The Causes of Wealth Inequality (32): How Inheritance Not Only Perpetuates But Also Aggravates Inequality

Inherited wealth – the value of all assets (real estate + financial assets – financial liabilities) transmitted at death or through inter-vivos gifts – has become more important over time. Thomas Piketty estimates that

the annual inheritance flow was about 20%-25% of national income around 1900-1910. It then gradually fell to less than 10% in the 1920s-1930s, and to less than 5% in the 1950s. It has been rising regularly since then, with an acceleration of the trend during the past 20 years, and according to the latest data point (2008), it is now close to 15%. (source, source)

The drop between the 1920s and 1950s was caused by the Great Depression and WWII, two events that destroyed a lot of wealth.

Inheritance has always been an important cause of the persistence of wealth inequality. I guess that goes without saying. Capital is unevenly distributed in most populations, and will remain so to the extent that it can stay in the same families. It’s more interesting to look at the mechanisms through which inheritance could, under some circumstances, aggravate inequality. What are those circumstances? Here are some:

  1. Birth rates. People in developed countries have fewer children than they used to, and the children they have survive into adulthood at higher rates. As a result, those children inherit a larger part of their parents wealth. If numerous siblings no longer have to split their inheritance among themselves, the effect of inheritance on wealth inequality becomes stronger. Piketty as well has made this point in a recent talk.
  2. Higher house prices. Housing has become more expensive. This incites people to save more so as to allow their children to buy a house, which has a ripple effect across generations: the biggest savers are those who enjoyed an inheritance because if you’ve inherited a house or the money to buy one it’s easier to save than when you have to rent or pay a mortgage. And if you can save, your children will inherit. And so on.
  3. Inheritance taxes have been reduced in most countries.
  4. Slow economic growth in most developed countries means that the wealth produced in those countries is smaller compared to the wealth inherited.

Not all of these circumstances can be brought under human control. Perhaps an inheritance tax – the dreaded death tax – is a realistic option. I mean, if even Nozick could get behind that, you would need to be an outright fundamentalist about property rights  in order to oppose it.

For increases in the inheritance tax to happen, however, we will need to start thinking differently. When David Cameron, for instance, promised to raise the threshold for inheritance tax to £1m he did so because he believes that people who work hard, save money, and bequeath it to their offspring are somehow doing the noble thing. But while it may be noble to work hard and save, it’s far from noble to live off of an inheritance and its often huge returns. Hard work for one results in an unproductive lifestyle for its beneficiaries. If you want to promote work and productivity, by all means impose a death tax. And if you want the best for your children, it may be tempting to give them cash or other assets, but beware that this will be self-defeating beyond a certain amount.

More posts in this series are here.

The Causes of Wealth Inequality (31): Automation and the Hollowing Out of the Labor Market

Conventional wisdom has it that automation comes at the expense of low-skilled jobs and aggravates income inequality because of labor displacement at the bottom of the income distribution. It turns out that this is a bit too conventional, and not only because it runs afoul of the lump of labor fallacy (machines need to be built and people can go on and do other things). Mid-level jobs are also hit by automation, and perhaps even more than jobs at the bottom of the skill continuum. This has been called the “hollowing out” of the labor market. This hollowing out, caused in part by automation, in turns causes an increase in income inequality. This is mere arithmetic: if the middle drops, then the extremes become relatively more important and inequality rises. Ryan Avent puts it well:

Work published in 2006 by David Autor, Lawrence Katz, and Melissa Kearney argued that employment and wage growth in America have “polarised” in recent decades, a conclusion that has been reinforced by subsequent research. Employment in high- and low-skill positions has risen substantially relative to middle-skill jobs. The resulting employment distribution generates a distribution of wages that is similarly polarised and more unequal than that which prevailed prior to this period. (source)

Why does technological automation focus mainly on middle skill levels?

Daron Acemoglu and Mr Autor pioneered a “task approach” to labour markets. Tasks can be completed by either labour or capital. The more routine a task is, the more susceptible it is to automation. But whether or not a task is automated depends upon the relative supply—and the real wage—of workers of various skill levels. Subsequent work has shown that automation and trade are responsible for displacement of routine tasks previously done by middle-skill workers, in both manufacturing and clerical or service activities, leading to polarisation of local and national labour markets.  (source)

Technological automation focuses mainly on middle skill levels because it’s relatively easy at that level, easier sometimes than at the extremes of high and low skilled tasks. “Easier” here means both technologically easier and more cost effective. Highly skilled tasks, such as teaching a philosophy course, are difficult for machines to do because they are complex (although we do sometimes see high-skilled jobs being automated, such as legal research for example). In the case of low-skilled tasks, some of these are surprisingly hard to automate, as in the case of truck driving or toilet cleaning. Even low-skilled jobs that aren’t technically hard to automate aren’t always automated because the pay-off may be too low – people doing those jobs are poorly paid so developing expensive machines to do it for them isn’t worth the trouble.

And then there’s the added worry that displacement of many low-skilled workers would create a permanent underclass unable to participate in the economy – unable, in other words, to buy the goods and services produced by machines. There’s a famous anecdote about Henry Ford mocking a labor union president in one of his factories, saying it wouldn’t be easy to get the robots to pay their union dues. To which the union president responded that Ford wasn’t going to get the robots to buy his cars.

The hollowing out of the labor market, driven by mid-level automation, has therefore a direct effect on income inequality, but it also a few indirect effects. For example, automation means lower production costs, and the savings or the added value go primarily to shareholders through capital gains and stock appreciation. Since stock ownership and capital income are concentrated among those already better off, income inequality is further increased.

If technology decreases the relative importance of human labor in a particular production process, the owners of capital equipment will be able to capture a bigger share of income from the goods and services produced. (source)

Another indirect effect: increasing automation of manufacturing jobs pushes unionization rates down, which in turn decreases bargaining power among low-skilled workers. This, in the end, aggravates inequality yet again.

More posts in this series are here.

The Causes of Wealth Inequality (29): The Declining Share of National Income Going to Labor

What I want to do here is look at a possible cause of increasing income inequality, namely the relative shares of labor and capital income. Your labor income is your wage, your pension, your bonus, your company health insurance etc. Most people have a labor income. You only have capital income if you receive dividend payments, capital gains, interest payments on savings etc.

During the last decades, the share of labor compensation in total national income has declined, and this has been a global phenomenon, occurring in most countries.

Can we blame this decline for the increase in income inequality during the same period? Only in part, I think, because there has also been a divergence within labor in the sense that some people, mostly high earners, have seen their labor income rise much faster than others. Income inequality is indeed, to some extent, wage inequality. The growth of the finance sector, where people are well-paid, is part of the explanation for the increasing wage inequality, at least in some countries. Tax policy, declining bargaining power among the low earners and wage competition from poorer countries – again affecting mainly low-end workers – may be other explanations for rising wage inequality, also depending on the country (unionization rates, for example, haven’t evolved in the same manner everywhere).

But I guess it’s true that not all of income inequality is wage inequality and that incomes from capital, such as profits, dividends, stock options etc. also explain something. Capital income is, compared to labor income, unevenly distributed across a population, and concentrated among the wealthy.

If capital income is more concentrated among the wealthy then a rise in capital income leads to a rise in income inequality. Part of this is just arithmetical: the flip-side of a lower share of national income coming from labor is a higher share of income coming from capital. Capital income needn’t be higher in absolute terms in order to get a larger share. If there’s widespread wage stagnation – perhaps due to international wage competition, trade and outsourcing – then capital income may rise relatively, if not absolutely. However, in some countries such as the US we also see an absolute rise of capital income.

More on capital gains here. More posts in this series are here.

The Causes of Wealth Inequality (28): Political Capture and Deregulation

Does income inequality result from “political capture” by the rich? Political capture is the process by which wealth buys policies that are favorable to the wealthy, who in turn become more wealthy. Through campaign contributions, lobbying, the monopolization of discourse etc. the wealthy may be able to convince politicians to approve policies such as deregulation, non-progressive tax rates, tax loopholes, weakened social safety nets, IP etc. Policies aimed at undermining the regulation of the role of money in politics also fit the list, in a meta sort of way. “One dollar one vote” rather than “one person one vote” would obviously be a perversion of democracy, but I’ll now focus on the purely economic effects of political capture, and more specifically on how wealth-backed deregulation affects the distribution of income.

In theory, political capture doesn’t necessarily aggravate income inequality because the economy isn’t always zero sum: policies favorable to the rich, and pushed by the rich, can also have benefits for the rest. Some types of deregulation may be an example. The word “deregulation” summons images of large companies being allowed to pollute, to pay their workers below subsistence wages etc. However, deregulation can also mean getting rid of occupational licensing which often serves no other purpose than to protect incumbents and frustrate enterprising low-income individuals. Deregulation more generally – again in theory – may lead to increased competition and therefore lower prices, something that also benefits the poor.

However, in practice we see that the wave of deregulation during the last decades, especially in the financial and banking sector, has coincided with increasing income inequality, at least in the US.

It’s not just the total level of inequality that is correlated with deregulation; more specifically, wages in the finance sector show the same trend.

Of course, correlation is not causation. Deregulation may not have been the product of political capture, or not entirely, and may not have been an important cause of rising inequality. But the correlations shown in the graphs above do put the burden of proof on those who deny causation.

But also if you accept the possibility of causation, you’ll need a convincing story. It’s true, I think, that deregulation has increased the number of activities that financial companies can engage in, and has therefore led to a rising demand for higher skilled workers and to more performance related compensation. Financial professionals made up almost twice as much of the top 1 percent of the US income distribution in 2005 as they did in 1979. However, deregulation is only part of the explanation of the disproportionate rise in compensation in the finance sector. Stock options and tax policy are also to blame. Of course, tax policy can also result from political capture, but that just goes to show that any explanation of inequality needs to look at a variety of factors. Inequality isn’t just the product of deregulation.

Another post on the same topic is here. More posts in this series are here.

The Causes of Wealth Inequality (26): The Length of Your First Name

Incredible:

On average, the shorter your first name, the more you will earn. In fact, the data show each extra letter “costs” you about $3,600 in annual salary. (source)

Online job matching site TheLadders has six million members … and a lot of salary data. For Mothers’ Day, the company decided to sort and analyze its information to see whether what our parents call us impacts our earning potential. (source)

More, and I think more serious posts in this series are here.

The Causes of Wealth Inequality (25): Globalization, Ctd.

Globalization is the usual suspect when people discuss the causes of contemporary increases in income inequality in many Western nations. As a result of easier transportation, trade and communication, low skilled workers in those nations now face ever tougher competition from cheap workers in developing countries, and this competition drives down wages at the poor end of Western income distributions: workers have to swallow wage reductions under the threat of outsourcing. Increased immigration – another facet of globalization – has the same effect.

At the top end of the income distribution, the reverse is happening: the job of a CEO is now more complicated in our globalized world, and hence his pay is higher. The threat of relocation also has an effect on income inequality through the channel of the welfare state: companies threaten to relocate, not just because of labor costs, but also because of tax rates. Taxes in Western countries tend to be relatively high because social security tends to be relatively generous. The threat of relocation convinces governments to reduce tax rates, but the price to pay is often a less generous welfare state. This as well puts pressure on the income distribution.

All this sounds convincing, but I’m afraid it’s too simple. The effects of globalization on inequality starts to look more complicated when we take consumption into account. Globalization tends to lower the consumption prizes of a lot of goods, and cheaper consumption can counteract downward pressures on wages and social security. If you can buy more and better stuff with your paycheck, your unemployment benefit or your disability check, then perhaps you’re not worse off.

There’s an interesting paper here by Broda and Romalis in which they look at

the compositional differences in the basket of goods consumed by the poor and the rich in America. Using household data on non-durable consumption between 1994 and 2005 we document that much of the rise of income inequality has been offset by a relative decline in the price index of the poor. By relaxing the standard assumptions underlying the representative agent framework we find that inflation for households in the lowest tenth percentile of income has been 6 percentage points smaller than inflation for the upper tenth percentile over this period. The lower inflation at low income levels can be explained by three factors: 1) The poor consume a higher share of non-durable goods —whose prices have fallen relative to services over this period; 2) the prices of the set of non-durable goods consumed by the poor has fallen relative to that of the rich; and 3) a higher proportion of the new goods are purchased by the poor. We examine the role played by Chinese exports in explaining the lower inflation of the poor. Since Chinese exports are concentrated in low-quality non-durable products that are heavily purchased by poorer Americans, we find that about one third of the relative price drops faced by the poor are associated with rising Chinese imports.

When measuring income inequality, we should correct for the different prices of goods and services consumed by people in different income groups. This doesn’t mean that we should be happy about the fact that poor people live on cheap stuff; it simply means that some of the rising income inequality is compensated by cheaper stuff. And we have cheaper stuff because of globalization. Turning globalization into some sort of bogey man is therefore rather too simple. Income inequality has many causes, and it’s not clear that globalization is, everything considered, an important one.

Finally, a word about the supposed wage pressures of increased immigration: they are indeed no more than supposed.

More posts in this series.

Measuring Poverty (15): A Common Misconception About Relative Poverty

Yesterday, I had a short email exchange with Tim Harford, in which I reacted to one of his claims in this article, more specifically the claim that the use of a relative notion of poverty in poverty measurement implies that poverty will always be with us:

Eurostat, the European Union’s statistics agency, … defines the poverty line as 60 per cent of each nation’s median income. (The median income is the income of the person in the middle of the income distribution.)

This has an unfortunate consequence: poverty is permanent. If everyone in Europe woke up tomorrow to find themselves twice as rich, European poverty rates would not budge. That is indefensible. Such “poverty” lines measure inequality, not poverty.

This argument against relative poverty is as common as it is mistaken. Here’s my email to Tim:

I read your article on poverty measurement a moment ago, and I wanted to object. You say that using a relative poverty measurement of income below 60% of median income makes poverty “permanent”. It does not. True, someone with an income of 61% of the median does not suddenly become poor because the median person receives a pay rise. But it’s also true that it’s perfectly doable – mathematically if not in reality – to raise every single poor person’s income above 60% of the median without changing the median. Poverty is only permanent when one would use 60% of the average as threshold, but no one proposes such a foolish thing, fortunately.

In fairness to Tim, his article does list some advantages of relative poverty and he qualified his views in our email correspondence.

More posts in this series are here.

The Causes of Poverty (60): Early and/or Single Motherhood?

The “culture of poverty” narrative claims that people are poor because they have the wrong values and habits and therefore make the wrong choices: they tend to be unable to resist drugs, violence and crime, they drop out of school, have a problem with punctuality and discipline etc. I’ve already made my own views about this narrative abundantly clear in previous posts. However, I failed to give sufficient attention to one subset of values, namely those related to marriage, family structure and early childbearing. So I’ll briefly have a look at those now.

As is often the case with explanations of poverty based on values and habits, there’s a certain superficial persuasiveness about the claim that early marriage, early childbearing and, most importantly, early out-of-wedlock childbearing result in a lifelong loss of income. Young mothers in general and young single mothers in particular have a relatively hard time finishing their education and finding a well-paying job because the combination of motherhood and work/education is a tough deal.

However, we may be wrong about the direction of causation here. Rather than poverty being the result of bad choices – in this case the choice of becoming a young and/or single mother – it may be the cause of those choices. There’s for example this study which finds that teenage pregnancy rates are indeed higher in U.S. States that have high rates of poverty, but which also postulates that high levels of income inequality cause high teenage pregnancy rates, not vice versa. When young people believe that their society is rigged against people like them, they abandon traditional norms; conversely, people will work hard when they feel that there’s a chance of success. When young women see that their chances of future economic success are slim, then early motherhood may even look appealing: it may give direction and a purpose to their lives, a purpose that would be difficult to find in an economy stacked against them.

“[B]eing on a low economic trajectory in life leads many teenage girls to have children while they are young and unmarried and … poor outcomes seen later in life (relative to teens who do not have children) are simply the continuation of the original low economic trajectory” (source)

In a sense, this is a discouraging finding because it means that the promotion of abstinence or contraceptive use won’t reduce early and/or single motherhood; only poverty reduction and realistic economic opportunities will do that, and that’s a lot more difficult and expensive. And, make no mistake about it, we would want to reduce early and/or single motherhood, because the causation goes in both directions and it’s very implausible to deny that early and/or single motherhood has any effect on income. What you do want to deny is that the “culture of poverty” narrative has an important explanatory value in all of this.

One final remark: while I focus here on mothers, many of the same remarks would be valid for young and/or single fathers as well.

More on poverty and family structure here. More posts in this series here.

The Compatibility of Freedom and Equality (13): More Income Equality Makes Us More Free

Another reason not to worry too much about the supposed incompatibility of equality and freedom is the fact that an equal level of monetary resources promotes freedom. Money in the form of a relatively decent income allows us to choose from and engage in a wide variety of activities. It makes it possible for us to buy the commodities and services we want to buy, and consequently do with them what we want to do. (Of course, within the legal limits that determine what can be commercially traded and how traded goods can be used; e.g. we can’t buy people, and we can’t use the guns we buy to kill people). As a result, we have a wider choice of life plans and more means to pursue our chosen plan.

This is freedom in one sense of the word: more choice. Freedom in another sense, namely the ability to do what we want without interference, looks absolutely anemic compared to this. After all, what good is the absence of interferes when the world we live in offers us only very few options or none of the monetary resources to choose and pursue options. This freedom from interference is hardly valuable, if it is freedom at all.

So, if we agree that monetary means promote freedom in a certain sense of the word because these means broaden our sets of choices, then I guess we’ll also agree that a more equal distribution of money, wealth and income promotes freedom: it gives people who receive more money in the new, more egalitarian distribution more freedom, without necessarily diminishing the freedom of those whose resources are diminished in the new distribution. The monetary freedom of the rich isn’t necessarily reduced after income redistribution and after reductions of income inequality, because of diminishing marginal utility. The ability to buy a fifth yacht doesn’t increase anyone’s freedom in any sense of the word. And taking away this ability doesn’t reduce anyone’s freedom. On the contrary, if the monetary means that could have been used for this fifth yacht are instead given to a number of other people who don’t have a lot of money, then these means will benefit the freedom of those other people, and aggregate freedom will have increased.

So that’s a good reason to reduce income inequality. However, it’s probably not a good reason to eliminate income inequality completely, for four reasons. First, even if, ideally, people have a right to the same extent of monetary freedom as it is defined here, that doesn’t mean they should have the same amount of money. In order to be able to do the same things and have the same choices, different people need different amounts of money. The handicapped, for instance, may need more than average.

The second problem with equal money is that it would mean deep and frequent violations of property rights, and property rights are important, perhaps just as important as freedom (and no, property rights and freedom are not the same thing: the former are a means to interfere with the freedom of others, namely the freedom of others to use goods that belong to you).

A third problem created by equal income is related to incentives. And finally, equal income doesn’t combine well with considerations of desert (one definition of desert is that people deserve different levels of monetary wealth for their contributions to society, culture etc.).

We could react to these different considerations by framing the issue as one of value pluralism: income equality and freedom are important values, and so are desert and property. The difficulty would then be to balance these different values which, it turns out, are sometimes contradictory. That would mean limiting the equalization of income at some point before total income equality, at a level that is compatible with respect for property rights (also limited), with due consideration of incentive problems (also limited), and with recognition of the moral value of desert (also limited).

There’s possibly some Gini value that would hit this balance. This Gini value of x gives a level of income inequality at which monetary freedom is maximized for a maximum number of people. A value lower than x (the lower the Gini value, the more equal the income distribution) resulting from higher levels of income redistribution would not increase the monetary freedom of the poor because the amount of money taken from the rich has become so high that it doesn’t just eat away at marginal utility but also produces disincentives high enough to reduce the size of total social wealth.

We could try this kind of delicate balancing between redistribution on the one hand and incentives produced by rewards for deserving actions on the other hand. (Alternatively, we could also drop income equality as a value and instead focus on a so-called sufficientarian approach in which we would try to give people enough monetary means to achieve a certain level of freedom – freedom as it is understood here – regardless of the means and freedom of the people at the top of the income or wealth distribution. However, I’ll leave that option aside for the moment).

However, there are some problems: we’re dealing here with a somewhat strange notion of freedom. Freedom is obviously much more than the use of monetary means to choose and pursue goals. Also, we don’t want to promote consumerism. The problem with consumerism is that the truly important parts of life can’t be bought, and that focusing on consumption tends to sideline those important parts. It also has ecological disadvantages.

And another problem I already mentioned: some people will be worse off if money is equalized because they need comparatively more money just to have the same capabilities. Hence, rather than equalizing money we should perhaps equalize capabilities.

More posts in this series are here. More on income inequality here. And here‘s a related post about the link between poverty and freedom.

The Causes of Wealth Inequality (24): Self-Confidence

A lot of income inequality is hereditary: wealthy parents can offer their children better education, connections, support and other resources that help to advance their prospects in life. Hence, these children will also be comparatively wealthy, on average. An initially unequal wealth distribution results in a self-perpetuating and perhaps even self-enhancing cycle of income inequality. It’s therefore unlikely that a socially mobile and meritocratic society arises automatically.

One of those “other resources” is self-confidence. Very confident people tend to earn more. In other words, levels of self-confidence are correlated with socioeconomic status:

University students are … poor at estimating their own test-performance and over-estimate their predicted test score. However, females, white and working class students have less inflated view of themselves. (source)

And self-confidence, like education opportunities and networking, is passed from generation to generation – not necessarily in a genetic sense. Self-confidence is, therefore, one reason – together with other parental resources – why income inequality survives the passing of generations.

What is more, there is a feedback mechanism at work between two hereditary resources, self-confidence and education: self-confidence has a beneficial effect on education. A positive self-perception has a positive impact on the expected probability of educational success:

Even small differences in initial confidence can result in diverging patterns of human capital accumulation between otherwise identical individuals. As long as initial differences in the level of self-confidence are correlated with the socioeconomic background (as a large body of empirical evidence suggests [see also above]), self-confidence turns out to be a channel through which education and earnings inequalities are transmitted across generations. (source)

Self-confidence can even improve human capital if it’s baseless, as it often is; if, in other words, it’s not grounded in superior personal qualities:

Say you have two people of equal cognitive skills, but one is over-confident about his ability and the other under-confident. The over-confident one is more likely to stick with a subject during the early steep phase of the learning curve – believing that “I can master this if only I apply myself” – whereas his under-confident colleague is likely to give up, thinking the material too difficult for him. Alternatively, the over-confident student might choose “difficult” academic subjects at high school, which qualify him for entry to some elite universities, whilst the less confident one would choose less academic subjects which disqualify him. (source)

And self-confidence does not just perpetuate income inequality when it reinforces the education opportunities of those who already have better education opportunities given to them by their parents. Self-confidence is helpful in the labor market as well, and the labor market is, like education, an area in which parental resources tend to skew opportunities (wealthy parents are better connected to possible employers, for example):

Overconfident people might select into occupations where there’s a high pay-off to the lowish probability of success, such as management, law journalism or politics. Less confident folk, under-estimating their chances, might prefer occupations which yield less skewed rewards. People misperceive overconfidence as actual ability. The overconfident job candidate is thus more likely to get the job than the more rational one. Posh white blokes can – perhaps unwittingly – manipulate the social awkwardness of others for their own advantage, and thus progress at work. (source)

Hat tip. More posts in this series are here.

The Causes of Poverty (54): Lack of Trade Liberalization

I mentioned before that trade liberalization – the removal of trade barriers such as tariffs, subsidies and other distortions of international trade – is, on aggregate and in the medium term, a powerful mechanism for poverty reduction. I say “in the medium turn”, because some structural adjustment may be necessary, and “on aggregate” because some may lose while others gain.

The usual fears about trade liberalization – that it reduces government revenues necessary for redistribution, that it leads to labor competition, lower wages and higher unemployment rates, or that it raises prices in developing countries – are, in general and on aggregate, unfounded (an overview of the evidence is here). Of course, trade liberalization may cause local economic shocks, and there can be distributional effects: some people will benefit more than others, and some may even be worse of after liberalization, especially in the short term. But it’s the aggregate medium term effect on a country or an economy that counts.

This is similar to the positive effect of economic growth on poverty reduction:

The vast majority of the world’s poor live in the rural areas of these two countries [China and India]. Both countries achieved significant reductions in poverty during 1980–2000 when they grew rapidly. According to World Bank estimates, real GDP grew at an annual average rate of 10 percent in China and 6 percent in India during these two decades. No country in the world had as rapid growth as China, and fewer than ten countries exceeded the Indian growth rate. The effect on reduction in poverty in both countries was dramatic, entirely in keeping with the “Bhagwati hypothesis” of the early 1960’s that growth is a principal driver of poverty reduction. (source)

Not all of the poor will be automatically better of as a result of economic growth, and growth may widen income inequality or relative poverty while reducing absolute poverty. But on average and on aggregate, economic growth – like trade liberalization – reduces poverty. That’s not just a story of “trickle down” or “all boats rising on a rising tide”; economic growth also means that the government has more resources to fund welfare and redistribution. (Obviously, none of this implies that growth is always beneficial or that there isn’t room to make growth even more “pro-poor” than it already is).

Arguments in favor of trade liberalization

The interesting part of the argument is that the positive effect of trade liberalization on poverty reduction passes through enhanced economic growth: liberalization reduces poverty because it enhances growth.

[P]ractically no country that has been close to autarkic has managed to sustain a high growth performance over a sustained period. Furthermore, … if one classifies countries into globalizers and nonglobalizers by reference to their relative performance in raising the trade share in GNP during 1977–1997, the former group has shown higher growth rates… [T]he outward-orientation of the Far Eastern strategy … led to the Asian miracle. (source)

Free trade is one of the determinants of economic growth. Growth requires increased productivity, and that’s what free trade delivers. Free trade means more productivity because it means

  • more specialization
  • more use of comparative advantage
  • better access to technology and knowledge
  • better and cheaper intermediate goods (raw products etc.) and capital goods (machines etc.)
  • benefits of scale
  • and increased competition.

All these consequences of free trade have a positive effect on productivity and hence on growth. And that’s not just theory; there’s empirical proof. Reductions in trade barriers were almost always followed by significant increases in productivity (source).

And it’s not just productivity; trade liberalization has other effects as well. The removal of tariffs can reduces prices for consumers and hence reduce poverty. It’s often the case that goods consumed by poor people have a higher tariff tax than goods consumed by rich people:

In his research, [Edward Gresser, senior fellow and director of trade policy at the Progressive Policy Institute] found that the tariff rate on a cashmere sweater is 4 percent; the rate for one made of much cheaper acrylic is 32 percent. A silk brassiere has a tariff rate of less than 3 percent, but the rate on a polyester one is slightly less than 17 percent. The tariff rate on a snakeskin handbag is just over 5 percent but climbs to 16 percent for one made of canvas. Similar variations occur when it comes to household goods. Drinking glasses that cost more than $5 each have a tariff of 3 percent, while those that cost less than 30 cents each have a rate of 28.5 percent. A silk pillowcase has a rate of 4.5 percent; this goes up to nearly 15 percent for one made of polyester.

Overall, clothes and shoes contributed nearly $10 billion in tariff revenue in 2009, while higher-cost items including audiovisual equipment, computers and even cars added less than $2 billion. Gresser contends that the $10 billion is disproportionately borne by people who can’t afford to buy luxury goods. What’s more, when customers pay sales tax on these products, that amount is also higher than it would otherwise be thanks to the tariff that drives up the retail price. (source)

Hence, not only does free trade alleviate poverty, trade restrictions and protectionism actually aggravate poverty. Take also the example of restrictions on rice exports in rice-producing countries:

At first glance, this seems understandable, because a country may not wish to send valuable foodstuffs abroad in a time of need. Nonetheless, the longer-run incentives are counterproductive. (source)

When farmers can’t export, there’s little incentive for them to farm rice. Result: the shortages that were meant to be avoided.

Arguments against trade liberalization

However, we shouldn’t lose sight of the undisputed downsides of trade liberalization. The removal of subsidies can hurt certain producers and it can, especially in the short run, depress employment and wages in certain sectors. It can therefore reduce some people’s incomes and push them into poverty. Trade liberalization can destroy entire markets: it can force a country to abandon tomato production for example, because nonsubsidized local producers are no longer able to compete with increased import competition coming from countries with a comparative advantage. The local producers will lose their jobs and income. However, these same people may benefit in other areas: products which they consume may become cheaper. So, when assessing the impact of trade liberalization on poverty, one has to aggregate all the losses and gains in different areas, and that’s ultimately an empirical question that has to be investigated country by country. Overall, the evidence is that, on aggregate, the effect is probably positive.

There can be individual losers from liberalization, and even individual countries can lose: countries that depend on mineral resources, for example, can take the fast lane towards the resource curse when trade is liberalized. But it’s the global balance of poverty alleviation that determines the desirability and success of trade liberalization.

The claim that liberalization negatively affects government revenues because of decreasing income from tariff taxes, and hence diminishes the generosity of the welfare state, is also not well founded. First of all, liberalization also means reduced subsidies, which should improve governments’ fiscal situation. Secondly, trade volumes increase as tariffs are reduced, and hence the net effect of reducing tariffs doesn’t have to be falling revenues. And finally, even if revenues fall, the poor don’t necessarily have to suffer: it’s ultimately a political decision where to spend which types of government revenues. Priorities can change when revenues change.

Another possible disadvantage of free trade is a cultural one. The claim is that free trade means cultural imperialism: small cultures don’t have the resources to export their cultural products and risk being overwhelmed by, in particular, American culture. Hence, there may be a case for cultural protectionism, but this case doesn’t extrapolate to protectionism writ large.

Conclusion

Liberalization isn’t a magic bullet, neither for economic growth nor for poverty alleviation. Sustained growth and substantial long term poverty reduction require more than free trade. Conflict resolution, good governance, education etc. need to accompany liberalization. It’s no secret that we don’t yet fully understand all the determinants of growth and poverty reduction. The advantage of trade liberalization, compared to other possible pro-growth or pro-poor policies, is that it’s relatively easy to implement: it is – or should be – easier to abolish tariffs and other trade restrictions (especially if there’s an element of reciprocity in global negotiations) than to create a solid education system or a non-corrupt judiciary able to enforce market rules and property rights.

The evidence in favor of the pro-poor effects of trade liberalization is compelling, but we shouldn’t underestimate some measurement difficulties: the measurement of poverty, of trade liberalization and of the effect of the latter on the former is by definition imprecise. The concept of trade liberalization may also be too broad or too vague. And the specific outcomes of liberalization policies depend not only on the precise reforms being undertaken, but also on the context in which they are undertaken. The same measures will have different results in different economic environments. The extent of multilaterality also determines the effects.

Read more on the topic here and here. More posts in this series are here.

Measuring Poverty (14): Measuring Income Inequality

Income inequality may or may not be the best definition of poverty,  but it’s certainly one that is often used. In many European countries, you’re counted as poor when your income is below 50% or so of the median income. Maybe this is the wrong way to measure poverty, but if you use absolute measures for poverty (such as a basic income, minimum consumption etc.) you’ll also face some problems. So it’s worthwhile to examine some of the usual methods for measuring income inequality and see how they hold up, while at the same time bracketing the discussion about poverty as either absolute deprivation or unequal distribution.

Methods for measuring income inequality

The Gini coefficient is the most widely used. It’s based on the proportion of the total income of a population that is cumulatively earned by a % of the population; a value of 0 expresses perfect equality where everyone has equal shares of income and a value of 1 expresses maximal inequality where only one person has all the income. A low Gini coefficient indicates therefore a more equal distribution. (The complete formula is here).

A disadvantage of the Gini measure is that it doesn’t capture where in the distribution the inequality occurs: is a society unequal because the top 1% has astronomically high incomes, because the poor are very poor, because there is practically no middle class, or because of some other reason?

Other measures are

  • the ratio of the incomes of the top 10% (best paid) to the bottom 10% (worst paid)
  • the proportion of a population with income less than 50% of the median income
  • a population may be split into segments, e.g. quintiles or deciles, and each segment’s income share is then compared to each other segment’s (for example, the top 10% of the population – “top” in income terms – has x % of total income)
  • some other measures are here.

These different measures can give contradictory numbers: two societies with the same Gini score can have different ratios of top-bottom, top-middle or middle-bottom incomes (see an example here). Hence, no single measure will tell us the last word about inequality in a society.

What is income?

The focus of all these measurement systems is income, but we should first decide what to count as income. Income doesn’t have to be cash or currency. A farmer in a poor country who grows his own products has non-cash income. Perhaps public services such as healthcare or education should count as income. And how about tax reductions, tax refunds, government benefits such as unemployment insurance, food stamps and various vouchers?

All those forms of non-cash or non-labor income are important when measuring income inequality because the poor profit disproportionately from those non-cash or non-labor related forms of income. Hence, including them in total income can make a large difference in income inequality numbers. (Higher income groups may have less or different tax refunds and their education may represent a smaller portion of their total income – the returns of their education may of course be higher, but those returns are typically cash based in the sense that they lead to higher labor compensation).

We should also decide if we want to use income before or after taxation; depends if we want to measure the effectiveness of redistribution or simply gross inequalities. And what about capital gains, imputed house rents from home ownership, inheritance etc. In general, how should wealth be included in income? Or shouldn’t it be?

How do we measure income?

Once we’ve solved the difficult problem of defining income, we’re still left with the practical problem of measuring it. Most cash income is captured in tax return data, but not all, and not equally well in all countries. Sometimes, you’ll need to use consumption data as a proxy for income data, or surveys about living standards. “Informal” income typically does not show up in tax data, but does in consumption data.

Another problem with measures of inequality is that they may be contaminated by notions of fairness. Some deliberately design their measurement system in such as way that inequalities look bigger than they actually are. For example, they use pre-tax inequalities because those are often larger than post-tax inequalities – a lot of tax systems are redistributive towards the poor (e.g. progressive taxation systems). Or they focus on income inequality when consumption inequality may have diminished. Others may mistakenly deduce evaluations of fairness or injustice from the simply fact of income distributions and forget that measures of income inequality are silent about who is on which side of the divide. If person A in a two person economy has twice the income of person B, then the measurement of inequality would be absolutely the same when B switches places with A. Measures of income inequality say nothing about who deserves what, about how income has been acquired, about whether some occupations should yield higher compensation (for example because we want the right incentives), or about how income should ideally be distributed.

And then there is the opposite mistake: assuming that income inequality is always necessary and just because it’s the automatic result of the fact that people have different levels of human capital and productive abilities. This is a mistake because it ignores a number of facts: no one has ever been able to prove that some abilities or occupations deserve higher wages from a moral point of view, and a lot of inequality is the result not of different abilities or efforts but of differences in luck and connections. Hence, fairness remains a legitimate concern. Contrary to the “left-wing mistake”, the “right-wing mistake” will not distort the measurement of inequality: if you believe inequality is not a problem you hardly have a reason for measuring it, let alone distort the measurement.

What I want to stress is how difficult it is to measure income inequality and how many mistakes we can make. This doesn’t mean that the numbers are rubbish. We should just be careful when drawing sweeping conclusions, that’s all.

Something more about the causes of income inequality, rather than the measurement of it, is here.

The Causes of Wealth Inequality (23): Capital Gains

It’s hard to investigate the causes of income inequality without looking at the sources of income. In turns out that, in the U.S. at least but probably also in other developed countries, the majority of a population gets almost all of its income from wages, while people at the top of the income distribution get most of it from capital gains and dividends.

Dividends are payments made by a corporation to its shareholder members, usually a portion of corporate profits. Capital gains are profits that result from investments into a capital asset, such as stocks, bonds or real estate, which exceeds the purchase price. A capital gain is the difference between a higher selling price and a lower purchase price, resulting in a financial gain for the investor.

Given these differences in the sources of income, income inequality will rise if incomes from capital gains and dividends rise more rapidly than wage incomes, perhaps because taxes on the former are cut. And indeed, most of the recent increase in the Gini score for the US (higher Gini numbers imply a less equal distribution) comes from higher capital gains and dividends and from lower taxes for high earners (lower taxes not only on capital gains, by the way; many taxes have become less progressive in the U.S.).

This cause of income inequality suggest a problem that goes deeper than inequality:

I think a lot of people sense that there’s something unsettling about this shift from labor income to capital incomes. It seems endemic of a society that devalues work while providing outsized rewards for speculation and asset accumulation. (source)

More posts in this series are here.

The Causes of Wealth Inequality (22): Non-Progressive Taxation and Weak Transfers

This post applies to the U.S., but I guess the same conclusion are valid for a number of other countries as well. In the case of the U.S., very high levels of income inequality could, in theory, be reduced in several ways:

Unfortunately, very little of this is happening. Let’s focus on the last two options. The tax system in the U.S. is not progressive at all. As you can see from this graph, taxation in the U.S. hardly influences income shares.

The poor only get a little bit more thanks to taxes, and the rich only lose a little bit. This is all the more regrettable given the fact that the rich have done very well over the last decades.

Higher tax rates for the wealthy and other more progressive taxes such as a higher inheritance tax, a higher capital gains tax, a Tobin tax etc. are politically impossible it seems.

Increased benefits for the poor are equally unrealistic given the fiscal situation and the predominant ideology. Although the poor in the U.S. do profit from the existing benefit system in absolute terms (unemployment insurance for example saves millions from absolute poverty), income inequality barely moves because of it. Income shares after benefits are hardly less unequal than before. This graph shows the influence on income shares of the sum of taxes and transfers, but you get the picture.

Taxes and transfers result in the poor having a bit more and the rich having a bit less, but fundamentally they don’t change the distribution of income.

More posts in this series are here.

What is Poverty? (4): Does the Concept of Poverty Collapse Under the Weight of Historical Comparisons?

Many of the people who are considered poor in developed countries have a higher living standard than the average middle class citizens of some centuries ago. If we bracket the minority of the extremely poor in developed countries (the homeless for example), poverty today seems to be a relatively comfortable position to be in, once you see it in a historical perspective.

The same is true for people in poor countries. In 1820, average income per person was low everywhere in the world: about $500 in China and South Asia, and about $1000-$1500 in Europe (1993 US$ PPP). In developing countries today the range is between $1000 and $3100 (the world average is about $6000, the US has more than $40,000). So, the poor of today are equally well off or even better off than the average world citizen 200 years ago. 75% of the world’s population lived on less than $1 a day in 1820. Today, almost no one does in the West. In China it’s less then 20%, in South Asia 40%, in Africa half. Globally, it’s less than a quarter. Historically, almost everyone was poor; today it’s a minority.

So it seems almost futile to talk about poverty today. What is defined as poverty now was the normal way of life not so long ago. However, if that’s the way you want to go, the concept of poverty evaporates. You’ll always find someone who’s worse off. You just need to go sufficiently far back in time (or move in space) to find people who are more deprived and who make the current poor (or the local poor) seem relatively well off. The baseline is then the caveman and everyone else isn’t really “poor”.

Hence, if you want to keep talking about poverty, you can’t engage in historical comparisons. Does that mean that poverty can only be measured against the current average standard of living? That poverty is a percentage of current median income? In that case, there will always be poverty and the fight against it is a Sisyphean task. I’m not entirely convinced of the usefulness of the concept of relative poverty – that you should compare people’s living standards to society’s average standard (where poverty becomes basically income inequality) – and the historical rather than spatial version of relative poverty reinforces my doubts. However, I know that people commonly see poverty as a relative thing and that they may feel deprived because they compare themselves to their living compatriots and not only because they are below a certain absolute level of income, consumption or capabilities. Conversely, the middle classes of some centuries ago, even if they had the same standard of living as some of today’s poor, felt good about themselves because they looked at the poor of their time and felt that they had done comparatively well.

Still, relative poverty is not the only solution to the problem of historical comparisons. Poverty can be measured relative to average historical or current standards of living, but can also be measured by comparing consumption, income or capabilities to a commonly accepted absolute minimum level (for example a minimum amount of calorie intake).

In the latter case, it’s not important how rich the rich really are, or what the median income is, or how poor the poor were centuries ago. It’s important to know what are people’s basic needs, how much they cost, and how many people currently can’t buy the stuff to fulfill their basic needs. Of course, these basic needs can’t always be determined scientifically (as in the case of calorie intake) and some level of arbitrariness is unavoidable. A lot depends on the capabilities we believe are necessary in order to have a minimally decent life, and that’s controversial.

I also understand that social norms evolve and that basic needs can change over time. Several centuries ago a microwave and a cellphone were obviously not a basic need; now you will be considered poor if you lack these tools. In a pre-modern agrarian society, you would have been considered poor only when you were on the brink of starvation. You didn’t need technological tools, child care, education etc. in order to have a minimally decent life, because no one had those things and your functioning in the economy didn’t require them. Today, if you don’t have them, you’ll feel excluded, less than normal, weird, “trash” and in certain cases you’ll end up deeper in poverty because you’ll have a hard time finding a job if you don’t have a car, a cell phone or child care.

Also, why shouldn’t we become more ambitious over time? Should we be content if we’re able to avoid only the worst kind of deprivation? Or should we try to continually improve many different capabilities? The latter is I think a sign of civilization and progress. That doesn’t mean we should scatter our attention and forget to focus on the worst deprivation. It only means we shouldn’t stop after we’ve dealt with the worst. And we haven’t dealt with the worst simply because the percentages of those worst off have been coming down (see the numbers cited above). Indeed, a smaller share of the world’s population suffers from low income than some time ago. But because of population growth – which is a good thing resulting from higher life expectancy rates – the total number of people with low income is now higher. And total numbers also count, just as much as percentages. As Thomas Pogge has argued, the Holocaust wouldn’t be any less horrible if it turned out that the number of people killed was a smaller percentage of the world’s population than initially thought.

Income Inequality (25): And Economic (In)Efficiency

As I stated before, economic theory suggests that income inequality is a necessary price to pay for economic efficiency: unequal rewards incite those with talents, skill and perseverance to innovate and to be productive, so they can reap higher benefits. Ultimately, this serves the welfare of the whole of society (a process which is then caricatured in trickle down economics). The mirror image of this is reductions of inequality that take away incentives for doing well, and that therefore result in economic inefficiency and less prosperity for all.

Tyler Cowen has framed it like this:

Redistribution of wealth has some role in maintaining a stable democracy and preventing starvation. But the power of wealth redistribution to produce net value is quite limited. The power of wealth creation to produce net value is extraordinary … We should be putting our resources, including our advocacy and our intellectual resources, into wealth creation as much as we can. (source)

But is that really true? There is some evidence that reducing inequality through redistribution actually promotes wealth creation. What’s the mechanism? Sam Bowles claims to have identified one element of it:

Inequality breeds conflict, and conflict breeds wasted resources … [I]n a very unequal society, the people at the top have to spend a lot of time and energy keeping the lower classes obedient and productive. Inequality leads to an excess of what Bowles calls “guard labor”. (source)

More about that effect here and here. Other parts of the mechanism through which inequality impedes and equality promotes growth may be the following:

Poverty causes credit constraints. This stops the poor investing in businesses or education; the low aspirations caused by poverty can have the same effect. … Inequality can create the threat of redistribution which can blunt incentives to invest. Or it can lead to state interventions – such as the minimum wage – that harm wealth creation. … The backlash against wealth-creating processes such as globalization, offshoring and private equity in the UK and US are founded in the view that they create inequality. If we had better redistribution mechanisms (say, a basic income) such backlashes would be reduced, and the wealth creation process enhanced. (source)

That sounds persuasive and I want to see some evidence. In the meantime, it’s perhaps a bit glib to announce that “the power of wealth redistribution to produce net value is quite limited”.

The Causes of Wealth Inequality (20): Weak or Declining Unionization, Ctd.

Not all countries where income levels are very unequal are also countries where labor unions are weak or in decline; but some are, notably the U.S. For that reason, and because labor unions are generally regarded as forces advocating for a more equitable wage distribution, it’s tempting to see a causal link between declining unionization and increasing income inequality.

There’s a study out which estimates that approximately a fifth of the increase in hourly wage inequality among women in the U.S., and about a third among men, is explained by declining union membership.

Deunionization also increases inequality in sectors where unions have always been weak or absent, because companies in those sectors tended to follow wage levels in unionized sectors as a means to compete with union employers or to discourage unionization. Unions also influenced general government policy – e.g. minimum wage laws – which benefited non-unionized sectors. And, finally, with unions no longer making the general moral case for equality, voices against equality have gained the upper hand.

I know it’s only a correlation and hence no evidence of causation, but the correlation is indeed striking.

More posts in this series here.

The Causes of Poverty (50): The Structure of Income Inequality

It seems that one particular aspect of income inequality – namely the degree of inequality between middle income and lower income people – determines the degree of redistribution in a society, and hence the level of poverty of the poorest:

the key factor determining redistribution is the income gap between middle income voters and lower income voters. Where this gap is low, middle class people feel some degree of solidarity with the poor and exhibit what Lupu and Pontussen describe as “parochial altruism.” That is, they are more likely to support income redistribution because they feel that the poor are in some sense, “like them”. When the gap is high, middle class people will have a much weaker sense of solidarity with the poor, and hence be less supportive of redistribution.

Lupu and Pontussen suggest that the US is an outlier, with weaker solidarity than the structure of US inequality would suggest. They argue that the explanation for this is straightforward – “it is clearly attributable to the high-concentration of racial-ethnic minorities in the bottom of the income distribution.” More bluntly put – middle class Americans feel less solidarity with the very poor because the very poor are more likely to be black. (source, source, source)

Yet another reason to worry about income inequality. More posts in this series are here.

What is Equality? (2): Or, Equality of What?

As I mentioned before, when people talk about equality they mean equality of something very specific. The problem is, they hardly ever agree on the specifics. So it’s not uncommon to see two people talking about equality and actually talking about something completely different. And even when they’re talking about the same specific type of equality, they often disagree about its importance, its definition and its (lack of) merits.

Here’s a list of some of the types of equality that are frequently discussed:

  1. equality of respect and/or dignity
  2. equality of income or wealth (sometimes equality of consumption)
  3. equality of a bundle of basic resources needed for a minimally decent human life
  4. equality of capabilities
  5. equality of power (political and other power)
  6. equality of rights
  7. equality of luck or opportunity, i.e. equality of natural and social endowments.

I’ll skip the first one for now (I may come back to it in a later post) because it’s vague in its policy implications, and it’s those implications I want to focus on here. In fact, what do we want to do when we say that we want to promote one of the remaining 6 types of equality? And what are the likely problems we’ll face? Let’s go over them one by one.

2. Equality of income or wealth (sometimes equality of consumption)

Few people actually want to strive towards complete equality of income, wealth or consumption, for several good reasons.

  • First, people have different consumption needs and hence different income or wealth requirements. And I’m talking about needs, not preferences. People who prefer expensive stuff will have a hard time justifying the inequality of income or wealth that they require to satisfy their tastes. On the other hand, a blind person will have no difficulties making the case for a higher income. Preferences may also be problematic when they aim too low rather than too high. People who are born into deprivation and only see deprivation around them may adjust their preferences and expectations so that they are satisfied with their lives. However, it would be wrong to follow their preferences rather than their real needs.
  • And secondly, equality of income or wealth creates an incentive problem. See here. If people are not rewarded for their efforts, they may decide that their efforts aren’t worth their while, and society as a whole may be worse off as a result.

So equality of income is in fact shorthand for reduced income inequality. As we don’t want this type of equality to collapse into the next one (see number 3 below), let’s assume that we’re not talking about a society in which income inequality means that the people at the wrong side of the inequality are poor – poor in the sense that they lack the basic resources needed for a minimally decent human life. So, instead picture a society in which all prosper but some prosper a lot more than others.

Is that kind of inequality a problem? Many say it isn’t. Why should a university professor care about how much a business tycoon earns? However, income inequality in this sense can be problematic. It can, for instance, shock people’s notions of fairness and justice. If the professor successfully teaches her students about morality, and the business tycoon earns his wealth by polluting the earth, it may seem unjust that the professor should be rewarded less. Merit and desert are powerful ideals, and a society that systematically violates these ideals through its system of rewards may not be the ideal place to live.

Even if the tycoon earns his wealth by way of morally sound activities, there can be a problem of justice: perhaps he started life in an advantaged position compared to the professor, and therefore doesn’t (entirely) earn his rewards. Maybe the professor also wanted to become a tycoon, but her blindness forced her into a different career. (See point 7 below). And even if the starting positions are equal, the result of the tycoon’s wealth may be that he, compared to the professor, has a larger influence on democratic politics. (See point 5 below). This may destroy democracy, or at least result in a highly fragmented and therefore also unstable society.

So we have some good reasons to do something about this type of inequality. However, when we try to reduce – not eliminate – income inequality, we’ll probably reach a point at which redistribution starts to discourage people from being productive (the incentive problem mentioned above). Or not. Perhaps the loss of income they suffer because of redistribution makes them want to be more productive. Higher productivity can be the means to compensate for the loss of income. It’s not clear how strong these two possible effects are.

In any case, many of the problems caused by income inequality don’t need to be solved by way of reductions in income inequality. Unequal political influence generated by unequal wealth can be solved by limiting the influence of wealth on politics, rather than by limiting wealth.

More on income inequality here.

3. Equality of a bundle of basic resources needed for a minimally decent human life

Let’s now drop the assumption that we’re talking about a society in which all prosper, albeit unequally. That’s unrealistic anyway. Even in the richest countries on earth, there are many people who are unable to secure the bundle of basic resources necessary for a decent human life. There’s a theory called sufficientarianism that wants to focus, not on income inequality or relative poverty, but on absolute destitution. It claims, correctly I think, that all have a right to an equal bundle of basic resources and that this is what equality means.

The easiest way to make sure that people possess these basic resources is to give them enough money to buy them. For example, there’s a political movement advocating a guaranteed basic income (an income people receive whether they work or not; Philippe van Parijs is a notable supporter of this policy). But also employment benefits, healthcare benefits etc. aim to provide people with access to the basic resources necessary for a decent life.

The advantage of giving people money is of course that money is fungible: people can use it the way they want. That means it takes into account the fact that different people need different and different amounts of basic goods (take again the case of a blind person). If you give people basic goods directly, rather than the money necessary to buy them, then it becomes difficult to tailor the given goods to the specific and variable needs of individuals. An all-purpose means such as money is clearly better.

However, you’ll still have the problem that some people may need more money than others because they have basic needs that are more expensive, again not because of differences in taste or preferences, but because of different abilities. A blind person does not only need different resources but also more resources in order to lead a minimally decent human life. So we’ll have to factor in capabilities (see point 4 below). Hence, equality of basic resources, outside of the capabilities approach, isn’t enough. If that’s your goal, you won’t do justice to everyone.

An additional difficulty is that the composition of the bundles has to be different from one country to another, and not just from one individual to another. A minimally decent life in one society is more costly than in another one. In a highly industrialized and technological society, it’s more expensive to earn a living than in a society where, in a manner of speaking, you can just pick the fruit from the threes. If you add up all these differences in the content and quantity of the bundles you risk ending up with something very arbitrary. The whole concept of a basic bundle may lose its meaning.

Even if we assume that this type of equality does retain some meaning as a separate type of equality, we’re faced with the same incentive problem as in income equality, depending on how costly the bundle of resources is and how heavily we have to tax to produce it.

A final problem with this type of equality is one of fairness. The guaranteed basic income approach, as well as all other forms of unconditional provision of basic resources, seems to reward the lazy and punish the hard working. It’s reasonable to provide basic resources to people who are poor because of bad luck, lack of talents, bad health etc., but not to those who voluntarily choose not to be productive.

4. Equality of capabilities

So let’s turn to this next type of equality, which can be seen as a fine-tuning of the previous type. Why do we say that people need a bundle of basic goods for a minimally decent life? Because a minimally decent life means something. It means having the capabilities to engage in certain functionings that are part of a minimally decent life. These functionings include “beings and doings” (in the words of Amartya Sen), such as being nourished and in good health, taking part in community life, culture and thinking etc. People’s capabilities to achieve these functionings should be equalized. That doesn’t necessarily require a fixed and equal basic income. On the contrary, because a fixed basic income does not take into account the different levels of incapability across individuals. Some people need no help whatsoever. Others may need a lot. The blind person mentioned a few times already may need more than the average poor person, but perhaps less than a particular person who’s very deep in poverty.

The problem with this type of equality is the precise determination of the list of functionings and capabilities that really matter and that should be equalized. There’s a risk of paternalism, a lack of neutrality and a sectarian bias. Maybe a democratic approach to this determination can solve that problem. And that’s the link to the next type of equality.

5. Equality of power (political and other power).

In a democracy, people have – formally at least – equal political freedom. They all have the right to vote, to voice criticism or support, to campaign and demonstrate, to assemble and associate, and to stand for office. However, a lack in some of the other types of equality mentioned above may reduce the fair value and effectiveness of this democratic equality for a certain number of citizens, e.g. the poor, the blind, etc. As already argued, even prosperous citizens can have unequal power in a society with large income discrepancies (remember the professor and the tycoon).

So, if we want to promote this kind of equality of power, we first need to promote other types of equality. People may need access to basic resources in order to have the time and energy to devote to politics. And some of these resources are directly necessary for political participation (people have to drive to the polling station, read the newspapers etc.). However, equality of power can also be promoted without first promoting other types of equality. We can regulate campaign financing and access to the media and thereby limit the influence of wealth on politics. We don’t necessarily need to reduce wealth inequality to do that (although there may be other reasons to limit wealth inequality, see above). Equality of power, therefore, doesn’t necessarily collapse into other types of equality. It’s a concept that merits a separate existence.

Equality of power isn’t just equality of political power. Slaveholders have power over their slaves, husbands may have (had) power over their wives etc. Again, equality of power in these contexts can be promoted by first promoting other types of equality. If slaves and women are given basic resources then we reduce the cost of exiting the oppressive relationship as well as the power of the counter-party to keep them in that relationship. We may also want to given them equal rights.

However, I see that this post is dragging along and is now way past the saturation level, I guess. So I’ll stop here and just link to some previous posts dealing with the two remaining types of equality:

6. Equality of rights: here
7. Equality of luck or opportunity, i.e. equality of natural and social endowments: here

The Causes of Wealth Inequality (19): Talent, Effort or Luck?

Talented people usually earn more, especially when their talents are “marketable”, highly valuable and in demand among large groups of consumers or users. Hence, it’s tempting to conclude that income inequality is the natural and necessary result of the given inequality in the distribution of marketable talents. However, that conclusion only holds up when you turn things around: rather than talented people earning more, it has to be true that people who earn more generally have more and better talents, talents moreover which are in demand. I don’t know of any study confirming this claim, but my anecdotal observations in the matter tell me that the claim isn’t true: many rich people don’t have special talents, and many talented people aren’t rich at all.

But then why are some people rich? Perhaps they have some other native endowments, such as a strong will, discipline and a natural willingness to make an effort. Or perhaps they have successfully acquired these characteristics during the course of their upbringing and education. Income inequality is then the product of the natural and/or acquired inequality of effort. But, again, it’s easy to find wealthy people who are neither talented nor strong willed, and many poor people work very hard. As someone has said: hard work is much more common than success.

Maybe luck plays a large part in the creation of wealth: some people have the good fortune of acquiring – perhaps through inheritance – certain means of production. Others are born in a place and family that provides good education, numerous wealth creating opportunities, encouragement etc. Still others find themselves in an economy where demand for their particular contributions is high, or where these contributions are highly valued. Or maybe they find themselves in a political system where discrimination and certain government policies give them an advantage.

Your personal thoughts on the relative importance of talent, effort or luck will determine what you think should be done about income inequality. Those who believe effort is the main cause tend to assume nothing should be done. If wealth distribution is the sole result of differences in effort, then redistribution is not only unfair to those who invest more effort, but also has perverse consequences: it will destroy all future wealth and therefore make all future redistribution impossible, because punishing people for their efforts means taking away their incentives to invest effort.

If you think talent or a native endowment of discipline is the main cause of wealth inequality, then you will probably be more sympathetic to redistribution. Since no one deserves his or her talents or other native endowments, no one deserves the unequal rewards that come with unequal endowments. However, since people still need to use and develop their endowments, you’re likely to reserve at least a small role for effort. Hence, you’re not likely to be a strict egalitarian. Still, you will favor education as a means to foster some people’s lingering talents and underdeveloped sense of discipline, and perhaps you’ll also favor a more equal distribution of the attention society gives to different talents.

If you think income inequality is mainly caused by luck or the lack of it, you will be a strong egalitarian. You view talent and effort, as well as the ability and willingness to use and develop talents and to invest effort, as the products of good fortune: you’re lucky to have the right genes, parents and teachers who encourage you etc. And you also view other types of good fortune as causes of wealth: being in the right place at the right time, inheriting means of production, meeting the right business partners etc. Luck is undeserved, and so are its products. Hence redistribution is morally required.

The Causes of Wealth Inequality (18): Government Backed Corporate Expropriation

Consider these two commonly accepted ideas:

  1. the interests of business and government are incompatible: business wants as little government as possible, and government wants to regulate and tax business for the common good
  2. wealth or income inequality is to some extent or perhaps even principally caused by differences in effort, talent and productivity: those who have greater wealth deserve it.

These ideas have intuitive appeal and are undoubtedly correct in some cases. As overall assessments, however, they are clearly false. Inequality has many causes. Regarding #2: very deserving people may end up very poor, and very undeserving people may end up very rich. Many other factors besides effort or talent determine monetary outcomes, such as disability, the coincidence of place of birth, parental influence, education facilities, tax policy, discrimination, technological evolution etc.

Regarding idea #1: one could just as easily make the case that big business depends on government and uses government to acquire unfair advantages, thereby deepening the inequality gap. These unfair benefits should perhaps even be called forcible expropriation because some people are getting better off at the expense of those who have less, and are using the government for this purpose.

For example, you often see big corporations embracing government regulation of their business (e.g. Philip Morris accepting restrictions on cigarette advertising) because they know that smaller competitors will have a much harder time digesting the regulatory burden (and, in the case of Philip Morris, filling the name recognition gap when advertising is prohibited). Regulation in such cases gives big companies and big earners a competitive advantage, and causes the income gap to widen. Another example of regulation are quality standards: those also favor big existing companies and make it harder for new and smaller players to enter a market. The same is true for intellectual property rules, zoning restrictions, occupational licensing, capitalization requirements and many other types of regulation. Legislation or regulation is often embraced by big business and wealthy economic actors as a means to benefit at the expense of smaller actors.

Some types of collusion between big corporations and government are even more direct and open: protectionist import tariffs, subsidies, bailouts, expropriation of private property for corporate use (through eminent domain rules) and military interventions abroad.

By the way, this logic does not only widen the wealth gap but also drives the growth of government. Big business leads to big government, which in turn favors big business. Even if you don’t identify as a libertarian – and I don’t – you’ll probably do well to accept that government backed corporate expropriation is a thing.

More posts in this series are here.

The Causes of Wealth Inequality (17): Education

People who have enjoyed a relatively high level of education tend to have higher wages. They are more likely to be employed. And their marketable skills give them a competitive advantage. It would seem to follow from this that countries with low percentages of the population having completed some specified level of education (say secondary education) should also be countries that have relatively high levels of income inequality. However, that’s not really the case (the correlation is obviously weak if it’s there at all).

It’s also true that educational attainment levels have risen in countries where income inequality has risen. All this would suggest that it’s not insufficient education that causes income inequality and that it’s futile to try to reduce income inequality by way of broadening the levels of education in a country.

However, that statement may go a bit too far. Education probably helps, but its effects are swamped by the effects of other factors that go the other way and aggravate income inequality. For instance, wage premiums aren’t the simple product of one’s education level. The type of education also matters (engineers will probably always earn more than philosophers), as do some noncognitive traits that are fostered by education but that are also more difficult if not impossible to equalize through education (such as discipline and intelligence). Add to this all the other elements that determine the levels of income in a society – the nature of one’s parents, peers and neighborhood, the social selection of desirable skills, international wage competition, regulation, corporate governance, taxation etc. – and it becomes clear that education alone can’t possibly produce a lot more income equality.

But that doesn’t mean it can’t help or that it shouldn’t be promoted for other reasons. Education is a good in itself, regardless of its effects on inequality. Furthermore, education promotes social mobility (the correlation between parents’ earnings and children’s earnings). See here; a much stronger correlation, especially without the US.

The Causes of Wealth Inequality (16): Wages in the Financial Sector

[I]nequality has been soaring in part because of politics. Piketty and Saez document that the very rich today are different than those several decades ago, most importantly because they are not rentiers enjoying returns on their or their parents’ capital, but W-2 earners, enjoying very, very high salaries. Recent research by Thomas Philippon and Ariel Resheff shows a concurrent increase in salaries in the financial sector relative to the rest of the economy, confirming the pattern suggested by casual empiricism that many of these very high W-2 earners are in the financial sector.

But the expansion of the financial sector and the salaries therein over the last two decades may not have been just an unavoidable consequence of economic tides but a very political process. The deregulation of finance, despite the presence of implicit and explicit government guarantees to financial institutions which would have ordinarily necessitated significant regulation, appears to have been partly won by the financial industry as a result of lobbying, campaign contributions and the access to politicians that the industry enjoys (though this is not to argue that some of this deregulation did not have a compelling economic logic nor that free-market ideology played no role). If so, politics may have been the key factor in setting in motion the forces that have led to the massive rise in top inequality. (source)

More posts in this series are here.

Income Inequality (23): Income Inequality and Poverty

At first sight, income inequality and poverty are completely different things. Poverty is clearly a human rights issue, while income inequality is clearly not, at least not directly (it can have an impact on some human rights). Income inequality is a relative indicator, not an absolute one, and is, for this reason, claimed to be not about poverty at all. Poverty, it is said, is about absolute deprivation and is a lack of the resources necessary to satisfy certain basic needs. Income inequality just describes the unequal possession of resources, basic or otherwise. And indeed, it’s possible to imagine a very rich society in which no one is poor in the sense of lacking basic resources, but in which the distribution of resources is very unequal. Vice versa, there may be countries in which everyone is (almost) equally poor.

However, if we compare countries, we see that the more unequal a society, the larger the numbers of people suffering from poverty. Does that mean that high income inequality leads to more poverty? Not necessarily. That would probably be the case if we saw that a country’s poverty rate grows with increasing inequality. But that doesn’t happen:

If we look across the rich nations, it turns out that there is no relationship between changes in income inequality and changes in the absolute incomes of low-end households. The reason is that income growth for poor households has come almost entirely via increases in net government transfers, and the degree to which governments have increased transfers seems to have been unaffected by changes in income inequality. …

In some countries with little or no rise in income inequality, such as Sweden, government transfers increased and so did the incomes of poor households. In others, such as Germany, transfers and the incomes of low-end households did not increase.

Among nations with sharp increases in top-heavy inequality, we observe a similar disjunction. Here the U.S. and the U.K. offer an especially revealing contrast. The top 1%’s income share soared in both countries, and through the mid-1990s poor households made little progress … But over the next decade low-end American households advanced only slightly, whereas their British counterparts experienced sizable gains [thanks to the Labour government, FS]. (source)

So, in other words, there are countries with soaring inequality that still manage to make the poor better off in absolute terms (not in relative terms obviously) through redistribution. Other countries that witness the same evolution of inequality don’t make their poor better off. And trickle down also doesn’t seem to work, by the way. Vice versa, the less unequal countries also differ in the way they treat the poor. Income inequality doesn’t produce poverty because it doesn’t affect the welfare state.

It’s often argued that income inequality not only fails to produce poverty but actually helps to reduce it. That argument goes something like this. High levels of income inequality – and therefore high wages at the top – are necessary for economic growth. If the top economic performers are allowed to earn very high wages, they will have an incentive to produce and innovate. That will lead to economic growth, which will in turn, through a trickle down mechanism, benefit everyone, including the poor and those earning very little.

However, from the quote above it follows that it’s government transfers rather than automatic mechanisms that have helped the poor during the last decades of increasing inequality. If inequality by itself would reduce poverty, these government transfers would not have been necessary. An increase in income inequality by itself does not improve low-end incomes, as is shown by the example of the US.

And even if it could be shown that rising inequality pushes up the absolute income of the poorest, there are other reasons to object to inequality (such as this for example).

Income Inequality (23): The Fable of Egalistan and Opportunistan, or the Relationship Between Income Inequality and Inequality of Opportunity

Let’s imagine two fictional societies. One – call it Egalistan – has almost total income equality, as well as consumption equality (the latter following from the former). However, people are stuck in their social roles, and there’s very limited social mobility, vertical or horizontal. The quality of education is terrible. No one has any real ambitions, and talents are dormant. However, there’s not a lot of discrimination (otherwise equality would not have been possible) and people with few or negative natural endowments are assisted so that they can come close to the average level of income. This average level, however, is rather low because people are lethargic and the high degree of equality has destroyed economic incentives.

The other society – call it Opportunistan – is very unequal: it has a very high score on the Gini coefficient for income inequality. And yet it provides a lot of social mobility and desert-based rewards, as well as good, inclusive and cheap education, and even a tax regime that doesn’t reward hereditary benefits (e.g. a high “death tax”). It also rewards a wide variety of different talents and allows people to develop their non-mainstream talents and to act on their ambitions. People with relatively little natural endowments as well as people with a handicap are assisted and jobs are reserved for them. There’s little discrimination on any basis, and people are insured against misfortune. This society therefore provides a high level of equality of opportunity. However, this equality of opportunity results in high levels of income inequality, perhaps because some people choose not to earn a lot (so-called threshold earners) or because natural endowments (like IQ or talents) are distributed in a very unequal way.

While Opportunistan is obviously more appealing than Egalistan, I don’t agree that it shouldn’t be improved. Some would argue that Opportunistan has done all it is morally obliged to do and doesn’t need to reduce the level of income inequality. I don’t think so. First, it’s not obvious that Opportunistan can maintain its equality of opportunity. Those with greater wealth and income can provide to their children resources and thus opportunities that the less wealthy cannot. The good luck of being born in a wealthy family – which is probably also a well-functioning family with a good set of values – is hard to equalize with the existing set of policies in Opportunistan. Hence, even Opportunistan will find it difficult to achieve or maintain real equality of opportunity.

So, what can Opportunistan do? Obviously, it doesn’t want to adopt the cruel and unacceptable policy of platonic child redistribution. It would lose its a priori appeal if it did. What it can do is reduce some of its income inequality. A certain level of income redistribution could remove some of the unequal benefits resulting from some people’s good fortune of being born in a wealthy family. This redistribution can, to some extent, equalize this good fortune. If there are less poor families, there are less children growing up with the wrong values or with other sets of hereditary burdens (which doesn’t mean that poor people are poor because they have the wrong values; it means that being poor tends to produce the wrong values, e.g. lack of ambition etc.).

Secondly, Opportunistan hasn’t done enough because high levels of income inequality tend to undermine the functioning of democratic institutions. Those institutions are premised on the equal influence of all voters. Obviously that’s a utopian assumption, but there’s no reason to make it more utopian than it should be. Unequal financial resources produce unequal political influence. And the same argument can be made for the judicial domain.

So, it’s I think important that we don’t delude ourselves on the merits of Opportunistan: equality of opportunity is notoriously ambitious and difficult to achieve and maintain (even though equality of outcome is generally but erroneously considered the more utopian type of equality), and yet it’s not even enough. Reducing the levels of inequality of income is also important, but not all the way towards Egalistan.

The Causes of Wealth Inequality (15): Slavery

Income inequality doesn’t have the same causes everywhere, as is evident from this study which points to the fact that slavery in the U.S., which was abolished almost 150 years ago, still has nefarious effects today.

Within the US, the institution of slavery has historically been associated more heavily with specific areas – primarily the South. This geographic differentiation allows us to identify the link between past slavery and current outcomes. We start by reviewing, over a cross section of counties, the effect of the intensity of slavery in 1870 on the current level of income per capita. For the year 2000, we find no evidence that those counties that employed slave labour more heavily are poorer than those that did so to a lesser extent or not at all (even though a negative relationship between slavery and income was still present until 1970).

Next we turn to the impact of slavery on current income disparities and we find that it is indeed associated with a higher degree of income inequality. In other words, former slave counties are more unequal in the present day. They also show a higher poverty rate and a higher degree of racial inequality. Moreover, the data say that the impact of slavery on economic inequality and poverty runs through its impact on racial inequality, and not vice versa. (source)

How exactly does slavery lead to long turn income inequality? If slavery is seen as a symptom of feelings of racial superiority, then it’s not far-fetched to assume that those feelings didn’t die with slavery and continued to affect blacks by way of discriminatory policies and practices, including in wage determination and other areas that influence economic inequality, such as the provision of education.

This, by the way, also makes the case for reparations a bit stronger. More posts in this series are here.

The Causes of Wealth Inequality (14): Wage Stagnation at the Bottom of the Income Distribution

Income inequality has risen in many countries during the last decades, including the U.S. The causes of this evolution obviously differ from country to country, although some causes may be universal. If we focus on the U.S., one important cause is wage stagnation for middle class and poor families since the 1970s. This stagnation, combined with the fact that the incomes of the wealthy continued along their pre-1970s growth path, caused increasing income inequality. The 1970s are a clear turning point, as you can see here.

The decades before the 1970s were what has been called a time of “shared prosperity”. Maybe trickle down economics really did work back then. Since the 1970s, however, income gains went almost entirely to the very wealthy, without much of the gains trickling down.

If that is why inequality has increased, we still have to answer the question why lower wages have stagnated. Maybe the decline of the minimum wage has something to do with it.

The Causes of Wealth Inequality (13): Deliberate Policy?

Some say that the increase in income inequality in countries such as the U.S. has been the result of deliberate government policy. That’s quite an accusation. It’s not controversial to assume that tax policy under right wing governments tends to be less burdensome on the rich, and that social welfare policy under such governments tends to be more stingy. If you look at it like this, it’s not crazy to argue that right wing policies can aggravate income inequality. But it’s quite another thing to claim that right wing governments use these policies in order to deliberately aggravate income inequality. That accusation is incompatible with right wing ideology, which claims that the preferred policies also and ultimately help the poor (trickle down economics etc.), and that left wing policies supposedly favoring the poor are in fact self-destructive (unemployment benefits create labor disincentives, taxes create production disincentives, etc.). However, it’s possible that this ideology is just a smokescreen for anti-poor policies. But I guess that’s somewhat difficult to prove.

If we look at the tax rates, it’s true that the rates for the wealthy tend to go down under Republican presidents:

In 1979, the effective tax rate on the top 0.01 percent (i.e., rich people) was 42.9 percent. … By Reagan’s last year in office it was 32.2 percent. (source)

However, things aren’t as simple as that:

From 1989 to 2005, … as income inequality continued to climb, the effective tax rate on the top 0.01 percent largely held steady; in most years it remained in the low 30s, surging to 41 during Clinton’s first term but falling back during his second, where it remained. The change in the effective tax rate on the bottom 20 percent (i.e., poor and lower-middle-class people) was much more dramatic, but not in a direction that would increase income inequality. Under Clinton, it dropped from 8 percent (about where it had stood since 1979) to 6.4 percent. Under George W. Bush, it fell to 4.3 percent. (source)

The tax rate for the rich dropped somewhat around 2005 following the Bush tax cuts, but all the tax effects over the last decades taken together don’t really make a good case that tax policy is the major cause of rising income inequality. So it’s even more difficult to make the case that tax policy was part of a conscious strategy to aggravate inequality. The increase in inequality has been too big compared to the possible impact of taxation. That’s corroborated by the fact that pre-tax inequality in the U.S. rose faster than after-tax inequality.

What’s interesting, however, is that pre-tax inequality in the U.S. tends to rise much faster under Republican rule. So inequality can still be the result of policy, but policy expressed in other ways than taxation. Other policies that may have contributed – deliberately or not – to rising income inequality are anti-labor union policies, decreases in the minimum wage, etc.

More posts in this series are here.

The Causes of Wealth Inequality (12): Immigration

Immigrants are usually somewhat poorer than natives, mainly

  • because they come from poorer countries,
  • because they are less well educated and less skilled (on average) and
  • because they are sometimes more at risk of being unemployed.

So it’s tempting to use data on increasing immigration flows – such as those that occurred in the U.S. during the last decades – in order to explain rising income inequality. Inequality is then viewed, not as the result of an unjust economic system, but as the mechanical result of demographic changes.

The timing is hard to ignore. During the Great Compression, the long and prosperous mid-20th-century idyll when income inequality shrank or held steady, immigration was held in check by quotas first imposed during the 1920s. The Nobel-prizewinning economist Paul Samuelson saw a connection. “By keeping labor supply down,” … a restrictive immigration policy “tends to keep wages high.” After the 1965 immigration law reopened the spigot, the income trend reversed itself and income inequality grew. (source)

However, there’s little evidence that immigration keeps wages low at the bottom end of the native income distribution (except for high-school dropouts and to a limited extent), which is where immigration’s effect on inequality is supposed to occur. See here for a discussion of the evidence. One can even make the case that immigration benefits the poorest sections of the native population. See this post. So, immigration can’t explain rising income inequality. But perhaps the sheer number of poor immigrants can account for rising inequality? Maybe immigration doesn’t produce inequality by pushing down native wages but simply by changing the demographic: more poor people (in this case immigrants) means higher inequality.

Gary Burtless [notes] that immigrants “accounted for one-third of the U.S. population growth between 1980 and 2007”. [E]ven if they failed to exert heavy downward pressure on the incomes of most native-born Americans, the roughly 900,000 immigrants who arrive in the United States each year were sufficient in number to skew the national income distribution by their mere presence. [However,] [h]ad there been no immigration after 1979, he calculated, average annual wages for all workers “may have risen by an additional 2.3 percent”. (source)

And that number would have been hardly sufficient to stop the actual increase in income inequality. So even if there had been no immigration, inequality would have increased. There must therefore be other causes and explanations.

Maybe you’re wondering what the problem is, in which case you can go here. More on immigration is here. More posts in this series are here.

The Causes of Wealth Inequality (11): Family Structure

In the U.S., and probably in other countries as well, there’s been an increase in the number of single parent families. Most of the time, that means a single mother, divorced or unmarried, or with a husband in prison, and raising one or several children on her own. As a result:

The percentage of children living with one parent has doubled since 1970, from 12 percent to more than 26 percent in 2004. (source)

There are about 13.7 million single parents in the United States today, and those parents are responsible for raising 21.8 million children. 84% of those single parents are mothers.

Single mothers often earn relatively lows wages, partly because they can’t afford to work long hours. Combine that with the fact that they have higher per person expenses (heating a house costs just as much for a two parent family as for a single parent family) and the fact that women in general have lower wages, and you have a recipe for inequality.

However, the growth in the number of single parent families in the U.S. flattened when income inequality continued to increase. So, family structure may be a good although partial explanation of poverty levels, but not necessarily of inequality. There must be other causes, some of which are discussed here.

Income Inequality (23): U.S. Public Opinion on Income Inequality

Despite what foreigners usually believe about the U.S., and despite the confused ramblings of a tiny group of anti-“socialist” loudmouths high on tea, U.S. public opinion is actually very egalitarian:

Americans are in broad agreement on the need for a more equal distribution of wealth. … that’s what a forthcoming study by two psychologists, Dan Ariely of Duke University and Michael I. Norton of Harvard Business School, has concluded. First, Ariely and Norton asked thousands of Americans what they thought the nation’s actual wealth distribution looks like: how much is owned by the wealthiest 20 percent of the population, the next-wealthiest 20 percent, and on down. The researchers then asked people what, in an ideal world, they would like the nation’s wealth distribution to be.

Ariely and Norton found that Americans think they live in a far more equal country than they in fact do. On average, those surveyed estimated that the wealthiest 20 percent of Americans own 59 percent of the nation’s wealth; in reality the top quintile owns around 84 percent. The respondents further estimated that the poorest 20 percent own 3.7 percent, when in reality they own 0.1 percent.

And when asked to give their ideal distribution, they described, on average, a nation where the wealth distribution looks not like the U.S. but like Sweden, only more so—the wealthiest quintile would control just 32 percent of the wealth, the poorest just over 10 percent. “People dramatically underestimated the extent of wealth inequality in the U.S.,” says Ariely. “And they wanted it to be even more equal.” (source)

The Causes of Wealth Inequality (10): Racism

In the U.S., the median annual income for black families is 38 percent lower than for their white counterparts. So, income inequality in the U.S. has a racial component, and some of the explanations or causes of income inequality may have something to do with racism. I say “may” because if income inequality were essentially or mainly a consequence of racism, then there wouldn’t be any white poverty. Moreover, given the growth of total income inequality in the U.S. during the last decades, the income gap between whites and blacks should have grown in the same proportion if racism is the sole cause. And that didn’t happen:

the black/white gap in median family income has stagnated; it’s a mere three percentage points smaller today than it was in 1979. … [D]uring the current economic downturn, the black/white income gap widened somewhat. … [T[he black/white income gap can’t be a contributing factor to the [increase in inequality] if it hasn’t grown over the past three decades. And even if it had grown, there would be a limit to how much impact it could have on the national income-inequality trend, because African-Americans constitute only 13 percent of the U.S. population. (source)

The growth of income inequality in the U.S over the last decades can’t be blamed on racism, since inequality has risen across social groups, but perhaps part of the level of income inequality can be blamed on it. I don’t know how large a part, but probably not a very large part, given all the other likely causes of income inequality.

Still, I focus on the U.S. here, and that isn’t by far the only country plagued by inequality. If racism isn’t a particularly good explanation for income inequality in the U.S., maybe it is in other countries, and then I’m thinking in particular about some South American countries.

The Causes of Wealth Inequality (9): Merit

In my ongoing exploration of the possible causes of high income inequality in rich countries, I stumbled across this politically incorrect quote:

A reason for the “wealth or income gap”: Smart people keep on doing things that are smart and make them money while stupid people keep on doing things that are stupid and keep them from achieving.

People who get an education, stay off of drugs, apply themselves, and save and wisely invest their earnings do a lot better than people who drop out of school, become substance abusers, and buy fancy cars and houses that they can’t afford, only to lose them.

We don’t have an income gap. We have a stupid gap. (source)

It’s not only politically incorrect, it’s just plainly no-qualifier-needed incorrect. Of course, people’s efforts and wise decisions do make a difference. As well as their different talents (or lack thereof). So there will always be inequality. But society rewards certain talents more than others – or, if you object to the description of society as a moral agent, “we all” reward the talents of our fellow humans differently. And we often do so in a morally arbitrary way: we reward some talents more whereas other talents would perhaps, from a moral point of view, deserve higher rewards. The same is true for efforts: we reward some types of efforts more than others, and this isn’t always just.

So some people, because of their talents and efforts, create better outcomes for themselves, reap more lucrative rewards, and thereby create an income gap. However, this fact doesn’t necessarily imply that the resulting gap is morally right: society – all of us – may have been morally mistaken about the kinds of talents and efforts that we reward. Hence the gap can be immoral. Even if income inequality could be explained entirely by differences in effort and talent – which is implied in the quote but which I think isn’t true – that would not necessarily have any moral significance. Income inequality could still be wrong.

And we could still go one step further: even if income inequality could be explained entirely by morally significant differences in effort and talent – in other words, even if only morally worthy efforts and talents were rewarded by society – that would not necessarily exhaust all moral considerations. The moral judgments regarding efforts and talents could be offset by superior moral considerations about inequality.

And anyway, how does the guy from the quote above explain the fact that different countries have different levels of income inequality? Do we really believe that the American population has a higher standard deviation around average intelligence, talent and effort? In other words, does the U.S. have more smart and more stupid people than Sweden? Are the bell curves for intelligence, talent and effort flatter in the U.S.? I don’t think so. And if I’m right, then you need other and more sophisticated answers to the question why inequality is relatively high in the U.S.

The Ethics of Human Rights (38): Should People Be Equal or Should They Have Enough?

There are people who believe income inequality is a major problem – and I’m one of them – and there are others who say that the real problem isn’t a relational one but rather one of absolute means. Harry Frankfurt for example argues that it’s not important whether a person has less than another regardless of how much either of them has. What is important is whether people have enough of what they need for a decent human life.

Sufficientarianism

This so-called sufficientarian approach – as opposed to the egalitarian one – is supposedly not comparative or relational but humanitarian. It focuses on the alleviation of absolute suffering and deprivation instead of relative inequalities. Rather than diminishing the distance between the worst off and the best off, it wants to improve the situation of the worst off. The latter goal can be the result of the former, but doesn’t have to be. Or it can promote the former but doesn’t have to. For example, imagine a society where incomes are highly unequal but where none of the people at the wrong side of this inequality are below a threshold value of wellbeing (the threshold determines the difference between suffering and non-suffering). So, according to the sufficientarian approach, there’s no need to diminish inequality in such a society. There’s no need to do anything, in fact. Conversely, you can have a society – not so imaginary perhaps – with low levels of inequality but almost all of the people live below the threshold. Tinkering with inequality will not do much good in that society. What you have to do is raise the living standard of almost all the population.

Income inequality for sufficientarians is relevant only to the extent that the wealth of those who are better off is a useful means to alleviate the suffering of the worst off. Diminishing inequality isn’t a goal in itself, and inequality doesn’t do any harm in itself.

It’s an appealing view, and I have been tempted by it myself. Even if you believe, as I do, that inequality can be harmful no matter what the income levels of the worst off are (harmful to democracy for instance) and that more equal societies almost always do better, you may still agree that the most urgent priority is the suffering of those who are worst off. Income inequality should then only be tackled afterwards. Anyway, tackling that first priority is a good step on the way to more equality; helping the worst off will reduce inequality almost automatically I would believe.

However, appealing though it may be, is sufficientarianism really all that much different from egalitarianism? As soon as you talk about the “worst off”, you have already engaged in comparative and relational analysis, by necessity. Another problem with sufficientarianism is the setting of the threshold: that is bound to be somewhat arbitrary. Of two people in very similar situations only one will receive help. You may say that cut offs are always inevitable, and perhaps that’s true, but sufficientarianism makes them painfully obvious to those concerned. People just above the threshold are told that they don’t matter, even if their neighbors who are just below matter a great deal. And finally, basic needs change over time, hence also the meaning of “suffering”. Will sufficientarians keep the threshold fixed, or allow it to rise over time? In the latter case, the difference between their approach and that of egalitarians is again rather small.

Prioritarianism

Some of these problems are sidestepped by a similar view called prioritarianism, made famous by Temkin and Parfit: benefiting people is more important the worse off they are. No need for a threshold here. When having to choose between two policies, you always take the one that is best for the worst off, whatever their level of well-being.

Benefits to the worse off matter more than benefits to the relatively better off. A benefit has greater moral value the worse the situation of the individual to whom it accrues. If we have some benefit to distribute, and this benefit has a value of x (no matter how we define “value”), it’s better to give this to the worst off than to anyone else. Strict utilitarianism, as opposed to prioritarianism, doesn’t care about who gets the benefit of x, because who gets it doesn’t change overall well-being. However, utilitarianism does take into account the possibility of the diminishing marginal utility of something: lots of money for a rich person isn’t as useful as the same amount of money for a poor person. But when comparing two people who would benefit just as much from such an amount of money, utilitarianism – as opposed to prioritarianism – doesn’t care who gets it; either person, the better off or the worse off, can get it. Prioritarianism doesn’t merely say that the worse off person should get it, but also says – contrary again to utilitarianism – that we should benefit the worse off even if that means diminishing total well-being; e.g. we can harm the interests of the better off if that means improving the well-being of the worse off:

Imagine choosing between two outcomes: In outcome 1, Jim’s well-being level is 110 (blissful); Pam’s is -73 (hellish); overall well-being is 37. In outcome 2, Jim’s well-being level is 23; Pam’s well-being level is 13; overall well-being is 36. Prioritarians would say that outcome 2 is better or more desirable than outcome 1 despite being lower than outcome 1 in terms of overall well-being. Bringing Pam up by 86 is weightier than bringing Jim down by 87. If we could move from a society described by outcome 1 to one described by outcome 2, we ought to. (source)

So prioritarianism avoids some of the counterintuitive implications of strict utilitarianism. And it also avoids the equally counterintuitive implications of strict egalitarianism. The latter may demand bringing everyone down to the level of the worst off while benefiting no one. Prioritarianism on the contrary does not propose a move toward more equality if that doesn’t benefit the worse off. And finally, it avoids some of the practical problems of sufficientarianism, while maintaining the appeal of the sufficientarian focus on the absolute deprivation of the worst off.

The Causes of Wealth Inequality (8): Weak Unionization

Among the rich countries that are very unequal are also some which have very weak labor unions. It’s tempting to see a causal link in this correlation, since the purpose of a labor union is – among other things – to negotiate a better income of its members. Declining labor union membership and influence should then translate in declining wages (at least relatively speaking) and more income inequality. If most workers are members of labor union, most low incomes benefit from the influence of labor unions. It’s even likely that non-members also profit from wage increases negotiated by labor unions, since employers don’t like to differentiate between the wages for identical jobs.

[W]eak unions are a key cause of US inequality. The argument goes that weak unions have little political presence in policy debates, which tend to be dominated by business. The result is that policy debates in the US are systematically skewed in favor of business (which tends to favor policies that advantage, or at least do not hurt) rich people, with little in the way of countervailing voice, let alone power. …

In analyzing sources in [news] stories … the fundamental pattern is the same. Those in government, and especially Obama administration staffers, dominated the conversation. Representatives of business and industry came next, followed by academics and independent observers. … fully 61% of stories included a government representative of some kind, including those from state and local government. … Representatives of business, those identified as clearly speaking on behalf of the company or corporation, were the next most prominent sources, figuring in about 40% of the stories. … ordinary citizens and workers were well down the rung of sources. … One subset of the American workforce was virtually shut out of the coverage entirely. … Representatives of organized labor unions were sources in a mere 2% of all the economy stories studied. …

This measure is not the only index of strength in policy debate, obviously, but it is an important one. And on it, business representatives were twenty times as visible in public debate as union representatives. That’s a whopping disparity. (source)

The Causes of Wealth Inequality (7): Education and Demographics

First education. Many people believe that increasing income inequality in countries such as the U.S. should be blamed on immigration: low-skilled workers have to compete against low-wage immigrants with similar skills. However, immigration’s effect on wages is one of the biggest political myths out there. If you want to understand the income stagnation at the bottom of the income distribution – mostly unskilled workers – you have to compare this group of people, not to immigrants, but to the high earners.

Starting about 1950, the relative returns for schooling rose, and they skyrocketed after 1980. The reason is supply and demand. For the first time in American history, the current generation is not significantly more educated than its parents. Those in need of skilled labor are bidding for a relatively stagnant supply and so must pay more. … In contrast, from 1915 to 1950, the relative return for education fell, mostly because more new college graduates competed for a relatively few top jobs, and that kept top wages from rising too high. Tyler Cowen (source)

Hence, income inequality rose not because of downward pressure on the lower wages (supposedly caused by immigration) but because of upward pressure on the higher wages (caused by increasing returns for schooling, which are in turn caused by stagnant supply of high education). That means we can do something about income inequality. We can improve education levels, diminishing inequality both at the bottom – by giving low-skilled people a better education and hence a better income – and at the top – by reducing the scarcity of supply of the higher educated and hence lowering the relative wages at the high end.

Now to demographics.

In general, there is more income inequality among older populations than among younger populations, if only because older people have had more time to experience rising or falling fortunes. … Since the United States is growing older … income inequality will naturally rise. Tyler Cowen (source)

Income Inequality (22): Social Mobility in Anglo-Saxon Economies, Ctd.

After completing my older post on the subject – in which I argued that Anglo-Saxon economies don’t do a very good job promoting social mobility despite the focus on individual responsibility and policies that (should) reward merit (e.g. relatively low tax rates) – I found this graph which I thought would illustrate my point.

Although the US and other Anglo-Saxon countries aren’t in the graph, the UK is. And the effect of parental education on child earnings in the UK is particularly large. The children of the well-off and well-educated earn more and learn more than their less fortunate peers in all countries in the world, and that’s hardly surprising given the importance of a head start, both financially and intellectually. What is surprising is that this is less the case in countries which pride themselves on their systems that offer people incentives to do well (low taxes, minimal safety nets etc.).

So one wonders which fact-free parallel universe David Cameron, the new UK Prime Minister, inhabits:

The differences in child outcomes between a child born in poverty and a child born in wealth are no longer statistically significant when both have been raised by “confident and able” parents… What matters most to a child’s life chances is not the wealth of their upbringing but the warmth of their parenting. (source, my emphasis)

Extolling the virtues of good parenting can never hurt, except if you have a low boredom threshold because it’s so goddamn obvious. But making it sound like parents’ wealth or education are “insignificant” is truly grotesque and an insult to those poor parents who have children that aren’t doing very well. And even for those living in the alternative reality where only bad parents keep children back, the Conservative leader’s position in fact, and unwittingly, should lead to left-wing policies, as Chris Dillow points out:

Because of bad parenting – which begins in the womb – some people do badly in school and therefore in later life; they are less likely to be in work, and earn less even if they are. However, we can’t choose our parents; they are a matter of luck. It’s quite reasonable to compensate people for bad luck, so there’s a case for redistributing income to the relatively poor, as this is a roundabout way of compensating them for the bad luck of having a bad upbringing.

High levels of social mobility can compensate for high levels of income inequality: if people can be socially mobile, and if their earnings and education levels don’t depend on who their parents are but on their own efforts and talents, one can plausibly claim that the existing inequalities are caused by some people’s lack of effort and merit. However, the UK and the US combine two evils: low mobility and high inequality, making it seem that whatever effort you invest in your life, you’ll never get ahead of those rich lazy dumb asses. So why would you even try? Low mobility solidifies high inequality.

Just to show that the U.S. isn’t better than the U.K.:

Parental income is a better predictor of a child’s future in America than in much of Europe, implying that social mobility is less powerful. