Inequality: What has happened, why care, and what can be done
Inequality within most developed countries is higher today than it was 30 years ago. Growth in emerging economies has reduced inequality between nations, but the benefits have been unevenly spread within those economies. Unsurprisingly, concerns about inequality and its consequences have become central in political debates globally (see, for example, Milanovic 2016).
Political events, such as the gilets jaunes movement in France and Brexit, and the election of populist leaders in Hungary, Italy, Poland, and the US all seem to have been born of these concerns. Is this really the case? If so, why should we care? And what can we do about it? A recent issue of the Oxford Review of Economic Policy (Volume 35, Issue 3, 2019) seeks to address these questions and in this column, we discuss some of the key themes that have emerged.
Drawing a picture of inequality
The picture we draw of inequality depends a lot on how we measure it. Most discussions focus on people’s income and wealth, though these are simply easily measured proxies for overall welfare. McGregor et al. (2019) point out that, when it comes to welfare, the type of wealth matters (whether it is liquid or illiquid, earned or inherited) and that definitions of wealth should include intangibles like education.
Similarly, the sources of income are important: income from a salary in exchange for hours of labour has a different effect on someone’s welfare than that earned passively from owning capital or from cannily capturing economic rents. Account must also be taken of the ways income and wealth vary over a lifetime, and before and after tax.
The picture depends on who we are comparing with whom, and on how we compare them. Comparisons can be of individuals across the whole world, between countries (when aid and diplomacy become issues), or within countries (when national redistributive policies become relevant).
Local measures of inequality are particularly important because of the way people benchmark themselves against their peers. The particular statistic used will depend on social judgements about how the welfare of different individuals should be weighted and on preferences between a larger pie and more equal slices.
Thankfully, measuring inequality is becoming easier, particularly in developing countries. In the past, it would take many months to get an accurate snapshot of people’s income and wealth by conducting door-to-door surveys. McGregor et al. (2019) describe recent innovations in using data from satellites, mobile phones, and online payment platforms that have made information much more readily available.
How inequality has changed
Income and wealth inequality increased in most of the OECD between 1980 and the 2008 crisis, most notably in Finland, Sweden, and the UK. Nolan and Valenzuela (2019) find that, since the 2008 crisis, inequality in the OECD countries “went down or was stable as often as it increased”. But even in those countries where inequality did not increase or even fell, any gains have not been evenly distributed across the population.
In the UK, for example, Obolenskaya and Hills (2019) show that the growing wealth of the old has obscured the declining fortunes of the young. This disparity is in large part due to the rise in house prices – a consequence of extremely loose monetary policy – which suggests that more attention should be paid to the distributional consequences of decisions taken by unelected central bank officials.
Inequality between countries has fallen since the 1980s, due in large part to the rapid rise in the fortunes of China and India. Kanbur (2019) points out that this rise has not been shared equally within those countries. The majority of the world’s poor now live in middle-income countries. So, addressing poverty is becoming less an issue of international organisations providing aid between countries than it is about national government implementing social welfare policies within countries.
It is easy to see why inequality matters if it leads to outright poverty. It is also easy to see why it matters to someone towards the bottom of the distribution – who feels that the system is working against them and that they cannot fully participate in what society has to offer. But why would it matter to someone at the top or even in the middle?
Why care about inequality
There are several reasons. The first, often linked to notions of ‘fairness’, is that inequality matters for its own sake. Fairness is hard to pin down, but perhaps the widest agreement can be found in the idea of a level playing field, or ‘equality of opportunity’. This is closely linked to Sen’s (1985) ‘capabilities approach’ to welfare, where policy should focus less on utility and more on people’s ability to pursue their own goals.
But the notion of fairness extends beyond equality of opportunity. To take an example from the labour market, paying people fairly is difficult to define, and economists often resort to the concept of monopsony – or firms’ ability to pay workers less than their marginal product because of their difficulty in changing jobs.
Fairness, however, may also extend beyond the idea of a level playing field. The historic solidaristic wage policies of Sweden emanated from a societal view that inequality in market outcomes should be limited. This is an example of what Atkinson (1999) called the ‘pay norm model’, where workers are paid a fraction of their productivity plus a constant amount.
Whenever one thinks about how society should be organised, we need a way to add up the welfare of all the people who live in it. Under even the most basic assumption, that an extra dollar has a bigger impact on the welfare of someone with $1,000 than someone with $1 million, it becomes easy to see that transfers from the latter to the former improve the welfare of society in aggregate.
But that is still taking money from those at the top. Why would they accept this? One reason is that inequality makes societies function less well. Populist movements are believed to stem, in part, from inequality, and they often endorse policies that are bad for business.
Nolan and Valenzuela (2019) discuss research that explores the relationship between inequality and physical and mental health problems, drug abuse, trust and community life, violent crime, obesity, and social mobility. They find that the picture is more nuanced than often depicted by the received wisdom, which often confuses association with causation.
What is certainly true is that low absolute levels of income lead to poor health, which increases the risks of diseases transmitting throughout society. This has been rendered in high relief by the global coronavirus crisis of 2020. So, inequality matters because it makes societies less pleasant and sometimes more dangerous places to live for everyone.
What causes inequality and what can be done
What, then, causes inequality, and what can be done to mitigate it? Furceri and Ostry (2019) point to important roles of the stages of economic development, demographics, technology, globalisation, fiscal policy, and structural reforms. To these, Nolan and Valenzuela add financial market influences and capital income, and Gans et al. (2019) and Ennis et al. (2019) add the market power of firms. Kanbur highlights the role of changes in technology that favour particular skills, such changes often being a by-product of government intervention (the internet being one of the most obvious examples).
Inequality is strongly transferred between generations and this phenomenon is becoming more entrenched. Breen (2019) shows that cohorts born before the mid-1950s in OECD countries experienced increasing upwards social mobility and declining downwards mobility (both in absolute and relative terms). This was largely because the structure of production changed from manufacturing to services, which created more ‘space at the top’. In cohorts born after this, social mobility stalled at best.
Thus, at least in the developed world, we live in societies which are significantly more unequal than they were 30 or 40 years ago and where parental background has become more influential in determining a person’s life chances.
The good news is that policy can make a difference if the will is there. This is not just a job for national governments. The international community also has a role to play. At the lowest level, this should be motivated by enlightened self-interest.
Between-country inequality worsens diplomatic problems like migration, war, pandemics (on the impact of COVID 19, see Baldwin and Weder di Mauro 2020 and Heathcote et al. 2020) and climate change, and reduces the size of potential export markets. Global policies also constrain what can be done domestically, for example in taxing internationally mobile capital and skilled labour.
Nationally, governments have not focused enough on pre-market policies that prevent inequality arising in the first place. Such policies often bring the added benefit of fixing other distortions that reduce the size of the economic pie, like unequal bargaining power between workers and firms, or economic rents coming from natural resources and uncompetitive markets.
In this light, the recent policy fascination with post-market interventions like universal basic income should be seen as too little, too late. Instead, we need a call-to-arms for governments to re-focus on the deep underlying drivers of inequality, to create fairer and more liveable societies for all.
There is a way. The question is whether there is a will.
Atkinson, A B (1999), “Is rising inequality inevitable? A critique of the Transatlantic Consensus”, UNU/WIDER.