Council of Europe Development Bank conference, “From Imperative to Urgency: Investment for Social Inclusion” Concluding remarks by Governor Carlos da Silva Costa 1 Good afternoon, It is a great pleasure and honour for me to close this conference on social inclusion promoted by the Council of Europe Development Bank. The lively debates and the range of issues touched upon in the previous sessions illustrate how challenging and complex the topic of social inclusion is. In this closing statement, I will briefly comment on three interrelated issues: • First, I will argue that the dynamics taking place at different jurisdictional and territorial levels are critical to our understanding of the factors promoting or threatening social inclusion. • Secondly, I will comment on the main policy instruments available at national level to promote social inclusion; • And finally, I will stress the key role of a community’s culture and values in determining its ability to generate and sustain inclusion dynamics. 1. The dynamics taking place at different jurisdictional and territorial levels At a global level, we are witnessing the resurgence of nationalism and protectionist policies. The arguments by those defending such policies are largely based on the notion that globalisation has benefited the elites and penalised a large number of workers. As prepared for delivery. www.bportugal.pt With globalisation and technological progress, international flows of people and firms have intensified, and production became increasingly automated and integrated into global value chains. A number of workers in advanced economies, especially those with lower qualifications, have lost their jobs and seen their relative wages and living standards deteriorate. As a result, populist forces have risen, and the risk of reversal of the global integration process is currently very high. This has occurred in spite of notable gains at a macro level over the last few decades. The world has become much richer, and poverty has declined. According to World Bank indicators, between 1981 and 2015, the share of the world population in extreme poverty declined from 42% to 10%, and the world’s real GDP per capita grew by 63%. Naturally, these global dynamics have produced asymmetric impacts across regions. In 2012, the World Bank report Golden Growth described Europe as a “convergence machine”, fuelled by trade and financing. The region had gone through the largest and deepest regional integration process in recent history, generating a sizeable convergence in living standards. However, the convergence machine has left some people and regions behind. A more recent World Bank report, Growing United, identifies two emerging divides that interfere with the convergence process: a productivity divide between countries and regions; and household income inequality within countries. If growth and wealth are not spread equitably in European regions and their several communities of citizens, the Union will be politically challenged and may even cease to be desired. The report goes one step further to show that, within countries, regional divides are widening. And World Bank research found that the main reason for this is low economic potential: lagging regions have poorer institutions, a lower share of skilled workers, and limited access to markets. www.bportugal.pt Interestingly, Portugal had a contrasting experience in the recent past. An empirical study from Universidade do Minho shows that, between 2008 and 2015, inequality among the Portuguese regions in terms of real GDP per capita actually decreased by 12%. This is an encouraging performance compared to European peers, especially when compared to those that were implementing financial assistance programmes during that same period. On a less positive note, in 2016, the vast majority of Portuguese regions were still below the European Union average in terms of GDP per capita in purchasing power parity. This subnational regional analysis is important for two main reasons: • On the one hand, within-countries inequalities in advanced economies have been intensifying – they are the ultimate expression of global and supranational dynamics and are giving rise to growing social and political tension; • On the other hand, policy instruments tailored to address inequality remain mostly in the hands of national authorities. This brings me to the second point I would like to cover. 2. Coping effectively with inequality at the national level The World Bank’s Growing United report argues that the revival of the European convergence machine should be pursued by ensuring equal opportunities for people and firms. This is crucial advice to all policy authorities responsible for addressing inequality: the most effective and sustainable path to reducing inequality is not by redistributing income, but rather by ensuring everyone has comparable opportunities to take part in the generation of income. In other words, although redistribution remains an important complementary tool, the strongest instrument to promote social inclusion is inclusive growth. Three institutions are particularly relevant for generating inclusive growth: education, the labour market and the business environment. www.bportugal.pt Let me start with education. As already pointed out by many studies, universal access to highquality education ensures equal access to opportunities, and subsequently, equal access to income. But the education system needs to be adequately tailored to respond to the evolving needs of labour and product markets. As technological progress changes the nature of work at an increasing pace, firms become more demanding with respect to the human capital they hire. For example, while demanding for more cognitive skills, they are also requiring better socio-behavioural skills, which are crucial for agile adaptation to change. The education system also