6.4.1 Productivity, Unemployment, and Inequality

Much of the period spanning the 1990s to the present has been dominated by a policy and strategic focus on macroeconomic management, heavily influenced by arguments for liberalization of the “Washington Consensus” and the unproven belief that growth over time will reduce unemployment. This perspective supported the view that state intervention in employment issues was inefficient, harkening back to the New Deal or state-backed programs in the former Soviet Union or in China. Such beliefs have had a lasting and negative impact on efforts to strengthen the abilities of municipalities to address urban employment and underemployment by developing unrealistic expectations from the private sector, and by side-stepping the public sector – that is, city government – rather than working to strengthen its areas of comparative advantage for job creation.

For these reasons, we should be surprised that the past decades have been marked by increasing inequality. Although aggregate economic growth and local productivity have increased, wages have stagnated, and structural inequality of both income and wages has become a social and economic concern (Bivens and Mishel Reference Bivens and Mishel2015).

In 17 out of 22 OECD countries, inequality has increased since 2000 (OECD 2015). Industrialized countries are currently experiencing levels of inequality not seen since the nineteenth century, and many developing countries have become more unequal over the past decade. Asia, the region that experienced the highest growth rates in the world (with a GDP growth rate of about 7 percent) and the largest reduction in poverty ever recorded in history (from 54 percent living in poverty in 1990 to 21.5 percent living in poverty in 2010), is also the region in which the rich-poor divide is widening most quickly (OECD 2015).

Piketty’s (Reference Piketty2014) ground breaking historical analysis of inequality offers an explanation for this surge in inequality. The present state of affairs, which he refers to as “patrimonial capitalism,” favors capital owners and “rentiers” over the working population. According to his analysis, the reason for this scenario is the rate of return on capital (r), which has increased at a much greater level than the rate of economic growth (g): in mathematic terms, r > g. For the last 300 years, the rate of return on capital has increased at a steady rate of about 5 percent, while g, conversely, has shown severe fluctuations and lower growth rates. As wealth grows faster than economic output, economic growth is accumulated in the hands of a few, increasing the wealth gap between the famous 1 percent and the rest of society.

Piketty (Reference Piketty2014) stresses that conditions vary across countries, depending on the level of government intervention in the market. Figure 6.2 displays the relationship between GDP per capita and the Gini coefficient – a measure of inequality – in selected countries in Latin America and the Caribbean. The relationship illustrated here confirms Piketty’s theory, revealing that there is no clear link between these two variables. Mexico and Brazil, for example, have similar levels of income per capita, yet starkly contrasting levels of inequality (Mexico’s Gini is .45; Brazil’s reached .57 in 2010).

Figure 6.2

The relationship between income per capita (current USD) and Gini coefficient in Latin American countries.

Source: Jerker Lokrantz/Azote, modified after UN Habitat (2014).

Among many developed countries, there is increased concern about a productivity-pay gap, where wage growth has fallen greatly behind productivity growth. The case of the United States is particularly striking. Figure 6.3 presents the cumulative growth in net productivity of the total economy and inflation-adjusted average compensation of workers in the private sector since 1948. In the decades following World War II, hourly compensation of workers increased in tandem with economy-wide productivity. After 1973, however, hourly wages stagnated for the majority of US workers, while productivity continued to rise. This trend became even more severe after 2000, after which a mere 1.8 percent of the net productivity growth of 21.6 percent was translated into compensation for workers.

Figure 6.3

Cumulative change in productivity (orange) and hourly compensation (green) in the United States between 1945 and 2015.

Source: Jerker Lokrantz/Azote, modified after EPI (Bivens and Michel 2015).

According to the Economic Policy Institute’s Bivens and Michel (Reference Bivens and Mishel2015), the central driver of this productivity-pay gap is inequality, inequality of compensation, and the falling share of income allocated to workers relative to capital owners, which confirms Piketty’s theory of r > g, where rate of return on capital has become greater than the rate of economic growth.

Because cities play an important role in national economic development and productivity growth, the next logical step provoked by these patterns is to consider possible implications of these national trends on urban areas, and to identify how urban areas impact developments on a national level.

