FAC­ULTY FO­CUS Will Mitchell

Rotman Management Magazine - - CONTENTS - Will Mitchell, Pro­fes­sor of Strate­gic Man­age­ment, Rot­man School of Man­age­ment

ARE STRONG MAR­KET-BASED ECONOMIES more so­cially eq­ui­table? My cur­rent re­search looks at whether the strength of mar­ket economies — based on fac­tors such as the ro­bust­ness of cap­i­tal and labour mar­kets — re­lates to in­come equal­ity and life ex­pectancy in those coun­tries. Ac­cord­ing to my analysis of cur­rent pat­terns in more than 160 coun­tries, the an­swer is Yes: On av­er­age, a stronger mar­ket ori­en­ta­tion cor­re­lates with both more-even in­come dis­tri­bu­tion and greater longevity for peo­ple born in that coun­try.

These re­sults stand in the face of re­cent pop­ulist ar­gu­ments in the U.S. and Europe that are seek­ing to over­turn mar­ket-based in­sti­tu­tions. At the same time, though, the pat­terns I have ob­served high­light lim­its in mar­ket-based in­sti­tu­tions and point to a need for more thought­ful so­cial poli­cies as com­ple­ments to mar­ket ac­tiv­ity.

Be­fore I discuss the pat­terns iden­ti­fied in my analysis, it is im­por­tant to re­mind our­selves of what ev­ery stu­dent of statis­tics learns in their first class: Cor­re­la­tion does not im­ply cau­sa­tion. As a re­sult, we need to be care­ful in ex­plain­ing why mar­ket economies might help cre­ate more eq­uity. Nonethe­less, in this ar­ti­cle I will at­tempt to pro­vide some in­sights about op­por­tu­ni­ties for achiev­ing both mar­ket-based ac­tiv­ity and so­cial eq­uity—while high­light­ing lim­its that point to a need for ef­fec­tive so­cial in­sti­tu­tions as com­ple­ments to mar­ket ac­tiv­ity.

First, let’s con­sider two mea­sures of so­cial eq­uity. One is the Gini in­dex, which mea­sures the in­come dis­tri­bu­tion of a coun­try’s res­i­dents. In the Gini in­dex, 0 rep­re­sents ‘per­fect equal­ity of in­come dis­tri­bu­tion’ and 1 rep­re­sents ‘per­fect in­equal­ity’. Hence, a lower num­ber in­di­cates greater in­come equal­ity. Coun­tries with low Gini val­ues (i.e. evenly spread in­comes) in­clude Ukraine, Slove­nia, Nor­way, the Czech Repub­lic, Swe­den, Ice­land and Den­mark, all with scores be­low 0.30. Coun­tries with high Gini rat­ings (i.e. un­even in­come dis­tri­bu­tion) in­clude South Africa, Namibia and Haiti (all above 0.60).

A sec­ond in­di­ca­tor of so­ci­etal eq­uity is life ex­pectancy: How long can a per­son ex­pect to live if they are born in a par­tic­u­lar place, and what is the coun­try’s rate of in­fant mor­tal­ity? Coun­tries with longer av­er­age life­spans and lower in­fant-mor­tal­ity rates have greater ‘life ex­pectancy eq­uity’. Cur­rently, Hong Kong has the long­est life ex­pectancy in the

world (84 years), while Swazi­land is low­est (48 years). Lux­em­bourg has the low­est in­fant-mor­tal­ity rate (1.5 deaths per 1,000 births), while An­gola has the high­est (96 per 1,000).

The ques­tion is, does the strength of a coun­try’s mar­ket in­sti­tu­tions re­late to ei­ther in­come eq­uity or life ex­pectancy?

To mea­sure the strength of a coun­try’s mar­ket in­sti­tu­tions, I de­vel­oped what I call the in­dex of Voids in Mar­ketBased In­sti­tu­tions, VIMBI for short. The VIMBI in­dex in­cludes six as­pects of mar­ket ac­tiv­ity:

1. Strength of cap­i­tal mar­kets

2. Qual­ity of labour mar­kets

3. Sim­plic­ity of busi­ness rules

4. Ease of con­tract en­force­ment

5. Qual­ity of phys­i­cal in­fras­truc­ture, and

6. Ex­tent of cor­rup­tion.

When com­bined, the six VIMBI items cre­ate an in­dex with a scale of 0 to 1 that in­di­cates how straight­for­ward it is to es­tab­lish and op­er­ate a busi­ness in that coun­try, with a high value on the in­dex indi­cat­ing stronger mar­ket ori­en­ta­tion. In 2017, Sin­ga­pore and Hong Kong rate high­est (0.94), while Libya ranks low­est (0.14). Other high-ranked coun­tries in­clude Den­mark, New Zealand and Aus­tralia; while oth­ers with a low mar­ket ori­en­ta­tion in­clude Afghanistan and Eritrea.

