correlation between its overall scores and GDP per capita globally. However, there is wide variation in scores among countries at the same level of GDP per capita, driven by weak correlations in two of the EPI’s three pillars, those of Climate Change and Ecosystem Vitality. These variations are explained in substantial part by governance factors, both substantive and procedural. In other words, policies and institutions matter. Figure 5.1 illustrates such variability in performance on the EPI’s individual pillar scores among countries with similar levels of GDP per capita in the same region.

Fig. 5.1

Relationship between GDP per capita and environmental performance

Finally, SDG 8 sets a goal of promoting “sustained, inclusive and sustainable economic growth, full and productive employment and decent work for all”. As such, it covers growth, social inclusion and environmental integrity, similarly to the IDI. The ILO is the custodian of SDG 8 within the UN system. It has developed a measurement framework of 22 indicators across these three dimensions and calculated the scores of each for 11 subregions of the world. These are presented in “rosebud” graphics in which stronger scores are represented by longer petals shaded green whereas moderate and low scores have shorter petals shaded yellow and red, respectively. Certain subregions with comparable levels of GDP exhibit significant differences in scores within and across the three sets of indicators. For example, there is considerable variation in the environmental scores of the three relatively advanced regions of Northern, Western and Southern Europe; Eastern Europe; and North America. Similarly, scores varied considerably in all three pillars among three subregions predominantly composed of lower-middle-income countries: Western and Central Asia; South Asia; and North Africa (Fig. 5.2). While geography and culture inevitably contribute to these variations, policies and institutions appear to play a more important role given that there is also significant variation in performance on many of these indicators among countries in the same subregion. This recalls the findings of the 1993 World Bank study on the East Asian miracle, which found that key institutional features were decisive in distinguishing the performance of eight high-performing Asian economies from that of many other developing countries both within and outside Asia.

Fig. 5.2

Performance in three dimensions of SDG 8

Narrowing Welfare Gaps by Strengthening the Aggregate Distribution Function of Economies

What strategies can a country use to narrow its welfare gap—to increase its median standard of living, or important dimensions thereof, relative to that of well-performing countries at a comparable level of economic development? What policy and institutional levers can it feasibly activate more fully to improve one or more of household employment and entrepreneurial opportunity, disposable income, availability and affordability of material necessities, and economic and environmental security relative to the frontier of country practice and performance in its cohort?

There follows a discussion of some of the most salient opportunities in this respect for each of the aggregate distribution function’s five factors of distribution. This presentation is not intended to be exhaustive of the policy opportunities with respect to each such factor. Nor is it meant to suggest that the effect on living standards of any one, let alone all, of these policy interventions occurs only through the factor of distribution under which it is listed. In fact, many have an influence on more than one of the five factors (employment, income, affordability of necessities, and economic and environment security). They are listed in their area of primary or most direct influence.

In each of the five sections below, I first summarize the relevance of the policy area in question for the lived experience of median households; second, I describe some of the primary policy and institutional strategies countries use to strengthen their performance in that aspect of household living standards; and, third, I illustrate the extent of unutilized policy space most countries have to narrow their welfare gap in each policy domain—to more fully activate the relevant policies and institutions—by presenting data on the wide range of experience and performance among peer countries, that is, those with a comparable level of national income per capita.

The primary point of this lengthy presentation is to illustrate the considerable agency virtually every country at every level of economic development has to make its economy perform more equitably and sustainably for the benefit of its entire population by taking a comprehensive view of its relative strengths and weaknesses across the entirety of the policy and institutional ecosystem described by the aggregate distribution function. Readers looking for a single recommended policy prescription—a one-size-fits-all solution—in this regard will be disappointed, as the contours of countries’ welfare gaps across the five dimensions of household living standards represented by the function vary widely. The book’s more prescriptive policy recommendations are reserved for international governance and cooperation in Chap. 6. These describe in considerable detail how the international institutional architecture should be recast to provide much more effective support of countries wishing to render their economies more inclusive, sustainable and resilient, i.e., to strengthen the rate and breadth of progress in living standards by addressing weaknesses or areas of underdevelopment in their social contracts.

As emphasized in Chap. 4, the policy and institutional ecosystem presented in Box 5.1 is the practical manifestation of a country’s social contract. The policy choices and investments the country makes in these five domains largely determine how well it translates its society’s values with respect to inclusion, sustainability and resilience into the way its economy functions.

Box 5.1 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, 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 hour, 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

Employment and Entrepreneurial Opportunity (O)

The relative quantity and quality of jobs within economies at similar levels of GDP are influenced by many structural and institutional factors. Prominent among them are those which influence competition and innovation, investment in productive capacity, workforce skills, labour market discrimination and exclusion, and support for the transition of dislocated workers.

Competition and Rents

Restrictive business practices and public policies that suppress competition and concentrate rents within an economy were arguably Adam Smith’s top preoccupation in writing The Wealth of Nations. These practices and policies constrain the spread of enterprise and innovation on which broad-based employment opportunity and improved productivity depend. There are considerable differences in how countries set and enforce anti-trust, anti-corruption, property rights and land tenure, and intellectual property and data stewardship rules, and these have an important influence on industry and employment—on the fairness and equality of access to opportunity and concentration and potential for abuse of power within an economy.

Anti-trust Policy

Over the past generation anti-trust interpretation and enforcement have shifted in a number of advanced economies. In some cases, this has contributed to a notable rise in industrial concentration, expanding the power of large firms to set the terms of their relationship with distributors and suppliers, extract rents and arbitrage labour costs, including by changing (or suggesting they could change) the location and job intensity of production. About two-thirds of employment and a substantial share of innovation take place in small and medium-sized enterprises, a level that is fairly consistent across rich and poor economies.

In 2019, the OECD reported

a clear increase in industry concentration in Europe as well as in North America between 2000 and 2014 on the order of 4 to 8 percentage points for the average industry. Over the period, about 3 out of 4 (2-digit) industries in each region saw their concentration increase. The increase is observed for both manufacturing and non-financial services and is not driven by digital-intensive sectors.⁴

The following year, the organization issued a study of business dynamism across 18 countries and 22 industries over the past two decades and found that

declines in business dynamism have been pervasive in many countries and are driven by dynamics occurring at a disaggregated sectoral level, rather than reallocation across sectors … In particular, entry rates and job reallocation rates declined on average by about three and five percentage points, respectively. Although declines have been pervasive—all countries display some signs of declining business dynamism—there is significant heterogeneity in their magnitude and speed across countries and sectors.⁵

Business dynamism is important for employment and entrepreneurial opportunity because

Young firms, and more specifically a few high-growth firms, are the engine of job creation and are crucial for the introduction of new business models and the introduction and diffusion of innovation. Furthermore, young businesses can be a springboard for younger workers … and represent employment opportunities for women, immigrants and labour market outsiders, e.g. unemployed and entrants in the labour markets … Business dynamism is also significantly related to aggregate productivity. Job reallocation and dynamism are key for an efficient allocation of resources, allowing successful firms to grow and the less productive ones to shrink. This allocation of resources importantly relies on both reallocation between incumbents, but also the extensive margins on firm dynamics, i.e. the continuous process of firm entry and exit. In addition, business dynamism may favour the introduction of radical innovation and the diffusion of technology and knowledge, the key drivers of within-firm productivity growth.⁶

The OECD’s researchers identified market structure and firm heterogeneity to be factors correlated with the decline in business dynamism, and concluded that

institutions and framework conditions are found to play an important role in explaining cross-country differences in the observed trends … Thus, policy reforms can significantly help limit declines in business dynamism. Indeed, reforms reducing administrative requirements and barriers to entrepreneurship, improving the enforcement of contracts, and enhancing innovation potential and skills may boost business dynamism with positive longer-term effects. Focusing on these policy areas together may reduce barriers to entry and to knowledge diffusion, allow experimentation and favour creative destruction, while increasing absorptive capacity and the potential to benefit from technological change.⁷

As for market structure, economist Thomas Philippon has observed that the US and Europe have reversed roles over the past twenty years with respect to competition policy: “Until the 1990s, US markets were more competitive than European markets. Today, however, many European markets have lower excess profits and lower regulatory barriers to entry.”⁸ The deterioration of competitive conditions in the United States is further illustrated by the extent to which increases in the ratio of market to book value within industries (known as Tobin’s q) results in new firms entering the market. This relationship has deteriorated markedly over the past generation.⁹

More specifically, Philippon and colleagues observed that,

Twenty years ago, access to the internet was cheaper in the US than in Europe. In 2018, however, the average monthly cost of fixed broadband in the US was twice as high as in France or Germany. Air transportation is another industry in which the US has fallen behind. The rise in concentration and profits aligns closely with a controversial merger wave that included the merging of Delta and Northwest in 2008, United and Continental in 2010, Southwest and AirTran in 2011, and American and US Airways in 2014. In Europe, over the same period, the growth of low-cost carriers has driven competition up and prices down.

European industries did not become cheaper and more competitive by chance. In all the cases that I have studied, there was a significant policy action, such as the removal of a barrier to entry or an antitrust action. The French telecom industry, for instance, was an oligopoly with three legacy carriers that lobbied hard to prevent entry. The oligopoly lost in 2011, a fourth operator obtained a license, and prices decreased by 50 percent within two years.¹⁰

By contrast, in the United States, Philippon found evidence of a decrease in the independence and vigour of anti-trust regulation accompanied by an increase in industry lobbying and campaign contributions. He explained that

Incumbents may, for example, influence antitrust and merger enforcement as well as regulations, ranging from the length and scope of patents and copyright protection to financial regulation, non-compete agreements, occupational licensing, and tax loopholes. Consistent with these ideas, we find that the elasticity of firm entry to Tobin’s q has decreased more in industries that have experienced larger increases in lobbying and regulations.¹¹

Similarly, the OECD’s Product Market Regulation database documents a decrease in restrictive market entry regulation during a recent fifteen year period in all countries except the United States and Hungary. Figure 5.3 illustrates the significant variation in the level and trend of this and other aspects of policy relating to the competitiveness of product markets, underscoring the point that policy design and implementation matter, and many countries have considerable room for improvement relative to their peers.¹²

Fig. 5.3

OECD—Product Market Regulation (PMR) indicators

Governments and citizens wishing to benchmark their countries’ policies and institutional capacities relating to competition policy and the entrepreneurial climate have a relatively new source of data at their disposal. The Columbia University and University of Chicago Law Schools recently established a Comparative Competition Law Dataset, which covers competition laws in 130 jurisdictions between 1889 and 2010 and includes a second Comparative Competition Enforcement Dataset providing data on competition agencies’ resources and activities in 100 jurisdictions between 1990 and 2010. These global data sets, which cover far more countries than those of the OECD, offer “the most comprehensive picture of competition law yet assembled and provide a new foundation for empirical research on the legal regimes used to regulate markets”.¹³ Some additional relevant global data on relevant aspects of the policy and institutional enabling environment for business dynamism can be found in the World Governance Indicators, and in particular their Regulatory Quality and Rule of Law pillars.¹⁴

Anti-corruption Policy

The strength of anti-corruption policies and institutions also has a big influence on the concentration of rents and restriction of competition and entrepreneurial dynamism in an economy. While this is a particular challenge in many developing countries, it also remains a significant issue in some advanced economies in both hard (outright bribery) and soft (electoral financing and lobbying) forms.

Systemic corruption exacts a major toll on employment and entrepreneurial opportunity. It siphons rents, restricts competition, suppresses investment, exacerbates inequality and reduces government tax revenue.¹⁵ In a 2017 Transparency International survey of more than 160,000 adults in 119 countries, 25% of people reported that they had to pay a bribe to access public services in the preceding 12 months. A majority, 57%, judged their government to be performing “badly” in the fight against corruption, with police and elected officials ranked as the most corrupt public sector actors on average.¹⁶

Global estimates vary and suffer from methodological challenges,¹⁷ but there is broad agreement that corruption is a pervasive problem and acts as a significant drag on economic growth and employment, including in the formal sector.¹⁸ It has many causes and dimensions, but historical experience demonstrates that it can be markedly reduced through concerted action, in particular stronger public policy and institutional capacity in key areas. These include corporate liability and asset forfeiture laws; measures to ensure the independence of anti-corruption investigators and prosecutors; rules regarding plea bargains and whistleblowers; open procurement processes; increased citizen access to information regarding public budgets and services; digitalization of tax systems; participation in international cooperative initiatives; and special initiatives applying several of these tools at once to accelerate progress in problematic industries. Countries and jurisdictions as diverse as Hong Kong, India, Rwanda, Indonesia, Prague, Mauritius, Costa Rica, Uruguay and Bratislava have had important successes through applying these and other strategies.¹⁹

A number of cross-country benchmarking databases of the policy and institutional strength of anti-corruption frameworks in these and other dimensions have become available relatively recently. These complement and are an important evolution beyond the well known Corruption Perceptions Index, which has been issued since 1995.²⁰ They can be used by countries wishing to gain a better understanding of how they can strengthen this important aspect of their aggregate distribution function by moving their policies and institutional frameworks closer to good or leading country practice.

