(This essay was published in Hong Kong Economic Journal on 28 January 2015.)

 

Since 1980 the world has experienced the highest rate of growth in real GDP per capita in human history. The global economy has become more open and free, and also more integrated. Economics professor Andrei Shleifer of Harvard has called it the era of Milton Friedman. The communist economies entered the global marketplace. South Asia, Latin America, Sub-Sahara Africa, and other developing economies became more integrated into the world economy.

 

At the same time, poverty rates have declined significantly. According to the World Bank: “The number of people living on less than $1.25 a day has fallen from 52% in 1981 to 21% in 2010, even as the developing world’s population grew by 59%.”

 

Many poor people from developing countries have joined the world’s new middle-income class, resulting in a decline in world income inequality from 0.665 in 1980 to 0.61 in 2006, as measured by the Gini-coefficient.

 

Yet in every country the popular media is full of reports that globalization has worsened income inequality and further impoverished the poor. Why?

 

In the rich developed countries, by contrast, many in the middle-income class, who are actually among the world’s high-income class, have experienced no improvement in their standard of living in this period of globalization and rapid economic growth.

 

Domestic income inequality has worsened within many countries, even though world income inequality has improved. The former is far better known and reported in the media than the latter. At the end of the day, improving world income inequality is a humanitarian concern, but worsening domestic inequality is a political problem for national governments.  Domestic issues attract far more daily media attention.

 

Precisely because it is so much discussed, there is a mistaken belief that the world today has become more unequal and impoverished because of globalization. That rapid economic growth has not brought benefits to the poor people. That trickle down economics is not working when the exact opposite is true.

 

The enormous economic achievement brought about by globalization in alleviating world poverty and promoting growth has been hugely under appreciated. Indeed, for as long as I can remember people have been told that there is a tradeoff between efficiency and equity.

 

Policies that promote economic efficiency are seen as to worsen equity, and vice versa. Policy debates between the political left and the political right in most countries have been framed in these terms. The right favors more efficiency and faster economic growth and the left wants greater equity at the expense of economic progress. But the evidence since 1980 is that there does not appear to be any such tradeoff between efficiency and equity.

 

People around the world are wealthier and healthier today as a result of economic progress. They are working shorter hours, living longer lives, and have more money to spend on goods. Vast numbers of people now have a higher proportion of free time that they can devote to voluntary work. And this means growing numbers will choose to spend time working for non-profit corporations without being paid.

 

All this is possible only because business corporations have been hugely successful in striving to become more productive and innovative. They have thrived through competition in the marketplace, in a growing, integrating world economy. Competition has brought out the best of many for-profit corporations.

 

But there are looming challenges. The coming of the Third Industrial Age will shed many jobs as businesses continue to innovate and become even more technologically productive. This could create social and political problems.

 

Should governments retain less productive companies in order to save jobs?

 

Japan has supported a retail distribution system, which everyone in Japan knows to be obsolete and frightfully expensive, but it is kept as a form of social security for a small group of older people. Propping up inefficient, low-productivity businesses to keep people employed harms the economy and is a very expensive form of social welfare.

 

Japan is suffering from such self-inflicted wounds in failing to undertake long overdue structural economic reforms. By keeping a small group of older people employed, they prevent innovation of their retail distribution system. And this prevents the creation of new well-paying jobs and the hiring of more people. The entire economy suffers as a consequence.

 

The idea of retaining sunset industries is a badly misguided one. It is just another side of the old narrative about tradeoffs between efficiency and equity. Japan sacrifices higher growth in order to achieve greater equity.

 

Unfortunately, these misguided ideas have believers everywhere. In Hong Kong, highly intelligent people believe it was a mistake to privatize public housing estate shopping spaces because it harms the livelihood of a small group of older shopkeepers. Others lament that the city’s fond memories of yesteryear will be lost as “papa mama” stores disappear. What is missing in these lamentations is the fact that quality jobs were created after the economic value of these shopping spaces was enhanced.

