OVERVIEW

U N I T E D N AT I O N S C O N F E R E N C E O N T R A D E A N D D E V E L O P M E N T

TRADE AND DEVELOPMENT REPORT, 2012

UNITED NATIONS CONFERENCE ON TRADE AND DEVELOPMENT

Geneva

TRADE AND DEVELOPMENTREPORT, 2012

OVERVIEW

UNITED NATIONSNew York and Geneva, 2012

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• TheOverviewcontainedherein is also issued aspartof theTrade and Development Report, 2012(UNCTAD/TDR/2012,salesnumberE.12.II.D.6).

Note

UNCTAD/TDR/2012 (Overview)

OVERVIEW

The world economy, which continues to suffer from the fallout of the financial crisis that began in late 2007 and the meltdown in September 2008, has not been able to revive the growth conditions of the preceding decade. Those conditions had been particularly supportive of economic and social progress in the developing world, and the resulting momentum, especially in some of the larger developing countries, helped to stoke recovery in the world economy once the worst of the crisis had been contained. However, those countries are now losing that momentum and downside risks for the world economy are growing again.

The immediate problem is the inability of the developed countries to return to a normal growth pattern, but there is also an equally serious problem of contagion. Amidst their fragile recovery, an unreformed (and unrepentant) financial sector and macroeconomic policies that are timid at best, and counterproductive at worst, the developing countries will find it difficult to sustain their own growth dynamic, let alone that of the global economy.

In the United States, a sluggish recovery remains vulnerable to events in Europe given their strongly intertwined financial systems. Europe as a whole is on the brink of a deep recession, with some members having been stuck in reverse gear for several years. In both cases, attempts to overcome the present crisis are dominated by fiscal austerity, combined with calls to further “flexibilize” their labour markets. In practice, this means wage restraint and in some cases massive wage reductions. However, these policies are more likely to further weaken growth dynamics and increase unemployment instead of stimulating investment and job creation. At the same time, as has been demonstrated with similar structural reform policies in the developing world over the past 30 years, they will also serve to reinforce the trend towards greater inequality,

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which has become a visibly damaging feature of finance-driven globalization.

Therefore, a fundamental policy reorientation is needed, recognizing that healthy and inclusive growth will require a stable expansion of consumption and investment in productive capacity based on favourable income expectations of the working population and positive demand expectations of entrepreneurs. This requires a rethinking of the principles underlying the design of national economic policy and supportive international institutional arrangements.

In particular, while globalization and technological change, and their interplay, have created both winners and losers, their apparent adverse impacts on overall income distribution in many countries must be understood in the context of the macroeconomic, financial and labour market policies adopted. Those policies have caused unemployment to rise and remain high, and wages to lag behind productivity growth, and they have channelled rentier incomes towards the top 1 per cent of the income ladder. Neither globalization nor technological improvements inevitably require the kind of dramatic shift in the distribution of income that favours the very rich and deprives the poor and the middle-class of the means to improve their living standards. On the contrary, with more appropriate national and international policies that take into account the crucial importance of aggregate demand for capital formation, structural change and growth dynamics, job creation can be accelerated, inequality reduced and the requisite degree of economic and social stability guaranteed.

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Global recovery: uneven and fragile

The recovery from the global financial and economic crisis,beginninginmid-2009,hasbeenunevenandfragile.Whilegrowthhasregainedsteaminsomedevelopingregions,ithassputteredinmostdeveloped countries,with ongoing deleveraging across the privatesector,highunemploymentspreadinguncertaintyamonghouseholdsandgovernmentsscramblingtoconsolidatetheirbudgetsprematurely.Globaldecision-makers,includingattheleveloftheG-20,havelackeda clear idea of how to pierce through the thick fog of uncertaintyenveloping theglobaleconomyand to“lift allboats”on toamoresustainablegrowthpath.

The global economyweakened significantly towards the endof2011andfurtherdownsiderisksemergedinthefirsthalfof2012.Growthofglobalgrossdomesticproduct(GDP),whichhadalreadydeceleratedin2011,isexpectedtoexperienceafurtherslowdownin2012,toaround2.5percent.

DespiteaverymodestimprovementofGDPgrowthintheUnitedStatesandamoresignificantoneinJapan,developedeconomiesasawholearelikelytogrowbyonlyslightlymorethan1percentin2012owingtotherecessioncurrentlygrippingtheEuropeanUnion(EU).Thatrecessionisconcentratedintheeurozonewheretheauthoritieshave so far failed to present a convincing solution to the area’sinternalimbalancesandrelateddebtoverhangs.Thechosenpolicyofunconditionalausterityissuffocatingthereturntosustainableeconomicgrowth.Indeed,afurtherdeteriorationofeconomicconditionsinEuropecannotbeexcluded.

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Growth in developing and transition economies has been driven by domestic demand and high commodity prices

Whiledevelopedcountriesarestillstrugglingtoreigniterecovery,GDPgrowth indevelopingand transitioneconomies is expected toremainrelativelyhigh,ataround5percentand4percentrespectively.Indeed,mostdevelopingcountrieshavemanagedtoregainthegroundtheyhadlostasaresultofthecrisis.Thisowesmuchtotheadoptionofexpansionarydemand-sidepolicies.Forexample,Chinawasabletoabsorbadramaticfallinitscurrent-accountsurpluswithonlyasmallreduction of its overall growth expectation andwithout restrainingrealwagegrowth.ThecontrastwithGermany,whichcouldnotavoideconomicstagnationdespiteitshugesurplus,isstriking.

Privateconsumptionandwagegrowthhavealsoplayedacrucialrole in the superior performance ofmany developing countries.AlthoughGDPgrowthisslowingdownmoderatelyinLatinAmericaandtheCaribbean,itisexpectedtoremainintheorderof3.5percentin2012.Thisgrowthstemsfromstrongdomesticdemand,whichisbeingsustainedbyrisingrealwagesandcredittotheprivatesector.Severalcountrieshavebeenrespondingtothedeterioratingexternalenvironmentwith countercyclical policies, including higher publicspending and amore accommodativemonetary stance.They havebeenprofitingfromthepolicyspacemadepossiblebyhigherpublicrevenuesandactivefinancialpolicies, includingthemanagementofforeigncapitalflows.Asaresult,investmentratesareontheriseandtheunemploymentratehasfallentoitslowestlevelindecades.

GrowthratesincreasedinAfrica,owingtocontinuingexpansioninsub-SaharanAfricaandtoeconomicrecoveryintheNorthernAfricancountriesfollowinganendtotheinternalconflictsin2011.Relativelyhigh prices for primary commodities benefited external andfiscalbalances,enablingmanycountriestoadoptfiscalstimulusmeasures.Investment in infrastructureand innatural resourcesalso supporteddomesticexpenditureandgrowth.

