Market capitalism should benefit the many, not just the few. Can 2017 be the year we finally make it happen?

Reforming market capitalism in the wake of the Lehman Brothers crisis is still unfinished business. The financial crisis of 2008 morphed into an economic recession, a social crisis, a debt crisis and 2016 was the year where it clearly became a political crisis. Markets are not delivering inclusive growth in the industrialized economies.

A significant share of households in industrialized countries have experienced flat or falling real incomes for a decade or longer with serious intergenerational effects. Jobs and gender gaps are not shrinking; neither is the level of youth unemployment nor the share of young people not in education, employment or training (NEETs). These factors have combined to raise the prospect of “secular stagnation”. They have also contributed to a popular backlash against governments, institutions and the very functioning of economic systems.

The Brexit vote, the US election results and the tenor of ongoing election campaigns in Europe reveal a major crisis of trust. These trends are reflected differently across regions, age-groups, gender, and are not universally evident in all countries. They are triggered by different issues: slow growth and stagnant median wages, rising inequality, persistent unemployment, the implications of increased migration, insecurity posed by globalization and technological change. The common feature is that significant segments of populations feel that, whereas others have gained despite an economic slowdown, they have lost out and feel more insecure about their future. The claim that “elites are out of touch” has struck a chord.

The question should not be so much “can” but “how” to reform.

The lack of economic dynamism weighs heavily on employment performance. Unemployment rates in several, mainly European, OECD member states are unacceptably high. Meanwhile, there is a vast labour force potential to be tapped in those economies and regions where official unemployment rates have come down but training and active labour market policies are not sufficiently working.

The OECD and the IMF have now recommended that in order to escape from the low growth trap, a coordinated fiscal expansion that boosts public investment is necessary. This reflects a growing consensus that monetary policy is overburdened and cannot provide by itself the demand stimulus needed. Given the exceptionally low interest rates, the latest Outlook recognised that fiscal policy makers have room for manoeuvre to lift growth.

These warnings need to be heeded – governments’ must shift from austerity that has dominated policy thinking since 2010. Fiscal room does exist to:

In the industrialised economies over three decades the share of labour in national income has declined by on average 10 percentage points of GDP. Income inequality increased within the wage share in 22 out of 25 OECD countries with comparable statistics. Since 2008, market income inequality increased in three years as much as in the previous 10. Latest OECD work on top incomes and taxation shows that in all countries the “very top of the income distribution” have benefitted most.

The trend has been most extreme in the United States where the bottom 60% of the population did not see any increase in their living standards over the past 25 years, whereas the top 1% increased its share in the total income from 13% in 1990 to 18% in 2014. In the short term, inequality is stifling the recovery. In the medium term, it is fuelling public mistrust as to whether benefits of growth are shared and creates the conditions for rising populism across economies. In the longer term, inequality will result in rising skills gaps, which will not help an inclusive transition to a digitalized, globalized economy.

The claim that “to distribute more, we first need to increase economic efficiency” and just push ahead with trade and investment liberalisation and labour market “flexibility” is unconvincing. In the US, productivity rose by 60% over the past two decades but real median wages only increased by 6%. If (real) wage growth continues to lag behind productivity, as has been the case in the majority of OECD countries, this will push down the share of labour in GDP. The US has one of the most “flexible” labour markets in the OECD. The result is worker insecurity.

Stronger wage dynamics, through robust collective bargaining and well set minimum wages, have to be a central element of an “inclusive growth” policy agenda. They would yield a multiple dividend. First, stronger wage growth will inject additional demand in the economy, contributing to strengthening the recovery. Second, stronger wage dynamics will help central banks in re-establishing their credibility and commitment to price stability. If wage dynamics continue to stagnate at extremely low values of 1 to 1.5%, core inflation and inflation expectations will continue to be undershot.

Narrowing the problems of rising income inequality and falling wage shares to megatrends such as automation obscures the fact that certain policy choices and austerity in particular played a decisive role, including by weakening the bargaining power of workers and trade unions. IMF research finds that almost half of the increase of the share of the top 10% incomes is caused by a decline in union density, with technological change or globalization playing a more limited role. As union membership declines, inequality rises. When union membership is higher, the top 10% incomes are under control (IMF).

Furthermore, social dialogue and collective bargaining can accompany technological change in a coordinated manner and offset negative effects on the distribution of income and potential job losses.

Governments have to develop strategies to raise middle and lower incomes to boost demand and purchasing power. This should be done by strengthening labour market institutions, notably collective bargaining and minimum wages in order to reduce income inequality, and halt the increase in precarious, informal or irregular work that is crowding out regular labour.

A reform agenda must:

Faced with economic stagnation and slowed growth in world trade, some have called for faster trade and investment liberalization. This is missing the point - causality does not run from weaker global trade (or rising trade barriers) to weaker growth but the other way around. The central problem in the current context is not increased protectionism or inadequate trade and investment liberalization but weak aggregate demand in the global economy.

Ignoring the link between weak demand and weaker trade runs the risk of falling again into the trap of a “competitiveness” narrative. Economies trying to “export themselves out of the crisis” by depressing the labour share end up deepening the lack of demand for the world as a whole.

What is needed is a trade and investment agenda enforcing respect for labour standards and under which foreign investors respect domestic legal systems and international standards. The corporate accountability agenda covering responsible business conduct, decent work in global supply chains and effective corporate governance must ensure that business models encourage long term and patient investment and a fair distribution of corporate wealth between stakeholders.

Policy must go beyond the notion of “compensating the losers”. It should ensure that economies and markets are structured so as to produce more fair outcomes in the first place. Workers need to benefit from job protection and, in the event of unemployment, from a robust social security net and active labour market policies. Investment in skills and training systems to equip workers with the tools they need to profit from change, worker participation and social dialogue need to be enhanced to achieve balanced internal flexibility.

The trade and investment agenda must focus on:

Above all 2017 must show that policies and politics can reform market capitalism to make economies work for the advancement of both social justice and economic efficiency.