As a first step in study­ing whether stronger mar­ketbased economies are more eq­ui­table, I cal­cu­lated cor­re­la­tions be­tween the VIMBI and Gini in­dices. Fig­ure One re­ports the cor­re­la­tions. As in­di­cated, there are pos­i­tive re­la­tion­ships with the de­gree of in­come equal­ity (re­verse scal­ing of the Gini in­dex) and the strength of the ag­gre­gate VIMBI in­dex (the green col­umn in Fig­ure One, with cor­re­la­tion equal to 0.38), as well as with each of the six com­po­nents of the VIMBI in­dex (the blue col­umns in Fig­ure One). Therefore, coun­tries with stronger mar­ket-based in­sti­tu­tions tend to have more evenly- dis­trib­uted in­comes.

Be­fore we discuss why strong mar­ket economies might be more eq­ui­table, it is use­ful to ad­dress a ques­tion that thought­ful read­ers may well raise: Does greater in­come eq­uity sim­ply mean that peo­ple eq­ui­tably set­tle for lower av­er­age in­comes?

The two col­umns on the right hand side of Fig­ure One help to dis­pel this idea: These pos­i­tive cor­re­la­tions (0.24 to 0.30) demon­strate that coun­tries with greater in­come eq­uity also tend to have higher av­er­age in­comes (gross na­tional in­come per capita, based on pur­chas­ing power par­ity) and higher growth in per capita in­come over the past quar­ter cen­tury. Thus, greater in­come eq­uity tends to oc­cur in coun­tries with higher — rather than lower — av­er­age in­comes.

As we discuss how mar­ket strength might con­trib­ute to in­come equal­ity, it is im­por­tant to rec­og­nize that any causal­ity in these re­la­tion­ships is com­plex. It is pos­si­ble that greater eq­uity in­flu­ences the for­ma­tion of mar­ket in­sti­tu­tions, for in­stance, as well as the other way round. And other fac­tors, such as so­cial norms, likely in­flu­ence both eq­uity and mar­ket in­sti­tu­tions. Nonethe­less, it is use­ful to con­sider how the

pres­ence of strong mar­ket in­sti­tu­tions might con­trib­ute to so­cial eq­uity.

I will now discuss each of the six VIMBI el­e­ments re­lates to in­come eq­uity.

STRONG LABOUR MAR­KETS. The labour mar­ket in­di­ca­tor in­cludes three fac­tors: The ex­tent of post-se­condary ed­u­ca­tion in a coun­try, the flex­i­bil­ity with which busi­nesses can add or sub­tract em­ploy­ees, and the ex­tent to which em­ploy­ees re­ceive sup­port if they lose em­ploy­ment. I found that, of the six VIMBI el­e­ments, strong labour mar­kets have the strong­est cor­re­la­tion with in­come eq­uity (0.38). Stronger labour mar­kets mean that it is eas­ier for busi­nesses to cre­ate high qual­ity jobs and for peo­ple to shift be­tween jobs. In turn, greater em­ploy­ment qual­ity, flex­i­bil­ity and sup­port mean that more peo­ple have ac­cess to well-pay­ing jobs. Clearly, some ex­ec­u­tive po­si­tions will earn far above av­er­age wages—and those dis­par­i­ties some­times cre­ate sub­stan­tial so­cial ten­sion. Nonethe­less, op­por­tu­ni­ties for de­sir­able em­ploy­ment tend to ex­tend through­out an econ­omy, im­prov­ing in­come equal­ity.