To be specific, the Capacity to Combat Corruption Index benchmarks policy and institutional strength in 15 Latin American countries across 14 key variables, including the independence and efficiency of judicial, prosecutorial and anti-corruption agency institutions, quality and enforceability of campaign finance legislation, access to public information, strength of investigative journalism, level of resources available for combating white-collar crime, and the extent of civil society mobilization with respect to corruption. The Index relies on extensive data and a proprietary survey conducted among leading anti-corruption experts from academia, civil society, media and the private sector.²¹

The British Commonwealth Secretariat has created its own set of anti-corruption policy enabling environment benchmarks as part of a voluntary initiative by member countries. The Commonwealth Anti-Corruption Benchmarks are intended primarily to help governments and public sector organizations assess their anti-corruption laws, regulations, policies and procedures against international good practice and consider implementing appropriate improvements. There are 25 benchmarks, each of which comprises a principle supported by a corresponding benchmark. The benchmarks address corruption across key areas of the public and private sectors which are either important for combating corruption or vulnerable to significant corruption. In relation to each key area, the benchmarks promote the concepts of honesty, impartiality, accountability and transparency and provide for specific anti-corruption measures.²²

Finally, the OECD is constructing a new Public Integrity Indicators database, which is intended to measure “the preparedness and resilience of the public integrity system at the national level to prevent corruption, mismanagement and waste of public funds, and to assess the likelihood of detecting and mitigating various corruption risks by different actors in the system”. The effort will seek to frame

minimum legal, procedural and institutional safeguards for the independence, mandate and operational capability of essential actors in the integrity system with more outcome-oriented sub-indicators drawing on administrative data and surveys … [The aim is to] help enhance the capacity of countries to measure corruption, corruption risks, effects of anti-corruption interventions and the resilience of the public integrity system and will provide an evidence-based approach to developing and implementing better integrity policies for better lives.²³

Land Governance

Restrictive and discriminatory land tenure systems have historically played an important role in hindering socially inclusive development, particularly in rural settings. As discussed in Chap. 3, Adam Smith was particularly critical of the land tenure system of his day in Great Britain, which he argued was not only unfair and exclusionary but also economically counterproductive. It inhibited improvement in agricultural productivity by severely limiting ownership of land by individuals who would be motivated by such ownership to invest, innovate and steward the land more effectively.

Unfortunately, distorted and exclusionary land use systems are still common in much of the world (indeed vestiges remain in the United Kingdom itself). Seventy per cent of land is unregistered in developing countries, a situation that makes residents vulnerable to displacement and less likely to invest in productivity-enhancing improvements. In many countries, land governance regulation and compliance systems are weak. Rights and claims are often undocumented and overlapping,²⁴ which leads to uncertainty, conflict and increased inequality. Outdated and insecure land tenures and institutions undermine both the rule of law and government revenues.²⁵

There is a long, cross-cultural track record of the crucial role that broadly distributed and secure land rights for smallholder farmers have played in advancing sustainable and inclusive development.²⁶ A study of 33 countries found that stronger property rights were associated with a 5% increase in GDP growth.²⁷ A study of 108 countries found that stronger property rights were associated with an increase of 6 to 14 percentage points in the average annual growth of per capita income.²⁸ And another global study of 101 countries found that more secure property rights were associated with higher private investment.²⁹ In sum, when land rights for smallholder farmers, both women and men, are strong and broadly distributed, they can increase agricultural investment, reduce hunger, feed the rural poor and growing urban population and promote equitable and inclusive growth.³⁰

The World Bank advises that

Secure land titles provide incentives for farmers to invest in land, borrow money for agricultural inputs and improvements to their land, and enable land sale and rental markets to ensure full utilization of land. They are also crucial for sustainable urbanization. By 2050, about two-thirds of the global population, six billion people, will be living in urban settlements and one-third in rural areas, a complete reversal from the pattern in 1950. Most of this increase will be in Africa and Asia. Failure to clarify land rights and fix distorted land policies contributes to increased property values, making them potentially unaffordable to the urban poor. These gaps have already led to the formation of large informal settlements in many cities around the world. According to the World Bank report Africa’s Cities: Opening Doors to the World, the top priority for African cities to create more affordable and livable urban environments is to formalize land markets, clarify property rights, and institute effective urban planning.³¹

Thus, institutional improvements in land governance, including taxation, can make a big difference for growth, employment and inclusion. It is important for sustainability as well, since half the forests in developing countries have insecure tenure, and this is often a driver of deforestation. Countries and stakeholders wishing to compare the strength of their policy and institutional ecosystem against good and best practice in this domain can consult the Global Land Governance Index, a project of the International Land Coalition (ILC). The ILC is a network of over 200 civil society and intergovernmental organizations committed to advancing people-centred land governance that “responds to the needs, and protects the rights, of the women, men and communities who live on and from the land, respecting that they should be the ultimate decision-makers on how their land and natural resources are used”. The Index includes data on 33 cross-country indicators in three broad areas: legal and institutional framework; implementation; and outcomes.³²

Technology Governance

Technology policy and governance are playing an increasingly important role in ensuring fair competition and preventing concentration of rents. There has been a resurgence of interest in intellectual property rights regimes in recent years, with critics arguing that advanced economies have failed to strike an appropriate balance between maintaining adequate incentives for innovators and their investors, on the one hand, and protecting the public’s interest in having affordable access to technological advances with important implications for social welfare (especially when these advances have benefited from public R&D expenditure), on the other.³³ Similarly, as industries digitally transform and algorithmic automation gathers force, data have become a crucial factor of production. Much of this information concerns the personal behaviour and preferences of individual citizens, whether or not they provided it in the act of consuming a product or service. Proprietary monetization of such data is an increasingly important business model for many companies and industries, but it raises questions about whether, as a matter of fairness, citizens should have a measure of control over and even ownership of such data. These include whether citizens should have the right to port their data to competitors and whether firms should have to obtain consent before using data for commercial purposes beyond the services individuals have purchased.

Fair competition and distribution of rents in the digital economy are increasingly contested concepts. Good and leading policy practice remain under development, including in advanced economies. For this reason, the benchmarking of country practice is difficult and in need of further international research and cooperation. Given the cross-border nature of such policy questions, they are taken up again in Chap. 6, which examines the implications of human-centred economics and its emphasis on institutions for international economic policy.

Real Economy Investment

Macroeconomic conditions are principally responsible for the overall level of investment within an economy. However, corporate governance and financial system rules have an important influence on the pattern of investment—the extent to which the private sector finances the productive capacity, innovation and skills upon which the quantity and particularly the quality of job creation depend. Policies in these areas shape the balance between short- and long-term investment, corporate profits and labour’s share of national income, greenfield investment and the levering, exchange or combination of existing assets, and tangible and intangible investment.

In poor economies characterized by financial repression, weak rule of law and a large unbanked population, the first priority is to establish basic investor protections, promote financial inclusion for households and small businesses and ensure the prudential regulation of banks. These policies help to create a system that progressively expands the flow of domestic savings and foreign investment to productive uses. In more developed economies with financial systems supported by sound legal and regulatory frameworks, the challenge is to continue the process of financial deepening—more efficient intermediation—but in a way that remains true to a key “first principle” of human-centred corporate governance and financial regulation: corporations and financial institutions are social constructs. They are vehicles to intermediate savings to productive economic uses and the satisfaction of society’s material welfare. They must not be permitted to become the tail that wags the dog of these real economy imperatives by erecting barriers to entry, concentrating rents or creating excessive leverage and other risks to financial stability.

A sophisticated financial and corporate sector in the form of deep and liquid financial markets and well-managed and accountable corporations is a boon to economic development. But there is a crucial balance to be struck through law and regulatory oversight in ensuring that capital serves the real economy rather than the other way around.

As discussed in Chap. 2, history has repeatedly demonstrated that this balance cannot be taken for granted by societies and their governments—or assumed by economists in their models of economic growth and development. Businesses are constantly in search of higher margins and, as Adam Smith emphasized, not infrequently succumb to the temptation to suppress competition in order to achieve them. At the same time, financial markets are prone to herd behaviour that leads to periodic panics and crashes that destroy jobs and household income through recessions and even depressions. Thus, an additional “first principle” of sound regulation of corporate and financial governance is that market actors are not self-regulating. Fair competition and financial stability are not equilibrium conditions of capitalism; they do not obtain and sustain naturally. They rely on sound institutional frameworks and diligent regulatory oversight.

What are the practical implications of these first principles of human-centred corporate governance and financial system regulation? Where specifically is this policy balance to be struck in order to ensure that excessive rents are not created for the owners of capital and their agents to the detriment of progress in the real economy?

During the twentieth century, this debate revolved around the question of state ownership of enterprises and banks, that is, socialism. How extensively should governments intervene directly in capital allocation by owning firms and financial institutions? But state ownership is a very crude instrument for improving an economy’s intermediation of private savings to productive real economy investment. Moreover, it generates negative externalities of its own, including the concentration of information and reduction in individual initiative which tend to accompany centralized systems of control. Moreover, the politics of state enterprise and credit allocation were highly charged during the Cold War. The capitalism–socialism ideological polemic of the time had a polarizing effect on this debate, partially obscuring the wider spectrum of corporate governance and financial system policy options available to ensure that finance serve the purpose of mobilizing investment in real economy productive capacity.

Corporate Governance

In a modern market economy, the essential question for policymakers with respect to corporate governance is not whether to promote laissez-faire or state ownership. It is how to balance shareholder and broader enterprise value creation, and in particular how to incentivize firms to pursue the former within the broader and more fundamental pursuit of the latter.

If corporations are a social construct—vehicles for channelling capital to purposes that increase employment, labour productivity and living standards—then by definition they cannot be run solely in the interests of generating short-term financial returns to investors. Near-term profitability does not necessarily equal medium- to long-term firm strength in terms of market share and employment or indeed profitability and market valuation. The value of an enterprise over time is shaped by a more complex mixture of tangible and intangible as well as short- and long-run factors than those which influence its current returns to shareholders.

How should a country’s corporate governance legal framework reflect this larger social purpose of companies without diminishing their ability to raise capital from investors? Rather than a binary choice between private shareholder primacy and state ownership, this policy challenge is better represented today as a continuum reflecting the considerable diversity of corporate structures and market economy systems in operation around the world. There are multiple corporate governance constructs in use that place varying degrees of emphasis on shareholder versus broader enterprise value creation—on near-term financial versus medium- to long-term economic and social returns—as represented in the Social Market–Market Socialism Corporate Governance Continuum shown in Fig. 5.4.

Fig. 5.4

Social Market–Market Socialism Corporate Governance Continuum

At one extreme of this continuum is the laissez-faire, self-regulatory approach best captured by the dictum attributed to economist Milton Friedman: “the business of business is business”.³⁴ At the other is comprehensive state ownership of the means of production—direct alignment of resource allocation with social priorities through direct or indirect government control. Few if any economies today are characterized by these two extremes; all are mixed economies in the sense of not only combining private and state ownership to one degree or another but also employing different corporate legal structures that balance shareholder and wider company stakeholder interests in differing ways and degrees.

This spectrum of mixed approaches has developed across the world economy in part because the Friedman, or neoliberal, approach relies on assumptions that do not hold in the real world—particularly that corporate boards and financial markets weigh all relevant factors in allocating capital, making rational decisions on the basis of complete information. We know from long experience that financial markets and corporate boards do not always have access to or properly weigh information about all material tangible and intangible factors—that is, those which can reasonably be expected to influence a firm’s value over the medium term.³⁵ Moreover, they sometimes exhibit significant biases in their decision-making, whether because of principal–agent issues, moral hazard, groupthink, herd behaviour, or misaligned incentives related to executive compensation practices or rent-seeking opportunities in the form of regulatory capture or collusion.

The other reason these mixed approaches have proliferated is that, in contrast to the United States, most societies fundamentally accept the notion of the corporation as a social construct and seek to reflect this in their corporate governance statutes and practices. Whether formally or informally, the enterprise value (as opposed to shareholder value) concept is pre-eminent in most countries,³⁶ albeit in different ways as reflected in the Social Market—Market Socialism Corporate Governance Continuum. For example, Germany legally mandates employee board seats in large firms and either requires or encourages the formation of works councils that serve as an employee–employer consultative interface in virtually all firms.³⁷ In Scandinavia, Germany and Switzerland, there are over 3000 family-controlled shareholder foundations and holding companies, which have as their legal purpose the continuation of the firm, that is, sustainable enterprise value creation, as opposed to shareholder value creation alone. These account for over a third of the GDP of Sweden and over half of the market capitalization of the Copenhagen Stock Exchange as well as a significant share of the German and Swiss corporate communities.³⁸ The European Union has been moving more formally in this direction by establishing new rules regarding sustainability-related corporate disclosure and due diligence in supply chains.³⁹

In Latin America and Asia, family-owned or -controlled businesses dominate the corporate landscape. Many retain a strong sense of responsibility to the communities hosting their major operations. India has codified such behaviour as a legal requirement of larger firms, mandating the expenditure of 2% of their average net profit on corporate social responsibility projects in communities.⁴⁰ In Northeast Asia, corporate governance is characterized by cooperation and consensus-building, with a sense of the company’s shared responsibility for maintaining social cohesion. In addition, there is a tradition of extensive corporate cross-shareholding, which tends to reinforce the creation of durable enterprise value as opposed to near-term shareholder value.

Even the United States has experienced considerable experimentation with alternative structures and practices to those emphasizing shareholder primacy, whether in the form of chartered “B corporations”⁴¹ or the expanding practice of stakeholder capitalism, which seeks to overcome the information asymmetries and incentive misalignments described above by explicitly recognizing the purpose of the corporation as creating enterprise rather than solely shareholder value and instituting processes to ensure that the key material interests of all of the firm’s key stakeholders—employees, customers, suppliers, distributors, communities hosting operations, etc.—are properly considered.⁴² Nevertheless, the shareholder primacy ethos remains dominant in US boardrooms and capital markets for reasons of both law and tradition, which is to say, the path dependency of accumulated, customary practice.

