Kaushik Basu | Economic impossibilities for our grandchildren?

Austria’s close-call presidential election on 4 December, which almost brought a far-right nationalist to power, was a telling coda to a sad year. The uncertainty and fear that many people feel today is reminiscent of W.H. Auden’s poem September 1, 1939: “As the clever hopes expire/Of a low dishonest decade.”

This was a year when many countries lurched rightward, towards leaders and political parties that serve partisan interests and narrow identities. This trend is no fleeting aberration: the turn to vicious politics is partly rooted in ongoing economic changes that have now reached an inflection point.

The poor and the middle class have seen their jobs disappear and their incomes erode, and they are now flailing against the status quo, desperately ignoring the fact that they are choosing leaders who will only make matters worse.

The root cause of the problem is not immigration or trade, as the populists argue, but rather the steady march of technology. As jobs are replaced by machines or off-shored to emerging economies, global gross domestic product (GDP) is expanding, but the gains are not being distributed evenly, and some groups are losing out altogether. Many countries are experiencing higher inequality amid negative GDP growth—now at -3.3% in Brazil, for example, -10% in Venezuela, -1.8% in Argentina and -0.8% in Russia. Others, like Japan and Italy, are growing, but just barely.

China and India, for their part, are growing reasonably well. But India just threw a wrench into its economic engine by announcing a bafflingly inept demonetization policy; and China is maintaining growth by allowing corporate debt to pile up unsustainably, which poses major risks that are being partly hidden, but also accentuated, by new high-yield financial products.

More from The Year of Surprise

More important, manufacturing employment is deteriorating, notwithstanding Chinese officials’ claims that new graduates are simply taking a break before launching their careers. In 1995, wages as a share of GDP in China were 53%; that percentage now stands at 47%.

In the US, the nominal unemployment rate has fallen, but this belies a more jarring trend.

Official data show that the median household is worse off now than in 1999, even though overall per capita GDP has grown substantially. This implies that all of the gains have gone to the top earners.

There are two primary forces behind these trends: technological innovation, which is both inevitable and desirable; and the appropriation of incomes from workers by those who own the new labour-displacing machines, which is neither inevitable nor desirable.

The problem is often characterized as one of labour versus labour: workers in advanced economies are competing with those in developing ones. In truth, it is a problem of labour versus capital. After all, it is the number of manufacturing jobs, not the manufacturing sector itself, that is shrinking.

Consider the example of Eastman Machine, in Buffalo, New York—a city where manufacturing is making a comeback, but in a different form than in past decades.

Eastman Machine makes machines and tools for the textile sector, and it exports half of its output, often to developing countries such as Bangladesh and Vietnam. The key to its success is that it relies on virtually no human labour; it employs 122 people, who account for a mere 3% of its total production costs.

There is another, related problem. With new technologies creating vast economies of scale, firms like Eastman Machine—after incurring substantial start-up costs—can manufacture their products at a negligible marginal cost. This has made certain markets more oligopolistic, and even monopolistic in some cases. This trend will continue.

In addition, because companies are increasingly armed with extensive customer and user information, they can price-discriminate, extracting all surplus out of consumers, more easily than ever. These changes have created new challenges for regulators.

John Maynard Keynes, prophetic as he was about so many features of economic life, made one big mistake. In his 1930 essay Economic Possibilities for our Grandchildren, he predicted that all major economic problems would be “solved” within a hundred years, and we would only have to figure out how to pass the time. But he failed to anticipate that economic problems would continuously evolve.

For example, business strategies are constantly changing, because every time governments introduce regulations to serve consumers’ interests, producers find new ways to serve their own.

We need new, innovative regulations to reverse the trends of widening inequality and market monopolization. Such measures should embody ideas that once seemed radical, such as corporate profit sharing for workers, and new consumer protections to prevent price discrimination.

To be sure, any new regulatory regime must take care not to eliminate entrepreneurs’ incentive to produce, innovate, and expand their businesses. But safeguarding the profit motive should not be an alibi for market fundamentalism.

If we have learned anything in 2016, it is that leaving everything to the market can lead to social and political turmoil.

Of course, nowadays, to advocate innovative forms of state intervention to fight inequality is to risk being redbaited. Once, in Kolkata, after telling my mother about an upcoming international conference on welfare, which would be attended by the world’s leading economists, I heard her brag to her cousin that I was meeting with other “communists” to discuss how to make the world a better place. At 90, she had begun to confuse similar-sounding words. Today’s trolls have no such excuse—only a morbid fascination with an increasingly dangerous status quo. ©2016/PROJECT SYNDICATE

Kaushik Basu, formerly chief economist at the World Bank and chief economic adviser to the government of India, is professor of economics at Cornell University.