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Althoughitremainsthefastestgrowingregion,Asiaisexperiencinganeconomicslowdown,withGDPgrowthexpectedtofallfrom6.8percent in2011toslightlybelow6percent in2012.Severalcountries–includingChina,IndiaandTurkey–havebeenadverselyaffectedbyweaker demand fromdeveloped countries andby themonetarytighteningtheyappliedin2011topreventariseininflationandassetprices.Giventheheadwindsfromtheinternationaleconomy,theyhavesincerelaxedtheirmonetaryconditionsandmanyofthemhaveappliedcountercyclicalmeasures.Regionalgrowthisbasedonacontinuousexpansionofhouseholdincomesandashiftfromexternaltodomesticdemand,aswellasonhighlevelsofinvestment.

Thetransitioneconomiesareexpectedtomaintainagrowthrateexceeding4percentin2012.ThisisentirelyduetothedynamismofmembersoftheCommonwealthofIndependentStates(CIS).GrowthintheCISisbasedonstrongdomesticdemand,spurredbygainsfromthe termsof trade and/or strongworkers’ remittances,whileon thesupplysidetherecoveryof theagriculturalsectorhasalsoplayedasignificantrole.

Slow expansion of global trade

International trade expansion, after a strong rebound in 2010,slowedtoonly5.5percentin2011,andislikelytofurtherdeceleratein2012.Inmostdevelopedeconomies–particularlyintheeurozone–tradevolumeshavenotrecoveredtotheirpre-crisislevels,althoughinthefirsthalfof2012theydidgrowsomewhatinJapanandtheUnitedStates.Tradewascomparativelymoredynamicindevelopingcountries,butitsgrowthhassloweddownsignificantlyeveninthesecountriestoaround6–7percentin2011.Theexceptionsaresomecommodityexporters,whichwereabletoincreasetheirimportsattwo-digitratesowingtogainsfromthetermsoftrade.Thesecountriesbenefitedfromcommoditypricesthatremainedhighbyhistoricalstandardsin2011andthefirsthalfof2012.However,thosepricescontinuetodisplay

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strongvolatilityandhavebeenexhibitingadecliningtrendafterpeakingduringthefirstmonthsof2011.

Considerable downside risks to global recovery

Themainobstaclestoglobalrecoveryandabenignrebalancingareconcentratedindevelopedcountries.Amongthesecountries,theUnitedStates,whichcontinuestohavethelargestcurrent-accountdeficitbyfar,sawitsexternaldeficitdeclinetoaround3percentofGDPin2009duetoamarkedcontractionofimports.Sincethen,itscurrent-accountdeficithasremainedstable,whiledomesticdemandgrowthhasbeensluggish.Moreover,amajorriskaheadisthatprematureandexcessivefiscalausteritybyearlynextyearcouldchokegrowthdramatically.Anevengreaterproblemforglobalrecovery isEurope’s increasingdependenceon exports.Germany’s external surplus is only slightlysmallertodaythanitwaspriortothecrisis.Sofar,muchoftheGermansurplus isoffsetbydeficitsmainly in the rest ofEurope.However,theongoing crisis is reducing incomes and imports, andwithmostcountriesseekingtoimprovetheircompetitiveness,theEU’sexternalpositionmaybeshiftingtowardsasizeablesurplus.Thewholeregionis,ineffect,tryingtoexportitswayoutofthecrisis.Thiscouldexertanenormousdragonoverallglobalgrowthandworsentheoutlookformanydevelopingcountries.

ThecrisisinEuropeisbeingwidelyreferredtoasa“sovereigndebtcrisis”,aspublicfinanceshavedeterioratedmarkedlysincethestartoftheglobalfinancialcrisisandinterestrateshavesoaredinanumberofcountries.However,thesituationwithpublicfinancesislessdramaticinmostcountriesintheeurozonethaninotherdevelopedeconomiessuchasJapan,theUnitedKingdomandtheUnitedStates,whichhaveneverthelessseentheirbondyieldsfalltohistoricallows.Overall,indevelopedcountriestheworseningofpublicfinancesisprimarilyduetotheworkingofautomaticstabilizersandtothebailoutsoffinancialinstitutionsaftertheshockoflate2008,thoughthelatterwereentirelyjustifiedbythegravityofthesituation.Since2010,however,callsfor

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an“exitstrategy”fromfiscalstimulusandforquickfiscalconsolidationhavegainedtheupperhand.Asaresult,fiscalausterityhasbecomethe“goldenrule”throughouttheeurozone,entailingespeciallydraconianfiscalretrenchmentintheSouthernEuropeanmemberStates.Suchameasuremayprovetobenotjustcounterproductive,butevenlethalfortheeuroanddirefortherestoftheworldaswell.

RisingfiscaldeficitsinEuropearebutsymptoms–nottherootcause–oftheeuro-zonecrisis.Underpinningthehugedivergenceoflong-terminterestratesintheEconomicandMonetaryUnion(EMU)arethewidewageandpricedifferentialsandtherelatedbuild-upoflargeregionaltradeimbalancesamongthemembers.Theseimbalancesstartedtobuildupattheveryjuncturewhenthemostimportantinstrumenttodealwithsuchimbalances–namelychangesintheexchangerate–wasnolongeravailable.Withfiscalpolicyideologicallyblockedinmanykeycountriesandtheexistingmonetarypolicytoolkitclearlyinadequate,unconventionalpolicyinstrumentsarenowneeded.

Structural reforms are no substitute for a growth strategy

Ingeneral,theroleoffiscalpolicyindeveloped,developingandtransition economies alike needs to be reassessed from a dynamicmacroeconomic perspective. Fiscal space is largely an endogenousvariablewhich depends on a combination of policy choices andinstitutional capabilities. In particular,macroeconomicpolicies thatstabilizeGDPgrowth andkeep interest rates lowcan contribute tosecuringfiscalspaceandachievingasustainablepublicdebt.Clearly,fiscalspaceisnotevenlydistributedeithergloballyorregionally,butslowingdomesticdemandandGDPgrowthhasneverbeenaviableoptiontohelpconsolidatepublicfinances.Itiscrucialfortheworldeconomyandfortheprospectsofdevelopingcountriesthatsystemicallyimportantcountries,inparticularthosewithcurrent-accountsurpluses,makewiseuseof their availablefiscal space to restoregrowth andsupportcurrent-accountrebalancing.

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Addingtothebleakprospectsforglobalrecoveryistheproblemthatpolicymakersindevelopedcountries,particularlyinEurope,nowappeartobepinningtheirhopesonceagainon“structuralreforms”.However, thosereformsareall toooftencodedlanguagefor labourmarketliberalizationincludingwagecuts,aweakeningofcollectivebargainingandgreaterwagedifferentiationacrosssectorsandfirms.Thereasoningbehindsuchastructuralreformagendaisflawedbecauseit isbasedonpurelymicroeconomic considerationsand ignores themacroeconomicdimensionoflabourmarketsandwagedetermination.Afixation on reformsof this kind canbe dangerous in the currentsituationofrisingunemploymentandfallingprivatedemand.Moreover,asymmetric rebalancing thatplaces theburdenofadjustment solelyon crisis-stricken current-account deficit countries in theEuropeanperipheryisboundtofurtherundermineregionalgrowth.