CON­TRACT EASE. This el­e­ment also has a sub­stan­tial cor­re­la­tion with in­come eq­uity (0.38). The eas­ier it is to cre­ate and pro­tect con­tracts, the eas­ier it is to cre­ate and change busi­nesses, and in turn, this cre­ates more em­ploy­ment op­por­tu­ni­ties. More­over, the abil­ity for busi­nesses to adapt means that busi­ness ac­tiv­i­ties tend to re­main in­no­va­tive, so that em­ploy­ment is more likely to of­fer well-pay­ing op­por­tu­ni­ties for a larger num­ber of peo­ple, again pro­mot­ing in­come equal­ity.

GREATER TRANS­PARENCY/LOWER COR­RUP­TION. A high de­gree of trans­parency en­cour­ages new in­vest­ment, in­clud­ing in­vest­ment that can cre­ate mar­ket-lead­ing op­por­tu­ni­ties. The new in­vest­ments then cre­ate new jobs, in­clud­ing those in higher mar­gin new busi­nesses. This again pro­motes both higher in­come and wide-rang­ing em­ploy­ment op­por­tu­ni­ties. As a re­sult, lower cor­rup­tion has sig­nif­i­cant cor­re­lates with in­come eq­uity (0.30).

RO­BUST PHYS­I­CAL IN­FRAS­TRUC­TURE. Roads, air­ports, en­ergy avail­abil­ity and other key sup­port for busi­ness ac­tiv­ity also cor­re­late with in­come equal­ity (0.26). Such in­fras­truc­ture also pro­motes busi­ness ac­tiv­ity, and that ac­tiv­ity again cre­ates de­sir­able em­ploy­ment op­por­tu­ni­ties.

SIM­PLIC­ITY OF RULES. The sim­plic­ity of a coun­try’s busi­ness rules also cor­re­lates with in­come eq­uity (0.26). Coun­tries with straight­for­ward rules — such as stream­lined con­struc­tion per­mits and clear tax sys­tems — fa­cil­i­tate busi­ness cre­ation and adap­ta­tion. This busi­ness dy­namism, again, of­fers broad-based em­ploy­ment op­por­tu­ni­ties.

RO­BUST CAP­I­TAL MAR­KETS. Fi­nally, the pres­ence of ro­bust cap­i­tal mar­kets cor­re­lates with in­come eq­uity (0.24). Ease of ac­cess to cap­i­tal and the abil­ity to pro­tect in­vestors fa­cil­i­tate busi­ness cre­ation and growth. Once again, the dy­namism helps cre­ate broad-based em­ploy­ment.

Over­all, then, we can say that the pres­ence of a strong set of mar­ket-sup­port­ing in­sti­tu­tions pro­motes busi­ness ac­tiv­ity, and that ac­tiv­ity not only gen­er­ates em­ploy­ment op­por­tu­ni­ties but also helps busi­nesses in a coun­try stay on the lead­ing edge of their mar­kets, so that many of the jobs are well­pay­ing. The most vis­i­ble part of that ac­tiv­ity is of­ten high ex­ec­u­tive com­pen­sa­tion, yet even if it is less vis­i­ble, there also tends to be a broad base of em­ploy­ment op­por­tu­ni­ties. Hence, ro­bust mar­ket-based in­sti­tu­tions can help to fa­cil­i­tate in­come eq­uity.

At the other end of the VIMBI scale, coun­tries with lim­ited mar­ket-based in­sti­tu­tions of­ten have both lower per capita in­come and highly un­equal in­comes. The high dis­per­sion in in­come dis­tri­bu­tion arises be­cause a small pro­por­tion of the pop­u­la­tion, of­ten po­lit­i­cally con­nected, con­trols many of the re­sources and op­por­tu­ni­ties in the coun­try.

Fig­ure Two shows that the VIMBI In­dex also cor­re­lates with both longer life ex­pectancy at birth (0.72) and lower in­fant mor­tal­ity (0.71). Let us briefly con­sider why ro­bust mar­ket in­sti­tu­tions might con­trib­ute to these health out­comes.

The greater dis­per­sion of in­come in the U.S. partly re­flects lesser in­te­gra­tion of im­mi­grants into its core econ­omy.

The sim­plest ex­pla­na­tion is that more ac­tive busi­ness ac­tiv­ity gen­er­ates wealth that can be in­vested in health­care, ide­ally widely avail­able to a pop­u­la­tion.

