Inequality, Institutions and Globalisation 2.0

We are only at the beginning of this year, yet the signs of how 2016 will be remembered are already surfacing: inequality, political unrest and market volatility.The fallout of the financial crisis has developed into a unique concoction of political and economic uncertainties within western economies. The US lacks an amicable Presidential candidate; Britons are in favour of a ‘Brexit’; Germany has succumbed to deflation; and Europe’s free movement of labour is in jeopardy due to “the gravest humanitarian crisis…since World War II”.

Inequalities and growth

As global pressures have mounted, society is splitting at the seams, catalysed by the distribution of income going the wrong way. Inequality is a large deterrent of growth, especially within developed economies that are already producing close to capacity. As Nobel Laureate Joseph Stiglitz puts it when considering the US, “The lack of aggregate demand that has resulted from this inequality is a key factor hindering return to growth.”

Thomas Piketty outlined the fundamental issues with capitalism in his 2014 bestselling book ‘Capital in the 21st Century’, showing how inequality can be expected from such a system that harbours a faster rate of return on capital than the rate of economic growth. Tony Atkinson’s 2015 book, ‘Inequality: What Can Be Done?’ follows in the same vein as Piketty, documenting a number of policies that could be implemented to correct such natural divergence. One of Atkinson’s suggestions, the ‘National Living Wage’, is about to be implemented in the UK, although the government has overlooked the second part to his two-pronged approach: a varying executive salary cap. What both of these economists are advocating is the need for government intervention, to create convergence within a capitalist society in order to achieve sustainable economic growth.

The role of governments

The current level of inequality has been voiced by a number of prominent artists in the entertainment industry, particularly in the US regarding civil rights and the ‘Black Lives Matter’ movement. As compelling as it is to see celebrities in the public eye using their influence for such a cause, what is alarming is the media’s coverage of such events. Rather than continuing the discussion, they prioritise the celebrity’s morality instead of focusing on the call for institutional reform, a viewpoint that quickly transfers to the consumer. If anything, this highlights another concern within society and displays how institutions have played a part in developing such a culture, but any further comment would be reliant on conspiracy.

Institutions are the cornerstones of any society; even the most indigenous ones have informal constraints such as tradition and social norms. In the modern world, formal institutions that establish and enforce law, property rights, taxation and market regulation govern much of society, in turn influencing the informal constraints that determine the decisions made by individuals. This cycle is, in one way or another, how consumer behaviour can be predicted.

Daron Acemoglu and James Robinson are the pioneering institutional economists, having spent over 15 years deconstructing the role of institutions, culminating in the book ‘Why Nations Fail’ in which they built a conclusive picture that institutions are the main factor in determining the prosperity of an economy. A prime example is the differences between North and South Korea, two almost identical economies when divided in the 1940s, but after differing decisions on how they wanted to evolve their institutions, South Korea now has living standards 10 times higher than its counterpart. In short: where political rights are more broadly distributed and the state incentivises citizens to invest and innovate, by providing them with the education and infrastructure to do so, the economy will have more capacity to grow.  When looking at countries around the world this thesis holds true. So, why then, are western economies seeing low growth rates and an increase in inequality, when their institutions are supposedly more geared up for the job?

It is not said explicitly, but the conditions we are witnessing may imply an equilibrium point between institutional quality and the output of an economy. Since the 1980s, financial institutions have made it possible for capitalists to outpace the rate of economic growth, leading to a shift in this equilibrium. As a result, this step back in inequality can be seen as a market correction; we are currently at a level of equality that has overstepped the degree to which the elite members of society are willing to share with us, and they are powerful enough to resist change that will bring in institutional reform to ignite sustained economic growth.

Globalisation 2.0

Although the short run prospects for internal social change within western economies appear bleak (populists sieging governments; segmentation spurred by political elite) there are a number of externalities that can bring prosperity to these states. Globalisation 2.0 is a concept focusing around the interdependence of several identities and cultures characterised by non-Western modern doctrines. This is a multilateral approach in stark contrast to the previous phase of globalisation, one that was defined by cultural imperialism in the image of the west creating a market following democratic values.

In Globalisation 2.0, Asia (China in particular) will play a prominent role. Currently in the midst of their largest ever shift in the distribution of wealth, the institutional reforms various states have achieved will empower their societies and boost aggregate demand on a global scale. To meet this demand, a greater understanding of cultural and political differences across the world is required in order for individual nations to prosper, and the nations that reform to embed this development into their institutional structures will be the ones that reap the rewards.

That being said, the institutional difficulties in doing so are evident, especially for the developed nations of the EU, and the US, when considering the current climate of western economies. Nathan Gardels of the NPQ is concerned that a “failure to find an institutional response to this double challenge will result in a crisis of legitimacy for any governing system” – those being inequality and marginalisation. The way states adapt their institutions to meet these demands will depend on how they are currently structured. According to Mr Gardels, China requires more transparency, accountability and democratic feedback mechanisms; US-like systems require consensus-building institutions strong enough to offset their short-term political culture; and Europe needs to further legitimise its democratic structure.

Looking through the crystal ball

There is much ambiguity on how the global economy will develop in the next five years, Britain may have divorced the EU and Donald Trump could be in his second term of office, if 2016 is anything to go by there is an abundance of uncertainty ahead. Questions still remain unanswered as to when Western economies will start boosting output without sacrificing productivity and how greater equality be achieved. However, what is evident is China’s impact on the global economy and how its own institutional reforms will be felt around the world. Western economies must also seek institutional development to encourage the informal constraints at all levels of society in order to form a breeding ground that can foster sustained economic growth.

Photo credit: noname; unedited;


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