Countries are positioned on the Social Market–Market Socialism Corporate Governance Continuum according to the extent to which the legal mission of corporations is socialized beyond a narrow duty to shareholders and how this is most commonly manifested in ownership structure. The role of the private sector is extensive all along the continuum, but countries appearing on the left side are those in which there is a strong de jure or de facto primary corporate governance duty to shareholders, while broader economic and social considerations are integrated on a more informal—that is, less systematic—basis, for example through the growing voluntary practice of stakeholder capitalism. Those appearing towards the right side of the spectrum instantiate the duty of a corporation to multiple stakeholders and society at large more formally and systematically, for example through substantial use of state-owned enterprises⁴³ and sometimes an emphasis on the primacy of enterprise value creation in statutory law. At the far right of the continuum are countries in which state-owned enterprises play an extensive role in the economy, a defining feature of “socialism”. Finally, countries positioned in the centre make extensive use of alternative corporate governance legal frameworks, e.g., non-profit foundations, cooperatives and public-purpose B corporation or “fourth sector”⁴⁴ firms, all of which are privately held but governed by a formal legal obligation to maximize wider enterprise and stakeholder or societal value rather than solely or principally shareholder value. Governments in this category take steps through various aspects of law and regulation to incentivize the use of these ownership structures within their economies, expanding the “social and solidarity economy”.⁴⁵

Corporate governance codes and cultures are in flux in much of the world, moving along this continuum in one direction or other in response to social, environmental and economic pressures. Countries wishing to achieve a more inclusive, sustainable and resilient pattern of economic growth and development should give serious thought to where on this continuum they wish to position their own corporate governance legal and institutional regime. Unfortunately, existing sources of comparative benchmarking information on country corporate governance legal environments do not yet adequately capture the policy trade-offs represented in the continuum. They tend to focus only on more traditional dimensions of corporate governance practice.⁴⁶ Thus, this aspect of the aggregate distribution function is particularly ripe for further policy research and benchmarking analysis by scholars and international organizations.

Financial System Governance

If financial markets and institutions like corporations are fundamentally a social construct—vehicles for channelling capital to purposes that increase employment, labour productivity and living standards—then by definition they also cannot be run in the primary let alone sole interest of generating returns for their investors. While such returns are an entirely necessary and legitimate objective, they cannot be the driving logic of financial system governance. This is especially so when the government serves as a lender of last resort and more generally underwrites the financial sector’s stability, as is the case to one degree or another in all countries.

Financial sector development is critically important to economic development, but policymakers have a duty to set it in this larger context. They should certainly seek to build the public and private institutional foundations of more efficient and sound financial intermediation, as summarized by such important policy guidelines and benchmarking resources as the IMF Financial Development Index.⁴⁷ But they must also work to ensure that the process of financial deepening does not overshoot, creating negative social externalities and collateral financial stability risks. These may include increased inequality and the diversion of capital to uses that contribute relatively little to employment, productivity and living standards, such as financial engineering that is essentially speculative in nature and results in the churning of existing assets rather than investment in new ones.

Striking the right balance in financial sector regulation in these respects will require policymakers to think seriously and expansively about the policy tools available to manage the degree of leverage and risk-taking throughout the financial system, on the one hand, and to promote the system’s net performance in intermediating funds for primary investment in real economy productive capacity and innovation, on the other. These are crucial parameters of human-centred financial sector regulation—of ensuring that finance serves the purpose of enhancing both the growth and living standards potential of economies, which includes but is not limited to strengthening their capacity to avoid and withstand crises.

The full panoply of tools relevant to these two policy challenges are not yet fully covered by cross-country policy analysis and guidance, since some of them extend beyond the traditional focus of banking and securities regulators. But, as in the case of corporate governance, the challenge confronting policymakers is not a binary one—such as between the polar extremes of a laissez-faire, self-regulatory approach and state-directed credit allocation. A spectrum of approaches to controlling credit creation and leverage and promoting real economy investment exists in theory and increasingly in practice as well. This typology of policy options and practices is represented in the Financialization–Real Economy Investment Financial Regulation Continuum in Fig. 5.5.

Fig. 5.5

Financialization–Real Economy Investment Financial Regulation Continuum

With respect to credit creation and leverage, the international capital and liquidity requirements for large banks were raised following the Great Financial Crisis (Basel III reforms).⁴⁸ This has reduced the degree of leverage in the banking system appreciably⁴⁹ but is only a partial response to the inherent pro-cyclicality of financial sector behaviour which makes financial markets prone to instability and outright crisis, as observed by Hyman Minsky, Charles Kindleberger and others. While financial regulators are to be commended for increasing the discipline of regulatory oversight, including by stress-testing their banks against these post-crisis capital and liquidity requirements, such efforts are insufficient for two reasons. First, these requirements and tests do not yet adequately cover non-bank financial institutions, which represent a large and growing proportion of financial intermediation, particularly in advanced, systemically important countries.⁵⁰ Non-bank institutions like hedge funds, private equity firms, asset managers and other institutional investors, cryptocurrency exchanges and the trading operations of investment banks often operate at very high rates of leverage that create risk for the financial system as a whole. Second, the adequacy of the existing requirements for banks remains questionable given their central role in credit creation. It is now widely accepted that credit creation is endogenous to the banking system; bank loans actually create deposits rather than the other way around, and banks borrow reserves from central banks on demand at the prevailing rate for such funds.⁵¹

Thus, the status quo, in the form of the post-crisis Basel III requirements, is represented towards the left side of the continuum, just to the right of the very light regulatory approach that characterized international macroprudential supervision before the crisis. The new supervisory regime is a significant improvement over its pre-crisis predecessor, even if it is still in the process of implementation⁵² and falls well short of what many experts consider prudent, particularly with respect to bank capital adequacy.⁵³ Most countries fall within this category, but some of them impose or are considering imposing somewhat tighter capital and leverage requirements on banks as well as non-bank institutions in order to limit further the risk within their financial systems. They also encourage socially inclusive and environmentally sustainable credit allocation by creating a significant role for social, postal and microfinance banking institutions focused on serving communities and small businesses⁵⁴ as well as requiring related portfolio management and disclosure requirements for banks, such as those promoted by the Network for Greening the Financial System (NGFS), a group of 121 central banks and other financial regulatory authorities,⁵⁵ and the supporting corporate disclosure standards being developed by the new International Sustainability Standards Board (ISSB) of the International Financial Reporting Standards Foundation.⁵⁶ These strategies, combined with accelerated implementation of the modest agenda of regulatory oversight of non-bank financial institutions agreed by the FSB in 2014,⁵⁷ constitute an approach to advancing financial sector reform moderately beyond the status quo. This is therefore represented towards the centre of the continuum.

A more ambitious strategy to de-risk the financial system and prioritize the capital investment requirements of real economy firms would involve government intervening at a more structural level while maintaining credit creation and allocation within the private sector. This approach appears further to the right on the continuum. First, all financial activities characteristic of the role of depository institutions would be statutorily ring-fenced from riskier financial service provision such as investment banking and proprietary trading, irrespective of what kinds of institutions sponsored them, and subjected to some combination of significantly higher capital requirements, restrictions on the classes of assets in which they could invest, and public deposit insurance. Second, these measures would be accompanied by others that provided preferred regulatory and possibly tax treatment for lending for economically viable purposes that also have positive real economy, social or environmental externalities, including certain small business, community and household loans such as those supporting disadvantaged communities or climate mitigation and resilience as well as the activities of alternative or social banking institutions. Third, non-bank activities would be subjected to a thorough financial supervisory regime going well beyond current FSB and BIS mandates in order to mitigate substantially the stability risks their large flows and complex structures create, potentially including stricter capital and margin requirements, liquidity buffers, clearing system requirements, transparency, stress-testing, etc.

This approach would treat the payment-processing and retail and business financing functions of banks like a regulated public utility owing to their vital importance to the robustness and resilience of real economy activity. It would segment and more fully de-risk the part of the financial system which government is prepared to stand behind in the event of a crisis as well as focus it on the financing of business capital formation and working capital as well as the practical needs of households. Other parts of the financial system that do not merit government backstopping (non-bank institutions, the trading and securities structuring and underwriting activities of universal banks, crypto, etc.) would nevertheless be subjected to a substantial tightening of regulation given their still considerable potential to generate systemic risk.⁵⁸ This more proactive regulatory posture would further reduce the risk of financial instability in riskier markets spilling over into and becoming the tail that wags the dog of the real economy, as such instability has done so many times before. It would privilege and therefore likely reduce the cost of financing of employment- and wage-supporting real economy investment, a crucial priority of Keynes’s General Theory, as discussed in Chap. 3. Given the pressures building within the financial system that relate to fintech trends, debt levels and societal demands for greater inclusion, sustainability and resilience, this could well be where consensus thinking about financial regulation will lead in the coming years, particularly in the event of another severe global financial crisis.

This regulatory posture would return the core of the financial system to its roots and fundamental purpose. Up until about a century ago, banks primarily financed industry and to a lesser extent households on a relatively short-term, collateralized basis. They engaged in very little maturity transformation, let alone financial engineering designed to multiply leverage and effectively enable speculation. In the absence of deposit insurance, they tended to operate conservatively, matching the tenure of assets and liabilities while serving real economy purposes—financing tangible investment in trade, inventory and plant and equipment that could be collateralized.⁵⁹ This stands in contrast to today’s highly financialized economies in which financial market activity is largely decoupled from the core task of mobilizing primary investment in productive capacity. The former chairman of the United Kingdom’s Financial Services Authority, Adair Turner, estimated that “no more than 15% of lending by the UK banking system is funding the ‘new investment projects’ on which theoretical descriptions of banking systems still tend to concentrate”.⁶⁰ This phenomenon is also evident in the US economy, as illustrated in Fig. 5.6, where

Fig. 5.6

Net share buybacks and net capital formation as a share of net operating surplus for operating corporations

the separation of asset valuations from underlying economic performance is perhaps the most conspicuous feature … with firms being managed to maximize asset valuations separately from, or even at the expense of, growth, productivity, and other socially beneficial objectives.⁶¹

Finally, further to the right along the continuum are even more fundamental and interventionist approaches to ensuring that credit creation and capital allocation are aligned with broader economic and social priorities. At the far end of the spectrum is state ownership or effective control of major financial institutions, such as one sees to a considerable extent in China, Russia, India and Gulf Cooperation Council countries and, to a lesser but still substantial extent, Brazil, Mexico and Indonesia. Another, less statist approach would not go so far as to place credit allocation under the control of government, but it would place credit creation more strictly within its purview. Following the 1929 crash and the Great Depression of the 1930s, there was considerable debate about this option, known as the “Chicago Plan”, that calls for the

separation of the monetary and credit functions of the banking system, first by requiring 100% backing of deposits by government-issued money, and second by ensuring that the financing of new bank credit can only take place through earnings that have been retained in the form of government-issued money, or through the borrowing of existing government-issued money from non-banks, but not through the creation of new deposits, ex nihilo, by banks.⁶²

Theoretically, this approach would have several advantages:

First, preventing banks from creating their own funds during credit booms, and then destroying these funds during subsequent contractions, would allow for a much better control of credit cycles, which were perceived to be the major source of business cycle fluctuations. Second, 100% reserve backing would completely eliminate bank runs. Third, allowing the government to issue money directly at zero interest, rather than borrowing that same money from banks at interest, would lead to a reduction in the interest burden on government finances and to a dramatic reduction of (net) government debt, given that irredeemable government-issued money represents equity in the commonwealth rather than debt. Fourth, given that money creation would no longer require the simultaneous creation of mostly private debts on bank balance sheets, the economy could see a dramatic reduction not only of government debt but also of private debt levels.⁶³

The Chicago Plan was never implemented. It raises a number of practical questions and remains in the realm of theoretical debate.⁶⁴ However, it did attract renewed interest in the immediate aftermath of the Great Financial Crisis.

Public Investment

In addition to incentivizing private investment in productive capacity through appropriate corporate and financial system governance, governments have an important investment role of their own to play in supporting employment and entrepreneurial opportunity. The public sector typically accounts for a large share of investment in infrastructure, technology, public works and, in many countries, strategically important industries. These kinds of public investments can be crucial enablers of productivity and economic growth if structured well, and they often create a further multiplier effect by “crowding in” additional private investment in industry and innovation.

The public sector finances the vast majority of infrastructure globally—an average of 83% in emerging market and developing countries, where private financing is limited mainly to renewable energy.⁶⁵ There is solid evidence that such investment contributes importantly to productivity growth, particularly in developing countries⁶⁶ and especially in the absence of major cost overruns, project delays or political manipulation of site selection. As illustrated in Fig. 5.7, it is also relatively employment intensive. An IMF study of 41 countries over 19 years determined that US$1 million of public spending in infrastructure creates an estimated 3–7 jobs in advanced economies, 10–17 jobs in emerging market economies and 16–30 jobs in low-income developing countries.⁶⁷ Countries wishing to maximize the job creation potential of infrastructure can access policy guidance and databases permitting cross-country comparison and benchmarking, such as the World Bank’s Benchmarking Infrastructure Development tool⁶⁸ and the G20 Global Infrastructure Hub.⁶⁹

Fig. 5.7

Jobs multiplier effect of public infrastructure investment (per USD 1 million investment)

Similarly, public investment in technological research, development and diffusion also plays a critical role in economic progress. Indeed, most economists believe that so-called “total factor productivity”, a residual measure of the contribution of technical progress after accounting for changes in labour and capital, accounts for a majority of economic growth. Detailed estimates of the US economy in the twentieth century found that total factor productivity accounted for about 60% to 65% of growth, with about 26% attributable to improvements in labour quality and 14% to growth in capital inputs.⁷⁰ While these proportions likely vary across countries and time, economists who have studied the topic do broadly agree that how well an economy integrates better technologies and techniques largely determines (in addition to population growth) how fast it will grow and hence generate employment and entrepreneurial opportunity for its people.