In a study of 220 metropolitan areas in the United States, Hsieh and Moretti (Reference Hsieh and Moretti2015) found that the most productive cities, including New York and San Francisco, are not contributing to national GDP growth as one might expect. The New York metropolitan area serves as a prime example. It ranks among the top 20 most productive metropolitan areas in the United States (Parilla and Muro Reference Parilla and Muro2017). According to Hsieh and Moretti’s analysis, however, the New York metropolitan region was only responsible for 5 percent of the country’s aggregate output growth. While cities like New York are more productive and offer higher nominal wages, these pull factors are offset by extremely high costs for housing, which present constraints to worker mobility and a spatial misallocation of labor across the country.

The case of Colombia’s capital, Bogotá, is a more positive example of shared economic growth. After the 1998 crisis, both Colombia and Bogotá experienced economic recovery; in 2007, Bogotá’s GDP grew by approximately 7 percent (UN-Habitat 2014). As depicted in Figure 6.4, the economic growth occurred in tandem with a constant reduction in the city’s Gini coefficient, as well as a reduction in the differential between the salaries earned by the richest and the poorest 10 percent of the population. A study by UN-Habitat (2014) finds that this reduction in income inequality is a result of structural changes and the introduction of local social policies aimed at reducing inequality, including a wide provision of public services. Even in times of economy recovery from the 2008 crisis, when economic growth slowed significantly, inequality in Bogotá continued to decrease, falling below the national urban Gini coefficient.

Figure 6.4

Changes in the Gini coefficient, as well as the differential between the salaries earned by the richest and the poorest 10 percent (a metric called D10/D1) in Bogotá between 1991 and 2010.

Source: Jerker Lokrantz/Azote, modified after UN-Habitat (2014).

In sum, increased urban productivity does not always go hand in hand with more equitable income distribution and better working conditions. This is not to say that economic growth and the generation of inequalities are inextricably linked, but rather point to the importance of national and local government efforts to limit increases in inequality.

6.4.2 The Informal Sector

The informal economy is widespread and increasing in size in most parts of the world, especially in low- and middle-income countries, where it accounts for half to three-quarters of all nonagricultural employment (Chen Reference Chen and Chant2010; ILO 2013). Informal employment comprises about 65 percent of nonagricultural employment in developing Asia, 51 percent in Latin America, 48 percent in North Africa, and 72 percent in sub-Saharan Africa; in these regions, this labor force produces between 20 and 40 percent of GDP.

How the informal sector fits into and develops within individual regions and countries varies considerably. Asia has felt the impacts of globalization, with its effects on capital and labor flows, movement of technology, and wage rates, most intensely. The East Asian financial crisis of 1997–1998 affected the small-scale sector, weakening the demand for locally produced products while increasing interest rates and reducing purchasing power. Bank credit became scarce at a time when input prices for energy and other raw materials increased. At the macro-level, economists nonetheless assumed that local economies were relatively sheltered from this regional crisis. Some observers with their feet on the ground wrote about “the geography of change” in this period (Amin and Robins Reference Amin and Robins1990), raising questions about the resilience or vulnerability of the urban and local economies to external shocks.

Many studies on the informal sector have argued that there is a negative correlation between the size of the informal sector and the growth rate of per capita GDP, as is illustrated in the downward sloping trend line in Figure 6.5 (Slonimczyk Reference Slonimczyk2014).

Figure 6.5

The relationship between GDP per capita and the shadow economy as a percentage of total GDP on a global average.

Source: Jerker Lokrantz/Azote, modified after Slonimczyk (2014).

In contrast, other studies (for example, Heintz Reference Heintz2006) point out that the correlation between informality and slow growth of GDP does not necessarily imply causality. In fact, slow growth could explain a certain degree of informality, rather than the other way around. Rather than perceiving the formal and informal sectors as conflicting, the two economies may work in symbiosis. In an era of globalization and outsourcing, many key components and services used by the formal sector are outsourced to the informal economy.

The perception of the informal sector as a pool of potential entrepreneurs whose wealth creation capacity is constrained by a regulatory burden sidesteps the fact that most workers in the informal economy are engaged in disguised employment relationships (Chen Reference 145Chen2006). This alternate vision views the informal economy as linked, in a dynamic and often subservient relationship, with the formal economy, and indicates that efforts to “formalize” the informal economy are doomed to failure without addressing the broader dynamics that stimulate job creation in the larger economy – formal and informal, rural as well as urban.

