“I believe this [income inequality] is the defining challenge of our time.”
Barack Obama (2013)
“One of the leading economic stories of our time is rising income inequality, and the dark shadow it casts across the global economy.”
Christine Lagarde (2015)
There is a clear recognition of the risks, dangers and the pain which income inequality imposes on society. Despite the recognition, it is a problem which seems to constantly be forwarded on to successive generations to resolve rather than finding a decisive set of solutions.
We will all do well to pay heed to the US Senator John Sherman who in 1890 when he introduced his landmark Sherman Antitrust Act said that he sought to “put an end to great aggregations of capital because of the helplessness of the individual before them” and also because he fundamentally believed that amongst all of the nation’s problems, “none is more threatening that the inequality of condition, of wealth and opportunity.”
So why does inequality matter? Why is it important that we all strive towards resolving it? Societies that are hugely imbalanced and unequal ultimately become fractured which in turn lead to painful social and economic consequences that affect everyone. Neither the rich nor the poor will be able to avoid the huge social costs of a fractured society.
The stark facts
- 62 of the richest people in the world own what the bottom 50% of the world’s population own.
- 1915: The richest 1% of Americans earned 18% of the national income.
1930s to 1970s: The share plummeted and remained below 10%
From the 1970s: The share has increased to almost 30%
- 1980: The top 0.1% wealthiest Americans controlled about 9% of all household wealth
2015: The top 0.1% own 22% of all household wealth.
- USA: The top 1% of America control 40% of America’s wealth
- Germany: Poverty has risen by half since 2000.
- 1965: CEO pay at the largest 350 U.S companies was 20 times as high as the pay of the average workers
1989: The figure is 58 times as high
2012: The figure is now an astounding 273 times as high.
(It is worth bearing in mind that Peter Drucker argued that the pay ratio between the top executive and the humblest worker should be no greater than 20 to 1.)
- OECD: The gap between the rich and poor is now at its highest level in OECD economies in 30 years according to a report produced in 2014. The overall increase in income inequality has been driven by the richest 1%.
- 2008: The United Nations University (UNU) and the World Institute for Development Economic Research (WIDER) estimate that the global Gini coefficient (a measurement of inequality between 0 – representing complete equality and 1 – representing complete inequality) was 89. An alternative way to interpret this is that in a population of 10 people, if one person had $1000, the other nine have only $1 each.
- 2014: The Credit Suisse Global Wealth report estimates that that the richest 0.7% (who hold over US$1 million in wealth) held 44% of the global net worth.
The economic success stories of many countries hides a dangerous truth – that a significant majority of economic gains are going to those at the very top of the income distribution whereas those lower down have seen real incomes stagnate or diminish.
This has in turn perpetuated further inequality as those in a position of privilege often use their wealth and influence to shape policies that further increase their concentration of power. These policies have not necessarily been in the interests of those lower down the income ladder.
A research conducted by Martin Gilens, a political scientist at Princeton, lends credence to the notion that the US government responds more positive to the most affluent ten percent of Americans whilst “the preferences of a vast majority of Americans appear to have essentially no impact on which policies the government does or doesn’t adopt.” (A video of Gilen’s lecture can also be viewed here.)
The erosion of the social compact
This wasn’t always the case though. Whilst there has always been inequality, it has never been to this extent or been as pervasive. There was also more concerted effort to reduce the level of inequality and dampen its deleterious impact on society.
The experience of the First World War revolutionised American attitudes towards taxation and redistribution of income. When the War Revenue Act of 1917 was passed, there was talk of “conscription of income” and “conscription of wealth” at a time when young men were enlisting en masse. “Let their dollars die for their country too,” one congressman said. The call for fiscal patriotism helped legitimate the progressive income tax in the United States, and by 1944 the top marginal rate had risen as high as 94 percent.
Across Europe, a fear that the lack of reform could lead to social and political turmoil and the horrors of two World Wars meant that policies such as social insurance, minimum wage, a strong welfare state and progressive income tax were implemented leading to more egalitarian societies and economies.
The experiences of global ears produced visions of a social bond holding countries together and nurtured the notion that every single person owed a debt to the welfare of the broader community and society.
However since the 70s, the disappearance of these conditions has meant that the support for egalitarian public policies has also diminished.
We now live in a world where even high skilled jobs are being commoditised so that even highly educated workers are not making sufficient progress as gains in economic growth are limited to a very elite group of financiers, entrepreneurs and managers. In the past only unskilled workers lost jobs to automation, now even highly skilled occupations are at risk with the advancement of artificial intelligence, robotics and automation.
The social structure of Silicon Valley provides us with an instructive view of the future: One where expert systems have replaced the majority of people and a tiny but well-remunerated minority direct the economy whilst the majority exist to serve them alone.