This implies that the policy and institutional enabling environment for research, development and the application of knowledge and innovation deserves priority attention from policymakers seeking to advance median living standards. In high- and upper-middle-income countries, where most of the world’s R&D investment occurs, roughly 60% of R&D expenditure is in the private sector. For this reason, many governments provide considerable support for such activities through preferential tax treatment in addition to directly funding basic research in universities and government laboratories. In other words, it is quite common for technical progress to be subsidized by governments, whether directly or indirectly. Figure 5.8 shows the diversity of policy practice in public subsidization of private R&D investment, mainly through the tax code.⁷¹

Fig. 5.8

Direct government funding and tax support for business enterprise R&D (BERD), 2019 (percent of GDP)

For example, 20 OECD countries have special deduction rules for R&D costs, 18 have a tax credit for R&D, and 19 countries have a patent box (preferential tax treatment for patents and certain other intellectual property). These policies vary in their definitions of R&D costs, deduction amounts, credit rates, and eligibility rules. Three countries (Belgium, Ireland and the United Kingdom) have versions of all three policies in their tax systems. Only Estonia and Sweden have none of the three policies, although Sweden directly finances business R&D at twice the level of the OECD average. Five countries, including the United States, only apply their R&D tax benefits to incremental R&D expenses. The country with the most generous tax credit is Australia (43.5% on a refundable basis for smaller firms and 38.5% for larger ones), whereas the United Kingdom has the least generous credit rate, at 13% on qualifying expenses.⁷²

In sum, empirical research suggests that public R&D financing has a sizable payoff for the economy and job creation, with US$1 million in such spending yielding an average range of 5–11 jobs in R&D in OECD countries, a higher ratio than for infrastructure spending in those countries.⁷³ However, as the work of Ricardo Hausmann, a leading international development economist, and colleagues have emphasized,⁷⁴ policy support for technological progress is not just an issue for wealthy countries, where most advanced research takes place. In fact,

the two main ingredients for the development of new technology are codified knowledge in the form of theories, frameworks, scientific papers, patents, recipes, protocols, routines and instruction manuals and tacit knowledge or knowhow, which is acquired through learning by doing in a long process of imitation and repetition and which exists only in brains.⁷⁵

The key policy objective is therefore to cultivate economic innovation, whether through development of new or the application of existing technology and processes within industry and agriculture. This implies a wider range of policy and institutional tools than direct financing or tax subsidies. It argues for a broader effort to diversify and upgrade an economy’s industrial base, using a blend of industrial, foreign investment, human capital, technology and immigration policy to activate both formal and tacit channels of innovation more fully.⁷⁶

This wider conceptualization of innovation cum industrial policy has been gaining momentum in theory and practice in recent years.⁷⁷ It combines elements of traditional state subsidization of industries deemed strategically important for an economy’s next stage of economic development, for example the much-publicized initiatives of China, Europe and the United States in frontier technologies, with cross-cutting strategies to promote economic diversification and value-added industrial production by improving the institutional enabling environment in multiple domains. Active industrial policy is particularly in vogue in middle-income countries worried about the so-called “middle-income trap”. Of the 101 countries that were middle income or below in 1960, the only non-EU countries and jurisdictions with a population greater than five million to have since graduated to high-income status are Japan, South Korea, Taiwan Province of China, Israel and Singapore.⁷⁸ In fact, South Korea is the only country to have ascended from low-income to high-income status during this period, a feat China may also achieve in the next few years according to recent trends. Whether China will be able to maintain this status—a few countries, such as Russia, Argentina and Venezuela, attained and later lost it—will likely depend on the effectiveness of its approach to innovation cum industrial policy, a consideration not lost on its leadership given the ambitious policy targets and state-driven investment strategies it has set.⁷⁹

Two comparative databases are useful tools for identifying country strengths and weaknesses and planning strategies with respect to innovation cum industrial policy; one is focused on the innovation ecosystem and the other on economic complexity and diversification. They are, respectively, the World Intellectual Property Organization’s Global Innovation Index⁸⁰ and Harvard Growth Lab’s Country and Product Complexity Rankings⁸¹ based on the Economic Complexity Index,⁸² which measures the diversity and sophistication of the productive capabilities embedded in the exports of countries.

Labour Force Skills, Transitions and Participation

A person’s job prospects depend crucially on his or her skills and capabilities. The general skill level of a community or nation is determined mainly by public policy. Through their policy and funding decisions, governments at the national and subnational levels heavily influence the extent of access to quality primary and secondary schools, school-to-work training programmes; universities, and worker and lifelong training. They also influence the job market through the extent of their implementation and enforcement of key norms—in particular, international labour standards that prohibit forced and child labour and discrimination on the basis of gender, ethnicity or other personal characteristics. Beyond upholding universal human rights, the abolition of forced and child labour ensures that workers do not compete against people whom society has determined should not be in the workforce. Regulation against discrimination ensures that employers draw from the widest possible pool of eligible talent and must consider applicants fairly, on the basis of their capabilities.

As the empirical work discussed above has found, the quantity and quality of labour are second only to technical progress in their importance for an economy’s growth potential. Since skilling and labour rights profoundly influence both the quantity and quality of a country’s workforce, they deserve to be a central focus of economic policy. However, this is far from uniformly the case—a situation contributing to substantial inequality in employment and entrepreneurial opportunity among and within countries.

Skills and Transitions

In most low- and lower-middle-income developing countries, the primary skilling imperative is to expand basic literacy and numeracy by increasing access to and the quality of primary and secondary education. The advent of mass schooling in Europe and North America in the latter decades of the nineteenth century was instrumental to rapid productivity gains and economic development in these regions. But while enrolment in primary school has risen significantly in developing countries over the past two decades, serious problems remain.

First, primary and secondary school completion rates are lagging in many of these countries. Even when children do reach the last grade of primary or lower secondary school, they often fail to attain basic levels of literacy and numeracy. For example, in Central, South and Western Asia as well as North Africa, only about half of students complete primary school education and acquire a basic level of reading proficiency; roughly 40% complete but do not attain such proficiency and 10% do not complete their primary education. These figures are much worse for sub-Saharan Africa (10%, 53% and 37%, respectively) and better for Latin America (75%, 18% and 7%, respectively).⁸³ Moreover, they vary considerably within regions, even among countries with similar GDP per capita.

The corresponding figures for basic numeracy are markedly worse. And while reading and numeracy proficiency improves for children of lower secondary school age, scores remain far behind levels in high-income countries, in part because in developing countries fewer students complete lower secondary than complete primary school—more than a third fewer in low-income countries and about one-sixth fewer in their lower-middle-income counterparts.⁸⁴ On current rates of progress, it will take an estimated 70 to 100 years for these developing countries to attain the 12 twelve years of schooling of today’s developed countries.⁸⁵

These large inequalities in educational access and attainment within and among developing countries—in the basic skill set of their populations—reflect differences in policy priorities and resourcing. For example, public education expenditures in about a third of developing countries are below both of the SDG targets of 4% of GDP and 15% of total government expenditure.⁸⁶ In a cross-regional sample of 30 lower-middle-income countries, per capita public education spending ranged between about US$50 and US$700—a factor of 14!⁸⁷ This wide disparity owes partly to similarly wide differences in the level of domestic resource mobilization. Tax revenues vary between about 20% to 60% of GDP in lower-middle-income countries and roughly 12% to 40% in low-income countries.⁸⁸ This striking divergence in available fiscal resources contributes to similarly wide variation in the proportion of education expenses that households incur out of pocket, anywhere from 25% to 80% in low-income, lower-middle-income and upper-middle-income countries, with the highest average burden falling on households in lower-middle-income nations.⁸⁹

By contrast, the main policy challenge in advanced economies is strengthening training and tertiary education in terms of both access and job market relevance. A major exception in a number of countries is the need to improve the regional consistency of basic education quality and attainment. In particular, the United States relies to an unusual extent on local property taxes to finance its public primary and secondary schools, a practice that results in public expenditure per pupil being about three times higher in the wealthiest communities than in the poorest.⁹⁰ Most countries’ school-financing systems do the opposite; to a greater or lesser extent they cross-subsidize schools in disadvantaged communities in order to promote more equitable educational attainment and consistent basic skills within their economies, leading to much smaller geographic variation in public education spending per pupil. Moreover, on average, US teachers earn about 60% of the average wage of all tertiary-educated workers and 50% of that of similarly educated workers. Out of 26 OECD countries for which data were available, only Hungary has a lower performance; the overwhelming majority of these countries have teacher pay rates between 80% and 100% of those of all tertiary-educated and of similarly educated workers.⁹¹

Public investment in school-to-work and workforce training also varies widely among high-income countries. For example, the proportion of youth between the ages of 18 and 24 not in employment, education or training (NEET) ranges from 7% or 8% in the Netherlands and Germany to about 15% in the United Kingdom and United States and 24% in Italy (2019 figures).⁹² And public expenditure on active labour market policies—e.g., worker training, employment services and income maintenance during retraining—varied before the pandemic in these countries between about 0.2% and 1% of GDP—a factor of five.⁹³

Enrolment rates in tertiary education are similarly disparate, ranging from near universal (95% and above) in Japan, Belgium, the Netherlands and the United States to about two-thirds in Sweden, Switzerland and Israel (with female enrolment rates substantially above those for males in the latter two). This partly reflects considerable differences in the use of public versus private institutions to deliver tertiary education and in the total amount of expenditures devoted to tertiary versus basic education. Tertiary spending varies widely, from about 1% of GDP for several OECD countries at the bottom of the distribution to about 2.5 times this proportion in the United States, Canada and Chile at the top of the distribution.⁹⁴

Finally, advanced economies are increasingly recognizing the importance of investing in early childhood education, given the significant cognitive and social benefits that have been demonstrated by research.⁹⁵ Participation in early childhood education is increasingly compulsory and publicly supported in these countries, with an average of 87% of 3–5-year-olds enrolled in such programmes. Even where it is not compulsory, countries often offer universal legal entitlements for at least one or two years before the start of compulsory schooling. As a result, in more than half of 42 OECD member and partner countries with available data, enrolment of children between the ages of three and five is nearly universal, that is, at least 90%. The highest enrolment rates of 3–5-year-olds are in Belgium, Denmark, France, Iceland, Ireland, Israel, Norway, Spain and the United Kingdom, where they equal or exceed 97%. In contrast, less than 50% of 3–5-year-olds are enrolled in education in Saudi Arabia, Switzerland and Turkey. Public support of such education also varies considerably, ranging from 98% in Belgium and Luxembourg to two-thirds in the United Kingdom and about half in Japan, the rest of the funding coming from households and other private sources.⁹⁶

Rights and Participation

Households and communities are composed of people with diverse workforce and demographic profiles with respect to age, experience, gender, ethnicity and time availability, etc. Given the central role of labour income in living standards, progress at the median depends on fair access to employment and entrepreneurial opportunity for all who seek it, irrespective of gender, race, ethnicity, age, disability, etc. This in turn relies upon the implementation and enforcement of laws regarding non-discrimination and the elimination of forms of work so odious that society has deemed them illegal, particularly forced and child labour.

Since the early 1920s, the world’s governments and employers’ and workers’ organizations have negotiated through the ILO a large number of international legal standards covering these and other dimensions of the world of work. In 1998, a subset of these conventions were designated as Fundamental Principles and Rights at Work,⁹⁷ meaning that the ILO’s 187 member governments agreed to “promote, respect and realize” these instruments irrespective of whether they had ratified them domestically. These so-called “core labour standards” are universal; governments and employers of all kinds are obliged to create the policy and institutional environment necessary to ensure their faithful implementation.

In addition to providing technical assistance to help governments and social partners translate international labour standards into domestic regulation and practice, the ILO tracks implementation on the ground. Its most recent estimates find that progress has been mixed on forced and child labour; there is a long way to go to full realization of international norms. For example:

• Forced labour and human trafficking:⁹⁸

  • i. In 2021, 49.6 million people were living in modern slavery, of which 27.6 million were in forced labour and 22 million in forced marriage. There was an increase of 2.7 million in the number people in forced labour between 2016 and 2021, which translates into a rise in the prevalence of forced labour from 3.4 to 3.5 per thousand people in the world.

  • ii. Of the 27.6 million people in forced labour, 17.3 million are exploited in the private sector, 6.3 million in forced commercial sexual exploitation and 3.9 million in forced labour imposed by the state. Women and girls account for 4.9 million of those in forced commercial sexual exploitation and for six million of those in forced labour in other economic sectors. Twelve per cent of all those in forced labour are children. More than half of these children are in commercial sexual exploitation.

  • iii. Forced labour is a concern regardless of a country’s wealth. It is highest in the Arab States (5.3 per thousand people), followed by Europe and Central Asia (4.4 per thousand), the Americas and Asia and the Pacific (both at 3.5 per thousand) and Africa (2.9 per thousand). More than half of all forced labour occurs in either upper-middle income or high-income countries.

• Child labour:⁹⁹

  • i. At the beginning of 2020, 160 million children worldwide—63 million girls and 97 million boys—were in child labour, accounting for almost one in 10 of all children worldwide. Seventy-nine million children—nearly half of all those in child labour—were in hazardous work that directly endangered their health, safety and moral development.

  • ii. The percentage of children in child labour remained unchanged from 2016 to 2020. The global picture masks continued progress against child labour in Asia and the Pacific as well as Latin America and the Caribbean. In both regions, child labour trended downwards over the preceding four years, whereas sub-Saharan Africa has seen an increase in both the number and percentage of children in child labour since 2012. There are now more children in child labour in sub-Saharan Africa than in the rest of the world combined.

  • iii. Child labour continued to decline over the preceding four years among children aged 12 to 14 and 15 to 17; however, it rose by 16.8 million among young children aged five to 11.

• Gender discrimination:

  • i. The gender pay gap is substantial and remains high in nearly all G20 countries, between 5% and 40%. When adjusted for education, the gap is even larger. Women are twice as likely as men to be in low-paid jobs, and they continue to be under-represented in leadership positions across the G20, accounting for 15% to 45% of managerial jobs, depending on the country.

  • ii. The share of women in informal employment is greater than that of men in eight of the 12 G20 countries where such data are available. Women work disproportionately in the home, in domestic work or in own-account work—the lowest echelons of the informal economy. The rate of self-employment for women is on average 7.5 percentage points below that of men.

  • iii. At their 2014 Summit in Brisbane, G20 leaders committed to reduce the gender gap in labour force participation by 25% relative to 2012 by the year 2025. G20 ministers of labour further agreed on a set of key principles to improve the quality of women’s employment. Most countries have been making progress towards the goal despite the recent pandemic, as illustrated in Fig. 5.9.

