Want to solve income inequality? Simple: pay workers more

We accord the ‘dismal profession’ too much respect and listen to too much of its baloney

Economic forecasts aren’t what they were. Not much attention has been paid to them since the crystal ball gazers failed to spot the global financial crisis. Forecasts of an immediate recession in the UK after last June’s Brexit vote were wide enough of the mark to shred what little respect is left for the dismal profession. It is almost anachronistic to see headlines proclaiming the latest forecasts of the likes of the IMF and the OECD. Who pays attention to this stuff any more?

If, indeed, nobody listens to forecasters, then the harm that they can do is probably minimal. Their work is, at most, an academic curiosity. To the extent that they are needed, forecasts feed into corporate and government planning cycles: budgets need projections of revenues and expenditures.

But the way we treat forecasts, even after all that has happened, suggests that we accord them far too much respect. We still invest too-large resources into building complex forecasting models rather than making a few simple conservative assumptions, and then having an in-depth conversation about strategy when those assumptions turn out to be wrong.

As they will always be. We obsess about whether or not GDP will grow by 3 or 4 per cent, but we will never discuss what we will do if another recession suddenly appears from nowhere. (As they always do: they are never forecasted.)


Waste of resources

Forecasting wastes precious research resources in other ways, some quite insidious. Take, for instance, this week’s claim by our own Economic and Social Research Institute that the Government should start considering tighter fiscal policy since the forecast unemployment rate is heading for a level consistent with full employment. In that innocuous statement are too many dodgy forecasts, assumptions, leaps of faith and pretences of knowledge to count.

Both the Bank of England (in particular) and the Federal Reserve have been forced to admit that their thinking of just what constitutes full employment needs serious revision.

More generally, most economists have learned to be pretty humble when it comes to professing any knowledge about what a tight labour market looks like. It’s usually a debate about inflation; how many jobs have to be created before wage inflation starts to take off? Globally, the conclusions from recent experience are clear: whatever we used to think needs serious revision.

The UK and US economies have been run at levels of unemployment that were once considered to be dangerously inflationary. Indeed, both central banks would have been described as reckless if they had allowed sub-5 per cent unemployment levels to persist. But – hey presto! – low unemployment has had no effect on wage inflation at all.

Orthodox economists depend on the idea that there is a predictable level of unemployment and a knowable level that will generate an inflation problem. Such beliefs are based on weak foundations. But these beliefs feed directly into strong recommendations for government spending and taxation policies.

Cheering wage rises

Because we predict that unemployment will fall to a level that threatens inflation, government spending is urged to be lower and taxation higher – strong policy proposals that have less than robust foundations.

Actually, it is worse than that. Even if the forecasts about jobs and inflation are spot on, is it right, as the ESRI seems to think, that we should worry about this to the point where government has to act? There is actually a strong case for arguing that we should be cheering wage inflation to the rafters.

If there is a single global problem that almost everyone agrees needs to be tackled, it is income inequality. It’s a bigger deal in some countries than others: bad in the US, less so here (thanks to relatively aggressive tax and spending policies). But it’s a problem everywhere.

Of course, there is a vigorous debate about why we have so much inequality around the world, or what policies should be adopted to do something about it. But the simple fact is that a lot of people don’t earn very much. Redistributive welfare policies, raising minimum wages, and strengthening trades unions are usually on the proposed menu of choices.

Hot growth rates

By contrast, an old remedy once favoured by lots of economists is no longer considered. How about running economies at growth rates hot enough to generate a bit of wage inflation? That would do a lot to alleviate the inequality problem. More people will have jobs (the single biggest thing that can be done for the poor), and those jobs will pay more when labour becomes scarce. What’s not to like?

What about “competitiveness”? So much baloney is spoken about this. We want a high-wage, high-productivity economy. We can’t compete on wages. Most importantly, we shouldn’t want to. Higher wages in the construction sector will not cause economic Armageddon. But they might be accompanied by more houses being built. Which, I thought, is something that we all want.

Pay workers more and the global inequality problem starts to go away. Simple really.