Heintz (Reference Heintz2006: 5) recognizes the growing importance of urban informal employment “as rapid urbanization continues and the growth of formal job opportunities lags behind the expansion of the urban labor force.” He further argues that “municipal regulations frequently fail to recognize urban informal activities as legitimate.”

The International Labour Organization (ILO 2013) argues that the root of the informal economy problem is the inability of economies to create sufficient numbers of quality jobs. Employment growth in the formal segment of the economy in most countries has lagged behind the growth of the labor force, trends that are likely to continue in the future (ILO 2008). Even in China, where the rates of economic growth and poverty reduction have been remarkable, the informal economy is growing.

Workers in the informal economy are not only disproportionally affected by global economic forces, but also by changing climate patterns. In turn, the informal economy can, and already does, play a crucial role in greening the urban economy and contributing to climate resilience. Brown et al. (Reference Brown, McGranahan and Dodman2014) encourage local governments to collaborate with the informal sector in achieving more inclusive and green economies.

6.5.1 Future Challenges

The pace of urbanization combined with a lack of institutional capacity presents a major challenge for cities in the developing world. As fiscal powers continue to concentrate at the national level, local governments lack the resources to manage and accommodate the growth of cities. Lagos exemplifies this challenge. Estimates suggest that 2,000 new people arrive in the city daily; it is expected to double in size by 2031 (Obioma 2013). How can a city possibly cope with such a population increase? This challenge manifests itself particularly in increasing demand for infrastructure and access to basic services, including public transportation, water, sanitation, electricity, and access to health care and education. Yet, if urban growth continues to be unplanned and underfinanced, informal settlements will continue to proliferate and overcrowding will become worse, which could lead to the creation and spread of new and old diseases.

Cities in upper-income countries face major challenges regarding their infrastructure, too, as they find infrastructure aging and in desperate need of repair. Especially in large and growing cities, existing systems built in the early phases of industrialization are coming under increasing strain. Insufficient maintenance and expansion efforts limit the transport possibilities within cities, affecting productivity and growth. In the case of New York City, estimates suggest that approximately $47 billion is needed over the next five years to bring the city’s aging infrastructure to a state of good repair (Forman Reference Forman2014). The neglect of public infrastructure will pose a financial and logistical challenge to the city and its capacity for future growth.

Second, adapting to the changing patterns of demographics will present a growing challenge for cities everywhere. Low fertility rates and a declining and aging population pose a particular challenge to cities in Europe and Northeast Asia (see also Chapter 5). This demographic shift places a major burden on the public welfare system and decreases the likelihood of productivity growth; it will further increase the stress on public infrastructure services, too. Shrinking cities negatively affect economic growth, as vacant buildings reduce the capital value of real estate and create a diminishing tax base; financing public sector services, such as schools and hospitals, requires a strong tax base.

Cities in developing countries face demographic challenges, too, yet they are very different in kind than the cities in the developed world. In the developing world, the very young will constitute the majority of the population living in cities. In Uganda, for example, close to 50 percent of the national population is currently below the age of 14, and a mere 5 percent of the population is older than 55 (Indexmundi 2017). If these young people are not successfully absorbed into the labor market, pathological urbanization processes are unlikely to contribute to sustained urban productivity growth, but are likely to exacerbate urban poverty, social and political instability, and emigration of the highly skilled members of the labor force.

This brings us to the next challenge: changing migration patterns. An increasing number of people are fleeing conflict, economic stresses, and climate change hazards in their home countries, and are seeking new homes in cities within developed countries. Strict labor protection laws in the recipient countries often prevent migrants from working in the formal sector, who find themselves either working in activities in the informal sector or as recipients of public assistance programs. If not accounted for, a large influx of migrants increases local pressures on land and housing, and can increase the costs of living in cities. Countries that migrants are fleeing from are also left with challenges, including the emigration of members of a highly skilled labor force. This so-called brain drain reduces the potential of local productivity. Overall, when highly skilled migrants are legally constrained from contributing to high-productivity activities in their recipient countries, the global urban productivity frontier is diminished.

Rising inequalities in wages and wealth present another major challenge for the future of urban productivity. High inequality, paired with distorted land and housing prices, results in spatial misallocations of labor away from high-productivity and into low-productivity cities. Inequality disproportionately affects women, minority groups, and lower-income earners, reinforcing differences among classes, genders, and races. While inequality is on the rise in cities of developed countries, inequality levels in cities across Africa, Asia, and Latin America continue to be the highest in the world and are increasing in many cities. If unaddressed, inequality levels could reach new thresholds, reducing the labor productivity potential of a large share of the world’s population.