Fig. 5.9

Progress in reaching G20 Brisbane goal set back by COVID-19 pandemic (% point change in gender gap in labour force participation rate 2012–21)

As with other drivers of employment and entrepreneurial opportunity, labour rights and protections can be improved on the ground through increased policy and institutional effort. The ILO helps strengthen their legal frameworks and administrative oversight and enforcement capacity. Upon request, it can prepare a Decent Work Country Profile,¹⁰⁰ a data-based analysis of the strengths, weaknesses and opportunities for progress of a country’s laws and institutional strength in employment, labour rights, social protection systems, active labour market policies, etc. Given the centrality of these policy domains to median progress in living standards—they correspond to three of the aggregate distribution function’s five factors of distribution—countries should consider undergoing such an evidence-based review and tripartite consultation on a regular basis, perhaps every three or five years, analogous to the IMF’s Article 4 policy consultations on macroeconomic and financial system conditions and policies.¹⁰¹ For developing countries, such strategic, evidence-based reviews on a periodic basis could also help to mobilize additional tangible support from the development cooperation community for their related institutional development priorities.

Disposable Income (I)

While the composition of household income varies somewhat according to wealth, the typical household relies overwhelmingly on wages from employment. Labour income, including from self-employment, accounts on average for roughly 70% of gross household income; pension, social insurance and other benefits account for about 20%; and investment income, including rental income, for about 1% to 4%. Payment of taxes and social insurance contributions typically reduces the gross amount by about 25%. The remainder is the household’s disposable income—the money it has available to spend on material necessities and discretionary purchases and to save and invest.¹⁰²

Public policy has a significant influence on the three largest of these variables: wages, benefits and taxes. Policy choices on each help to shape the extent to which disposable income is widely distributed among households. For example, with respect to wages, the statutory minimum wage has an important bearing on median living standards because it not only influences the pay of workers in entry-level and low-skill jobs but also has a knock-on effect on the earnings of workers several tiers above. Along with policies relating to benefits and taxes, the minimum wage has an important effect on the absolute level of household income at the bottom of the distribution (on working poverty) as well as on the degree of dispersion along the entire distribution (on income inequality).

Statutory minimum wage levels vary considerably among market economies, including among those at a similar level of development. Figure 5.10 illustrates this variation among a number of OECD economies; it presents the evolution of both nominal and real (inflation-adjusted) wages.

Fig. 5.10

Evolution of real minimum wages, selected countries, 2015–22

A critical consideration for policymakers is the relationship between the legal minimum wage and a “living wage”, defined as the gross wage income necessary for a typical household to meet its necessary living costs. In many countries plagued by high levels of working poverty and inequality, there is a large gap between the two. Moreover, this gap varies considerably among countries with a similar GDP per capita, suggesting that policymakers in many countries have plenty of scope to increase their legal minimum wage to levels consistent with human dignity and social justice without hindering business activity and employment. Among upper-middle-income countries, for example, the minimum wage is about 60% to 70% of a living wage in Malaysia and Guatemala, but only about half of this level, 30% to 40%, in Kazakhstan, Iraq and Azerbaijan. As for lower-middle-income countries, the ratio is 62% in Pakistan but only 34% in Egypt and 9% in Bangladesh.¹⁰³

Among high-income countries, in Spain and New Zealand the statutory minimum wage is above the living wage (108% and 167%, respectively), whereas in the United States it is well below: 30% for people earning the federal minimum wage, and rising to about 50% to 60% in states with a higher mandated minimum wage than the federal rate of US$7.25 per hour, which was last adjusted in 2009.¹⁰⁴ As the US example demonstrates, policymakers need to pay attention to not only the current level of the minimum wage in relation to the cost of living but also its adjustment mechanism given the tendency of prices to rise over time, sometimes dramatically so as with the recent round of inflation.

An additional policy variable that influences wages is the enabling environment created by government with respect to another Fundamental Principle and Right at Work: freedom of association and the effective recognition of the right to collective bargaining. Collective bargaining agreements play an important role in many countries in securing decent work, guaranteeing equality of opportunity and treatment, reducing wage inequality and stabilizing labour relations. They can promote trust, cooperation and stability and thus reduce labour turnover, including by enhancing the retention of experienced workers during periods of inactivity such as was experienced during the COVID-19 pandemic. Collective agreements can also reinforce compliance with statutory or negotiated standards, relieving labour administration systems of some of the costs of monitoring and enforcing labour standards. There is evidence, for example, of a positive relationship between collective agreements and compliance with OSH standards at the enterprise level. In short, collective bargaining can help to forge resilience in the short term while transforming and improving the productivity of work practices in the long run.¹⁰⁵

From the perspective of workers, collective bargaining is an important vehicle for securing a fair share of the fruits of their labour in the form of compensation that rises in proportion to their firm’s financial success and their increased productivity. But, as with minimum wage regulation, policies with respect to freedom of association and collective bargaining vary widely among countries. Developed economies tend to have higher proportions of their workers covered by collective bargaining agreements than do developing countries; however, there is considerable variation within all income groups and regions, as illustrated in Fig. 5.11.

Fig. 5.11

Dispersion of collective bargaining coverage rates

Among the features of the policy and institutional environment that influence collective bargaining coverage rates are the nature and enforcement of rules regarding union campaigns and elections; the extent to which bargaining is carried out in a single- or multi-employer setting; and the extent of coverage of such agreements, such as whether their terms apply to both members and non-members of the trade union that negotiated the agreement. For example, a recent ILO survey of 93 countries with available data found that multi-employer or a mixture of multi- and single-employer bargaining was the norm in about half of them, and single-employer bargaining was the common practice in the other half. Collective bargaining coverage rates were significantly higher in the former category of countries than in the latter. In sum, with respect to

shaping the regulatory coverage of collective bargaining, the effective recognition of the right to collective bargaining for all workers and the promotion of the full development of collective bargaining are foundational. It is when the process involves trade unions representing a significant proportion of workers and takes place in multi-employer settings at the territorial, sectoral and/or interprofessional levels that collective bargaining achieves the broadest and most inclusive regulatory coverage. In some countries, the manner in which collective agreements are applied, whether through their extension or through erga omnes applicability [automatic application to non-union members of the bargaining unit], can contribute to the inclusive governance of work.¹⁰⁶

Citizens and policymakers interested in understanding the relative conduciveness of their country’s regulatory ecosystem to freedom of association and trade union density,¹⁰⁷ on the one hand, and the effective realization of the right to collective bargaining, on the other, can consult a range of ILO resources. These include the country-specific reports of its labour standards supervisory mechanism¹⁰⁸ and the overall quantitative indicators it presents on a cross-country basis as part of its role in monitoring progress on SDG Target 8.8.2.¹⁰⁹

Thus, minimum wage and labour rights regulation, among other regulatory and non-regulatory factors, play an important role in shaping the level and distribution of wages within an economy. One useful barometer of whether these and other dimensions of labour market governance deserve increased attention within a given country is the country’s “low pay rate”, defined as the proportion of the workforce earning less than two-thirds of the median wage. Figure 5.12 presents this statistic for OECD countries. It demonstrates that this rate can vary by a factor of five or more among such high-income countries. For example, whereas the low pay rate in Italy, the Netherlands, Portugal and New Zealand is in the low single digits, the US rate is 23%!

Fig. 5.12

Incidence of low pay, 2021 or latest available

Taxes, fiscal transfers and non-wage employee compensation are also important factors in the distribution of disposable income among households, especially in countries plagued by a high incidence of low pay, working poverty and income inequality. The progressivity of a country’s tax system and the generosity and scope of coverage of its social insurance and employer-provided benefits are shaped by public policy. In a supportive policy environment, these additional sources of income and compensation can offset much of the precarity and deprivation resulting from highly unequal labour market outcomes. Figure 5.13 illustrates the extent to which taxes and transfers reduce market inequality in a selection of advanced economies, reflecting the wide variation in the overall level of such policy support and the trend in OECD countries before the COVID-19 pandemic.

Fig. 5.13

Redistribution decreased in a majority of countries after 2010 and before the COVID-19 pandemic. Percentage reduction of market income inequality owing to transfers and taxes, 2007–14 (or latest year), working-age population

Figure 5.14 completes this picture by also showing the level of household income inequality before taxes and transfers. Most OECD countries’ policies reduce their Gini coefficients (a standard measure of income inequality) by 10 to 15 coefficient points, typically from around 0.40 before taxes and transfers to about 0.30 or just below. The United States and, to a lesser extent, the United Kingdom are outliers, since they start and end at significantly higher levels of inequality: 0.47 pre-redistribution versus 0.39 post-redistribution for the United States and 0.46 pre-redistribution versus 0.36 post-redistribution for the United Kingdom.

Fig. 5.14

Differences in household income inequality pre- and post-tax and government transfers, 2018

Higher pre-transfer income inequality and lighter use of tax system progressivity and social insurance transfer payments translate into higher levels of poverty, other things being equal. OECD estimates of relative poverty rates, that is, the proportion of households whose disposable income is less than 50% of their country’s median, reveal that the United States and Israel had the highest relative poverty rates—nearly 18% of households, three times the 5% to 6% rates of Nordic countries such as Denmark and Finland. More than 20% of American and Israeli children (as well as those of Turkey, Spain and Chile) live in relative poverty.¹¹⁰

Child, old-age, disability and other social insurance benefit programmes that augment household disposable income will be addressed in the “Economic Security (EcS)” section below. With respect to tax system progressivity, it is necessary to consider the way a government both raises revenue and redistributes it through the tax code. Each has an important impact on median household disposable income and inequality. There is considerable variation in both the amount and composition of tax revenue among countries at a similar level of economic development, as illustrated in Fig. 5.15a, b.

Fig. 5.15

(a) Tax revenue, selected countries, as percentage of GDP and by country income group, 2018. (b) Tax revenue, selected countries, by type of tax and country income group, 2018

In particular, countries differ significantly in the degree to which they rely on the taxation of capital and income versus the taxation of labour and consumption. Greater emphasis on the former (e.g., corporate, inheritance and individual income taxes) than on the latter (e.g., payroll and goods and services or value-added taxes) tends to enhance a tax system’s contribution to the partial correction of market inequality discussed above. As Fig. 5.15b suggests, there is plenty of scope for most countries at all levels of economic development to improve the progressivity of their tax systems by increasing the emphasis on the former relative to the latter. Unfortunately, just the opposite has been occurring, by and large, over the past two generations.

A recent World Bank study found that over the past 50 years average effective labour and capital tax rates have converged as a result of a 10-percentage-point increase in labour taxation and a five-point decline in capital taxation. The global rise in labour taxation is driven by the expansion of payroll-based social security contributions in the 1970s and 1980s. Yet, as reflected in Fig. 5.16, the most striking pattern is the marked decline of capital taxation: in high-income countries, effective capital tax rates were close to 40% in high-income countries in 1965 and fell to about 32% in 2018, driven by the sharp decline in the taxation of corporate profits. In developing countries, both capital and labour taxation have risen, but capital taxation has been rising at a faster pace.¹¹¹

Fig. 5.16

Composition of tax revenue, selected countries, by country income group, 2018

Finally, policies that support non-wage compensation—employee benefits—have an important bearing on the disposable income of households as well. For example, the cost of health and child care diverge significantly among countries as a function of their policy and institutional set-up. With respect to health care, not only does total spending per capita vary significantly among countries, but the structure of their systems, particularly the extent of their reliance on private health insurance and out-of-pocket expenses, diverges as well. The latter costs are borne by households directly (through the payment of insurance premiums and doctors’ and pharmaceutical bills) or indirectly (through a reduction in wages that offsets at least in part the premiums paid by employers). Figure 5.17 summarizes cross-country differences within these two dimensions for an illustrative group of advanced economies.¹¹²

Fig. 5.17

Level and composition of health spending in select high-income countries

Similarly, public support of the cost of child care, a major expense of young families, differs across countries. Figure 5.18 illustrates these differences, which translate into very different impacts on the monthly budgets of these households, particularly in countries with limited child allowances or “family benefits”.¹¹³

Fig. 5.18

Net child care costs (% of average wage, 2021 or latest available)

Availability and Affordability of Material Necessities (N)

The recent rise in inflation related to the COVID-19 pandemic and the war in Ukraine has revived appreciation of the state’s enabling and stabilizing role in ensuring access to material necessities. The moral and economic case for such policies and institutions was made long ago by Adam Smith in The Wealth of Nations, as discussed in Chap. 3. During the twentieth century, a strong legal basis for this important function of government also emerged, becoming embedded in international human rights treaties and the constitutions and domestic statutes of many countries.

The 1948 Universal Declaration of Human Rights states in Article 25(1) that “everyone has the right to a standard of living adequate for the health and well-being of himself and his family”. It refers in particular to the right to adequate food, clothing, housing, medical care and necessary social services. The 1966 ICECSR codified these rights and defined them further in the General Comments issued by its Committee on Economic, Social and Cultural Rights with respect to adequate housing (General Comments 4 and 7), food (General Comment 12), water (General Comment 15) and social security (General Comment 19).¹¹⁴ The criteria elaborated by these General Comments provide the single most comprehensive international legal interpretation of the right to the material necessities of life, the “progressive realization” of which states are committed to achieve “using available resources”.¹¹⁵

Governments seek to ensure the availability and affordability of material necessities in three main ways: investment in related infrastructure; regulation of public utilities; and subsidies targeted to needy populations or special policy objectives.