Again, we need to be cau­tious in in­ter­pret­ing life-ex­pectancy pat­terns, be­cause re­verse causal­ity can also ap­ply: Health­ier coun­tries, as re­flected in longer life ex­pectancy, can fa­cil­i­tate busi­ness ac­tiv­ity by pro­vid­ing healthy em­ploy­ees. In turn, growth in busi­ness ac­tiv­ity will of­ten en­cour­age the de­vel­op­ment of strong mar­ket-based in­sti­tu­tions. With this ex­pla­na­tion, the causal­ity would run from health to busi­ness ac­tiv­ity to mar­ket-sup­port­ing in­sti­tu­tions, rather than the other way around.

In prac­tice, it is likely that both di­rec­tions of causal­ity arise: Mar­ket in­sti­tu­tions fa­cil­i­tate busi­ness ac­tiv­ity and health; and, in turn, health fa­cil­i­tates busi­ness ac­tiv­ity and mar­ket in­sti­tu­tions. This com­bi­na­tion cre­ates a vir­tu­ous cy­cle, with mu­tual re­in­force­ment of mar­ket-sup­port­ing in­sti­tu­tions, busi­ness ac­tiv­ity, in­come and health — lead­ing to the de­vel­op­ment of ro­bust, eq­ui­table economies.

Ex­cep­tions to the Rules

The pat­terns I have dis­cussed so far are gen­eral ten­den­cies; they are not set in stone. In­deed, some coun­tries are no­table ex­cep­tions to the trends.

The two coun­tries with the high­est VIMBI rat­ings in 2017, Sin­ga­pore and Hong Kong, have rel­a­tively high re­cent Gini scores (0.46 and 0.54), well above the av­er­age score of 0.40 for the 164 coun­tries with re­cent Gini rat­ings from the World Bank. For these two coun­tries, the ex­cep­tions par­tially re­flect the re­cency of the de­vel­op­ment of mar­ket in­sti­tu­tions, as both have un­der­taken strong mar­ket ori­en­ta­tions dur­ing the past half cen­tury. Both coun­tries also have ex­ten­sive ‘guest worker’ pop­u­la­tions, many of whom have in­comes far be­low that of cit­i­zens of the coun­tries.

Nonethe­less, peo­ple in both Sin­ga­pore and Hong Kong en­joy high life ex­pectancy (83 and 84 years) — well above the global av­er­age of 72 years, partly as a re­sult of so­cial in­vest­ment in health­care ser­vices. Hence, although the strong mar­ket in­sti­tu­tions in a coun­try may not have gen­er­ated in­come eq­uity, they are con­sis­tent with life ex­pectancy, par- tic­u­larly when re­in­forced with so­cial poli­cies.

Com­par­ing the United States and Canada is also in­trigu­ing: The U.S. has a rel­a­tively high VIMBI rat­ing (0.83) and a Gini score (0.41) slightly above the av­er­age of the World Bank es­ti­mates. By com­par­i­son, Canada has a sim­i­lar VIMBI rat­ing (0.82) and a sub­stan­tially lower Gini score (0.34). The greater dis­per­sion of in­come in the U.S. partly re­flects lesser in­te­gra­tion of im­mi­grants into its core econ­omy. In ad­di­tion, the some­what weaker so­cial safety net in the U.S. — and in par­tic­u­lar, more lim­ited avail­abil­ity of health in­sur­ance — has made it more dif­fi­cult for some peo­ple to re­main em­ployed. The lower avail­abil­ity of health in­sur­ance also likely con­trib­utes to the some­what lower life ex­pectancy at birth in the U.S. (79 years vs. 82 in Canada) and higher in­fant mor­tal­ity rate (5.6 per thou­sand births vs. 4.3 in Canada). In this com­par­i­son, once again, greater eq­uity re­flects a com­bi­na­tion of mar­ket and so­cial in­sti­tu­tions.

Ex­cep­tions also arise at the other end of the VIMBI scale. São Tomé and Principe, Niger, Guinea, Cam­bo­dia and Bu­rundi all have low VIMBI scores (0.25 to 0.30) and

Gini rat­ings well be­low av­er­age (0.31 to 0.34). These coun­tries also have low per capita in­come (from less than $700 to about $3,300). In these cases, a lack of mar­ket-based in­sti­tu­tions has trans­lated into few op­por­tu­ni­ties for al­most all peo­ple in the coun­try.