Finally, cities across the world are encountering increasing pressures from global market economies. Cities that have managed to become one of these “global cities” now find themselves with high productivity levels, yet benefits are often captured by a global elite and seldom trickle down to the local workforce. In particular, those employed in the non-tradable sector experience stagnating wages, resulting in increasing polarization of income and wages. Cities that are not one of the “global players” are confronted with declining industries and emigration of skilled labor.

6.5.2 Opportunities

While pessimists are absorbed by these challenges, leading to predictions of economic slowdown in the foreseeable future, optimists believe in the human capacity to find creative ideas for future adaptation, turning challenges into opportunities for future growth. Nobody can predict the future of urban productivity with perfect accuracy. However, judging from the obstacles ahead, preventing these challenges from turning into crises is increasingly important.

For instance, cities experiencing an aging population could strategically incorporate newly arriving migrants into local labor markets to counter their negative population growth, ensuring sustained future economic growth that, in turn, is required to finance local infrastructure services. Wage-led growth could be an equitable strategy for recovery in economic downturns, as wage growth can support demand via consumption expenditures, and can induce higher-productivity growth. Changes in functional income distribution also have important supply side effects.

Moving towards a green economy could have tangible and considerable effects on productivity and economy growth. UNEP suggests that transitioning to a green economy does not only generate wealth and gains in natural capital, but it also produces a higher rate of GDP growth (UNEP 2011). The structural change from extractive capitalism towards a more sustainable system could create new jobs, especially for vulnerable communities. This requires reeducating and re-skilling the labor force, and must include those outside of the formal economy.

In addition, the role that cities and local governments can play in fostering urban productivity has yet to be realized. A great divergence between cities within the same country can be traced back to effective versus destructive policies at the local level. Yet, effective policy-making at the local level alone cannot overcome the challenges that lie ahead. Aside from enabling national policies, the international level is crucial in and of itself, too. Especially in a globalizing world in which cities are deeply embedded in and affected by global dynamics, international collaboration in addressing future challenges is key. According to Piketty for example, the introduction of a progressive global tax on capital is the only way to address patrimonial capitalism and increasing wealth inequality.

Considering the level of international collaboration needed to implement such an endeavor, the years 2015 and 2016 should be contributing to optimism rather than pessimism. In September 2015, more than 150 world leaders came together to adopt the Sustainable Development Goals; in October of 2016, a series of member states reconvened at the Habitat III conference to envision the future of cities. Still, achieving the necessary levels of structural change in the way our world operates will require more than international, high-level conferences that result in commitments without actions, or agendas that will be rapidly forgotten. Local and national governments must be held accountable for their commitments, their misallocation of public resources, and the maldistribution of increased returns on productivity.

In cities across the world, imbalances of labor markets, increasing costs of housing, and a lack of pro-poor policies are damaging. Astronomical levels of income inequality in cities point to institutional and structural failures in income distribution, which must be addressed to ensure inclusive urbanization. Considering Piketty’s findings on the state of today’s capitalism, a more progressive tax on wealth and a fundamental adjustment for the financial system will be necessary to make today’s economy socially equitable and ecologically sustainable. To reduce inequalities, we need accountable institutions, effective social programs, and strong links between the various levels of government in addition to stable economies and productivity growth.

Perhaps we should depart from using efficiency and productivity as the main metrics for judging the performance of urban areas and urbanization, and reintroduce moral philosophy into the equation, as Hausman and McPhearson (Reference Hausman and McPherson2006) suggest. Extensive public transfers and improvements to fiscal policy fostered better social cohesion in many Latin American countries, reducing poverty and widening access to both public services and opportunities at the national level. These strong national institutions must be recreated at the local level to address growing threats of urban inequality. A higher minimum wage, improved overtime thresholds, strengthening workers’ collective bargaining rights, and stronger employment protection legislation would not only improve the situation of the working poor, it would also help reduce the wage gap between men and women, and between minority and non-minority workers. After all, the values of ethics, liberty, justice, and equality influence the outcomes of economics, and therefore could help economies work more effectively.