Public Infrastructure Investment

Adequate drinking water, food, shelter, energy and telecommunications are all dependent on infrastructure systems for both production and delivery. Thus, the level and effectiveness of a country’s infrastructure investment largely determine how well it fulfils its duty to ensure broad access to the basic necessities of life, including in relation to the targets set by the SDGs on clean water and sanitation (SDG 6),¹¹⁶ zero hunger (SDG 2),¹¹⁷ affordable and clean energy (SDG 7)¹¹⁸ and sustainable cities and communities (SDG 11).¹¹⁹

Unmet needs in these areas are enormous in many countries, and not just the poorest. For example, approximately two billion people worldwide lack access to safely managed drinking water at home, and about 3.6 billion, or half the world’s population, lack access to safely managed sanitation. About one in 10 people suffers from hunger; and a third lack regular access to adequate food, including 149 million children under the age of five who suffer from stunting. Roughly 700 million people lack electricity, and 2.4 billion still use inefficient and polluting cooking systems. One billion or so live more than two kilometres from an all-weather road. In addition, an estimated one billion people live in urban slums and 1.6 billion live in inadequate housing. The best available data suggest that over 100 million people are homeless, including half a million in the United States.¹²⁰

The Global Infrastructure Hub, an initiative of the G20 launched during Australia’s 2014 presidency, has estimated global energy, water, transport and telecommunications infrastructure investment trends and needs to 2030 and beyond. It estimates there is a gap of roughly US$800 billion, or 25%, per year, totalling about US$15 trillion over the next two decades.¹²¹ A World Bank study estimates that low- and middle-income countries invest an average of about 4% of GDP, or US$1 trillion globally, per year on infrastructure, with the public sector accounting for nearly 90% of this amount, albeit with considerable variation from a low of 53% to 64% in South Asia to a high of 98% in East Asia and the Pacific.¹²²

Given the pressure on public finances in the aftermath of the COVID-19 crisis, closing this investment gap is going to require greater innovation and efficiency. When it comes to innovation, there is growing interest in blended finance, the combination or “stacking” of public and private forms of risk mitigation and finance in order to enlarge the flow of infrastructure investment in developing countries from global and domestic capital markets. These currently allocate only a tiny proportion of the US$120 trillion or so of funds under institutional management to such purposes. Since this portfolio shift would require considerable improvement in international economic policy and cooperation, this topic will be addressed in greater depth in Chap. 6. As for improved efficiency, it has been estimated that up to 38% of global infrastructure investment is not spent effectively because of bottlenecks, lack of innovation, and market failures. Improving the efficiency of infrastructure investment (fact-based project selection, streamlined delivery, and the optimization of operations and maintenance of existing infrastructure) could reduce spending by more than US$1 trillion a year for the same amount of infrastructure delivered.¹²³

These abstract statistical estimates have a very tangible manifestation in impaired living conditions and well-being on the ground. Taking the freshwater infrastructure gap as an example, Table 5.1 shows the impact on daily lives of inadequate infrastructure in each of 15 cities and nearby informal settlements across a range of middle- and low-income countries. Even in those locations with regular piped water, researchers found that the quality is poor and unhealthy, requiring remedial treatment. As a result, a substantial share of the income and time of people is spent on life’s most basic necessity, even in countries without high levels of extreme poverty. In almost all cities where tanker truck water is available, if households relied solely on this to meet their needs they would spend considerably more than the recommended 3% to 5% of their household income on water and sanitation.¹²⁴

Table 5.1 Household access to water services in 15 cities and informal settlements in the global South

In 12 out of 15 cities analyzed, households connected to the public piped system received water intermittently, which compromises quality. In the 15 informal settlements studied, seven receive water less than 17 hours a week. Households without reliable access to piped water service obtain water from other sources, such as tanker trucks which can cost up to 52 times as much as for the same quantity of water if it were provided through the local piped water system. In informal settlements in Kampala, Lagos, and Mumbai, no households had access to piped water. In informal settlements in three cities, Cochabamba, Kampala, and Mzuzu, basic supplies of water appear unaffordable to households with average income.

The lack of attention to these factors appears to be the result of water being conceived of as a commodity. This may explain why researchers, policy analysts, and urban change agents have failed to recognize that significant numbers of low-income urban residents do not have regular supplies of affordable water. Failures of privatization combined with the continuing need to identify effective structures for water provisioning have led to the rise of corporatized water agencies. Advocates of corporatization contend it can make public services more efficient. However, it is not clear that this approach can adequately improve access for low-income households in the global South. The focus on market-based provisioning principles has prevented public agencies from assuming responsibility for low-income households.

Our analysis points to the importance of policy makers, cities, and water providers changing their collective ethos and values about water access. Then city authorities and water utilities can work together to extend the public piped networks, address intermittent services, and ensure adequate supplies of water are affordable. Most cities in the global South will require a subsidy from the national government or investment on the part of international donors, to extend and maintain piped water service to all urban residents. In turn this demands collective acceptance that universal water access is a basic human need and a public good, in the broadest social sense. While not easy to manufacture, this will require a sustained political commitment on the part of leaders, coalitions of urban change agents, and stakeholders, so investments, subsides, and other financial tools can be deployed to build and maintain piped water infrastructure systems.¹²⁵

Public Utility Regulation and Targeted Subsidies

The recent spike in inflation has thrust popular concerns about the cost of living and consumer purchasing power into the political spotlight. In the European Union, for example, governments have responded with an estimated €300 billion of regulatory initiatives and consumption subsidies.¹²⁶ Table 5.2 provides an overview of the wide range of temporary actions taken to maintain the affordability of necessities, particularly for households of modest means.¹²⁷

Table 5.2 European Union energy cost-of-living relief measures 2021–22

In addition to such crisis-related measures, most governments routinely regulate the tariffs that electricity, water and transport utilities charge consumers, in the interest of maintaining affordable access for their citizens. The resulting subsidies are often very substantial relative to the tariffs that would have been required to cover all operating and most capital expenses. Globally, a clear majority of water and electricity utilities do not achieve this coverage; more of them do so in advanced economies, but still far from all.¹²⁸

In addition, many developing countries maintain a variety of direct consumption subsidies. For example, reflecting the fact that Indian households spend about 45% of their income on food, the country’s Public Distribution System provides nearly 800 million people with subsidized grain through a network of a half a million “fair price” shops.¹²⁹ The programme is both a production and consumption subsidy in that it sets prices for farmers at levels that assure their standard of living, and somewhat lower prices for consumers to ensure universal affordable access to key grains. It covers two-thirds of the population and, as the Indian government’s fifth-largest expenditure, costs about 5% of GDP.¹³⁰

Subsidy schemes of this nature in developing countries are often politically sensitive owing to their central role in the lived experience and well-being of large segments of the population. Taking fuel subsidies as an example, a study found that fuel riots occurred in 41 of 217 countries between 2005 and 2018. Some countries experienced several in that period: India had seven; Indonesia had five; and China and Yemen both had three. Of the 157 countries for which monthly domestic price data were available, 73 had regimes in which prices changed every month. Over three-quarters adjusted prices at least every two months, while only around a fifth adjusted prices infrequently. The researchers found that riots were more frequent and severe in the last-mentioned group of countries—those which tended to allow larger subsidy levels to build up and make less frequent, more abrupt price adjustments.¹³¹

More recently, in 2022, countries as diverse as Ecuador, France, Haiti, Iran and Kazakhstan experienced social unrest triggered by consumer fuel price increases. The consumer subsidies and protections often employed by developing countries have tended to limit the impact of the recent war- and pandemic-related rise in food and fuel prices on their populations, considerably more so than in wealthier countries that tend to have fewer consumption subsidies and regulations. However, this likely portends additional pressure on the developing countries’ public finances.

A 2022 IMF survey of 134 countries found that most had introduced at least one measure since the beginning of that year to shield their citizens from rising inflation (26 out of 31 advanced economies and 45 out of 103 emerging and developing economies); the lower amount of measures announced by developing countries can be probably be attributed to their higher ongoing reliance on energy and food subsidies and more limited fiscal space. More specifically:

In advanced economies, cash and semi-cash transfers (including vouchers and utility bill discounts) were announced by the greatest number of countries (in about half of all countries), while most other measures aimed at lowering prices including reductions in value-added tax (VAT) (for example, in Belgium and Italy) and excise taxes (for example, France, Korea, and New Zealand). A cap on fuel prices was announced in Slovenia, and France provided subsidies to distributors to reduce gasoline prices. Estonia, Luxembourg, and the Slovak Republic announced measures to reduce electricity prices. In emerging and developing economies, the most announced measures were reductions in VAT and excises (24 percent of all emerging and developing economies). This includes Poland and Turkey, which each announced a reduction in VAT rates on food and/or energy, and Côte d’Ivoire, Serbia, and Thailand, which each announced a temporary reduction or exemption of excise taxes. Some emerging and developing economies resorted to a temporary reduction or suspension of import duties (for example, Brazil, Iraq, Turkey). Finally, about 55 percent of all announced measures [were] intended to mitigate the impact of higher energy prices, 30 percent intended to mitigate the impact of higher food prices, and intention for the remaining measures is not narrowly defined.¹³²

The IMF, which has traditionally encouraged the rationalization of consumer subsidies in developing countries, has nevertheless been advising during the current cost-of-living crisis that “fiscal policy [should] prioritize the protection of vulnerable groups from the burden of rising cost of living through temporary and targeted support while ensuring fiscal sustainability” (emphasis added).¹³³ It has attempted to provide more specific guidance in this regard as follows:

Countries with strong social safety nets (SSNs)

• Allow a full pass-through of higher international fuel prices to domestic users.

• Provide targeted and temporary cash transfers to vulnerable households.

• If existing SSN programs do not adequately cover affected middle-class households, consider oneoff cash payments, smoothing energy consumption bills over time, or energy bill discounts.

Countries with weak SSNs and without existing energy and food subsidies

• Expand existing SSN programs, such as targeted transfers or child benefits, leverage measures introduced during COVID-19, and harness the power of digital tools to identify eligible households and to deliver assistance.

• Consider reducing education, health, or public transportation fees.

• If food security is a concern and all other options have been exhausted, consider temporarily lowering taxes or providing price subsidies with clear sunset clauses for basic food staples.

• Use the momentum to invest in strengthening the SSN system.

Countries with weak SSNs and with existing energy and food subsidies

• Gradually pass through higher international prices to retail prices while committing to the elimination of subsidies over the medium term.

• Carefully calibrate price increases considering the gap between retail and international prices, the available fiscal space, and the ability to put mitigating measures in place.

  • Fuel: Consider differentiating adjustment paths of domestic prices by type of fuel based on their relative weights in the consumption of different income groups.

  • Utilities: Adjust prices gradually in line with changes in costs while providing uniform lumpsum bill discounts and smoothing energy consumption bills over time.

  • Food: If a food subsidy program exists, increase rationed food prices gradually. Consider improving targeting and reducing leakages to higher income groups.¹³⁴

This framework recognizes the importance of public policy measures to maintain affordable access to material necessities—during crises. This distinction reflects a certain long-standing intellectual tension and programmatic incoherence within the IMF and the liberal economics policy establishment more generally regarding the fundamental legitimacy of such measures. The Bretton Woods institutions are more comfortable regarding them as temporary and targeted—that is to say, ad hoc—rather than as a natural design feature of economies with endemic poverty and precarity. This is evident in the reference to “safety nets” as opposed to “social protection systems”, a topic taken up in the following section. Particularly in countries plagued by large deficits of human dignity, security and capability—an inability to provide for people’s basic enabling rights—the priority on the ground must be the latter, as this discussion has demonstrated and for which the original principles of liberal political economy provide clear justification.¹³⁵

Economic Security (EcS)

There are three primary ways public policy supports the basic economic security of households and families. First is social protection, including health insurance, old-age pension benefits, disability insurance, unemployment insurance and anti-poverty programmes providing income maintenance and other benefits for the poorest. Second is worker protection based on international labour standards, including protection relating to occupational safety and health (OSH) , which was recently elevated to the status of a Fundamental Principle and Right at Work (core labour standard), and arbitrary dismissal. Third is support for the asset-building of households—in particular, policy incentives regarding homeownership, private pension saving, and protection of savings of individuals (e.g., deposit insurance and regulation of investment managers).

Social Protection

As discussed above, fiscal transfers account for a significant share of household disposable income on average. This is because it is not uncommon for breadwinners to experience setbacks during their working lives which lead to disruptions in their household’s labour income. Also, some households have no or proportionately few breadwinners because of their demographic profile, for example those consisting only of retirees or those with many children. Moreover, joblessness and poverty can be endemic in countries and communities, and people in them often require extra support to transcend these circumstances—to exit from cultures or geographies where poverty is deeply entrenched. For these reasons and others, a country’s social protection system is a key component of its policy and institutional ecosystem for broad-based progress in living standards. It is a principal source of resilience, a shock absorber for the vagaries of economic life.

Social protection systems are not solely a luxury of rich countries. The Universal Declaration of Human Rights Article 22 states, “everyone, as a member of society, has the right to social security”. In addition, SDG 1 on ending poverty includes a Target 1.3 that reads, “implement nationally appropriate social protection systems and measures for all, including floors, and by 2030 achieve substantial coverage of the poor and the vulnerable”. In addition, SDG Target 3.8 calls for universal health coverage, which is one of the components of the social protection floor.

In practice, however, three-quarters of humanity lacks adequate social protection and a majority, 53%, are not covered by any form of social protection.¹³⁶ Accordingly, the current emphasis in the multilateral system is to expand the implementation of social protection floors, including particularly by extending coverage to the two billion people in the informal economy, who are typically least covered. Social protection floors are nationally defined sets of basic social security guarantees that should ensure at a minimum that over the life cycle all in need have access to essential health care and to basic income security which together secure effective access to goods and services defined as necessary at the national level.

The ILO, which is the lead multilateral organization on social protection, has a two-dimensional strategy for the promotion of national social protection floors. The strategy encompasses both basic social security guarantees ensuring universal access to essential health care and income security at least at a nationally defined minimum level (horizontal dimension), in line with its Social Protection Floors Recommendation, 2012 (No. 202), and the progressive achievement of higher levels of protection (vertical dimension) within comprehensive social security systems according to the Social Security (Minimum Standards) Convention, 1952 (No. 102).

National social protection floors should comprise at least the following four social security guarantees, as defined at the national level:

• Access to essential health care, including maternity care; • Basic income security for children, providing access to nutrition, education, care and any other necessary goods and services; • Basic income security for persons of active age who are unable to earn sufficient income, in particular in cases of sickness, unemployment, maternity and disability; • Basic income security for older persons

Such guarantees should be provided to all residents and all children, as defined in national laws and regulations, and subject to existing international obligations.

Figure 5.19 illustrates that a large majority of countries have enacted legislation in most of these areas. This implies that the core challenge is one of expanding the implementation of domestic programmes, in particular extending their coverage and improving the adequacy of benefits. Figure 5.20 provides a somewhat contrasting picture of actual social protection coverage by specific population groups globally and within individual regions.

