Micky Mouse economics: how trade theory fails but policy still sells its fairytale benefits by Irene van Staveren

Worldwide, economic inequality is on the rise—both in incomes and in wealth. See, for example, the first World Inequality Report, published in December 2017. The problem occurs within developing as well as developed countries. And it occurs at a global scale: the world’s richest households get richer at a much faster rate than the global poor, while globally, middle class incomes are stagnating. The only decline in inequality we see is between developing countries as a group and developed countries as a group. But those are just country-level statistics not reflected in the everyday reality of people.

A related problem is the decreasing share of wages in national income. Again, this trend occurs in both developing and developed nations. In other words, the labour share in national income declines and the capital share in national income increases, with China being among the countries showing the strongest trend of this rising factor income inequality.

A logical question, then, is whether this trend is indeed problematic, or perhaps is inevitable for economic growth. If the rich would be more productive than the poor, thereby contributing more to economic development, as neoliberal policy-makers believe and would have us believe, rising inequality is perhaps the price to pay if we want economies to grow out of poverty. According to the dominant economic theory, the answer to the question is yes: let the rich be free to make money because by doing so, they stimulate the economy, create jobs, and let employees benefit too.

This is exactly what Donald Trump promises with his tax cut policy for the rich and large firms. The hardworking American would see his annual wages rise by a few thousand dollars if his boss’ tax bill is cut. So, when Scrooge McDuck gets richer, all inhabitants of Duckburg benefit, according to neoclassical economic theory.

The trickle-down effect: A fantasy

But institutional economists know, since Thorstein Veblen published his Theory of the Leisure Class in 1899, that such a trickle-down effect is a fantasy. The rich protect their vested interests and manage to change the institutional environment in such a way that they benefit as much as possible. Today’s statistics prove him right. The globalised economy of today, in which low-skilled jobs move around following the location choices of capital, and medium-skilled jobs get replaced by machines, the production factor labour is on the losing end everywhere.

To my surprise, this view suddenly receives support from researchers at the IMF in a working paper and in other IMF publications. They state that investment in the world’s stock of capital has become cheaper over time due to technological development. And, of course, the low interest rate in the developed world has helped too. As a consequence, more and more labour is being replaced by relatively cheap machines and software. Hence, however hard an employee or subcontractor works to add even more to the increasing labour productivity, it does not pay out in a higher wage or fee. Moreover, newly created jobs tend to be increasingly flexible jobs—a euphemism for insecure as well as low paid jobs.

This lack of power of labour over total income generated in the economy affects workers worldwide. In China, for example, wage growth is under pressure because the export products are not sold in a competitive world market to the highest bidder. Rather, the entire production process is contracted by oligopolistic multinationals controlling global value chains.

This means that just a few big companies control a whole sector, ranging from food to electronics and from personal care products to sports brands. They pay very low prices for the goods produced in local Chinese-run factories thanks to the threat to end the contract with the factory and move to another factory that keeps wage demands better in control. So, when a few big multinationals outsource their production through global value chains, local contractors, factories, sweatshops and workers are on the losing end.

So, the IMF has in fact admitted that technological development and globalisation disadvantages workers in both the developed and the developing world. This is nothing new for labour economists and development economists, but it is interesting to see this assessment coming from a mainstream and influential development institution.

Interestingly, this view goes against the dominant trade theory which has found strong support in the IMF. This theory predicts that trade is beneficial for low-skilled workers in developing countries—not only in terms of numbers of jobs but also through rising wages. The same theory also predicts that although low-skilled workers would lose jobs in developed economies, the middle class, relying on medium-skilled labour, would benefit.

Well, the disappointment expressed in populist votes by these middle class workers in the US, Europe and other western countries shows that also that prediction has not come true. The only benefit of trade for them is lower consumer prices of imported products—but what is the benefit of cheaper consumer goods if you don’t have sufficient income to buy them?

Of course wages in China have risen enormously over the past two decades. But China’s capital income has risen faster, alongside the capital earnings of shareholders of multinationals who are largely located in the developed world.

So, what was the policy advice that the IMF report came up with? What was the conclusion of the IMF in the face of evidence provided by their in-house researchers promoting this dominant theory that trade and elite development would simultaneously benefit workers and the poor? Amazingly (or not), the IMF’s report’s main conclusion was that workers worldwide should keep on investing in their education. As if one had advised the passengers of the Titanic to move up a deck to stay safe.

What surprises me most is that it has apparently not occurred to the IMF economists that there is a gap between their recommendation and the findings from their own study. I almost feel sorry for those poor IMF researchers. How attached the IMF economists are to out-dated theories. When will they open their eyes for the benefits of shifting taxation from labour income to capital earnings? Or to the disadvantages of free trade of goods and free capital flows when at the same time labour migration is severely restricted?

Perhaps they should watch the short YouTube video by a Disney heiress, Abigail Disney, who informs us about the immoral and ineffective tax cuts for the rich in the US. She states how appalled she is that her already relatively low tax bill is cut even further. She is convinced that this will not help middle class Americans in any way, let alone those with low incomes without access to affordable healthcare. In conclusion, if such rich individuals in the entertainment industry can relinquish their Scrooge McDuck personas to see through the rhetoric, IMF economists should do so too.

Picture credit: Fibonacci Blue. Photo has been edited by cropping and applying a filter.