What policies will reduce poverty – and how do we pay for them?
Social policy debates about income distribution have shifted sharply in the past few years. For decades, Canadian attention was focused almost exclusively on the ups and downs of the “poverty rate.” The one great success of the Occupy Movement in 2011 was to shift attention to the larger issue of income inequality and the phenomenal rise in the incomes of the top 1 per cent, a trend that has continued. As a result, “poverty talk” has faded somewhat.
Is it time for another look? One reason to think so is that in normative terms, trends in inequality immediately bring us back to asking questions about poverty.
In his influential A Theory of Justice,1 John Rawls concluded that a rise in inequality is morally acceptable if it is to the absolute benefit of the least well off. He attached substantial ethical weight to absolute – not relative – improvement for the poor. We know that income inequality has risen significantly since the 1980s. So a reasonable question to ask is whether the forces that have generated the inequality surge have been accompanied by improvement in the living standards of the poor. At first glance, the question may appear odd. If inequality rises, doesn’t this mean that the poor are worse off? Not necessarily. Poverty is measured relative to the “middle,” not to the top. By and large incomes in the middle and the bottom have moved in tandem in the past three decades, while top incomes have gained.
A second reason for reviving poverty talk is the analytical turn in poverty policy that has been with us at least since the 1990s. Often expressed with the metaphors of “social investment” and “active labour market policy,” these new ideas were widely adopted by the OECD and the European Union, and have been very influential in Canada.2 They remain with us today.
The core idea of both metaphors was that we could more effectively reduce poverty by structurally replacing “redistributive” (cash benefit) strategies with “productivist” (employment-centred) strategies. In other words, instead of spending money on “after-the fact” cash benefits to individuals and families, we should be spending money on “before-the-fact” programs that raise employment and wages with new social investments in early childhood education, job training and active labour market policies that bring jobs to people.
My reading of the evidence has led me to four basic conclusions.
Conclusion 1: The rise in income inequality between 1980 and the mid-2000s brought little or no improvement in the absolute living standards (Rawls’s criterion) of Canada’s low-income population. Some evidence, however, suggests modest improvement since the mid-2000s. And of interest to many (but not my main topic), there has been no improvement in relative living standards of the poor over the whole period.
My evidence for the first part of the claim is drawn from Lane Kenworthy’s Progress for the Poor.3 Kenworthy is the author of several major works on income inequality. His concern here is with absolute, not relative, living standards. He sets out to assess the extent to which economic growth in the affluent democracies has led to rising incomes among the poor and to identify the policy instruments that matter. Standard poverty measures, he points out, measure relative poverty, and there are good reasons for this approach. However, relative poverty rates can rise even as the incomes of those at the bottom and their living standards improve.
His alternative is to examine the relationship between economic growth and incomes at the 10th percentile (p10) of the income distribution for the period 1979 to 2007 (for Canada 1981–2004) in 17 rich democracies. We can think of this as an exercise in social accounting: to what extent have the benefits of economic growth (per capita GDP) “trickled down” to improve living standards of the poor in recent decades? His conclusion is that, on average, across the 17 countries, growth has tended to be good for low-income families – but not in Canada.
Across the 17 countries, on average, an increase of $10,000 in per capita GDP was associated with a rise of about $3,000 for a single individual and $6,000 for a four-person household at the 10th percentile. In contrast, p10 incomes show essentially no increase over this period in Canada as well as in Australia, Germany, Italy, Switzerland, Britain (until 1995) and the United States (except for 1995–2000). The bottom line in Kenworthy’s analysis through the mid-2000s is that there has been considerable “trickle down” in many countries since the end of the 1970s but not much in Canada.
Kenworthy’s Canadian results hardly come as a surprise. Among others, Andrew Heisz has documented the stagnation in low incomes for over a quarter of a century from 1976 to 2004. Figure 1, taken from Heisz, shows little change in either p10 or p20 incomes.4 Until the mid-1990s, however, the top and middle also shared in this income “stagnation.” The movement of the top away from the middle and the bottom is largely a phenomenon of the economic recovery that occurred beginning in 1996. As Garnett Picot, René Morissette and I showed, the recovery of the late 1990s did not bring the reduction in “poverty intensity” experienced during the economic expansion of the 1980s.5
Both Kenworthy’s and Heisz’s results, however, only bring us to the middle of the last decade. There is some evidence that after a quarter century of stagnation, real incomes in the middle and the bottom half of the income distribution did begin to rise in real terms during the 2000s. The rise was not large enough to offset the growth in income inequality (real incomes in the top half also rose).6 But there is some modest evidence of “trickle down” after 2006. I draw this conclusion from inspection of long-term trends in Statistics Canada’s Low-Income Cut-Off (LICO).7
Statistics Canada routinely produces two “low income” or “poverty” measures, the LICO and the Low Income Measure (LIM), based on somewhat different poverty concepts. The LIM can be thought of as an inequality-type measure: it simply asks what proportion of the population is in families with less than 50 per cent of the median income in the year of observation. The only way the LIM can move is if incomes at the bottom rise or fall at a different rate than incomes in the middle. By this standard, the Canadian poverty rate in 2010 was where it was in 1979 but somewhat higher than in 1989 or 1999. Since 2000, it has been relatively stable at about 13 per cent of the population. No “progress for the poor” by this criterion.