The conflict is no longer just between the working class and the middle and upper classes – it is now between a tiny elite and the great majority of citizens. As the majority develop a sense of common interest, or what Marx may have termed ‘class consciousness’, the need to resolve inequality will become more acute as the resentment of it intensifies.
What happens when income inequality starts to become entrenched?
- Health: Societies that are more unequal tend to have lower life expectancies, higher infant mortality, higher levels of infant mortality and high levels of diseases and conditions such as HIV/AIDS.
- Human capital development: As inequality rises, scores on the UNICEF index of child well-being become significantly worse. Literacy rates are also lower and youth unemployment also becomes a major issue. A higher level of equality also leads to a greater level of innovation as a result of greater access to opportunity.
- Social mobility: Inequality restricts social mobility – equality of opportunity is enhanced by greater income equality. Reduced social mobility further exacerbates income inequality and this becomes a vicious spiral from which an effective functioning economy becomes more and more difficult.
- Economic progress and stability: An IMF report highlights that by reducing inequality and bolstering longer term economic growth are “two sides of the same coin.” In both rich and poor countries, inequality is strongly correlated with shorter spells of economic expansion and growth over time. Unequal economies are also more susceptible to severe boom-and-bust cycles leading to greater volatility and crisis. Extreme levels of income inequality depress economic growth. An OECD report estimates that inequality has had a cumulated loss of GDP across OECD economies of 8.5% over twenty-five years.
- Social challenges and issues: Inequality breeds corruption. Unequal societies also lead to greater economic instability. If one considers the root causes of the Arab Spring, the lack of economic opportunity or equality is one of the main drivers leading to revolt.
A blueprint for change and resolution
The solution and change required for income inequality is not a zero-sum game. There will be those who are impacted more than others, but it is essential in calibrating the world in a more equal way.
It is very easy to be dangerously complacent and ignore equality, but chronic economic inequality hurts everyone, both the rich and the poor.
Resolution of a problem like inequality requires a revolutionary approach. We need to accept a fiscal revolution or risk a social one.
I’ve highlighted below briefly some key practical steps that need to be considered as we seek an urgent resolution to the problem of income inequality.
- Tax reforms – Income taxes need to be more progressive (the way they were previously in times of greater equality). There needs to be a reform in the way the transfer of wealth is also taxed. The OECD has suggested that attempts to reduce inequality tax and transfer policies will not harm growth as long as the chosen policies are well designed and implemented. The OECD further argues that redistribution efforts should focus on families with children, on the youth and the improvement in human capital investment through the promotion of skills learning and development.
- Continued focus on economic growth and employment – Policies targeting economic growth need to continue as growth ensures jobs are created and ensures employment. Employment will support social mobility which is essential to the reduction of inequality.
- Ensure emphasis on social mobility – Social mobility is a key driver towards the reduction on inequality. Emphasis on education, skills learning and development is vital to support social mobility.
- Support small savers and small businesses – Policies should not be tilted towards just merely taxing the rich but also be aimed at increasing the wealth of small savers and businesses. For instance we should consider the introduction of accounts for small savers and businesses that guarantees positive returns in excess of inflation. It is also a widely observed phenomenon that lower income families borrow more to support their consumption and this in turn creates a systemic risk.
- Enhanced social policies – Governments and policy makers should also consider more directed interventions to enhance the social conditions of lower income families. For instance, in the UK, the Child Benefit offers a weekly allowance to parents for every child they raise. The transfer could be better targeted by making the income taxable as personal income, which will reduce the size of the benefit for those in higher tax brackets or who do not have face any other mitigating circumstances. In the UK, child poverty has dropped sharply whilst in the USA; it has risen by a third between 1969 and 2013. A child-benefit programme will help make a major dent in child poverty and also represent a powerful investment in the future. Introducing a child-benefit program in the US will make a major dent in child poverty and represent a powerful investment into the future.
- Minimum wage – Governments should also take an active review of the minimum wage policies in their countries and recalibrate them to local conditions. There is always a temptation to keep minimum wage lower because neighbouring countries are keeping theirs lower, but this beggar thy neighbour policy will not benefit anyone in the long run. Countries that make the effort to ensure greater equality will be healthier in the long term.
- Automation and technological change – Governments should take an active interest in the direction of technological change. It is mostly governmental grants and labs that are responsible for the underlying research that has led to the progress in automation and technology and they therefore have the right to ensure a clear review is undertaken to mitigate the social impacts of technological change through appropriate fiscal and taxation policies.
It is crucial that we as a collective rise up to face the challenges of income inequality and work closely to create a more equal society. The corrosive impacts of inequality will affect us all and the sooner we can find solutions to achieve an equal society, the better, for all.