FROM THE OFFICE OF PUBLIC AFFAIRS

It was 150 years ago this year that Marx and Engels wrote the Communist Manifesto. They turned out to be wrong in a number of respects. But they were surely right to stress the enormity of the change in human affairs that a global market economy would represent. It would be difficult to think of a time when the "colossal productive forces" of capitalism they wrote about have been more palpable -- to more of the world's peoples.

When history books are written about the last two decades of this century, it is possible that the end of Soviet-style communism will be the second story. The first story could well be the appearance of emerging markets -- the fact that developing countries where more than three billion people live have moved to embrace capitalism. And for the first time in human history, living standards for huge populations have quadrupled or more in a single generation.

Few doubt that a global economy based on market forces offers enormous potential. In different ways -- our sense of ideology, our sense of common interests, our sense of what promotes global stability -- all point us toward a world of changing technologies, increased market forces and increased globalization. There is no question that this is good for many and good for the size of the pie. But there is a real question as to whether it leaves too many people behind.

This is an important moral issue and an important issue for the political viability of this approach -- because, as we are learning, wherever economic reality lies, it will be that much more difficult to follow if too many people doubt that it works for them. Necessarily, it presents itself differently in developed and developing countries:

• in developing countries, the question is whether the adoption of market-based approaches can support rapid growth, but only at the cost of rising inequality and harsh adjustment programs that impose excessive costs on the poor and vulnerable.

• in developed countries, the issue is less about the merits of markets than about globalization -- and the fear that it poses a threat to the well-being of the less skilled that cannot be countered by sound domestic policies.

• finally, and at the broadest international level, there is the belief that the mobility of capital, and the leverage which that mobility provides, affords it too much leverage and democratic governments too little -- to the detriment of ordinary people everywhere.

I would like today to offer some observations about these critical issues and the best way that policy makers might seek to address them going forward.

I. Does market-led development breed inequality?

Forty years ago Simon Kuznets suggested there was a negative relationship between growth and income equality in the early stages of development, and for a long time that proposition went unchallenged. Partly as a result, the belief persisted that growth with equity was impossible -- and that development and poverty reduction could often be at odds. Time, and a mountain of empirical evidence has given ever weaker support for these claims.

First -- as Klaus Deininger and Lyn Squire have shown in recent work at the World Bank -- more rigorous empirics and better data, covering 91countries over more than 30 years, suggests scant evidence of a Kuznets-type rise in inequality over the early stages of growth. Indeed, periods of rapid growth have come with a rise in income equality at least as often as a decline.

Second, we have seen enormous reductions in poverty as a result of rapid growth. Consider Japan, or the "Asia Tigers", or China and Vietnam -- all cases in which many millions were lifted out of poverty in scarcely a decade. Once again, the World Bank evidence is powerful: Deininger and Squire found that growth produced rising incomes for the bottom fifth of the population in all but 15 percent of the economies represented.

Third, we have seen rising evidence that, far from being the handmaiden of growth, certain kinds of inequalities can actively impede it. Specifically, there seems to be quite a strong negative link between a highly unequal starting distribution of assets and subsequent rates of growth. Of the 15 developing countries with the most unequal distribution of land in the Bank sample -- only two grew by more than 2.5 percent a year between 1960 and 1992.

The bottom line for policy makers is that we now know that no given path of inequality is an unavoidable consequence of macroeconomic adjustment and market reform. Just as government has enormous power to shape how fast a society grows -- it has enormous scope to influence how equitably it grows. The challenge is to put in place policies and institutions that will not just increase the size of the pie but help include more in its benefits.

Eight years ago when John Williamson first summarized the gospel according to Washington, there was a place on the list for the re-ordering of public spending priorities away from unproductive expenditures -- and into win-win investment in basic education and social services and critical infrastructure.