But as Kenworthy notes, LIM-type measures are insensitive to changes in the absolute or real living standards of the poor: hence his p10 criterion. The LICO, which “fixes” the reference year for comparison (in this case 1992), is closer in spirit to the concept of absolute or “real” living standards of those at the bottom. The only way the LICO rate can move up or down is if real (absolute) living standards decline or improve relative to real living standards in 1992. So what does it tell us?
Unlike the LIM, the LICO is very sensitive to the business cycle and secular trends are less visible. The LICO rate hit a historic low of 10.2 per cent in 1989 at the top of the business cycle of the 1980s but then rose to 15.2 per cent in 1996, a result of the recession of the early 1990s. It began falling as recovery set in after 1996 and by 2006, at 10.3 per cent, was back at 1989 levels. Between 2006 and 2011 it declined further to 8.8 per cent, a new historic low, providing evidence for some modest trickle-down in the latter part of the 2000s – but not much of a gain relative to economic growth over the period.
Conclusion 2: Thus far, little evidence supports the claim that “productivist” strategies are an effective replacement for “redistributive” (cash benefit) strategies. But there is a time horizon problem here. Cash benefits still matter a lot in the short and intermediate term because the presumed benefits of social investment and active labour market policies by definition will take a long time to mature. Early childhood education, if effective, will show results only several decades from now.
Where does trickle-down come from? There are two potential sources. The first is the labour market – higher employment and rising wages. The second is income from government transfers. Lane Kenworthy’s conclusion is that rising transfers in line with GDP growth was the main source of trickle-down in the advanced democracies through the mid-2000s.
Kenworthy decomposes p10 income trends in the 17 countries into three components: earnings, other market income and net transfers (transfers minus taxes). He concludes that in almost all countries with significant trickle-down effects, earnings and other market income of low-end households increased little over time. Government transfers to low-end families produced the trickle-down in most countries by raising transfers in line with real GDP growth. In Canada, Australia and Germany both earnings and transfers were essentially flat over the period and trickle-down was negligible. In the United States, p10 households experienced a rise in earnings between 1995 and 2000, but there too net transfers to p10 families were essentially flat over the period.
The major reason that transfers provide the key is that for many people at the 10th percentile, non-employment is a fact of life: they have little labour to sell even in the best of times.
Countries in the European Union took a particularly aggressive stance toward shifting emphasis from cash benefits to employment-based strategies in the 1990s and embedded this commitment in the EU Lisbon Treaty of 2000. Thus far, according to Bea Cantillon and Frank Vandenbroucke, the results have been disappointing.8 Despite deliberate attempts to transform “passive” welfare states based on cash benefits into social investment states, and despite some success at increasing employment, European data through the 2000s suggest a “poverty standstill.” The EU uses a more luxurious cut-off to measure poverty (60 per cent of median income) than Canada, but over the 1990s and 2000s, by this standard, income poverty remained stuck at about 16 per cent, and poverty rates in the traditionally successful Nordic countries actually rose somewhat.
In the concluding chapter, Cantillon suggests that the social investment strategists promised too much. Programs such as early childhood education and job training, she points out, are most likely to advance the relatively strong, not the comparatively weak. Some people are simply difficult to activate relative to their peers.
To Cantillon’s caveat of promising too much, I would add the caveat of too soon. I am a big fan of employment-based strategies, but they are likely to show effects only in the long term.
Consider the labour market. Canada’s unusually high level of low-wage employment was highlighted in OECD reports in the late 1990s and more recently in a Statistics Canada analysis by Sébastien LaRochelle-Côté and Claude Dionne, who follow the OECD practice of defining low-wage work as the percentage of full-year, full-time workers who fall below two thirds of the country’s median earnings.9 By this standard, nearly 25 per cent of Canadian and U.S workers are in low-wage employment compared to 13 to 16 per cent in Germany, Spain, Austria and Belgium and between 7 and 11 per cent in Australia and the Scandinavian countries.