Fig. 5.19

Development of social protection programmes anchored in national legislation by policy area, pre-1900 to 2020

Fig. 5.20

SDG indicator 1.3.1: effective social protection coverage, global and regional estimates, by population group, 2020 or latest available year

There is a clear correlation between effective coverage and income, including for vulnerable groups.¹³⁷ But while higher levels of social protection coverage are usually associated with countries that have high levels of economic development, some poorer countries, such as Botswana, Cabo Verde, China and Timor-Leste, have demonstrated that sustained efforts to extend coverage can be effective at any level of development. The evidence suggests that all countries can pursue a high-road social protection strategy, starting from whatever their current situation may be and working progressively towards achieving universal social protection that is, accordingly to ILO guidance, comprehensive, adequate, resilient and sustainable.¹³⁸

Even among high-income countries, there is considerable variation in social protection system coverage and benefit levels, suggesting that many countries have considerable scope to accelerate progress on inclusion and resilience through greater activation of their social security programmes, irrespective of their level of economic development. For example, as illustrated in Fig. 5.21, public pension benefit levels vary among high-income countries from roughly 30% to 40% of income replacement in the cases of Japan, Australia, Canada and the United States, to 60% to 70% in the cases of France, the Netherlands, Spain and Austria.

Fig. 5.21

Gross pension replacement rates, men, percentage of pre-retirement earnings, 2020 or latest available

Similarly, public spending on family benefits is quite disparate. Among advanced economies, it ranges from a low of 0.6% of GDP in the United States, which is a clear outlier, to around 1.6% in Japan, Canada and the Netherlands and about 3% in France and the United Kingdom. The OECD average is 2.1%, three-and-a-half times higher than the US rate of public expenditure on children.¹³⁹ This is surely part of the explanation for the unusually high level of child poverty in the US (20%) mentioned above. Figure 5.22 illustrates the range of such support among 90 developing countries.

Fig. 5.22

Spending on child benefit packages in 90 low- and middle-income countries, by country (percentage of GDP)

Unemployment insurance is another dimension of social protection in which policy design and effort vary widely among countries at similar levels of economic development. Figure 5.23 summarizes this variability among OECD member countries by displaying the extent of public expenditure. This particular metric does not account for the prevailing level of unemployment and thus may somewhat exaggerate differences in the degree of policy support among countries. But Fig. 5.24 provides more specific comparison of coverage and benefit levels for select OECD and middle-income countries. While workforce coverage shows a reasonably strong correlation with national income (perhaps reflecting the higher share of informal workers in developing countries), income replacement rates vary considerably within and across both groups of countries, suggesting that many have considerable agency to further ease the transition of workers who lose their jobs.¹⁴⁰

Fig. 5.23

Public unemployment spending (Percentage of GDP, 2021 or latest available)

Fig. 5.24

Coverage of unemployment benefits and average replacement rates

Worker Protection

Workplace injury and exposure to hazards causing disease can have a devasting impact on the economic security of households. For this reason, OSH concerns were the subject of many of the first international labour standards established in the 1920s and 1930s. Only recently, however, during the COVID-19 pandemic, was OSH elevated to the status of a Fundamental Principle and Right at Work. As a result, governments are now obligated to respect, realize and promote two key OSH legal conventions regardless of whether they have formally adopted them in domestic legislation. Thus, the key policy and institutional variable on this important aspect of social protection is less the “what” than the “how”, namely how to mobilize the necessary rigour of regulatory implementation and enforcement as well as firm responsibility and worker education.

As for the crucial role of regulatory oversight in advancing compliance, labour inspectorates are woefully under-resourced in many jurisdictions. As the table in Fig. 5.25 illustrates, the level of economic development tends to matter; rich countries tend to have more inspectors per working population than middle-income countries, and low-income countries generally have the fewest. However, the rigour of labour regulation enforcement is not foreordained by level of economic development; it remains a policy choice, as illustrated by the accompanying scatter plot graphic. This graphic shows that the relationship between the strictness of de jure labour law and the rigour of its de facto enforcement is highly heterogeneous, including among countries at similar levels of economic development.¹⁴¹

Fig. 5.25

Labour inspection

Europe is a case in point. According to the European Trade Union Council, safety inspections declined by a fifth between 2010 and 2018, falling from 2.2 million annual visits to 1.7 million. There were 232,000 fewer visits in Germany and a 50% reduction in Portugal, for example. In all, the number of labour inspectors declined by 1000 across the European Union, and more than a third of European countries no longer meet the ILO’s standard of having one labour inspector per 10,000 workers.

Labour inspection is particularly challenging in the informal sector, which encompasses an estimated 60% of employment in the world, or two billion people. “Informal employment” is defined as all remunerative work (i.e., both self-employment and wage employment) that is not registered, regulated or protected by existing legal or regulatory frameworks, as well as non-remunerative work undertaken in an income-producing enterprise. Informal workers, 93% of whom live in emerging and developing countries, do not have secure employment contracts, workers’ benefits or workers’ representation. The majority lack social protection, rights at work and decent working conditions.

Labour inspection interventions usually take place in the context of the traditional model of labour relations, with its clearly defined components (employer, employee and work contract) and workplaces that are easily accessible. This approach in the informal economy can only have a minimal impact, since, by definition, it falls outside the typical more formal pattern of labour relations in advanced economies. The ILO has prepared a guide that seeks to narrow this gap by proposing an intervention methodology adapted to the informal economy. It frames a participatory approach to: making concrete and gradual improvements with respect to working conditions in specific sectors or activities, OSH, and the organization of work (and production units); supporting the promotion of Fundamental Principles and Rights at Work; encouraging the formalization of the informal economy; and broadening social security coverage.¹⁴²

Asset-Building

A disproportionate share of household wealth tends to be owned by households with the highest incomes. Indeed, wealth inequality tends to be even more pronounced than income inequality. But private household wealth is for many people a critical source of resilience against unforeseen shocks. Some countries seek to encourage and protect asset-building among lower- and middle-income households through incentives for homeownership and employee stock or business ownership and protection for the savings of retail investors through bank deposit insurance and asset management consumer protections.

Homeownership

The breadth of homeownership in a country is shaped by a complex mix of financial system, taxation, and zoning policies, among other things. Housing is the principal asset of the middle class; the share of housing in total assets of the middle three quintiles of the income or wealth distribution is larger than 60% in the majority of OECD countries.¹⁴³ And countries with higher rates of ownership tend to be less unequal, as illustrated in Fig. 5.26.

Fig. 5.26

High-homeownership countries tend to exhibit low wealth inequality

Countries employ mortgage lending, income and property tax, and residential zoning rules in complex ways to influence the nature and extent of homeownership. If the mix of such policies is not carefully considered, it can have the unintended result of reinforcing rather than mitigating inequality.¹⁴⁴ A study of 44 developed and developing countries found a mean homeownership rate of 73.9% in 2015.¹⁴⁵ Table 5.3 displays these rates for a subset of this group. In reflecting upon the factors contributing to these different outcomes, the authors of the study observed that

Table 5.3 Global Home ownership rates by country

government tax policy and regulations appear to play an important role in countries with below-average homeownership rates. For example, consider the evolution of homeownership in (the former) West Germany and the United Kingdom … Both countries pursued a similar policy of subsidizing post-war rental construction to rebuild their countries. However, in intervening years, German policies allowed landlords to raise rents to some extent and thus finance property maintenance while also providing “protections” for renters. In the United Kingdom, regulation strongly discouraged private rentals, whereas the quality of public (rental) housing declined with under-maintenance and obtained a negative stigma. As well, German banks remained quite conservative in mortgage lending. The result was that between 1950 and 1990, West German homeownership rates barely increased from 39 to 42 percent, whereas United Kingdom homeownership rates rose from 30 to 66 percent. Interestingly, anecdotes suggest that many German households rent their primary residence, but purchase a nearby home to rent for income (which requires a large down payment but receives generous depreciation benefits). This allows residents to hedge themselves against the potential of rent increases in a system that provides few tax subsidies to owning a home. Switzerland also has a low homeownership rate, and once again, tax regulations favor renting over owning … [Researchers have concluded] that income tax policy, especially the tax on imputed rents, as well as the high price of owning relative to renting are key determinants of why many more Swiss households are renters than in other countries. On the other side of the equation, the Netherlands, Switzerland, and the United States all have relatively generous mortgage interest deductions.¹⁴⁶

Housing taxation is one of the most important policy tools in promoting homeownership and, in some cases, creating an incentive for owner-occupied versus rental housing investment. For example:

• First, the vast majority of OECD countries tax rental income, but most do not tax imputed rents for homeowners (Denmark, Greece, the Netherlands and Switzerland are the exceptions, although this is generally at low rates). To some extent, property taxes replace taxes on imputed income in many countries, but revenue from property taxes tends to be low and they are commonly based on outdated property values. Property taxes are also to some extent de facto fees for local services as opposed to taxes on the imputed rental income from housing. In addition, if flat rates apply, property taxes may have less scope than income taxes to be progressive, and less scope to redistribute, particularly if levied at the local level.

• Second, tax relief for mortgage interest provides a significant advantage to debt-financing homeowners in many OECD countries, allowing homeowners to deduct mortgage interest payments from their personal income tax. The benefit provided by mortgage interest relief tends to outweigh the combined effect of all other taxes levied on a debt-financed housing investment.

• Third, owner-occupied dwellings are often exempted from taxes on capital gains, while this is typically not the case for capital gains on rental housing.

• As a result, countries effectively subsidise home ownership through their tax system—meaning that the tax credits and deductions available to homeowners are higher than the taxes that are levied on the dwelling over its lifetime. Because high-income and high-wealth households tend to own a larger share of housing assets relative to lower-income households (in terms of more expensive primary residences as well as investments in secondary residences), they accrue even greater benefits from housing taxation policies that provide disproportionate advantages to homeowners. In addition, policy such as tax relief for mortgage interest often provides larger benefits to taxpayers at higher income brackets who own larger homes and are taxed at higher marginal rates.¹⁴⁷

The bottom line is that countries need to contextualize their strategies for expanding homeownership within a broader set of objectives for housing policy—improving the quality and affordability of housing for all and not just those most likely to be interested in buying a home of their own.

Employee Stock and Business Ownership

Employee stock ownership is significant in many countries. Equity ownership of the firms in which they work provides employees with an additional opportunity to share the gains from their increased productivity. However, there can be downside risks as well, which regulation needs to guard against. In particular, the use of stock distributions to employees to fund pension plans creates the potential for diversification risks—that is, the prospect that workers could lose not only their income but also a big share of their wealth if their firm goes out of business.

As of 2017, Europe had about nine million employee shareholders compared with over 30 million in the United States. European employee shareholders held €388 billion in shares of their companies (almost entirely large listed firms) versus US$3.8 trillion held by their counterparts in US companies (a third of them small and medium-sized enterprises). Differences in fiscal incentives are part of the reason for this difference, as is the lack of a coherent EU-wide policy scheme.¹⁴⁸

Cooperatives are another important form of worker equity ownership. There is a strong tradition of worker cooperatives in a number of European and other countries. An estimated 800 million people around the world are members of cooperatives.¹⁴⁹ The economic activity of the largest 300 cooperatives (the “Global 300”) as of 2014 was equivalent to the ninth-largest national economy,¹⁵⁰ with France generating the largest share of revenue (28%), followed by the United States (16%), Germany (14%), Japan (8%), the Netherlands (7%), the United Kingdom (4%), Switzerland (3.5%), Italy (2.5%), Finland (2.5%), South Korea (2%) and Canada (1.75%).¹⁵¹ Fiscal and other government incentives matter for this form of worker ownership as well.¹⁵²

Environmental Security (EnS)

Serious degradation of the environmental setting of a household—the surrounding air, water, soil or natural habitat—can severely impair its standard of living. This impairment can take the form of illness and disease, diminished income and employment or lost access to some of life’s basic necessities. It can occur suddenly and severely or gradually and insidiously. In short, this “factor of distribution” has the potential to disrupt—or strengthen—any and all of the other four.

Neoclassical economics, with its central focus on allocative efficiency and production, is not designed to respond to major environmental challenges, certainly not of the severity and pervasiveness of those humanity faces in the twenty-first century. As argued in Chap. 4, its mental model of growth and development, as symbolized in the aggregate production function, provides no explicit entry point for the internalization of positive or negative environmental externalities. This is an increasingly problematic flaw in a world facing economically destabilizing environmental threats.

For example, national economic policies have yet to fully assimilate the implications of the Paris climate agreement. According to Climate Action Tracker, as of March 2022, 33 countries and the European Union had set a net-zero target, and more than 100 countries had proposed—or were considering—such a target. Some 7500 companies, 1100 cities, and institutional investors managing over US$130 trillion in assets had also committed to set net-zero targets. However, none of the 38 countries Climate Action Tracker has evaluated has future targets and current policies that are consistent with the Paris climate agreement goal of limiting global warming to 1.5 °C—or, at most, well below 2 °C—above pre-industrial levels. Only nine have targets and policies that would be consistent with that outcome if they made moderate improvements; the targets and policies of the rest either require substantial modification or are outright counterproductive.¹⁵³ Moreover, much of the action promised by those countries and companies setting net-zero targets is backloaded despite the fact that the feasibility of these targets depends crucially on emissions falling rapidly, by about 45%, over the next decade. Scientists advise that current national climate commitments, even when fully implemented, would lead to an estimated 2.4 °C to 2.8 °C—i.e., catastrophic—level of global warming.¹⁵⁴

As discussed in Chap. 2, the environmental performance of a country is only partially related to its level of economic development. Yes, richer countries have a greater capacity to expend resources and pay higher prices if required in order to grow sustainably. But many aspects of environmental sustainability do not incur incremental costs. Quite a few save money and support growth, including those related to improving resource efficiency. Indeed, failure to arrest severe environmental degradation can severely retard development and risk catastrophic losses—the loss of shelter, community or even life itself. Examples include water shortages from unsustainable use of groundwater, collapse of fisheries because of overfishing, endemic asthma and pulmonary disease from chronic air pollution, devastating floods because riverbeds have been altered by uncontrolled soil erosion, and highly destructive forest fires and coastal storm surges intensified by global warming.