Reforms in global governance need to be reinvigorated

TheG-20processestablishedin2008toenhanceglobalmacro-economicandfinancialcoordinationhaslostmomentum.Ithasmadenoprogresstowardsreformingtheinternationalmonetarysystem,eventhoughexchangeratemisalignmentsdrivenbycurrencyspeculationpersist. International financial reform is another unresolved issue.Whilethecrisispromptedtheconsiderationofanagendaforplacingthe internationalfinancial systemon a safer footing, policymakers’attentiontoitremainsfragmentaryandhesitant.

Itnowseemsthat themomentofopportunityhaspassed– theadvicetoneverlet“aseriouscrisisgotowaste”hasgoneunheeded.Thefinancialcrisisandthebailoutshaveledtoevengreaterconcentrationinthefinancialsector,whichhaslargelyregaineditspoliticalclout.Short-term rewards rather than long-term productivity remain theguidingprincipleforcollectivebehaviourinthefinancialindustry,eventoday.Thereisaveryrealthreatthatfinancialinstitutionsandshadowbanking activitiesmay again succeed in dodging the regulators, asvividlydemonstratedbyrecentbankingscandals.

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Bankdeleveragingindevelopedeconomies,evenifwarranted,may again have negative effects on developing countries. If thedeleveragingdoesnotoccurinagradualandorderlymanner,butisforcedbysuddenstressesinbanks’balancesheetsasaresultofnewshocks,itmayalsoaffectinternationalbanklending.Inthisregard,theavailabilityoftradefinanceisofparticularconcern,andmayrequireanewglobalinitiativetomakesurethatdevelopingcountriesarenotadverselyaffectedduetoanexternalcreditcrunch.

Rising income inequality: a feature of the past three decades

Fiscalausterity,combinedwithwagerestraintandfurtherflexi-bilizationoflabourmarkets,notonlycausesaneconomytocontract,butalsocreatesgreaterinequalityinthedistributionofincome.Theensuingthreattosocialcohesionisalreadyvisibleinseveralcountries.However,risinginequalityisbynomeansarecentphenomenon;ithasbeenaubiquitousfeatureoftheworldeconomyoverthepast30years,evenifinsomedevelopingcountriesthistrendappearstohavecometoahaltsincethebeginningofthenewmillennium.

After a longperiodof relatively stable distributionof incomebetweenprofits andwages, the share ofwages in total incomehasfallen since around 1980 inmost developed andmany developingcountries. In severalof the largerdevelopedcountriesmuchof thisdecline already occurred between1980 and1995,when increasingunemployment started to exert pressure onworkers and toweakenunionsandaveragewagesbegan to fallbehindoverallproductivitygrowth.Insomecountriesthistrendcontinuedfortwodecades.Withwagecompressionpursuedinmanydevelopedcountriestoovercomethe current crisis and new records in unemployment, this trend islikelytobeevenreinforced.Inseveraldevelopedcountriesithasbeenaccompaniedbyadramaticgapbetweenthetopincomegroupsandthoseatthebottomoftheincomeladder.

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Indevelopingcountriesthewagesharehasalsotendedtodeclinesincetheearly1980s.Ithastobekeptinmind,though,thatinmanyofthemdataonfunctionalincomedistributionarelessindicativeinthisrespectthanindevelopedcountries.Largesegmentsoftheiractivepopulationareself-employedinlow-productivityagricultureorretailcommerceactivities,anditwouldbemisleadingtoconsideralltheirrevenueascapitalincome.

Inequality of personal income distribution increased in all regions after 1980

Personal income distribution,which reflects the distributionbetweenprofitsandwages,disparitiesbetweenincomecategoriesandredistributionbytheState,hadbecomemoreequalinmostdevelopedcountriesduringthepost-warperioduntilthelate1970s.Subsequentlytheincomegapwidened.TheGinicoefficientthatmeasuresincomeinequalityacrossallincomegroupsconfirmsthistrend:in15outof22 developed countries, personal income distribution deterioratedbetween1980and2000,thoughin8ofthemthistrendwasreversedtosomeextentafter2000.

Indevelopingcountries,inequalityofpersonalincomedistributionisgenerallymorepronouncedthanindevelopedcountriesandtransitioneconomies.Asindevelopedcountries,theincomegapnarrowedduringthefirstthreedecadesaftertheSecondWorldWar,withtheexceptionofcountriesinLatinAmerica.Butduringtheperiod1980–2000therewasageneralincreaseininequalityinalldevelopingregions.Sincetheturnofthemillennium,trendsinincomedistributionhavedivergedamongdevelopingregions.

InLatinAmericaand theCaribbean inequality roseduring the1980sand1990sin14outof18countriesforwhichrelevantdataareavailable.Itreachedahistoricalpeakintheregionasawholeby2000,buthasfallensincethenin15ofthe18countries.However,overall,itremainshigherthanbeforethe1980s.

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InAfricaasawhole,between1980and1995inequalityincreasedfromanalreadyhighlevel,asinLatinAmerica,butthisincreasebeganafewyearslaterthaninotherregions.Outof23Africancountriesforwhichrelevantdataareavailable,inequalityincreasedin10countries(includingseveralwithlargepopulations),butfellinanother10andremained unchanged in the remaining 3 countries.After 1995, theincomegapnarrowedin15outof25countries,mainlyinSouthernAfricaandWestAfrica,butsub-SaharanAfricastillaccountedfor6ofthe10countrieswiththemostunequalincomedistributionintheworld.

InAsia,whereinequalityofpersonalincomeisgenerallylowerthaninotherdevelopingregions,ithasincreasedsincetheearly1980sintermsofbothincomedisparitiesacrossallincomegroupsandtheshare of the top incomegroups in total income.Greater inequalityisparticularlyevidentinIndia,butithasalsoincreasedinEastandSouth-EastAsia,where7outof9countriesforwhichrelevantdataareavailablesawanincreaseinpersonalincomeinequalitybetween1980and1995.DistinctfromsomecountriesinSouth-EastAsia,inequalitycontinuedtoriseinEastAsiaalsoafter2000,albeitataslowerpace.InmanyAsian economies, income from financial activities roseconsiderablyfasterthanfromotheractivities.

InChina, amarked rise in inequality has accompanied fasteconomicgrowthsincethe1980s,andthistrendhascontinuedbeyond2000.Despiterapidgrowthintheaveragerealwage,theshareoflabourincomeintotalincomehasdeclinedandwagedisparitieshavegrownon several dimensions: betweenurban and rural areas, interior andcoastalregions,andbetweenskilledworkersincertainoccupationsandlow-skilledmigrantworkers.Theshareofthetop1percentincomesintotalincomehasalsoincreasedsince1985,butitremainslowbyinternationalcomparisons.

InCentral andEastern Europe, income distributionwas themostegalitarianamongallcountrygroupingsuntil theearly1990s.Followingtheirtransitiontoamarketeconomy,thewageshareinGDPfelldramaticallyandinequalityofpersonalincomedistributioninthis

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regionincreasedmoresharplythaninanyotherregion,althoughitisstilllowerthaninmostdevelopingcountries.

