State of the Union: For the first time since Obama took office, the economy is big enough to share

Growth makes the rich richer – but then it also makes all of us richer

“Will we accept an economy where only a few of us do spectacularly well?” Obama asked in his State of the Union speech (Reuters)

The State of the Union address is always about America first and foremost, but this year it has a resonance beyond US shores. That is because President Obama seeks to tackle one of the concerns of pretty much the entire developed world: how do you spread the benefits of economic growth more widely?

His message, broken down, is that we can declare victory over the recession and that after six years’ slog the recovery is secure. So now is the time to use the resources generated by recovery to do something for the middle class – in particular, to help with higher education and to reduce the tax burden on middle-earners. To that end, there is the plan to make higher education free to a community college level – that is the first two years of university, from which students can either get an associate qualification, or transfer and study for another two years for the bachelor degree. And there are proposed increases in taxation on the wealthy and on big financial institutions, using the money to finance a tax cut for middle-earners, as well as additional spending on education and other programmes.

Since the Democrats have just been thrashed in the mid-term elections, it is not at all clear how much of this will ever get legislated. The long tradition of American politics is that the President proposes and Congress disposes. There are practical objections, too, objections that the Republicans have already made: for example that instead of increasing tax rates and making the system more complicated, the President should work with Congress to simplify the whole system. But if you step back from politics, what is interesting is this very real concern that the people in the middle are stuck.

Quantitative easing may have nudged the economy into growth and that growth is at last creating jobs. But it has also increased asset prices (the S&P 500 share index is up 10 per cent year-on-year) and hence delivered the biggest gains to the most wealthy. Inequality has risen as a result. Those concerns are of course evident here and in Europe, though in Britain the impact of our QE programme has been more in house prices than share prices.

In Europe, with its so-far more limited QE, the issue is more the lack of any recovery in the fringe economies and the tensions within the eurozone. What we all have in common, though, is a failure of median incomes to rise in real terms for a decade, and in the US longer still. Since the US has been the frontier economy, leading the way towards higher living standards, this is a troubling prospect for the future.

But is the outlook really so gloomy? Ultimately what will matter is overall growth, because while redistributive action by governments can help at the margin, it won’t fix the pressure on the middle class if there is little growth.

So what can be said about that? McKinsey Global Institute, the research division of the management consultant has just done a report looking at the outlook for global growth to 2050, asking what might be done to increase it. The nub is that the world has had a good half century, with growth driven in part by a rising number of people in the workforce and in part by rising productivity. The workforce rose by 1.7 per cent a year on average and productivity by 1.8 per cent. The first of these is now tailing off, and the workforce is likely to stop growing within 50 years. So the onus will be on productivity to drive growth, and even if that 1.8 per cent annual increase can be maintained, growth will be lower in the next 50 years than it was in the past.

What can be done? The paper notes a number of areas where we – that is we as the world, not as Britain or America – need to do better. These include increasing competition and transparency, giving greater incentives for innovation, increasing labour participation (ie getting more women and older people into work and matching skills to jobs), and opening up international trade.

Much of the advance will come in the emerging world. McKinsey reckons that three quarters of growth will come from catch-up, that is developing economies adopting the skills and technology of advanced ones, and only one quarter from pushing forward the frontiers of knowledge. But we in the developed world will benefit from catch-up elsewhere, as we are already doing by importing cheaper consumer goods from Asia. We can also benefit from catch-up at home, by encouraging low-productivity companies to adopt the practices of high-productivity ones.

So as far as we in the developed world are concerned the big point here is that there is no reason why we should not be able to increase living standards over the next 50 years. We just have to manage our economies better, accepting that there are tough trade-offs. This does not just mean harsher competition. For example, McKinsey notes the inefficiency of US healthcare as an area for improvement.

All this is about increasing the size of the cake, rather than sharing it more evenly. But if the cake is really growing, sharing becomes much easier. If it is not growing… well, we have had some experience of that and it has not been a bundle of fun, has it?