We live in a world of waste and wonder. Of poverty and plenty. The richest 10% of Americans account for about 50% of the country’s income. The situation is slightly better than Europe. The top 10% account for 40% of the country’s income. In Germany and France, it’s over one-third.
Inequality has been a major policy issue particularly in America. During the economic boom of the 1950s, the top 1% did only a little better than the rest, gaining some 5% of the increased income. But since the Great Recession, the top 1% have accounted for 95% of the income gain, leaving behind the bottom 99% with just 5% of the gain. Why? During recessionary periods, the government reduces the interest rates to drive recovery which typically boosts stocks. The numerous record highs since the 2008 crisis go to the households who own stocks. Of the richest 10% of US households, 93% of them own shares while the figure is only 11% among the poorest quintile of households.
How much does inequality affect the recovery?
2 Nobel Prize winners in economics, Joseph Stiglitz and Paul Krugman have contradictory views.
Stiglitz argues that inequality impedes economic growth. The poor spend a higher proportion of income on consumption (higher MPC) ; and the rich tend to spend proportionately less of their income. Thus, reducing income inequalities, or raising incomes for the poor would generate proportionately more consumption, and drive economic growth.
Krugman, on the other hand, claims that he hasn’t seen any evidence that the rich ‘under-consume’. In one sense, they actually spend more. For instance, 20% of $10000 ($2000) spent by the poor is less than 3% of $100,000($3000) spent by the rich. He also believes that it’s harder to predict how a person’s spending would change if incomes are raised.
Both of them, however, agree on the fact that high levels of income inequality are vulnerable for both economic and social reasons.
Why has inequality risen over the past century in the first place?
One reason could be that as countries industrialise and urbanise, they grow more quickly. Those who move into industry earn more than those who don’t. So basically inequality increases with economic development. A social welfare system is required to off-set the consequences in the form of redistribution. Thus, inequality is higher in China because of a lack of well-established system.
Another factor being globalisation, where those who gained from International trade, namely skilled workers and owners of capital have gained more while the middle and lower-skilled have lost to advanced economies. Also, as the economy becomes more technology driven, it’s again the skilled workers who reap the greatest rewards—called the skill biased technical change.
Earned income is yet another driver of inequality. The CEO earns about 200 times more money than the average worker in the same company. Why has this happened? Decreased unionisation weakening the bargaining power over wages of workers is one reason.
What is to be done then? There is a divide between people who support redistribution through taxes to those who don’t. Their concern is primarily the fact that taxing the successful and subsidising the less well-off create wrong incentives, thus discouraging both the rich and the poor to work.
What would Alfred Marshall, the father of neoclassical economics, make of this rise in inequality, which has become such an issue that it has led to question the validity of a capitalist system that permits it to happen?
Initially, Marshall did not support fiscal redistribution through taxes as he viewed it as inefficient because of its effect on work. But after the introduction of a graduate estate duty (higher rates on larger estates) in 1894, it was found that there was no disincentivising effect on the willingness to work. This led Marshall to change his views, as encouraging philanthropy(which was what he proposed before) was not really enough to reduce inequality. What he did NOT support was equalising income through extensive redistribution. Marshall saw the government’s role more as that of regulator than as a provider of goods and services.
To reduce poverty, he believed that the government could help by improving the skill set of the poor to make them more competitive in the market. He advocated education to make unskilled labour scarcer and thus better rewarded. He opposed nationalisation on principle, in line with his opinion that economic prosperity depended on forces of competition. So he would not support socialist experiments in production but came to accept fiscal policies designed to alleviate poverty.
Thus we may surmise that Marshall would weigh any tax purporting to reduce inequality carefully against the disincentivising effects. The IMF has looked at moderatively redistributive taxes and policies and concluded that they do no harm and might help to reduce income inequality.
So is inequality inevitable? It probably is. Who can possibly imagine to live in a world where everyone earns the exact same money? It wouldn’t be fair to people who work extra hard. There wouldn’t be any incentive to work extra hard. But can inequality be reduced to a great extent? Certainly. And it should be.
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