Elsewhere, I show with census data that none of this is new.10 The proportion of full-time, full-year workers taking in less than two thirds of median earnings rose from 22 to 24 per cent over the 30-year period from 1971 to 2001. Our low-wage economy is undoubtedly a major flaw in our social architecture but it has always been so, largely as a result of the comparative weakness of Canadian wage-setting institutions. Canada, like the United States, simply lacks the centralized wage-setting institutions that equalize wage rates in Continental and northern European countries.11 Given the decline of labour representation both at the firm level and in national politics, there is little likelihood of this changing anytime soon.
Will empowering individuals in the labour market through better childhood education change all this? I hope so. But the benefits will only be realized several decades from now when the kids start to work.
This observation leads to my third conclusion.
Conclusion 3: To experiment with productivist strategies, Canada, like all advanced democracies, faces what is often called a “double funding” problem. “Double funding” is a familiar issue in policy analysis. If you want to change your transport system from highways to railways, you still have to fund highways until your new high-speed railways are in place. In the case of the low-income issue, you have to fund “redistributive” (cash benefit) programs until you know that your “productivist” strategies are in fact having the desired outcome.
So let’s imagine that some as yet unelected government wants to shift gears and build an employment-based welfare state. As an old-fashioned social democrat, I am all for that. As Gunnar Myrdal argued, we can afford a luxurious welfare state only if most people are employed at decent wages, and hence pay taxes, for most of their lives. Shifting gears, however, will be expensive and take time. If Canada wants to place its bets on early childhood education, for example, that will require a lot of new “investment.”
There are lots of changes on the margin within our current budget that could improve things, and we should make them. For example, the Caledon Institute has pointed to elimination of pension income-splitting among seniors, which costs $1 billion a year and mainly benefits wealthy seniors. But big institutional changes usually take time. Serious employment-centred agendas have a long time horizon.
The problem is demography. Let’s imagine we prepare our 20-year-olds and the cohorts that follow them for the labour market much better than earlier cohorts, so that low-end wages begin to rise. That’s great! But it will take another 20 years until they are 40 and enough of the cohorts that follow them are in the labour market with appropriate skills to show big effects on the overall distribution of wages and earnings.
Consider the time trajectory of old age poverty, one of Canada’s success stories. By the mid-1990s, Canada’s old age poverty rate was among the lowest among the OECD countries, rivalling even egalitarian Sweden. Our big pension reforms, however, came in the mid-1960s. Even in 1980, Canada still had one of the highest old age poverty rates among the developed countries. It was only over the next decade and half that we began to see the payoff from the 1960s legislation.
Why was that? The answer is time and demography. The first cohort of retirees to receive full Canada and Quebec Pension Plan benefits turned 65 in 1976, the second cohort to receive full benefits turned 65 in 1977, and so on. It took several decades for the older cohorts without such benefits to die out and be replaced by cohorts covered by the new system.
Income distributions are a bit like supertankers. They can’t turn on a dime. And experiments are experiments: some will succeed while others will fail. The success rate of public-sector experiments is no different from that of experiments in the private sector. Most new firms disappear in a few years. There is risk in both sectors.
Since the time horizon on new investments is a long one, we need lots of what is called “patient capital”: investors (tax-paying citizens) who are prepared to wait for their return. My favourite example is a religious order that opened schools in small towns in the Dominican Republic in the 1950s where there were none before. It took 12 years before they had their first high school graduates and another four or five years before their graduates came back from university as teachers, nurses and doctors to meet the needs of their local communities. That’s “patient capital.”
To engage in new “social investments” requires money. Since the investments have long time horizons, we face a “double funding” problem. We can’t simply shift revenues from a “passive,” income-transfer welfare state to an “active” employment-centred welfare state at a point in time and expect “spot-market” results.
Until our new strategies begin to pay off, we have to fund both. And here is where the rubber hits the road. Since 2000, total government revenue in Canada has declined from 44 to 38 per cent of GDP. As Alex and Jordan Himelfarb note, all political parties have been trying to avoid the “tax-and-spend” label in recent elections.12 We’ve been on a downward trend since the 1990s. So if we have to wait for returns on new social investments, what do we do in the meantime? In the short and intermediate term we still need cash benefits, the “Robin Hood” welfare state.
