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The Great Leveller

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Until now, the relentless march of technology and globalisation has played out in favour of high-skilled labour, helping to fuel record-high levels of income and wealth inequality around the world. Will the endgame be renewed class warfare — with populist governments coming to power, stretching the limits of income redistribution, and asserting greater state control over economic life?Income inequality is the single-biggest threat to social stability around the world, whether it is in the US, the European periphery or China. Yet it is easy to forget that market forces, if allowed to play out, might eventually exert a stabilising role. The greater the premium for highly skilled workers, more is the incentive to find ways to economise on employing their talents.

The world of chess illustrates the way in which innovation in the coming decades may have a very different effect on relative wages than it did over the past three decades.

During the late 18th and early 19th centuries, a chess-playing "automaton" toured the world's capitals. "The Turk" won games against the likes of Napoleon and Benjamin Franklin, while challenging many great minds to penetrate its secrets. Concealing a human player in a shifting compartment amid a maze of impressive-looking gadgetry, it took decades for outsiders to correctly guess how the Turk really worked.

Today, chess-playing machines pretend to be chess-playing humans. Desktop-based chess programmes have considerably surpassed the best human players, and cheating has become a growing scourge. Of course, there are many other examples of activities that  computers have come to dominate. Many teachers and schools now use computer programmes to scan essays for plagiarism. Computer-grading of essays is a surging science, with some studies showing that computer evaluations are fairer, more consistent, and more informative than those of an average teacher, if not necessarily of an outstanding one.

Computer systems are also gaining traction in medicine, law, finance and entertainment. Technological innovation will lead ultimately to commoditisation of many skills. My Harvard colleague Kenneth Froot and I once studied the relative price movements of a number of goods over a 700-year period. To our surprise, we found that the relative prices of grains, metals, and many other basic goods tended to revert to a central mean tendency over sufficiently long periods. We conjectured that even though random discoveries, weather events and technologies might dramatically shift relative values for certain periods, the resulting price differentials would create incentives for innovators to concentrate more attention on goods whose prices had risen dramatically.

The same principles apply to people. As skilled labour becomes increasingly expensive relative to unskilled labour, businesses have a greater incentive to find ways to "cheat" by using substitutes for high-price inputs. The shift might come faster as artificial intelligence fuels innovation.

Perhaps skilled workers will try to get governments to pass laws making it more difficult for firms to make their jobs obsolete. But competition may not allow them to forestall labour-saving technology indefinitely.The next generation of technological advances could also promote greater income equality by levelling the playing field in education. Currently, educational resources — particularly tertiary educational resources (university) — in many poorer countries are severely limited, and, so far, the Internet and computers have exacerbated the differences.

But it does not have to be that way. Surely, higher education will eventually be hit by the same kind of sweeping wave of technology that has flattened the automobile and media industries, among others. If the commoditisation of education eventually extends to at least lower-level college courses, the impact on income inequality could be profound.

Many commentators believe the growing gap between rich and poor is an inevitable by-product of increasing globalisation and technology. In their view, governments will need to intervene in markets to restore social balance.

I disagree. Yes, we need genuinely progressive tax systems, respect for workers' rights, and generous aid policies from rich countries. But the past is not necessarily prologue: given the remarkable flexibility of market forces, it would be foolish, if not dangerous, to infer rising inequality in relative incomes in the future by extrapolating from recent trends.

The author is Professor of Economics and Public Policy at Harvard University, and was chief economist at the IMF. Copyright: Project Syndicate, 2011

(This story was published in Businessworld Issue Dated 18-07-2011)