In clos­ing

Un­ques­tion­ably, there is a sub­stan­tial sta­tis­ti­cal re­la­tion­ship be­tween mar­ket ori­en­ta­tion (the VIMBI In­dex) and so­cial eq­uity, as mea­sured by the Gini in­dex of in­come dis­par­ity and life ex­pectancy mea­sures. As noted, the causal­ity un­der­ly­ing these re­la­tion­ships is mul­ti­fac­eted. Nonethe­less, part of the ex­pla­na­tion stems from the abil­ity to cre­ate dy­namic busi­nesses that, in turn, cre­ate wide­spread em­ploy­ment op­por­tu­ni­ties and sup­port for good health. In turn, healthy em­ployed peo­ple help to fos­ter busi­ness op­por­tu­ni­ties, cre­at­ing a vir­tu­ous cy­cle of com­merce and eq­uity.

These pat­terns both de­fend mar­ket-based cap­i­tal­ism and il­lus­trate its lim­its. Mar­ket in­sti­tu­tions help to cre­ate eq­ui­table so­ci­eties, with wide­spread ben­e­fits; yet, these same in­sti­tu­tions are now un­der at­tack by pop­ulist re­volts in mul­ti­ple coun­tries — in­clud­ing coun­tries in which mar­ket in­sti­tu­tions first took root, such as the U.S. and West­ern Europe.

The pat­terns dis­cussed herein should serve as a warn­ing about the risks of de­stroy­ing the ben­e­fits of the mar­ket. Nonethe­less, these eq­uity pat­terns do not sup­port the idea of an un­fet­tered mar­ket, dom­i­nat­ing so­cial ac­tiv­ity in a coun­try. In­deed, over-re­liance of mar­ket dom­i­na­tion within coun­tries and via global strat­egy has con­trib­uted to the rise of pop­ulism in the U.S. and Europe. While, on av­er­age, mar­ket ac­tiv­ity may help to fa­cil­i­tate eq­uity, mar­ket economies also cre­ate losers, as some peo­ple suf­fer real de­clines in wel­fare. Oth­ers, per­haps more com­monly, do not face lower liv­ing stan­dards in ab­so­lute terms but face rel­a­tive de­clines, as oth­ers catch up and some­times move ahead. Hence, the reshuf­fling of po­si­tion — in­clud­ing the very process of cre­at­ing greater eq­uity — can gen­er­ate anger and op­po­si­tion.

In or­der to de­fend mar­ket-based cap­i­tal­ism, we need to rec­og­nize and ad­dress its lim­its. So­cial eq­uity within a coun­try does not stem solely from busi­ness ac­tiv­ity: So­cial en­gage­ment in sup­port mech­a­nisms is also crit­i­cally im­por­tant. In this re­gard, poli­cies that fa­cil­i­tate broad-based health­care are crit­i­cal.

Sim­i­larly, it is es­sen­tial to in­vest in in­sti­tu­tions that help peo­ple stay abreast of chang­ing em­ploy­ment needs and op­por­tu­ni­ties, and to catch up when their in­dus­tries and jobs are dis­placed. As a re­sult, on­go­ing sup­port for ed­u­ca­tion in grade schools, com­mu­nity col­leges, and other post-se­condary in­sti­tu­tions is crit­i­cally im­por­tant, as is in­come sup­port that helps peo­ple re­tain dig­nity and pro­vide time to go back to school when needed. Pro­grams that help im­mi­grants quickly en­gage in the eco­nomic and so­cial fab­ric of a coun­try are equally im­por­tant.

In­deed, many of the mar­ket-based in­sti­tu­tions that make up the VIMBI In­dex de­pend on so­cial in­vest­ments. Sup­port for ed­u­ca­tion and poli­cies that sup­port em­ploy­ees when they lose jobs (labour), le­gal poli­cies that pro­mote trans­parency (cor­rup­tion), pub­lic in­vest­ments in roads, air­ports, and other in­fras­truc­ture (phys­i­cal in­fras­truc­ture), and reg­u­la­tions that seek a bal­ance of risk and re­ward in fi­nan­cial ser­vices (cap­i­tal) are cen­tral to the In­dex. Hence, at the core, strong eq­ui­table economies re­flect a thought­ful mix of both busi­ness and so­cial in­sti­tu­tions.

The reshuf­fling of po­si­tion—in­clud­ing the very process of cre­at­ing greater eq­uity—can gen­er­ate anger and op­po­si­tion.

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