This element of the Washington Consensus has not entirely fallen by the wayside in the course of market reforms in Latin America, the Former Soviet Union, and elsewhere. But if most now agree that macroeconomic reforms took precedence over microeconomic in the earlier stages of reform, and reducing the size of government took precedence over improving its quality -- then it is fair to say that education and other basic social investments were especially ill-served by these biases.

Today, the lessons about the links between equity and growth find deeper expression in the policies of the International Financial Institutions -- policies which increasingly recognize that austerity is no substitute for adjustment. We see this:

• in the IMF's increased emphasis on the needs of the poor in designing adjustment programs, and encouraging governments to improve the quality of public spending and shift more resources to primary education, health care and critical investments. Since 1990 military spending has declined from 5.5 percent to 2.2 percent of GDP in IMF program countries and has declined as a share of public spending while social spending has risen;

• and in the sharply increased shares in social lending of the development banks. The World Bank, for example, is now the single largest source of external financing for education in developing countries. Since 1980 its lending for education has tripled and education's share in the total has more than doubled.

I am confident that whatever consensus exists ten years from now will give more weight still to these issues. But there should continue to be a presumption that issues of poverty and equality are best addressed directly, rather than indirectly, through more pervasive forms of protection, intervention and state controls.

That means, above all, investing in education. In 1990 around 130 million primary-school age children were not enrolled in a school, 60 percent of them girls. Yet years of development history show us that a dollar spent on education pays for itself many times over -- and a dollar toward female education most of all, in reduced fertility, healthier populations and higher wages.

And it must mean working to democratize access to finance. The world over, private financial markets fail when it comes to the very poor. Yet if you deprive poor people of the chance to lend or save then they are a good deal more likely to stay that way. The success of micro credit institutions the world over -- from South Africa to South Central -- shows how much can be achieved here, at what small cost. The First Lady likes to say it takes a village to raise a child. Equally, it takes capital to build a prosperous and cohesive village.

II. Does Integration Impoverish the Unskilled?

For all the dramatic rise in integration we have seen in the past decade, the share accounted for by imports from low-wage countries has increased by only one and a half percentage points. In the last 30 years, it has risen by only about three percent of GDP.

Compare that to the eight percentage point rise in the share of health care that has occurred during that period; to the 11 percentage point rise in the female share of the workforce; to changes in the levels of education attainment and in the mix of occupations due to changing technology -- and it is difficult to believe that increased trade with developing countries could account for more than a fraction of the rise in wage inequality we have seen in the United States in the past twenty years. In fact, most studies have concluded that it could account for 10 -- perhaps 20 -- percent of the problem.

Yet to absolve globalization from the blame will not make the problem of rising inequality go away. And it is scarcely a phenomenon that is now well understood.

My guess is that it has its roots in two primary trends. First, technologies that have tended to be skill-reinforcing, and second, greater market forces that have tended to make everyone be paid more like salesman -- on the basis of what they produce. The implication is that the dispersion of wages within a given occupation or company may have moved closer toward that of people who are paid on commission. Differing tax and benefit structures and labor market institutions in Europe have seen these things manifest themselves in higher unemployment more than rising inequality. But it seems clear that similar underlying forces have been at work.

Will these trends continue? No one should forecast confidently. When I went to graduate school two propositions in this area were central. The first was that the returns to education were declining, Americans were in danger of becoming over-educated and social investment in education could be excessive. The second was that the income distribution was remarkably stable in postwar America, despite a whole set of policies directed at addressing it.

These were mistakes of extrapolation. One needs to be careful about extrapolating from the last 20 years. While the bulk of attention has focused on skill-reinforcing technologies, and while these are clearly a major element of the story, it is worth noting that supermarket scanners, spell-checkers, cash registers with pictures instead of numbers -- all these are information technologies that reinforce those with less skill. Equally, computers will replace radiologists reading X-rays before they replace nurses. Equity traders will be replaced before gardeners -- credit analysts before hairdressers.

