Why the federal budget should get a 'fail' from the G20

For the G20 to play any role in economic development, member nations must embrace policies that promote fair and inclusive growth. Australia's budget will achieve neither outcome.

The Conversation

Everybody would agree that growth, defined as a steady increase in gross domestic product, is a necessary condition for economic development. There is simply no country that has reduced poverty and improved living standards without having gone through a period of sustained economic growth.

But discussion has recently centred on the idea that growth alone might not be sufficient. The experience of so many countries over the last several decades has taught us an important lesson: the extent to which growth promotes development depends on the evolution of income inequality.

As the distribution of income within a country becomes more unequal, the effect of growth on development weakens. Conversely, a combination of growth and decreasing inequality provides the best possible scenario for development. Hence the need for inclusive growth: broad-based growth such that all socioeconomic groups have access to the benefits and opportunities arising from economic expansion.

In this regard, the federal budget recently presented by the Australian government is worrisome. Using a non-existent debt problem as a justification, the government has introduced several harsh measures that hit hard those who are in greater need of protection: aged and disability pensioners, the sick poor, young people under 30, single-income families with children, and the Indigenous population.

In addition, the budget envisages cuts to foreign aid of A$7.5 billion. While it’s commonly accepted that development cannot just be financed through official aid, reducing aid is a blatant moral failure for the country chairing the G20.

And while this budget completely fails to deliver inclusiveness (and fairness, and equality, and solidarity), it also fails to promote growth (inclusive or not).

Australia’s macroeconomic outlook is fragile: output is still growing below its potential and unemployment is rising. A tight budget is likely to slow down the pace of economic activity even further. As a consequence, the economic downturn that Australia avoided during the global financial crisis might happen now.

From a longer-term perspective, the only thing that the budget supposedly does to promote growth is to increase investment in public infrastructures. But this is more wishful thinking than economic thinking. There is simply no clear evidence that in an advanced economy like Australia, infrastructure is a driver of long-term growth.

What this budget ultimately does is to set the stage for the advent of a patrimonial society dominated by the top 1 per cent of the population. The hope is that the other G20 countries will do the opposite of what the Australian government is doing.

Why inequality matters

To get a sense of why inequality is so important for development, it is useful to look at the Human Development Index (HDI) of the United Nations Development Project.

The HDI summarises a country’s development along dimensions like education, health, and wealth. Statistically, it is a number between 0 and 1. The highest level of HDI is currently observed in Norway (0.955), followed by Australia (0.938). Niger and Democratic Republic of Congo have the lowest HDI (0.304).

The average HDI for all countries in the world is 0.694. However, when “adjusted” to account for inequality, world HDI decreases to 0.532. This means that inequality reduces human development worldwide by about 23 per cent. This effect of inequality is strongest in Sub-Saharan Africa (35 per cent reduction) and South Asia (30 per cent reduction).

So, fighting inequality is central to fostering global development, especially now that inequality appears to be on the rise.

A new era of social polarisation?

Two factors in particular suggest that the world might be heading towards an era of high inequality and polarisation.

First, as extensively documented by French economist Thomas Piketty in his book Capital in the Twenty-First Century, inequality has been increasing in many advanced and developing countries since the early 1990s. In the United States, inequality is today as high as it was in the roaring 1920s.

Second, it is often the case that economic crises hurt the poor more than the rich. The GFC is no exception in this regard.

Recent data from the Organization for Economic Cooperation and Development confirms that in countries that were hit the hardest by the crisis, the disposable income of the bottom 10 per cent of the population has decreased more than average disposable income and far more than the disposable income of the top 10 per cent. This means the cost of the crisis was disproportionally higher for the most vulnerable in society.

The risk is that as income inequality rises, social polarisation also increases, which in turn produces even sharper income inequalities. If not stopped, this vicious cycle may lead to the emergence of a patrimonial society (to use a term from Piketty’s book): a small group of wealthy rentiers on one side, a large group of strugglers on the other side, no ground for a lively middle class, and very limited chances for strugglers to move up the social ladder.

In this society, rentiers would have no interest in seeking innovation and technological progress while strugglers would not have the means to do that. As a result, global growth would come to an end and so would human development.

The quest for inclusive growth

In their quest for growth, G20 countries must not lose sight of inclusiveness.

To this effect, growth should hinge on free access to goods and services like education and health. The public supply of these goods and services should be financed from strictly progressive forms of taxation.

On top of that, the policies for inclusive growth ought to include strong welfare programs to provide the bottom segments of the population with a buffer against economic shocks.

In fact, it was the tax-benefit system, together with fiscal stimulus packages, that absorbed a significant part of the inequality effect of the crisis until 2010. But when the policy focus (especially in Europe) shifted from fighting the recession to enforcing fiscal austerity, the pain for vulnerable groups (including broad segments of the middle class) was sharply aggravated.

For the G20 to play any role in development, countries should go to the Summit being hosted in Brisbane in November with a comprehensive growth plan that includes the abovementioned principles and policies for inclusiveness.

The Conversation

Fabrizio Carmignani receives funding from the Australian Research Council for a project on the estimation of the continuous piecewise linear model and its macroeconomic applications.

This article was originally published on The Conversation. Read the original article.