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Thursday, October 23, 2008

Executive Summary: World of Work Report 2008

The fi nancial crisis is hitting the world of work…
Th e fi nancial crisis which developed over the past year and erupted last August represents
one of the most signifi cant threats to the world economy in modern history. Th e credit
crunch and collapse of stock markets are starting to aff ect fi rms’ investment decisions as
well as workers’ incomes and jobs. Several major developed economies have practically
entered into recession and unemployment is on the rise. Economic growth in emerging
economies and developing countries has slowed down, in some cases signifi cantly.
Ongoing attempts to overcome the fi nancial crisis are of course welcome and, in principle,
should help avoid another Great Depression. Important as rescue packages are, however,
it is crucial to address the structural dimensions of the crisis as well. As this World
of Work Report shows, the widening of income inequalities that occurred before the crisis
is especially instructive in this respect.
… and happens in the face of income inequalities
which are widening…
While the costs of the fi nancial rescue packages will be borne by all, the benefi ts of the
earlier expansionary period were unevenly shared.
Between the early 1990s and the mid-2000s, in about two thirds of the countries for
which data exist, the total income of high-income households expanded faster than was
the case for their low-income counterparts (Chapter 1). Similar trends have occurred when
looking at other dimensions of income inequality such as labour income vis-à-vis profi ts,
or top wages vis-à-vis wages of low-paid workers. In 51 out of the 73 countries for which
data are available, the share of wages in total income declined over the past two decades.
Likewise, during the same period, the income gap between the top and bottom 10 per cent
of wage earners increased in 70 per cent of the countries for which data are available.
Th is was a period of relatively rapid economic growth and strong job creation. In
2007, world employment was almost one third higher than in 1990. In short, the gains
from the expansionary period which ended in 2007 benefi ted more high-income groups
than their medium- and low-income counterparts.

