The evidence does not support policy prescriptions
Mainstream economics has since long– both in academic tradition and as a source of policy formulation– tried to identify inequality as a natural consequence of productivity difference across the income group spectrum, and has assumed that markets left with minimal regulations and incomes kept away from redistribution policies, will in time, at the back of competitive market forces, ensure efficiency in the economy. Beyond that, any income inequality would be a residual for which no policy intervention is required.
Evidence-based research has shown otherwise, that, rather than there existing a trade-off between gaining efficiency or equity, sustained economic growth has not been achieved at the back of rising income inequality. Overall, countries where equity has enhanced saw increases in efficiency and more sustained economic growth.
At the same time, these results have required from government policy, and that contributed by multilateral agencies like International Monetary Fund (IMF or Fund) and World Bank (or simply the Bank), to put in perspective two general sets of economic policies– structural and macroeconomic policies– for enhancing per capita incomes, and not to overdo this, as has been the case to the detriment of achieving either efficiency or equity; which, as research has consistently shown, are necessary for sustained economic growth and are complementary (and not substitutes, as was a previously held belief in mainstream economics). Here, by structural policies is meant, broadly speaking, to be approaching greater openness to foreign capital inflows and trade, and reducing market regulations, both financial and real; while macroeconomic policies endeavour to rein in the fiscal deficit and inflation.
This is all the more important as the new government in the country tries to deal with issues related with both macroeconomic imbalance and economic growth, especially as it is in the process of negotiating, reportedly the largest bailout package with the Fund to the tune of $12 billion.
The Fund at the same time should adopt this research-based result of tackling inequality for ensuring sustained economic growth, into the programme that it negotiated with the country; after all a strong base of this research has been housed in the Research Department of the IMF itself, especially the results reached with regard to empirical studies made after the global financial crisis of 2008, and political events like the Tunisian crisis. This has been documented in a recent book, Confronting Inequality: How Societies Can Choose Inclusive Growth by three senior members of the Fund staff itself, based on their research of around a decade, studying a broad range of country case studies.
In contrast to this evidence-based research that has consistently been making rounds in books, research papers, academia and conference halls, and of late even in the research departments of think tanks like Oxfam and multilateral agencies like the IMF, for the last decade or so, the same has not much penetrated the realm of public policy and Fund programme conditionalities. For example, while any serious study of the past three decades shows a withering of relationship between labour productivity and income- where in general, in both advanced and developing countries, average real wages have continued to fall– and therefore greater need for capital controls, stronger labour unions, more requirement for government regulation for markets and the private sector, the same policy recommendations have not been put with matching force and focus in public policy, or those recommended by multilateral institutions; take say, the recently launched policy document of World Bank, ‘Pakistan@100’ or the programme negotiations with the Fund.
Last year, the policy rate hike in Pakistan was the highest in Asia, primarily to curb inflation; yet it stands currently at 8.2 percent. Why should the policy makers not learn from evidence-based research, which indicates that inflation should not be reined in too much by curbing aggregate demand, but by a combination of policies, including redistributive ones, so that rate hikes do not cause increase in income inequality, and hurt employment levels and economic growth.
So while the federal Planning Minister recently reportedly pointed towards the need for adopting a knowledge-based economic approach, where the creative and management levels of economic agents are improved through investing in improvements in cognitive capacities, in turn by improving the institutional and spending levels of the education and health sectors; these in turn cannot be achieved by curtailing these investments through adopting the long-held mantra of fiscal consolidation or by inordinate reliance on structural adjustment in the shape of lesser government controls and welfare spending.
The federal Finance Minister, as he reportedly highlighted that inflation and fiscal deficit were two main economic challenges, and as he negotiates a probable programme with the Fund, must ensure that there should not be undue reliance on structural and macroeconomic policies to deal with such issues; rather also through adopting anti-neoliberal policies, since there is strong evidence that countries that have followed those, have been able to bring in both efficiency and equity gains.
Sticking to organizational beliefs based on economic orthodoxy, rather than heterodoxy, has meant withering of voter confidence in public policy
Here too, the book indicated above and research otherwise as well point towards, among other things, addressing the issue of inequality- to bring in durability to the growth achieved- by adopting pre-distribution policies, and which are basically to ensure enhancing the institutional capacity and ensuring greater investments in education and health sector, so that the link between productivity and income could be properly restored across the spectrum. Moreover, welfare spending needs to be protected and rationalized. Both of these outcomes require that the government stays away from too much fiscal consolidation, and tries to sustain aggregate demand and focuses on supply side issues to allow aggregate demand to be met with higher production, and in turn lesser inflationary pressures are produced as a result.
In addition, any programme negotiated with the Fund, or policy in general, should not allow too much mobility of capital, since in the wake of lack of labour mobility and the presence of the speculative driver of portfolio investment, have shown the exploitation of labour rights, especially with capital moving to places where labour is cheaper, in terms of real wages not matching productivity gains. To unlock public and private investments, like the ones required under pre-distribution policies in education and health, and in economic sectors generally, would mean greater regulation of the capital markets so that loanable funds meet greatest possible investment needs.
Path-dependent nature of public policy and of the recommendations of multilateral institutions away from evidence-based research, has meant non-sustained economic growth consequences, with a loss of a lot of equity at the same time. This kind of stickiness to organizational beliefs based on economic orthodoxy, rather than heterodoxy, has meant withering of voter confidence in public policy, and in policy recommendations. This policy approach needs to change and that too quickly, since any representative empirical analysis shows policy choices that are more consistent with ground realities, and because lack of government intervention has resulted in increased income inequality and the fall of real wages, over the last three decades.