The society should agree on reducing inequality

(World Bank, Public domain)

There is a need for a new social contract that will include people working on flexible contracts, as well as the former middle class, says Hans Timmer, World Bank Chief Economist for the Europe and Central Asia Region.

CE Financial Observer: The old economic model has lost its steam – this is something you’ve been saying in your recent speeches. What are the aspects where the old economic model fails?

Hans Timmer: There are a few. First, during the boom period the structure of the economy was not balanced, you could see this in many countries. Especially overinvestment in the real estate sector. Capital was easily available, risks were poorly assessed and this created an over-leveraged system driven by increases in asset prices. The old economy was not stable during the boom and we cannot go back to that period and those methods to increase growth.

The second important factor is that during a boom basic trends are always ignored by policy makers and investors. We have technological progress which requires a different kind of investment and changes in the market, but no one is really implementing them because we are growing anyway and we are making a profit. Even when the old system eventually collapses, everyone is in the fire-fighting mode and we continue to ignore new trends. And they change a lot – the way we work, buy things and the way companies contact each other.

You say that we need a new social contract. Who should establish it and what should it include?

This should be a contract for those for whom the current system does not work anymore. The parties to that contract should be people working in the new economy, often on so-called flexible contracts. Some 20 per cent of employees in Poland already have such contracts, while in 2000 it was only 5 per cent. Another party to the new social contract should also be the former middle class, people whose jobs were taken away by automation.

The essence of the new contract should be the reduction of inequality. I will focus on two areas. We do not see high inequality in societies as a whole, but inequality among the youngest cohorts is much higher than in the past and flexible employment contracts play an important role here. We also see that inequality among the oldest cohorts is increasing, because for highly qualified people it is much easier to prepare for retirement than for those with lower qualifications. For this reason, you may want to reconsider the recent lowering of the retirement age in Poland. Of course, in many occupations involving physical labor it could be a problem to work until the retirement age, but in many others there is no reason to retire so early.

As I understand it, when you talk about the new social contract and the new economic model, you don’t mean replacing capitalism with something else, but rather correcting specific free-market policies?

Yes. The free market is not efficient, if the appropriate regulations and institutions are not put in place. And this new market with Uber and Airbnb is a challenge. The existing regulations simply do not work in a situation where, for example, the market is no longer limited to just taxi companies employing only professional taxi drivers. Of course the governments have a tendency to stick to the old rules, so Uber cannot operate in certain countries, but this is just delaying the inevitable, as the company will probably find some way to circumvent these restrictions anyway. It would be reasonable to prepare for this and to create new regulations, preferably tight ones, because many of these companies-networks have the characteristics of monopolies. In other words – we’re talking about a free market that is wisely regulated.

One example of such regulations you provide is Obamacare, i.e. market-based health care services, but with universal access to a minimum level of benefits enforced by the state. Is this a model that we should strive for?

The market of health services is the most difficult for an economist, because there should be no budgetary constraints here. The doctors want to prescribe as many treatments as they believe appropriate, and the patients want the same thing. We must therefore find a way to introduce competition while at the same time ensure a safe minimum for everyone. Obamacare and a similar system in my native Netherlands are such an attempt and indeed a good example of how public policies should be organized under the new social contract.

Where could this mechanism be used outside of health care?

One good example is education. I will once again refer to solutions from the Netherlands. In my country you can go to any school, even if it is on the other side of the country, and the government provides the selected facility with the same amount for each student. And it doesn’t matter whether it’s a public or a private school. This is a good solution, because the poorer schools that attract fewer students simply disappear. The students do not lose anything, because the minimum level of services (which is also required by the state) is provided to them by all other schools. In this approach your wealth and place of residence doesn’t matter, and although some people say that this policy favors the economically disadvantaged, I believe that its effects are very good for the society overall. It’s just that if you want to implement redistribution, the way to do it is through the tax system, and not by manipulating the quality of public services.

In your opinion states are already spending so much that almost all of them could afford the expenditures associated with a new social contract, and that we would only need to move the money. But is it so simple from a political point of view?

Of course, as an economist it’s easy for me to talk about designing mechanisms that would be beneficial for all, and it’s harder to introduce such changes for politicians, who are always thinking about the next election. This means, however, that we need strong leaders who think about the more distant future. We also need the enthusiasm of their voters. Consider what was happening in Europe one hundred years ago – back then people feared that machines would push people out of agriculture and that there would be no work for them. And on the wave of these concerns the difficult task of universal education was undertaken. That task was significantly more difficult than the one we are facing today.

During a debate with Swedish trade unions in May 2017 you talked about the advantages of a universal basic income. What are the pros and cons of this idea?

The advantages are obvious – it would be a system that matches the flexibility on the labor market, because it is for everyone and not only those who have full time jobs in large companies. What’s more, a universal basic income would create an environment in which it would be much easier to take risks. It is the concern about losing one’s job and not finding a new one that paralyzes many young people and prevents them, for example, from starting their own businesses.

The disadvantages of this idea, or perhaps its costs, are also obvious. It would require a lot of money and a reconstruction of tax systems. The latter, however, should not be seen as a burdensome necessity, but as a potential reform. Universal basic income wouldn’t differ so much from a tax-free amount, if the entire tax system was progressive, devoid of loopholes and if all foreign corporations paid their due tax obligations.

Is the universal basic income the only way to ensure security, which could lead people to take greater risks?

No, we could probably design other systems that foster a sense of security. In a few countries people can, for example, receive a retirement pension, even though they never worked. However, for many such a pension is insufficient to maintain their standard of living and they obtain additional retirement insurance from private pension funds. The same logic of not relying solely on the minimum provided by the state would probably also work in the case of the universal basic income.

Hans Timmer is the World Bank Chief Economist for the Europe and Central Asia Region.

Share this post