NEW YORK – The global economy is at a crossroads as the major emerging markets (and developing countries more broadly) become systemically important, both for macroeconomic and financial stability and in their impact on other economies, including the advanced countries.

Consider, for example, what has occurred over the past 20 years in the United States. Some parts of the tradable sector (finance, insurance, and computer systems design) grew in value added and employment, while others (electronics and cars) grew in value added but declined in employment, as lower value-added jobs moved offshore.  The net effect was negligible employment growth in the tradable sector.

The US economy did not have a conspicuous unemployment problem until the crisis of 2008 because the non-tradable sector absorbed the bulk of the expanding labor force. That pace of employment growth now appears unsustainable.

Government and health care alone accounted for almost 40% of the net increment in employment in the entire economy from 1990 to 2008. Fiscal weakness, a resetting of real-estate values, and lower consumption all point to the potential for long-term structural unemployment.

One response is to assert that market outcomes always make everyone better off in the long run. But that is not supported by theory or experience. In the US, for example, while many goods and services are less expensive than they would be if the country were walled off from the global economy, we cannot assume that these cost savings necessarily compensate for diminished employment opportunities. People might trade away cheaper goods for assurances that a wide range of productive and rewarding employment options would be available, now and in the future.

A second response is to acknowledge the distributional implications, but to accept them as the price of efficiency and openness. According to this view, the alternative – not having an efficient market system operating in a relatively open global economy – would be far worse.

There probably are real choices to be made between income levels and distribution, on the one hand, and the range of employment opportunities on the other. It is not realistic to define the challenge as resisting or overriding the powerful market forces operating in the global economy.

Rather, the challenge is how best to shift incentives at the margin in order to improve the distributional effects.

There are several dimensions on which action can be taken. On the supply side of the economy, the state can invest or coinvest with the private sector in physical capital (infrastructure), institutions, human capital, and the knowledge and technology underpinnings of the economy.

These investments generally have the effect (in advanced and developing countries alike) of raising the return to private investment, causing the latter to expand in scale and scope, lifting employment along with it.  Reforming the tax system to favor investment and eliminate complexity and inefficiency would help.

High value-added, higher-paying jobs, especially in the tradable sector, generally require highly educated people. Of course, more and better education does not by itself guarantee that the number of such jobs is significantly expandable, given the scope of the tradable sector.

But more scientific and engineering degrees might promote job growth and – together with some public-sector investment in promising technologies – it might also expand the scope of the tradable sector as well.

That said, private incentives and social objectives are not perfectly aligned. Nor are they are diametrically opposed either. Multinational firms have access to abundant global supplies of relatively low-cost labor in multiple skill categories, so there is not much payoff to investments that increase labor productivity in high-income countries’ tradable sectors.

Public-sector co-investment properly targeted, however, could shift these incentives by lowering the cost of private technology investment.

Similarly, investment in infrastructure would directly add employment and improve competitiveness and efficiency in a wide range of sectors. Given the difficult current fiscal situation, public-private joint ventures should be explored here too, building on a large body of experience with growth-supporting infrastructure investment in developing countries.

Restoring elements of manufacturing competitiveness is hard. Once skilled labor, training programs, and technical institutions in specific industries are gone, it is difficult to get them back.

Long-term policy should include an evolving assessment of competitive strength and employment potential across sectors and at all levels of human capital, with the goal of encouraging market outcomes that achieve social objectives.

Most countries invest public resources in assets that have the effect of increasing their human capital and technological base, and thus their competitiveness. That will and should continue.

It is a benign form of global competition that increases productivity everywhere, provided that the markets for final and intermediate goods and services remain open.

If a relatively open global system is to survive in a world where nation states are the principle decision makers, it will have to be managed and guided not just to achieve efficiency and stability (important as these goals are), but also to ensure that its benefits are distributed equitably between and within countries.

If employment in advanced countries like the US recovers strongly along with growth, political support for an open global economy will be easier to sustain. But, given adverse trends in the tradable sector and the non-tradable sector’s exhaustion as a source of job creation, a more likely scenario is that unemployment remains stubbornly high, despite a return of normal growth.

In that case, politics will become divisive and polarized, and the inclination toward protectionist "solutions” will increase, jeopardizing global economic openness.

It is not a good idea to assume that markets will solve these distributional problems by themselves; the evolution of structure and the income distribution are largely the result of market incentives. All countries, advanced and emerging, have to address issues of inclusiveness, distribution, and equity as part of the core of their growth and development strategies.

The late Paul Samuelson once said that every good cause is worth some inefficiency. Morally, pragmatically, and politically, he was right.

Michael Spence is Professor of Economics, Stern School of Business, New York University, and Senior Fellow at the Hoover Institution, Stanford University. Sandile Hlatshwayo is a researcher at the Stern School of Business.

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