Inallregionsgrowingincomeinequalitysincetheearly1980shasbeenassociatedwithanincreaseintheconcentrationofwealthinthehigherincomestrata.Ownershipoffinancialandrealassetsisnotonlyasourceofincomebutalsofacilitatesaccesstocreditandprivilegedparticipationinpoliticaldecision-making.Inmanydevelopingcountries,theconcentrationoflandownershipplaysaparticularlyimportantrolein this regard. It isespeciallyhigh inLatinAmerica,where incomeinequalityisalsothemostpronounced,whereasitisrelativelylowinEastandSouth-EastAsiaandinsub-SaharanAfrica.

Is greater income inequality inevitable?

The shifts in income distribution over the past three decadesoccurredinparallelwithacceleratingtradeandfinancialflows,thespreadofinternationalproductionnetworksandrapidtechnologicalchange,owing in particular to progress in information and communicationtechnologies (ICTs).This led to thewidespread assumption thatincreasingincomeinequalityisaninevitableby-productofstructuralchangesbroughtaboutbyglobalizationandtechnologicalchange,orevenapreconditionforsuchchange.However,structuralchangealsooccurredthroughoutthepastcentury,includingduringperiodswheninequalityofincomedistributionwasconsiderablylower.

It is true that in the past fewdecades globalization has beenspurredbytradeandfinancialliberalizationandthegreaterparticipationof developing countries in international production chains andin international trade ofmanufactures.Moreover, progress in theapplication of ICTs in recent decadesmay have been faster thantechnologicalchangeinearlierphasesofeconomicdevelopment.Butitisalsotruethattherewasrapidincreaseinproductivityduringthepreviousdecades,andyetincomedisparitiesnarrowedalongwiththesimultaneouscreationofasufficientnumberofnewjobs.

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Structural change and corporate strategies in developed countries

In developed countries, which entered a period of normal“deindustrialization”inthe1970sand1980s,structuralchangeinrecentdecadeshasbeenshapedbyfastgrowthofthefinancialsector,andtosomeextentbyadvancesinICTsandbyincreasedcompetitionfromdevelopingcountries.Insomecountries,thesehavebeenaccompaniedbyshiftsinthedemandforlabourwithdifferentskills–i.e.adeclinein the demand formoderately skilledworkers relative to both thehighlyskilledandthelow-skilled.Theriseofimportsfromdevelopingcountrieshas accelerated since themid-1990s largely as a result ofoffshoringofproduction.

The increasing frequency of such relocation of production isrelatednotonlytotheliberalizationoftradeandincreasingattemptsbydevelopingcountriestoattractforeigndirectinvestment(FDI),butalsotoachangeincorporatestrategiesofagrowingnumberoffirmsindevelopedcountries.Emphasisonthemaximizationofshareholdervaluehasledmanagerstofocusonshort-termprofitabilityandahigherstockmarketvaluationoftheircompanies.Thisapproachhaschangedthewaycompanieshavebeenrespondingtocompetitivepressuresunderconditions of highunemployment. Instead of adopting a long-termperspectiveandtryingtofurtherupgradetheirproductiontechnologyandtheproductcompositionofoutputthroughproductivity-enhancinginvestmentandinnovation,theyhaveincreasinglyreliedonoffshoringproductionactivitiestolow-wagelocationsindevelopingandtransitioneconomies,andonseekingtoreducedomesticunitlabourcoststhroughwagecompression.Thepursuitofsuchstrategieshasbeenfacilitatedbytheweakerbargainingpositionofworkersfacedwiththepersistentthreatofbecomingunemployed,whichhasstrengthenedthepowerofprofitearnersvis-à-viswageearners.Thistrendhasbeenassociatedwithgrowingwageinequalitybetweenworkerswithdifferentskills,andofthosewithsimilarskillsindifferentoccupations.

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Structural and macroeconomic factors influencing inequality in developing countries

Widening inequality in thedifferentdeveloping regionsand inthetransitioneconomiesisassociatedwithverydifferentdevelopmentpaths. In some cases, as in a number ofAsian economies, it hasaccompaniedrapideconomicgrowth.Inothers,ithastakenplaceduringperiodsofeconomicstagnationordepression,asinLatinAmericaandAfricainthe1980sand1990s,andinthetransitioneconomiesinthe1990s.

Inanumberofdevelopingcountries,especiallyinLatinAmerica,but also in some transition economies, the trend towards greaterinequalityinthe1980sand1990soccurredinacontextof“premature”deindustrialization.Labourmovedfrommanufacturingactivitiesintheformalsectortowardslowerproductivityjobswithlowerremuneration,suchasininformalservicesandtheproductionofprimarycommodities.Decliningindustrialemployment,combinedwithlargeabsolutefallsinrealwages,intheorderof20–30percentinsomeLatinAmericancountries,ledtoincreasingincomegapsinconjunctionwithstagnatingordecliningaveragepercapitaincomes.

Oneexplanationisthatmanycountrieswithrichnaturalresourceendowmentsandanascentindustrialsectorfounditdifficulttosustaina dynamic process of structural change after opening up to globalcompetition.Unlikedevelopedcountries, theyhadnotyet acquiredthecapabilitiesfortechnologicalinnovationthatwouldhaveallowedthemtoseizetheopportunitiespresentedbyglobalizationtoupgradetomorecapital-andtechnology-intensiveactivities.Moreover,unlikelow-incomecountriesattheinitialstagesofindustrialization,theydidnot,ornolonger,possessabundantcheaplabourandthuscouldnotbenefitasmuchfromtheoffshoringoflabour-intensiveactivitiesbydeveloped-countryfirms.Countries that possessed some industrialproduction capacity relatively earlymay also have been adverselyaffected by increasing imports ofmanufactured goods fromother,lower-wagedevelopingcountries.

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However, themaincauseofdeindustrializationinanumberofdevelopingcountries in the1980s and1990s lies in their choiceofmacroeconomic andfinancial policies in the aftermath of the debtcrises of the early 1980s. In the context of structural adjustmentprogrammesimplementedwiththesupportoftheinternationalfinancialinstitutions, they undertookfinancial liberalization in parallelwithtrade liberalization, accompaniedbyhighdomestic interest rates tocurbhighinflationratesortoattractforeigncapital.Frequently,thisledtocurrencyovervaluation,alossofcompetitivenessofdomesticproducersandafallinindustrialproductionandfixedinvestmentevenwhendomesticproducerstriedtorespondtothepressureonpricesbywagecompressionorlay-offs.

Inothercountries,suchasIndiaandmanyAfricancountries,themanufacturingsectorhasnotgrownfastenoughtogeneratesufficientemployment and amuch larger proportion of the labour force hasbeenabsorbedininformalandlessremunerativeemployment,whilepriceliberalizationinagriculturehasledtolowerincomesoffarmers,particularly inAfrica.To the extent that liberalization has broughtbenefits, these have accruedmainly to traders rather than farmers.Moreover,whereindustrializationhaslargelyreliedonintegrationintointernationalproductionnetworks,asinanumberofcountriesinSouth-EastAsiaandpartsofAfrica,productionactivitiesandjobcreationhavebeenmainlyinlabour-intensiveactivitieswithoutignitingorsustaininga dynamic process of industrial deepening.As a result, traditionalpatternsofspecializationinprimarycommoditiesandnatural-resource-intensivemanufactureshavebeenpreserved,ifnotreinforced.

Some improvements in income distribution since the late 1990s

Reductions in income inequalityover thepastdecade inLatinAmerica and in parts ofAfrica andSouth-EastAsia occurred in acontextofimprovedexternalconditions,especiallyhigherinternationalcommoditypricesandlowerdebtserviceburdens.However,owingto

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differentinternalstructuresanddomesticpoliciestheireffectsonincomeinequalitywerenotthesameeverywhere.Inresource-richdevelopingand transition economieswhere the concentration of ownership oflandandmineralresourcesistypicallyhigh,risingpricesofoilandmineralproductstendtoincreaseincomeinequality.Nevertheless,someresource-richcountries,especiallyinLatinAmerica,havesucceededintranslatingterms-of-tradegainsintobroad-basedincomegrowthintheeconomyasawholesince2002andthusinnarrowingtheincomegap.Theyachievedthisbyaugmentingtheirfiscalrevenuesandbytargetedfiscal and industrial policies,whichhelped to creategood-quality jobsoutside the commodities sector.Higherfiscal spendingcreatedjobsdirectlyinthepublicandservicessectors,andindirectlyinoccupationsrelatedtoinfrastructuredevelopmentandinmanufacturingindustry.Countercyclicalfiscalpoliciesandmoreprogressiveincometaxeswerealsoveryimportant.Moreover,manycountriesusedhigherpublicrevenuesforincreasedsocialspending.Severalcountriesalsoadoptedmanagedexchangeratesystemsandcapitalcontrolswiththeaimofstemmingspeculativecapitalinflowsandpreventingcurrencyovervaluation.

Rapid industrialization with growing inequality in Asia

InmanyEastandSouth-EastAsianeconomies,macroeconomicand industrial policies supportive of productive investment spurredrapid industrialization andbuoyed economic growth in the contextofincreasingglobalization.Inthesesubregions,theshiftsinincomedistributionoverthepastfewdecadeshavebeenstronglyinfluencedbythecreationofnumerousemploymentopportunitiesinhigh-productivityactivities,mainlyinmanufacturing.Thuslabourwasabletomovefromlow-productivity jobs,often rural, towardshigherproductivity jobs.Wagesintheseoccupationsrosefasterthanaveragewagesasthesupplyofbetterskilledworkersfellshortofdemand.Inaddition,financialliberalizationcausedincomesfromfinancialactivitiestorisefasterthanthosefromotheractivities.Totheextentthatincomeinequalityhindersthedevelopmentofdomesticmarkets,amovetomoreequalincome

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distributionwouldfacilitateaproductiveupgradingawayfromlow-wageandlow-skillspecializationwithininternationaland/orregionalproductionnetworks.

InChina, rising inequalityhasalso taken the formofgrowingregionalincomedisparitiesandawideningurban–ruralincomegap.Thisappearstobeduetofiscaldecentralizationandtradeandindustrialpolicies, including investment in infrastructure, that have favouredcoastalareasclosertointernationaltraderoutesandlarge-scalecapital-intensiveproductionoversmall-scaleproduction.At thesametime,disparitiesamongwageearnerscontributed tooverall inequality, asthedistributionofwagesshifted infavourofskilledworkers in thehigh-tech,financialandservicessectors,andmigrantsfromruralareasreceivelowerwagesandsocialbenefitsthanurbanworkerswithformalresidence.

The role of FDI and relocation of production

Theglobalproductionandinvestmentdecisionsoftransnationalcorporations(TNCs)haveplayedanimportantroleintheglobalizationprocess.Theyintegratetheoutputfromproductionstagesoutsourcedtoaspecificcountryseamlesslyintothecontinuouslyevolvingtotalproductionprocess.TNCstypicallyachievethisbyoffshoringspecificslicesof their technology to their foreignaffiliates,combining theiradvancedtechnologydevelopedathomewithcheaplabourabroad.Overthepasttwodecades,albeitunderthespecificcircumstancesofratherhighunemploymentandpossiblycontrarytoearlierperiodswithlowunemployment,FDIoutflowsattimeshavehadtheeffectofexertingdownwardpressureonwagesandemploymentinmanufacturing,whichmayhavecontributedtoanincreaseinincomeinequalityinthelargestdevelopedcountries.

Fordevelopingcountriestheevidenceismixed.However,FDIalonehasneverbeen sufficient to change thebalance in the labourmarketsinfavouroflabouroneithersideoftheflow.Paradoxically,

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homeandhostcountrieshavedisplayedsimilarresponsestogrowingFDIintermsoflabourmarketpolicyandwagesetting:homecountriesattemptedtocurbthetrendtowardstherelocationofproductionabroadbyderegulatingtheirlabourmarketsandputtingpressureonwages,whilehostcountriesalsomadeeffortstocreate“flexible”labourmarketstoattractadditionalFDI. In thesamevein,governmentshaveoftenaimedatcreatinglocationaladvantagesorcompensatingforpresumedlocationaldisadvantagesbyloweringtaxes,therebyboostingnetprofitsofTNCsandlimitingtheirpotentialtoreduceinequalitywithfiscalinstruments.

The turning point: financial liberalization and “market-friendly” policy reforms

Inordertocomprehendthecausesofgrowinginequality,itshouldbeborneinmindthatthetrendtowardsgreaterinequalityhascoincidedwithabroadreorientationofeconomicpolicysincethe1980s.Inmanycountriestradeliberalizationwasaccompaniedbyderegulationofthedomesticfinancialsystemandcapital-accountliberalization,givingrisetoarapidexpansionofinternationalcapitalflows.Internationalfinancegained a life of its own, increasinglymoving away fromfinancingfor real investmentor for the internationalflowofgoods to tradinginexistingfinancialassets.Suchtradingoftenbecameamuchmorelucrativebusinessthancreatingwealththroughnewinvestments.

More generally, the previousmore interventionist approachofpublicpolicy,whichstronglyfocusedonreducinghighunemploymentandincomeinequality,wasabandoned.Thisshiftwasbasedonthebeliefthattheearlierapproachcouldnotsolvetheproblemofstagflationthathademergedinmanydevelopedcountries in thesecondhalfof the1970s.Itwasthereforereplacedbyamore“market-friendly”approach,whichemphasizedtheremovalofpresumedmarketdistortionsandwasgroundedinthestrongbeliefinasuperiorstaticefficiencyofmarkets.Thisgeneralreorientationinvolvedachangeinmacroeconomicpolicies;monetarypolicygavealmostexclusivepriority tofightinginflation,

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whiletheintroductionofgreaterflexibilityinwageformationandin“hiringandfiring”conditionswasintendedtoreduceunemployment.Theideabehindthisapproach,basedonstaticneoclassicaleconomicreasoning,was thatflexiblewagesandgreater inequalityof incomedistributionwouldenhanceinvestmentbyboostingnetprofitsand/oraggregatesavings.

Inthecontextofexpandingfinancialactivities,greaterinequalityoftenledtohigherindebtedness,aslow-andmiddle-incomegroupswereunabletoincreaseormaintaintheirconsumptionwithoutresortingtocredit.Thisinturntendedtoexacerbateinequalitybyincreasingtherevenuesofownersoffinancialassets.Moreover,whenexcessivedebtseventuallyledtofinancialcrises,inequalityfrequentlyrosebecausethecostsofthecrisesgenerallyhadadisproportionateimpactonthepoorest.

Whilethisshiftinpolicyorientationoccurredinmostdevelopedcountriesfromthelate1970sonwards,thenewthinkingalsobegantoshapepoliciesindevelopingcountriesinthesubsequentdecades.Inparticular,alargenumberofcountrieswereforcedtocomplywiththeconditionalitiesattachedtoassistancefromtheinternationalfinancialinstitutionsorfollowedtheirpolicyadviceinlinewiththe“WashingtonConsensus”forotherreasons.

Deregulation of labour markets and tax reforms

With regard to labourmarkets, this new policy orientationmeant deregulation and the introduction of greater flexibility.Theunwillingnessofworkerstoacceptlowerwageswasconsideredthemainreasonforunemploymentinertia.Inanenvironmentofhighandpersistentunemployment,theinfluenceoftradeunionswasweakenedincountrieswheretheyhadpreviouslybeeninfluential,andincountrieswheretheywereinitiallyweak,theycouldnotbestrengthened.Asaresult,thepowerinwagenegotiationsshiftedtowardsemployers,andwageincreaseswerekeptlowincomparisonwithoverallproductivity

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gains,leadingtoawidespreadincreaseinthesharesofprofitsintotalincome.

Thenewspikeofunemploymentinthecontextofthefinancialcrisisin2008–2009,ratherthanmotivatingarethinkingofthisapproach,has,curiously,ledtoareiterationofthepresumedsuperiorityofflexiblelabourmarketsinmostdevelopedcountries.Onlyafewgovernments,notablyinLatinAmerica,havenotfollowedsuchanorientation.Instead,theyhavefocusedonpoliciesthatimprovetheeconomicsituationofthepoorandthebargainingpowerofworkerswithouthamperinggrowthandglobaleconomicintegration.

In termsoffiscal policy, the reorientation of economic policysince the early 1980s towards the principle ofminimizing Stateinterventionandstrengtheningmarketforcesentailedtheeliminationof “market distortions” resulting from taxation.According to thisview, thedistributionof the taxburdenand theallocationofpublicexpenditureshouldprimarilybedeterminedbyefficiencycriteriaandnotbydistributiveconsiderations.Lowertaxationofcorporateprofitsand lowermarginal income tax ratesat the topof the incomescalewereexpectedtostrengthenincentivesandincreasecompanies’ownfinancial resources for investment.Another argument in support oflowertaxationofhigh-incomegroupsandprofitswasthattheresultingshift in incomedistributionwould increaseaggregatesavings,sincetheseincomegroupshaveahigher-than-averagepropensitytosave.Supposedly,thisinturnwouldalsocauseinvestmenttorise.

Inmany developed and developing countries such liberal taxreformsreducedthetax-to-GDPratio,loweredmarginaltaxratesandcontributedtostrengtheningthoseelementsofthepublicrevenuesystemthathadregressiveeffectsonincomedistribution(i.e.ataxburdenthatfallsdisproportionatelyonlowerincomegroups).IndevelopedcountriesthiswasassociatedwithaconsiderabledeclineinrevenuesfromdirecttaxationasashareofGDP.

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Reduced fiscal space in developing countries

Fiscalreformsindevelopingcountriesinthe1980s,togetherwiththelossoftariffrevenuesresultingfromtradeliberalizationalsoledtoareductionofpublicrevenue,orpreventeditfromrisingtoanextentthatwouldhaveenlargedthescopeforgovernments toenhancethedevelopmentprocessandtoacttoimproveincomedistribution.Thisproblemwasaggravatedbythestagnationofpercapitaflowsofofficialdevelopmentassistance(ODA)inthe1980sandtheirdramaticfallinabsolutetermsinthe1990s.Asaresult,inmanycountriestheprovisionofpublicserviceswasreducedoruserfeesforpublicserviceswereintroduced,oftenwithregressiveeffectsorleadingtotheexclusionoflow-incomegroupsfromaccesstosuchservices,especiallyinAfricaandLatinAmerica.

ODA disbursements recovered from a historically low levelfromthemid-1990suntilrecently.However,alargeproportionofthisincreasewenttoonlyafewcountriesemergingfromseveralyearsofconflict,oritwasprovidedintheformofdebtrelieftoanumberofcountriesthatwereaccumulatingdebtarrears,sothatithadalimitedeffectonthecurrentbudgetsofmostrecipientcountries.AnincreasingproportionofODAwasalsodirectedtowardshealth,educationandothersocialpurposes,withpositiveeffectsonincomedistributionintherecipientcountries.ButsincetheincreasingshareofODAforthesepurposesmeantadeclineintheshareallocatedtogrowth-enhancinginvestment ineconomic infrastructureandproductivecapacities, itseffectsonstructuralchangeandthecreationofnewemploymentandwageopportunitieswerelimited.

The failure of labour market and fiscal reforms

Insufficient growth of average realwages, coupledwith inap-propriatetaxreforms,constitutetherootcausesofrisinginequalityinmostcountries,buttheyhavenotledtothepromisedoutcomesoffastergrowthandlowerunemployment.Thisisbecauseanypolicyapproach

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that dismisses the important contribution of incomedistribution todemandgrowthandemploymentcreationisdestinedtofail.Ashiftinincomedistributiontohighincomegroupswithahighersavingsrateimpliesfallingdemandforthegoodsproducedbycompanies.Whenproductivitygrowswithoutacommensurateincreaseinwages,demandwilleventuallyfallshortoftheproductionpotential,therebyreducingcapacityutilizationandprofits.Thisinturnwilltypicallyleadtocuts–andnottoanincrease–ininvestments.

Realwageincreasesbelowproductivitygrowthandgreaterjobuncertaintysystematicallydestabilizedomesticdemandandservetoincreaseunemploymentratherthanreducingit.Thissuggeststhatrelyingonthesimplemarketmechanismcannotpreventdisequilibriumonthelabourmarkets.Indeed,justaheadofthenewjumpinunemploymentindevelopedcountries−fromanaverageoflessthan6percentin2007tocloseto9percentin2011−theshareofwagesinGDPhadfallentothelowestlevelinthepost-warera.Duetotheirnegativeeffectonconsumerdemand,neitherloweraveragewagesnorgreaterwagedifferentiationatthesectororfirmlevelcanbeexpectedtoleadtoasubstitutionoflabourforcapitalandreduceunemploymentintheeconomyasawhole.Inaddition,greaterwagedifferentiationamongfirmstoovercomethecurrentcrisisindevelopedcountriesisnotasolutioneither,becauseitreducesthedifferentiationofprofitsamongfirms.Yetitispreciselytheprofitdifferentialswhichdrivetheinvestmentandinnovationdynamicsofamarketeconomy.Iflessefficientfirmscannotcompensatefortheirlowerprofitsbycuttingwages,theymustincreasetheirproductivityandinnovatetosurvive.

Equally,apossibleinitialimprovementofinternationalcompeti-tivenessthatmayresultfromtranslatingproductivitygainsintolowerexportprices isnot sustainable,because itadverselyaffectsgrowthand employment generation in other countries.Moreover,whensucha strategy ispursued simultaneously inmanycountrieswhoseproducerscompeteinternationally,itwilltendtotriggeradownwardspiral inwages. Such practicesmay deprive a large proportion oftheirpopulationsofashareintheproductivitygains.Thesameholds

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forinternationaltaxcompetition,especiallywithregardtocorporatetaxation.

A reorientation of wage and labour market policies is essential

Influencingthepatternofincomedistributioninawaythatsocietyasawholesharesintheoverallprogressoftheeconomyhastobealeadingpolicyobjective.Thatiswhy,inadditiontoemployment-andgrowth-supportingmonetaryandfiscalpolicies,anappropriateincomespolicycanplayanimportantroleinachievingasociallyacceptabledegree of income inequalitywhile generating employment-creatingdemandgrowth.A central feature of any incomespolicy shouldbeto ensure that average realwages rise at the same rate as averageproductivity.Nominalwageadjustmentshouldalsotakeaccountofaninflationtarget.When,asarule,wagesinaneconomyriseinlinewithaverageproductivitygrowthplusaninflationtarget,theshareofwagesinGDPremainsconstantandtheeconomyasawholecreatesasufficientamountofdemandtofullyemployitsproductivecapacities.Thiswayaneconomycanavoidthedangerofrisingandpersistentunemploymentortheneedtorepeatedlyadopta“beggar-thy-neighbour”policystanceinordertocreatedemandforitssupplysurplus.

Inapplyingthisrule,wageadjustmentshouldbeforward-looking.Thismeans that it should be undertaken in accordancewith theproductivitytrendandwiththeinflationtargetsetbythegovernmentorthecentralbankforthenextperiod,ratherthanaccordingtoactualrates of productivity growth and inflation in the preceding period(i.e. backward-looking).The latterwould only serve to perpetuateinflationwithoutsecuringthedesiredlevelofrealwages.Linkingwagesto bothproductivity growth and the central bank’s official inflationtargetwouldalsofacilitatethetaskofthecentralbankinpreventinginflation,while giving it greater scope to stimulate investment andgrowth.Collectivebargainingmechanismscancontributetoasuccessfulincomespolicy.

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Wageincreasesinlinewithoverallproductivitygrowthandaninflationtargetwouldprimarilyservetokeepthewagesharefromfallingandprevent theemergenceof largedifferencesinwagesforsimilaroccupations.Still,whenthewagesharefallsandinequalityofpersonalincomeincreases,ashasbeenthecaseinmostcountriesoverthepastfewdecades,governmentsmaytrytorestorethewageshareandreduceinequality.Achievingthisrequiresana priorisocialconsensus,whichmaybe reached throughaprocessofcollectivebargainingbetweenemployers’andworkers’associations,complementedbygovernmentrecommendationsorgeneralguidelinesforwageadjustments.

Therearealsootherinstrumentsthatcanbeusedtocorrectthemarket outcome in favour of thosewithweak negotiating power.These include creating additional public employment opportunities,establishing legalminimumwages, and progressive taxation, theproceeds fromwhich could be used for increased social transfers.Publicspendingdesignedtoimprovetheprovisionofessentialgoodsandservicesandmakethemmoreaffordablemayalsobeincreased.

Income supporting measures in developing countries

Theselatterinstrumentsareofparticularrelevanceindevelopingcountries,whichgenerallymayneedtoachieveamoredrasticreductionofincomeinequalitiesthandevelopedcountries.Thereisconsiderablepotential for enhancing productivity growth in these countries byincreasingthedivisionoflabourandexploitingopportunitiestodrawonadvancedtechnologies.Thismeansthatthereisalsoconsiderablescopeforthesecountriestoreduceinequalitybydistributingproductivitygainsmoreequally,therebyalsofosteringdemandgrowth.

Nodoubt,indevelopingcountries,whicharestillhighlydependentontheproductionandexportofprimarycommodities,thelinkbetweengrowth and employment creation is less direct than in developedcountries.Theirgrowthperformanceisoftenstronglyinfluencedby

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movementsininternationallydeterminedpricesofprimarycommodities.Moreover,inmanydevelopingcountriestheinformalsectorisquitelarge,andsmall-scaleself-employmentisrathercommon.Inmanyofthem,formalemploymentinthemanufacturingsectoraccountsforarelativelysmall shareof total remunerativeoccupations,and labourunionsandcollectivebargainingtypicallyplayamuchsmallerrolethaninmostdevelopedcountries.Itisthereforeimportanttocomplementanincomespolicyfortheformalsectorwithmeasurestoincreasetheincomesandpurchasingpoweroftheinformallyemployedandself-employed.

Mechanisms that link agricultural producer prices to overallproductivitygrowthintheeconomywouldgraduallyimprovethelivingconditionsof ruralpopulations.The introductionof legalminimumwages,andtheirregularadjustmentinlinewiththetrendofproductivitygrowthoftheeconomyandthetargetedrateofinflation,canhaveapositiveeffectontheinvestment-productivity-growthdynamic.Apartfrom reducingpoverty among thosewho earn theminimumwage,this can alsogenerate additional employment in response to higherdemand,whichislikelytobemainlyfordomesticallyproducedgoodsandservices.Moreover,thelevelofthelegalminimumwageanditsadjustment over time canprovide an important reference forwagesettingintheeconomymoregenerally.Itistruethatimplementationoflegalminimumwagesisdifficultineconomieswithlargeinformalsectors. In those economies, it is necessary to complement suchlegislationwithenhancedpublicemployment,andwithstrategiestoimprovetheviabilityofsmall-scaleproduction.

Influencing income distribution through taxation

Inadditiontolabourmarketandwagepolicies,taxationofincomeandaccumulatedwealthontherevenueside,andsocialtransfersandthefreeanduniversalprovisionofpublicservicesontheexpenditureside,playacentralroleininfluencingdistributionaloutcomes.

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Progressive taxation can lower inequality among disposableincomesmorethanamonggrossincomes.Thenetdemandeffectofanincreaseintaxationandhighergovernmentspendingisstrongerwhenthedistributionoftheadditionaltaxburdenismoreprogressive,sincepartoftheadditionaltaxpaymentsisattheexpenseofthesavingsofthetaxpayersinthehigherincomegroups,wherethepropensitytosaveishigherthaninthelowerincomegroups.

Theexperienceofthefirstthreepost-wardecadesindevelopedcountries, whenmarginal and corporate tax rates were higherbut investmentwas also higher, suggests that thewillingness ofentrepreneurs to invest innewproductivecapacitydoesnotdependprimarilyonnetprofitsatagivenpointintime;rather,itdependsontheirexpectationsoffuturedemandforthegoodsandservicestheycanproducewiththatadditionalcapacity.Theseexpectationsarestabilizedor even improvewhenpublic expenditures rise, and, through theirincomeeffects,boostprivatedemand.

Indeed, the scope forusing taxationandgovernment spendingforpurposesofreducinginequalitywithoutcompromisingeconomicgrowthislikelytobemuchlargerthaniscommonlyassumed.Taxinghighincomes,inparticularinthetopincomegroups,throughgreaterprogressivityofthetaxscaledoesnotremovetheabsoluteadvantageofthehighincomeearnersnortheincentiveforotherstomoveuptheincomeladder.Taxingrentierincomesandincomesfromcapitalgainsatahigherratethanprofitincomesfromentrepreneurialactivity–ratherthanatalowerrateaspracticedsofarinmanycountries–appearstobeanincreasinglyjustifiableoptiongiventheexcessiveexpansionoflargelyunproductivefinancialactivities.

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There is also scope for taxation in developing countries

Tackling income inequality effectively through progressivetaxation requires a relatively highdegree of formal employment intheeconomyandconsiderableadministrativecapacity,whichmanydevelopingcountriesdonotpossessatpresent.However,thesecountries(includinglow-incomecountries)haveanumberofpotentialsourcesofrevenuethatcancontributetoimprovingequalitywhileincreasinggovernmentrevenues.

Greatertaxationofwealthandinheritanceisapotentialsourceofpublicrevenuethatcanbetappedinmanydevelopedanddevelopingcountriestoreduceinequalityofbothincomeandwealthdistributionandenlargethegovernment’sfiscalspace.Forexample,taxesonrealestate, largelandholdings, luxurydurablegoodsandfinancialassetsarenormallyeasiertocollectthantaxesonpersonalincome,andcanrepresentanimportantsourceofrevenueincountriesthathavehighinequalityofincomeandwealthdistribution.

Inresource-richdevelopingcountries,incomesfromtheexploitationof natural resources and gains resulting from rising internationalcommoditypricesareanotherimportantsourceofpublicrevenue.Byappropriatingtheirfairshareofcommodityrents,especiallyintheoilandmining sectors, governments in such developing countries canensurethattheirnaturalresourcewealthbenefitstheentirepopulation,andnot just a fewdomestic and foreign actors.This is particularlyimportant,astherevenuepotentialfromnaturalresourceshasgrownsignificantlyoverthepastdecadeowingtohighercommodityprices.

TherealsoappearstobeconsiderablescopeformodifyingthetaxtreatmentofTNCs,andFDImoregenerally.DevelopingcountriesoftentrytoattractadditionalFDIbyofferingfiscalconcessions.However,competingwithotherpotentialhostcountriesbyofferinglowertaxesisproblematicsinceittriggersadownwardspiralintaxationthatreducesfiscal space in all the countries concerned,while initial locationaladvantagesbasedontaxationtendtoerodeovertime.

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Public expenditures to reduce inequality

Welltargetedsocialtransfersandthepublicprovisionofsocialservices can serve to reduce inequality of disposable income. Forexample,higherspendingoneducationmaycontributetomoreequitableincomedistribution,especiallyinthepoorercountries,butonlyifjobopportunitiesareprovidedtothosewhohavereceivedsucheducation.However,employmentcreationdependsonoverallgrowthdynamicsand especially on the expansion of the formalmanufacturing andservicessectors.

Publicemploymentschemes,suchasthoselaunchedinanumberofdevelopingcountriesinrecentyears,mayhaveapositiveeffectonincomedistributionbyreducingunemployment,establishingawagefloor,andgeneratingdemandforlocallyproducedgoodsandservices.These canbe implemented even in low-income countrieswith lowadministrativecapacity,andcanbecombinedwithprojectstoimproveinfrastructureandtheprovisionofpublicservices.Ifwellconceived,theymayalsohelptoattractworkersintotheformalsector.

Proceedsfromhighertaxrevenuesmayalsobeusedfordifferentformsofconcessionallendingandtechnicalsupporttosmallproducersinboththeurbanindustrialandruralsectors.Apartfromsupportingproductivityandincomegrowthintheseactivities,theprovisionofsuchfinancingcanalsoserveasavehicletoattractsmall-scaleentrepreneursandworkersintotheformalsector.

The international dimension

In aworld of increasingly interdependent, open economies, acountry’smacroeconomicperformanceismoreandmoreinfluencedbyexternaldevelopmentsandpoliciesinothercountries.Sharpfluctuationsininternationalpricesoftradedgoodsandcurrencymisalignmentscanleadtodistortionsininternationalcompetitionbetweenproducersindifferentcountries.

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Themacroeconomic shocks thatarise fromsuchmispricing incurrencymarketsaffectaneconomyasawhole,andthereforecannotbetackledatthelevelofthefirm.Theappropriatewaytodealwithsuchshocksisbyrevaluationordevaluationofthecurrenciesconcerned,rather than bywage cuts in countrieswhose producers are losinginternationalcompetitiveness.Movementsofnominalexchangeratesshouldreflectchangesininflationratedifferentialsorinthegrowthof unit labour costs.Thiswould alsoprevent beggar-thy-neighbourbehaviourininternationaltrade.

Another importantaspectof theinternationalframeworkis thewayinwhichcountriesdealwiththerelocationoffixedcapital.Greatercoordinationamongdevelopingcountriesmaybenecessarytoavoidwageandtaxcompetitionamongthem.Suchcoordinationshouldaimatobligingforeignfirmstoconformtotwoprinciples:tofullyacceptnational taxation schemes; and to adjust realwages to an increaseinnationalproductivityplusthenationalinflationtarget.Boththeseprincipleswouldsetastandardfordomesticfirms.Thelatterwouldnotdeprivetheforeigninvestorsoftheir–oftenhuge−extraprofitsarisingfromthecombinationofadvancedtechnologieswithlowwagesinthehostcountry,becausetheirlabourcostswouldnotriseinlinewiththeirownproductivitybutinlinewiththeaverageproductivityincreaseinthehosteconomyasawhole.

* * * *

Alltheseconsiderationsservetoshowthatanefficientoutcomeofmarketprocessesinanincreasinglyglobalizedeconomydoesnotrequiregreater inequalitybetweencapitalandlabourincomesandagreaterdispersionof personal incomes. Inclusive growth anddevelopmentrequires active employment and redistributionmeasures, aswell assupportivemacroeconomic,exchangerateandindustrialpoliciesthatfosterproductiveinvestmentandcreatedecentjobs.Abetterincome

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distributionwouldstrengthenaggregatedemand,investmentandgrowth.Thisinturnwouldaccelerateemploymentcreation,includinginhigh-productivityactivitiesthatofferbetterremunerationandsocialbenefits,therebyfurtherreducinginequality.

SupachaiPanitchpakdi Secretary-GeneralofUNCTAD