Nor can the march of market forces in compensation be thought to be ineluctable. Just as countries, in a world in which everything else moves, are coming to realize that their most unique asset is their people, so companies, in a world in which everything, including their people, can move, are coming to realize that their most distinctive resource is their culture. With teamwork an increasingly important value in business, companies are recognizing the benefits of a loyal workforce -- and likewise the possible costs to downsizing and invidious comparisons between personnel.

We should note, too, that the last two years have shown some signs, if not of a reversal, then at least of an important pause in the long-run trend here in the United States. Between 1996 and 1997 the hourly wages of the bottom fifth of US workers rose by 3.2 percent in real terms -- more than twice as fast as the wages of those at the top.

As in the developing countries, governments are not powerless. It is a feature of the successful move to more market-based strategies that all of the elasticities have increased -- small changes in incentives can reap very large changes in behavior, and the burden of a given intervention can shift far from the initial target. That means that the deadweight losses associated with direct redistributions have increased. But it also enhances the effectiveness of more supply-based strategies for reducing inequality.

This has been reflected in a much greater emphasis on the quality and quantity of education, including -- in this country -- a major expansion in pre-school programs, proposals for universal testing to maintain school performance and expanded college tax subsidies. Equally we have seen it in a welfare reform bill which stresses both motivating greater work effort and improved preparation for work.

III. Are Governments Powerless Before a Global Market?

It is often said that governments today have less power, but in a sense they hold a society's fate in its hands more than ever before. The right policies are now better reinforced and the wrong policies are more swiftly punished. Thus, the impact of policies has never been greater. The element of truth in this statement about the powerlessness of governments is that certain things thought important for government to do are becoming more difficult.

There is no question that increased economic integration -- be it of the 50 American states, the European Union or other less well-developed regional trade arrangements --- requires a careful balancing act between the benefits of mobility and competition within jurisdictions, and the need to avoid a damaging race to the bottom.

The implication is that the plane of global integration cannot fly on the single wing of freer trade and capital mobility. It must be complemented by the second wing of global cooperation on the range of challenges that integration brings -- from fair treatment of labor to global warming, from preventing money laundering to food safety and other consumer protections.

As President Clinton said last month at the 50th Anniversary of the WTO in Geneva, our goal as we integrate and converge must be leveling up, not leveling down:

• that is why we are working to open up the WTO to ensure that capital is not the only factor of production that gets a hearing;

• that is why we are working with other countries to promote global cooperation against corporate and legal tax havens, and working actively in the OECD on the issue of tax competition;

• that is why we have worked, within the IMF and the other IFIs to ensure that labor and environmental concerns are given due weight in devising reform programs and sustainable development strategies -- and why we have called on the WTO to step up its environment efforts and work with the International Labor Organization to ensure that open trade respects the rights of workers;

• and that is why we have given such strong encouragement to the World Bank and the IMF in their efforts to place governance issues at the top of their agenda, and have worked at the OECD to attack the supply-side of corruption with the criminalization of foreign bribes.

These are all international imperatives. But the vital domestic complement to this approach must be ensuring that the global economy works well for those at home. Just as the GI Bill of Rights was an integral part of the strategy behind the Marshall Plan, just as our interstate highway system was partly the result of an effort to marshal our Cold War defenses -- we must work to make both real and apparent the connection between our pursuit of stability and prosperity abroad and our pursuit of stability and prosperity for every American.

These are important issues substantively and they are also important issues politically. Indeed, it may well be that the biggest threat to our national security is economic insecurity -- and the backlash it produces at home.

So this conference could not be more timely or the subject more important. History teaches that internationalism cannot be a goal pursued by elites for its own sake. Domestically and collectively, we need to invest in policies and institutions that can realize the opportunities of this new global era, and a large part of that will be about investing in policies to ensure that everyone is included. You might say -- as Marx did not -- that we have nothing to lose but the false choice between growth and equity, and a world to win. Thank you.