 

The other alternative to saving jobs is to rely on non-profit corporations to create jobs, especially quality jobs, to absorb displaced workers. But to do this, the non-profits must also innovate and raise productivity. Even jobs of lesser quality require more funding either from government subvention, private philanthropy, business sponsorship, or paying clients.

 

In the past, heavy reliance on government subvention was the most important reason why productivity growth in many of non-profits was low. Government funding discourages innovation. Governments do not like failures even when they pay lip service to the importance of innovation. Innovation requires experimentation and cannot avoid failures. Non-profit corporations that rely mainly on government subvention have learned that failures will negatively impact future funding.

 

Accepting government subvention also means accepting government regulations that often end up eroding the incentive to innovate and raise productivity. All too often government funding is granted for familiar ways of doing things that are subsequently described as innovative. Evaluations of outcomes are usually forgiving in order to avoid embarrassing the government as the original funding source.

 

To encourage innovation and raise productivity, it is necessary to diversify the sources of funding for non-profit organizations. Drafting a new, longer, better-designed evaluation form is not the solution. Innovation can only happen if the non-profits are given greater operational flexibility. Conditions have to be created under which a task is outlined by government, and carried out locally and on a competitive basis by non-government corporations, including both for-profit and non-profit agencies, which are reimbursed so that public funding is given directly to clients rather than agencies.

 

At present in Hong Kong, vouchers are used to fund kindergarten places, elderly outpatient medical fees, and bed places in elderly homes. Many more services could adopt such arrangements – arts, culture, entertainment, counseling, teaching, training, personal care, health care, elderly care, child care, urban services, and numerous types of social services. A mix of for-profit and non-profit corporations is already delivering some of these services, but funding is primarily through subventions given to agencies rather than reimbursements to clients.

 

The neglected but critical element in funding arrangements is to foster competition among providers for clients. Direct subvention to service agencies is less effective in encouraging them to innovate than using vouchers or fee reimbursement to foster meaningful competition.

 

Too often, insider interests dominate non-profit agencies. Sometimes entire sectors and occupations are close to being monopolized and unionized, thereby contributing directly to the lack of competition. Such practice dampens the need to compete for clients, reduces the incentive to raise productivity and create quality jobs, and harms the rest of the economy.

 

The root cause of the problem is that direct government subvention of service agencies removes the client as the centerpiece of service focus.

 

When the partnership between government and service agencies becomes the only one that matters in deciding service provision, politics dominates the landscape. Each party has an exclusive hold over the other in a symbiotic partnership. The insider interests among service providers seek out government for funding and influence. Government extends patronage and financial aid to secure political support. The only form of competition that exists among the service agencies is political competition for influence and funding – not market competition to serve the client better.

 

Political competition discourages innovation and is naturally protectionist. It can end up defending uniformity and mediocrity, the exact opposite of what market competition is designed to foster.

 

Diversifying funding sources would be a healthy development for the client. The alternatives to government as a funding source are found among for-profit corporate sponsorship, private philanthropy, and client payment with reimbursement. Government funding can be more effective if it is used to match or reimburse private sources.

 

Developing these alternative sources of funding would necessitate making non-profits more transparent and accountable for their activities. Here the government has an important role in terms of establishing a governance and supervisory framework, setting standards of reporting, mandating audits, and in general requiring as much transparency as publicly listed companies have to report.

 

The purpose of funding diversification is to encourage non-profit corporations to behave and compete in the same manner as for-profit ones. Only when the Third Sector also succeeds in innovating and raising productivity will our economies be able to provide quality jobs for future displaced workers and address domestic inequality. Efficiency and equity do not have to be conflicting objectives, but only by harnessing the forces of competition for clients can these twin goals be made compatible. Globalization has demonstrated how increased economic growth rates and reduced world income inequality can both be achieved at the same time.

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