Over the past decade, there has been an explosion of policy analysis, guidance and measurement regarding these challenges. There is no shortage of frameworks, best practices, and metrics available to policymakers under the rubrics of green economy, blue economy, green growth, sustainable development, etc. These tools all fundamentally seek to capture the synergies and minimize the adverse trade-offs of the parallel pursuit of strong, socially inclusive and environmentally sustainable development. They all involve the administration of both carrot and stick—policies and institutional characteristics that appropriately incentivize investments and purchasing and production decisions in the public and private sectors.

As for policy frameworks, the UNEP was a pioneer with its Green Economy report, which made “a compelling economic and social case for investing two per cent of global GDP in greening ten central sectors of the economy in order to shift development and unleash public and private capital flows onto a low-carbon, resource-efficient path”.¹⁵⁵ The OECD has also produced comprehensive policy guidance in its Green Growth Strategy¹⁵⁶ and related set of country performance indicators.¹⁵⁷ These two institutions, along with the Asian Development Bank, UNDP and World Bank, subsequently collaborated on a green growth policy “toolkit” for G20 countries.¹⁵⁸ All of these frameworks remain relevant resources for national policymakers, as does the Green Growth Knowledge Platform, a research partnership created by the Global Green Growth Institute, OECD, UNEP and World Bank.¹⁵⁹

With respect to performance metrics, in addition to the OECD Green Growth Indicators the Sustainable Development Solutions Network (SDSN) has compiled an extensive set of indicators that track country progress in achieving the SDGs. Many of the goals relate to environmental sustainability: SDG 6 on clean water and sanitation; SDG 7 on affordable and clean energy; SDG 11 on sustainable cities and communities; SDG 12 on responsible consumption and production; SDG 13 on climate action; SDG 14 on life underwater; and SDG 15 on life on land. The SDSN’s SDG Index and country-specific dashboards present myriad parameters by which to assess and plan improvements in a country’s environmental security.¹⁶⁰ Its analysis finds that most countries are well off track in making progress towards the 2030 SDG targets at all levels of economic development. Indeed, a third set of metrics, the Global Green Growth Institute’s Green Growth Index shows considerable variation in scores among countries in the same region, as illustrated in Fig. 5.27.¹⁶¹

Fig. 5.27

Distribution pattern of country scores for the Green Growth Index by region, 2020

Sectoral policy frameworks and performance metrics have been developed more recently. Particularly notable in this respect are SDSN’s transformation pathways,¹⁶² the Mission Possible Partnership focused on hard-to-abate industries,¹⁶³ and the World Business Council for Sustainable Development’s Pathways projects and reports.¹⁶⁴ In addition, a coalition of think tanks has produced an evaluation of progress in 40 sectors and enabling factors relative to the IPCC’s 2030 interim targets for a 1.5 °C scenario. If found that

change is heading in the right direction at a promising but insufficient speed for 6 indicators, and in the right direction but well below the required pace for 21. Change in another 5 indicators is heading in the wrong direction entirely, and data are insufficient to evaluate the remaining 8. Getting on track to achieve 2030 targets will require an enormous acceleration in effort. Unabated coal in electricity generation, for example, must be phased out six times faster than recent global rates. Improvements in cement production’s carbon intensity must increase much more quickly—by a factor of more than 10. And reductions in the annual deforestation rate must accelerate 2.5 times faster.¹⁶⁵

Such sector-specific strategies are increasingly complemented by targets and disclosure frameworks. In particular, the Science-Based Targets Initiative is the leading framework for the setting of corporate net-zero greenhouse gas emission targets, and the ISSB is building a global baseline framework for the disclosure by companies of material sustainability-related aspects of their strategy and performance. It is backed by the International Financial Reporting Standards Foundation, which oversees the world’s financial accounting standards, as well as the world’s securities markets regulators (International Organization of Securities Commissions [IOSCO]) and is being built upon the foundation of voluntary frameworks pioneered years ago by the Climate Disclosure Standards Board,¹⁶⁶ Sustainability Accounting Standards Board and Value Reporting Foundation,¹⁶⁷ Task Force on Climate-Related Financial Disclosures¹⁶⁸ and Global Reporting Initiative.¹⁶⁹ An analogous voluntary framework with respect to nature-based (biodiversity) reporting, the Task Force on Nature-Related Financial Disclosures, is at an earlier stage of development.¹⁷⁰ And the UN High-Level Expert Group on the Net-Zero Commitments of Non-State Entities has issued important guidelines for ensuring the environmental additionality and credibility of—that is, avoiding greenwashing in—corporate net-zero targets and disclosures.¹⁷¹

These targeting, measurement and reporting protocols with respect to the private sector’s impact on environmental security are important to the growing efforts within the financial system to internalize sustainability considerations in capital allocation decisions. National policy has a critical role to play in scaling the application of them through regulation. As mentioned previously, a large and growing number of financial regulators are beginning to implement policy changes in this regard, particularly the more than 100 members of the NGFS. Indeed, some of the Network’s pioneering members are financial regulatory agencies of developing countries that are deploying a combination of restrictions, incentives and outright directives—that is, carrots and sticks. Complementing these regulatory initiatives is a market-led effort on the part of institutional investors to set and disclose investment portfolio decarbonization targets, the Glasgow Financial Alliance for Net-Zero.¹⁷²

Some countries are also applying a range of policy carrots and sticks to commerce and procurement. For example, six countries are negotiating to eliminate tariffs on a list of “environmental and environmentally friendly” goods and services, an arrangement they hope will attract the participation of more countries over time.¹⁷³ In addition, many governments are instituting procurement preferences for environmentally friendly products and services domestically, including the European Union, which has an extensive framework in this regard that can serve as a positive example for other jurisdictions.¹⁷⁴ The Japanese government maintains a pioneering regulatory scheme to incentivize continuous improvement in the production and procurement of resource-efficient goods and services. Under its Top Runner programme,¹⁷⁵ manufacturers are effectively obliged to surpass a weighted average value for all their products per category for each predetermined target year.

Another increasingly important aspect of strengthening an economy’s aggregate distribution function with respect to both environmental and social sustainability relates to a “just transition”—that is, approaches by which stronger policy measures to internalize environmental externalities can be designed and implemented without jeopardizing economic and social progress. In 2015, the ILO issued an extensive set of high-level policy guidelines in this respect, and more recently the United Nations Framework Convention on Climate Change (UNFCCC) has issued related policy guidance for countries (summarized in Fig. 5.28).¹⁷⁶

Fig. 5.28

Elements of a just transition

Biodiversity and natural ecosystems are another aspect of environmental security requiring priority attention. As summarized in Chap. 2, the world is experiencing an accelerating rate of species extinction. The recent Kunming-Montreal Global Biodiversity Framework sets out an ambitious international action plan to bring about a transformation in society’s relationship with biodiversity, with the objective of ensuring that by 2050 a shared vision of “living in harmony with nature” is fulfilled. The Framework comprises 21 targets and 10 “milestones” for 2030, including:

• Restore 30% of degraded ecosystems globally (on land and sea) by 2030.

• Conserve and manage 30% of areas (terrestrial, inland water, and coastal and marine) by 2030.

• Stop the extinction of known species, and by 2050 reduce tenfold the extinction risk and rate of all species (including unknown ones).

• Reduce risk from pesticides by at least 50% by 2030.

• Reduce nutrients lost to the environment by at least 50% by 2030.

• Reduce global footprint of consumption by 2030, including through significantly reducing overconsumption and waste generation and halving food waste.

• Reduce the rate of introduction and establishment of invasive alien species by at least 50% by 2030.

• Mobilize finance for biodiversity from all sources, domestic and international—both public and private—of at least US$200 billion per year by 2030.

• Identify by 2025 and eliminate by 2030 a total of at least US$500 billion per year in subsidies harmful to biodiversity.¹⁷⁷

Countries are increasingly promoting greater application and improved valuation of ecosystem services through policy.¹⁷⁸ The UN Millennium Ecosystem Assessment defined four categories of such services:

• 1. Provisioning Services. A provisioning service is any type of benefit to people that can be extracted from nature. Along with food, other types of provisioning services include drinking water, timber, wood fuel, natural gas, oils, plants that can be made into clothes and other materials, and medicinal benefits.

• 2. Regulating Services. A regulating service is the benefit provided by ecosystem processes that moderate natural phenomena. Regulating services include pollination, decomposition, water purification, erosion and flood control, and carbon storage and climate regulation.

• 3. Cultural Services. A cultural service is a non-material benefit that contributes to the development and cultural advancement of people, including how ecosystems play a role in local, national, and global cultures; the building of knowledge and the spreading of ideas; creativity born from interactions with nature (music, art, architecture); and recreation.

• 4. Supporting Services. Ecosystems themselves couldn’t be sustained without the consistency of underlying natural processes, such as photosynthesis, nutrient cycling, the creation of soils, and the water cycle. These processes allow the Earth to sustain basic life forms, let alone whole ecosystems and people. Without supporting services, provisional, regulating, and cultural services wouldn’t exist.¹⁷⁹

Work is ongoing to develop approaches to measuring the benefits of such services in specific community or project settings in order to strengthen the design and implementation of policy incentives, which remain at a formative stage.¹⁸⁰ There is also rising interest in the practice of so-called “regenerative agriculture”:

an alternative means of producing food that, its advocates claim, may have lower—or even net positive—environmental and/or social impacts … [through] processes (e.g., use of cover crops, the integration of livestock, and reducing or eliminating tillage), outcomes (e.g., to improve soil health, to sequester carbon, and to increase biodiversity), or combinations of the two.¹⁸¹

As part of its Green New Deal, the European Union’s Farm to Fork and Biodiversity Strategies aim to make European food production the global standard with respect to sustainability. These strategies include a range of ambitious targets intended to put the EU food system on a transformative path towards greater sustainability. Those with the greatest relevance to agricultural production include the following:

• agriculture to contribute to a reduction of at least 55% in net GHG emissions by 2030;

• reduction by 50% of the use and risk of chemical pesticides, and reduction in use of more hazardous pesticides by 50% by 2030;

• reduction of nutrient losses by at least 50% while ensuring that there is no deterioration in soil fertility. This will reduce the use of fertilisers by at least 20% by 2030;

• reduction by 50% of sales of antimicrobials for farmed animals and in aquaculture by 2030;

• reaching 25% of agricultural land under organic farming by 2030;

• a minimum of 10% area under high-diversity landscape features.¹⁸²

A recent landmark study of regenerative agriculture practices by European science academies concluded,

Our results demonstrate that many of the analysed practices show synergies between carbon capture and storage and enhancing biodiversity (although sometimes with modest effect sizes), while not having clear large negative effects on food production, especially in the long term. Practices that show synergies include the following: increased diversification within and among crops, introduction of permanent and perennial crops, expanded agroforestry and intercropping, keeping green plant cover on all farm fields during all seasons, and reduced tillage. We also found some examples of clear trade-offs (e.g. conversion of arable land to grasslands increase carbon storage and biodiversity but food production decrease [sic]). Practices that show clear synergistic effects should be given considerable attention in plans by member states for implementation of the new Common Agricultural Policy (CAP). Recent studies also suggest that the capacity of grasslands to capture and store carbon may have been underestimated, and that permanent grasslands be considered more strongly when developing policies on carbon farming in Europe.¹⁸³

The study ends by framing an extensive policy agenda. Other countries may wish to observe and learn from Europe’s evolving experience in this important new field, which aims to strike a better balance between agricultural livelihoods and environmental sustainability and security.

Conclusion

This chapter has sought to elaborate on some of the domestic policies and institutional features that are most relevant to the task of strengthening an economy’s aggregate distribution function in order to grow and develop in a more inclusive, sustainable and resilient manner. As the data presented here have demonstrated, countries at all levels of economic development have ample policy space to make major improvements in one or more dimensions of median household living standards. They can do so by following the golden rule of human-centred economics, which is to devote at least as much policy attention and effort to strengthening their economy’s distribution function as to its production function, specifically by investing in policies and institutional capacity relating to household employment and entrepreneurial opportunity, disposable income, availability and affordability of material necessities, and economic and environmental security on a systematic and sustained basis. This is a structural way of improving the social quality as well as quantity of growth—that is, median household living standards as well as productive output or GDP.

Inequality, environmental degradation, and precarity and fragility are not inherent or immutable features of market economies. A better balance can be struck between economic growth and social welfare if policymakers deliberately conceive, pursue and measure national economic performance through both of these lenses simultaneously. They must abandon the reflex of standard liberal economics to assume, whether explicitly or implicitly, that broad progress in these core dimensions of living standards trickles down inevitably from higher national income. A certain intentionality is required to optimize both—a sustained process of institutional deepening and investment to foster movement closer to the frontier of good policy and institutional practice in the aggregate distribution function’s five domains.

This ongoing process of institutional improvement should be assigned the same level of priority as policies traditionally relied upon to promote the quantity of growth (GDP): macroeconomic, trade and financial stability policies. Such a recalibration and rebalancing of economic policy is the way that countries can realize more of the living standards potential of their economies, narrowing their “welfare gap” irrespective of their level of national income.

In sum, this analysis has shown that all countries have considerable agency or policy space to strengthen inclusion, sustainability and resilience—to run their economies in a more human-centred fashion, rejecting the traditional trickle-down, capital-centric logic of standard liberal economics. But this will require them to rebalance their priorities, processes and personnel to reflect a more intentional approach to strengthening household living standards through ongoing structural–institutional reform as part and parcel of their growth and development strategy.

That said, no country is an island in today’s globally integrated economy in which finance, trade and technology cross borders in rapid and complex ways. Many economies face difficult constraints on public finances and domestic policy space more broadly, particularly lower-middle-income and low-income ones. For this reason, the two-lens, production function plus distribution function approach of human-centred economics has important implications for the priorities and conduct of international economic governance and cooperation as well, and that is the topic of the next chapter.