… at a pace which has probably been excessive
Wider income inequality can be helpful. It can signal stronger rewards to work eff ort,
innovation and skill development. Th is, in turn, will improve economic prospects for all,
rich and poor. Conversely, an overly compressed income diff erential may aff ect job prospects
– for instance because the labour market is not suffi ciently attractive to would-be
workers. Too little income inequality may also weaken the incentive to take risk or invest
in human capital, thereby adversely aff ecting economic growth prospects.
However, there are instances where wider income inequality is both socially harmful
and economically problematic.
Th ere is evidence that social confl ict grows when inequalities are perceived to be rising
excessively. Social support for pro-growth policies will be eroded if low-income groups and
the middle class believe that such policies do little to improve their situation or that of
their children, while benefi ting high-income groups. Surveys suggest a declining tolerance
among respondents vis-à-vis growing inequality.
Th e report also shows that, prior to the fi nancial crisis, there were already signs that
observed trends in income inequality might not be sustainable. In the face of strong wage
moderation, workers and their families became increasingly indebted in order to fund
their housing investment decisions – and sometimes consumption decisions as well. Th is
has sustained domestic demand and economic growth in some countries, and was made
possible by fi nancial innovations. However, the crisis has underlined the limits to this
growth model.
It is therefore crucial for policy makers to ensure that income inequality does not rise
excessively. At the same time, any action in this area should take into account the need
for sustaining employment. But the report shows that it is possible to fulfi l both employment
and equity objectives.
Inequality patterns refl ect, fi rst, a process of fi nancial globalization
which has intensifi ed economic instability…
Chapter 2 of the report shows that fi nancial globalization – caused by deregulation of
international capital fl ows – has been a major driver of income inequality.
Th e expectation was that fi nancial globalization would help improve the allocation
of savings and thus stimulate economic growth, while also relaxing credit constraints and
improve income prospects of low-income groups.
Yet, fi nancial globalization has failed to contribute to the enhancement of global
productivity and employment growth. Moreover, fi nancial globalization has intensi-
fi ed economic instability. In the 1990s, systemic banking crises were ten times more
frequent than was the case at the end of the turbulent 1970s. Such increased instability
typically comes at a steep cost to low-income groups. Earlier experiences suggest
that the job losses entailed by systemic fi nancial crisis have been especially strong, with
long lasting eff ects on vulnerable groups. Unemployment can also be expected to rise
as a result of the investment slump and this may further intensity income inequalities.
Moreover, there is evidence that fi nancial globalization has reinforced the downward
trend in the wage share recorded in most countries. On the other hand, fi nancial globalization
has exercised a disciplining eff ect on macroeconomic policies, in both developed
and emerging countries.
Th erefore, the policy requirement is neither fi nancial deregulation nor isolation.
There are several possible policy options to achieve this "mid-road". What matters is
that governments take into account the social impacts of each of the options. A cautious
approach to fi nancial globalization is especially important in countries where fi nancial markets
are not suffi ciently developed and where supervision mechanisms are weak, as is the
case in many developing countries. But in all countries, it is crucial to reinforce prudential regulation so as to reduce irresponsible risk-taking on the part of certain fi nancial actors.
Indeed, there is a "moral hazard" problem in that these actors grasp all the gains from irresponsible
fi nancial positions, while the losses from such operations are partly shift ed to
society and taxpayers. Th ere is also a role for coordinated action among countries.
…second, steep increases in executive pay
de-linked from fi rm performance…
Developments in global corporate governance have also contributed to perceptions of
excessive income inequality. A key development has been the use of so-called "performance
pay systems" for chief executive managers and directors.
Th e result has been a steep increase in executive pay. In the United States for example,
between 2003 and 2007, executive managers’ pay grew in real terms by a total of 45%,
compared with a real pay increase of 15% in the case of the average executive, and less
than 3% for the average American worker. Hence, by 2007, the average executive manager
in the 15 largest US fi rms earned more than 500 times the average employee in the
United States, compared with over 300 times in 2003. Similar patterns can be observed
in other countries such as Australia, Germany, Hong Kong (China), the Netherlands and
South Africa.
Importantly, empirical studies show only very moderate, if any, eff ects of these systems
on company performance. Moreover, large country variations exist, with some countries
displaying virtually no relation between performance-pay and company profi ts. Th ough
more research is clearly needed in this area, a plausible explanation behind observed trends
is that executives are in a dominant bargaining position with respect to company owners,
something which is facilitated by the institutional set-up.
Altogether, evidence suggests that developments in executive pay may have been both
inequality-enhancing and economically ineffi cient. Th is suggests a role for policy action.
In this regard, several options are being considered at present but it is too early to assess
the pros and cons of each of them.
… third, institutional change and weaker redistribution policies
Domestic labour, social and tax policies too have contributed to observed outcomes. Labour
institutions continue to play a redistributive role in the majority of countries under analysis,
despite the decline in trade union density documented in Chapter 3. In particular,
high trade union density, a more coordinated collective bargaining structure, and greater
coverage of collective bargaining agreements tend to be associated with lower inequality.
However, it is diffi cult for these institutions to counteract the global trends arising from
globalization. Overall, it seems that the bargaining position of employees has weakened,
even in countries where labour markets have been tight.
Another important factor has been the rising incidence of non-standard employment
observed over the past 15 years or so in the majority of countries (Chapter 4). Indeed,
non-standard jobs pay signifi cantly less than their standard counterparts. More fundamentally,
the changing employment patterns may have also contributed to weakening the
bargaining position of workers, especially the low-skilled.
Finally, taxation has become less progressive in the vast majority of countries and thus
less able to redistribute the gains from economic growth. Th is refl ects a cut in taxes on
high incomes (Chapter 5). Between 1993 and 2007, the average corporate tax rate (for all
countries for which data exist) was cut by 10 percentage points. In the case of top personal
income tax rates, the cut was of 3 percentage points over the same period. Chapter 5 also
shows that declining tax progressivity has generally not been off set by social policy.
Cutting taxes on high incomes or profi ts can be justifi ed on economic effi ciency
grounds. Th ey may even meet equity objectives in certain cases – the lift ing-all-boats effect. However there are other cases where such tax cuts produce sub-optimal results,
even when considering effi ciency-equity tradeoff s. Likewise, stronger social protection, if
well designed, can serve employment objectives. Th e report gives examples of such policies
among countries at diff erent levels of economic development. Th e use of conditional cash
benefi ts provides an interesting innovation in this respect.
It is therefore time to move ahead with the Decent Work Agenda.
But evidence presented in this World of Work Report shows that, if policy makers are
concerned about excessive inequalities in their country while also sustaining employment,
they have at their disposal an eff ective tool. Chapter 6 shows that countries that have relatively
strong tripartite institutions, well-designed labour regulations and social protection,
and respect for basic workers’ rights do well, not only in terms of employment but
also with respect to limiting the trend increase in income inequalities. Indeed, this is the
essence of the Decent Work Agenda.
Moving ahead with the Agenda would help address the social consequences of the
fi nancial crisis. Together with a reform of the fi nancial architecture, it would also contribute
to achieve a more balanced, sustainable economy.

Raymond Torres
International Institute for Labour Studies

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