August 29, 2018
The World Bank’s annual World Development Report (WDR) is viewed as the Bank’s official statement on best practices in development policy. It is important both because it often serves as a basis for project loans and IMF programs, and also because it is viewed as an authoritative document by many people in policy positions throughout the world.
For this reason, it is disconcerting that the draft report gets some very big things wrong. First and foremost, the overview dismisses concerns over growing inequality by noting that the Gini coefficient in 37 of 41 developing countries stayed the same or fell over the years from 2007 to 2015 (page 7). This is a bizarre conclusion because this is the period of the worldwide financial crisis. Inequality, even in the United States, was little changed over this period, even though there has been a massive increase in inequality over the longer period dating back to the late 1970s. While the experience of the developing countries may differ in this respect from the experience of the United States and other wealthy countries, it is strange that the Bank would use this clearly atypical period as the basis for dismissing concerns about growing inequality.
The other major concern, which is perhaps more important since it provides the basis for many of the specific recommendations, is a misunderstanding of the nature of the labor market. The draft largely accepts the idea that traditional employer–employee relationships are becoming obsolete and effectively urges developing countries to accommodate their policy to this reality. That means weakening or eliminating a wide variety of labor market regulations, such as minimum wages and employment protection rules.
While there has been a large amount of hype in the media about the gig economy, with the idea that workers are increasingly just taking temporary work through web-based apps rather than traditional employment, the data do not support this assessment. This is seen most clearly in the United States where the Bureau of Labor Statistics recently released its Contingent Work Survey (CWS), the first one conducted since 2005.
The CWS showed that there had actually been a slight decrease in contingent employment as share of total employment between 2005 and 2017. Pure gig jobs, like driving an Uber, accounted for less than 1.0 percent of total employment.
The US experience matters because it is often viewed as the model of a modern deregulated labor market. There are far fewer obstacles to gig employment in the United States than in other wealthy countries. This means that if gig employment is not as big a factor in the US economy as is widely believed, there must be greater advantages to the traditional employee–employer relationship than is generally recognized.
If this relationship is not destined to die a natural death, as the WDR seems to assume, then the focus should be on ensuring the right rules are in place to both protect workers and allow for businesses to prosper. The WDR rightly points to the much larger role of the informal sector in developing countries, to which labor market regulations do not apply. However, it is worth noting that the developing countries that have become wealthy (e.g. South Korea and Taiwan) and those in the process (e.g. China and Malaysia) have done so with large formal sectors, not through the modernization of their informal sectors.
This means the argument suggesting that excessive labor market protections are a major problem in developing countries is likely overstated. While there are undoubtedly cases where the protections are poorly structured, successful countries with high living standards for their workforces do have strong labor market protections. The argument that these protections are inconsistent with high employment and good growth has long been disproven. In fact, recent work from the IMF has shown that policies designed to weaken labor market regulations have been associated with large decreases in the labor share of national income. This is presumably not consistent with the World Bank’s goal for a world free of poverty.
The piece also seems to miss the point of some worker protections, most notably severance pay. It makes the argument that limiting the ability of companies to lay off workers can slow productivity growth; this is partly the point of severance pay requirements. It is very difficult for older long-term employees to find new employment after they have been dismissed from a job. This means that they are likely to receive substantial government benefits and still experience a substantial decline in living standards.
The logic of severance pay requirements is to force the company to partly internalize these costs. This may lead them to find ways to keep workers employed, upgrading their skills or training them for new types of work. It is possible this slows productivity growth at the firm level, but if the workers who would otherwise be displaced would largely end up unemployed, then the policy may still increase growth economy-wide.
The WDR also misses an important point about regulation of work hours. While shorter work weeks and work years, along with family leave and sick days, are important for allowing workers free time to pursue other activities, they also increase the availability of formal sector employment. To take the simple story, if the average work year is 20 percent shorter, this implies 25 percent more people will be employed.
While the relationship between hours and employment will never be as simple as this arithmetic suggests, there is little doubt that a reduction in hours per worker leads to an increase in the number of workers. This means that governments that want to increase formal sector employment should put their thumb on the scale to encourage workers to take part of the gains in productivity growth in shorter hours rather than higher pay.
There have been large reductions in the average work year in wealthy countries over the last century. This has been at least in part the result of mandates requiring overtime pay and paid leaves. It is reasonable to expect developing countries to follow a similar path.
The WDR also seems to accept the idea that the corporate income tax will be increasingly difficult to enforce, meaning that countries must turn to more regressive forms of taxation. It actually is not difficult to design a corporate income tax which will be nearly impossible to avoid. Countries can require companies to give them a quasi-equity stake in lieu of income taxes. The quasi-equity stake would take the form of shares of stock which are treated like other shares in terms of dividends or share buybacks but provide no voice in controlling the company. This means, for example, that if the targeted tax rate was 25 percent, the company would turn over a number of shares equal to 25 percent of total outstanding. (This figure would be adjusted, depending on the share of the company’s business in a specific country.)
Structuring the tax obligation in this way would make it nearly impossible for a company to avoid its taxes unless it was also cheating its shareholders. It also has the benefit that it would hugely simplify the tax collection process as well as the accounting burden for companies. They need only pay to the government what they pay to other shareholders. Instead of throwing up its hands and pronouncing the corporate income tax unworkable, it would be helpful to developing countries if the World Bank could assist in ways to make it workable.
One last point is about an issue that really pervades the report. The WDR treats the process of technology as an autonomous force that is imposing itself on economies. While technological progress may have its own logic, the winners and losers from technology is very much a matter of choice.
Specifically, the rules on patents and copyrights, which determine claims to the benefits of technology are the result of conscious policy, not the technology itself. Bill Gates is one of the world’s richest people because governments gave him patent and copyright monopolies on Microsoft software. Without these monopolies, it is entirely possible that Gates would still be working for a living.
It is remarkable that the discussion in the WDR never once mentions the structure of intellectual property as an important issue for developing countries. Imposing patent and copyright rules on these countries means that they paying large amounts of money for software, pesticides and fertilizers, and prescription drugs, all of which would be available for free or at a very low cost in a free market.
Paying monopoly prices for these products will be a major drain of resources for developing countries and a serious impediment to development. It would be reasonable for an organization committed to ending world poverty to be pushing both for weaker rules on intellectual property and alternative mechanisms for financing innovation and creative work. Developing countries need to be thinking about this issue, even if the World Bank isn’t.
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