Conclusion 4: Double funding requires higher public investment and higher taxes from everyone, not just the “rich.” But I doubt that “higher taxes from everyone” is a campaign platform that will get me elected prime minister.
I am all in favour of taxing the rich at higher levels than today. However, I doubt that it will do much to solve the poverty or inequality situation we now face. The top 1 per cent makes lots of money, but because they are so few, and have good accountants, I suspect that higher taxes on the rich will not turn the inequality-poverty dial very much.
Sorry folks! Most of us will have to pay more, including many in the middle. But “paying more” refers to “gross,” not “net,” taxation rates. To establish “net” rates (taxes less benefits),we have to include the benefits (including services) that most people receive from their contributions to both the public good and their own futures.
The “productivist,” employment-centred, turn in Canadian policy debate has been a good one, in my view. To steal a phrase from a recent volume on taxation, productivity is not a four-letter word.13 How else do we raise living standards? Raising productivity has been the strategy of the Swedish left for many decades. They were able to combine policies aimed at eliminating low-wage, low-productivity jobs with wage ceilings at the top. We don’t have the wage control option at our disposal because of our decentralized system of bargaining. So we will have to look elsewhere.
To motivate the majority to participate in a productivist strategy, however, requires that the majority experience a payoff. That’s what happened from the 1950s to the 1970s. Since 1980, in contrast, the gains of economic growth have not done much for those at the bottom or even the middle. We have puzzles to solve.
1 Cambridge, MA: Harvard University Press, 1972.
2 See David Green and James Townsend, “Drivers of Increasing Market Income Inequality: Structural Change and Policy,” in Keith Banting and John Myles, eds., Inequality and the Fading of Redistributive Politics (Vancouver: University of British Columbia Press, 2013), pp. 65–92; Jane Jenson, “Historical Transformations of Canada’s Social Architecture: Institutions, Instruments and Ideas,” in Banting and Myles, eds., Inequality and the Fading of Redistributive Politics, pp. 43–64.
3 Oxford, England: Oxford University Press, 2011.
4 Andrew Heisz, Income Inequality and Redistribution in Canada: 1976 to 2004, Analytical Studies Branch Research Paper Series (Ottawa: Statistics Canada, 2007).
5 Garnett Picot, René Morissette, and John Myles, “Low-Income Intensity During the 1990s: The Role of Economic Growth, Employment Earnings and Social Transfers,” Canadian Public Policy, Vol. 29 (2003), pp. 15–40.
6 The income trends documented by Kenworthy and Heisz, however, have to be carefully separated from trends in what has happened to the top 1%. Both rely on national income surveys (SCF/SLID) that are unable to track top 1% incomes or earnings. Results from Michael R. Veall’s paper “Top Income Shares in Canada: Recent Trends and Policy Implications” (Canadian Journal of Economics, Vol. 45, No. 4 , pp. 1247–72), based on taxation data, show that top 1% incomes since the 80s began rising in the 1990s and continued their upward rise in the 2000s.
7 See Brian Murphy, Xuelin Zhang and Claude Dionne, Low Income in Canada: A Multi-Line and Multi-Index Perspective (Ottawa: Statistics Canada, 2013).
8 Bea Cantillon and Frank Vandenbroucke, Reconciling Work and Poverty Reduction: How Successful are European Welfare States? (Oxford, England: Oxford University Press, in press).
9 Sébastien LaRochelle-Côté and Claude Dionne, “International Differences in Low-Paid Work,” Perspectives on Labour and Income, June 2009, pp. 5–13.
10 John Myles, “Postponed Adulthood: Dealing with the New Economic Inequality,” in Edward Grabb and Neil Guppy, eds., Social Inequality in Canada: Patterns, Problems, and Policies, 5th edition (Toronto: Pearson, 2009), pp. 317–23.
11 Michael Wallerstein, “Wage-setting insitutions and pay inequality in advanced industrial societies,” American Journal of Political Science, Vol. 43 (1999), pp. 649–80.
12 Alex Himelfarb and Jordan Himelfarb, “Introduction: Tax is Not a Four-Letter Word,” in Alex Himelfarb and Jordan Himelfarb, eds., Tax is Not a Four-Letter Word: A Different Take on Taxes in Canada (Waterloo, ON: Wilfrid Laurier University Press, 2013), p. 2.
13 Himelfarb and Himelfarb, eds., Tax is Not a Four-Letter Word.
John Myles is Emeritus Professor of Sociology and Senior Fellow of the School of Public Policy and Governance at the University of Toronto.