needs to take into account the development stage of the economy. Any serious mismatch between the skills offered by recent graduates and those demanded by firms inevitably leads to exclusion. A recent study by Associação Empresarial de Portugal, a Portuguese business association, shows that, between 2011 and 2017, the share of unemployed people with post-primary education increased from 34% to 48%. Such a growing share of high-quality untapped human resources highlights the need for an adequate interconnection between the education system and the next institution I would like to discuss: the labour market. In turn, a sound and dynamic labour market not only optimises initial matches between workers and firms, but also promotes fluid movements of workers across industries, regions and skills. While employment protection legislation and wage-setting institutions have successfully reduced wage inequality, excessive protection jeopardises firms’ productivity and job creation – especially for low-skilled workers and new entrants. Despite having become less restrictive since the 1990s, employment protection for permanent contracts in most of the European Union remains above the OECD average. www.bportugal.pt Lifelong learning is another critical element when considering the labour market, in the face of accelerating technological change. This means that authorities must search for the right balance between expenditure on passive labour market measures, such as income support and early retirement, and expenditure on active labour market measures, such as training or startup incentives – for most EU countries, passive measures absorb more resources than active measures. But as the World Bank’s Growing United report rightly states: “opportunities for firms and people are complementary and jointly determine the potential to grow inclusively”. If it’s true that an economy with few opportunities for people loses economic and political viability, it is also true that the lack of opportunities for firms promotes the migration of both people and firms towards more dynamic economies. This leads me to the third institution behind inclusive growth: the business environment. The business environment must be, simultaneously, supportive and challenging. One relevant component of the environment in which firms operate is physical infrastructure. Firms need to communicate at an increasingly faster pace, and for that they need not only a good and efficient road network, but also high-speed broadband connections. It is the role of public investment to provide such conditions, without overlooking or crowding out private investment. A second important element of the business environment is the ease of reallocating resources towards more productive sectors. The simplification of insolvency procedures, the acceleration of judicial decisions, or the reduction of red tape are of the essence here. A third element is the innovation ecosystem and its ability to involve entrepreneurs in the production of knowledge and its successful transformation into innovative technologies, processes or products. Empirical research shows that a pro-competitive business environment fosters innovation, and that innovation is a powerful driver of employment growth. Innovation www.bportugal.pt is thus instrumental for any society to remain economically, politically and socially included in today’s global economy. Conversely, international trade and investment are strong drivers of domestic innovation. In brief, these three institutions – education, labour market and the business environment – must be designed to generate a context that fosters personal initiative, either in the form of educational attainment, job searching or entrepreneurial activity. Nevertheless, one needs to realise that these are necessary – but not sufficient – conditions. The World Bank points out a set of factors that undermine the success of some of its social inclusion projects. Among these, one can find cultural preferences and social perceptions. This leads me to third and last topic I promised to address. 3. The key role of a community’s culture and set of values No institutional framework can ever be successfully established against or even in spite of the set of values, preferences and perceptions of the communities it intends to serve. A case in point is the dichotomy between the North and South of Italy. In spite of sharing the same institutional framework, these two regions show quite different development paths, due to their distinct historical backgrounds and sets of values. In the case of Portugal, many industrial areas appeared due to the entrepreneurial initiative of a given person, family or firm, which led by example, inspiring the surrounding community and generating adjacent businesses. In such a socio-economic fabric, social exclusion appears when a given community lacks success cases to look up to, ceasing to believe in the power of education, dynamic labour markets or friendly business environments. Socio-cultural factors must therefore be taken into account in the design of public policy, including in the design of the education system or in territorial planning. www.bportugal.pt Empirical evidence 2 points to social segregation in schools as a driver of skills inequality. The relatively poor performance by students from disadvantaged backgrounds is partly correlated to the fact that they are clustered together in lower quality schools. Likewise, social housing policies should not bring about the creation of loser and winner communities. Each community should include individuals considered winners and losers, in order for the former to be inspired by the latter and never stop believing they have equal opportunities to generate income. Inclusive social housing is precisely one area of public policy that has benefited extensively from the expertise and contribution of the Council of Europe Development Bank, which has the noble mission of supporting social inclusion in Europe. Conclusion In conclusion, let me highlight the following key messages. • Globalisation’s impact operates in at least two dimensions – income and employment. Globalised trade impacts the level and distribution of income, but it also impacts the way employment is distributed across territories and across sectors. • Redistribution will always be the reverse side of globalised trade. There will always be gains, but also losses… there will always be creation, but also destruction. Low-skilled workers and sectors competing with imports are evident examples. Studies show that redistribution costs rapidly surpass trade gains. And some of those costs are not reversible. When, for example, a given regional cluster disappears due to competition, it may never resurge again. • If there are no compensation mechanisms, discontent will rise. The European convergence machine has partially compensated for the impacts of globalisation through cohesion policies. Public transfers are adequate as a first, more agile, response. Ridao-Cano, Cristobal; Bodewig, Christian (2018). www.bportugal.pt • However, public transfers won’t effectively solve the problem of loser communities, socially and geographically marginalised. This redistribution across communities has been shown to be empirically more important than redistribution across skill levels. Without any other complementary policy, public transfers may generate dependency and destroy incentives. This problem can only be effectively solved o By adapting policy to the cultural preferences of those communities; o By designing basic institutions in a way that every community is involved in the production process and becomes the owner of its own destiny; o And by submitting globalisation to a set of basic rules ensuring everyone benefits from a fair level playing field and public intervention is dully framed. • In sum, a fine balance is needed between, on the one hand, inclusive rules and institutions, and, on the other, compensatory transfers. Both must be constantly calibrated, given that o the destructive power of each shock depends on its intensity and duration, and o there will always be a shock that no rule or institution may ever prevent – and that is technological innovation. The most effective strategy to overcome the challenges posed by technological innovation consists of ensuring an inclusive growth of potential output. This means promoting the sustainable growth of GDP per capita while simultaneously involving all the communities and classes of the working age population in the production process. Entrepreneurs and managers are particularly prominent actors in such a strategy. So, let me stop here, and congratulate the Bank for its increasingly relevant mission, and for bringing us together today to reflect on it. Thank you. www.bportugal.pt Bibliography: Alexandre, Fernando, Hélder Costa, Miguel Portela, Miguel Rodrigues (2018), Asymmetric regional dynamics: from bust to recovery, Working Paper Series, NIPE, Universidade do Minho Amador, João (2017), Portugal e o Comércio Internacional, Essays Series, Francisco Manuel dos Santos Foundation Associação Empresarial de Portugal (2019), Dinâmicas Socioeconómicas Regionais, AEP Estudos e Estratégia Baldwin, Richard (2016), The Great Convergence: Information Technology and the New Globalization, Harvard University Press Coady, David and Allan Dizioli (2018), Income Inequality and Education Revisited: Persistence, Endogeneity and Heterogeneity, Applied Economics, Vol. 50, No. 25, pp. 2747–61 de Mello, Luiz, Dutz, Mark A. (2012), Promoting Inclusive Growth: Challenges and Policies, Paris: OECD and the World Bank Farole, T., M. Roberts, J. Park, and C. Hooton (2018), Assessing the Economic Potential of Europe’s Regions, Washington, DC: World Bank Gill, Indermit S., Raiser, Martin (2012), Golden growth: restoring the lustre of the European economic model (Vol. 2): Main report (English), Europe and Central Asia Studies, Washington DC, World Bank. International Monetary Fund (2017a), Government Finance Statistics Yearbook, 2016, Vol. 40, International Monetary Fund, Washington D.C. (2017b), The IMF and Social Protection: IEO Survey of IMF Staff, Background Document No. BD/17-01/03 (2008), A Strategy for IMF Engagement on Social Spending, IMF Policy Paper No. 19/016 Lang and Tavares (2018), The Distribution of Gains from Globalization, IMF Working Paper Ridao-Cano, Cristobal; Bodewig, Christian (2018), Growing united: upgrading Europe's convergence machine (Vol. 2) (English), Washington, D.C.: World Bank Group www.bportugal.pt Rossi, Federico (2018), Human Capital and Macro-Economic Development: A Review of the Evidence, Policy Research Working Paper No. 8650, (Washington: The World Bank Group) Standing, Guy (2014), The Precariat: The New Dangerous Class, Bloomsbury Academic Schioppa, Tommaso Padoa (2010), “Markets and Government: Before, During, and After the 2007-20XX Crisis”, Per Jacobsson Foundation, BIS World Bank (2018), Inclusive Growth: A Synthesis of Findings from Recent IEG Evaluations, Washington, D.C. www.bportugal.pt Appendix Figures and tables from… Gill, Indermit S., Raiser, Martin (2012), Golden growth: restoring the lustre of the European economic model (Vol. 2): Main report (English), Europe and Central Asia Studies, Washington DC, World Bank. www.bportugal.pt www.bportugal.pt Ridao-Cano, Cristobal; Bodewig, Christian (2018), Growing united: upgrading Europe's convergence machine (Vol. 2) (English), Washington, D.C.: World Bank Group www.bportugal.pt www.bportugal.pt www.bportugal.pt www.bportugal.pt Associação Empresarial de Portugal (2019), Dinâmicas Socioeconómicas Regionais, AEP Estudos e Estratégia www.bportugal.pt Lang and Tavares (2018), The Distribution of Gains from Globalization, IMF Working Paper www.bportugal.pt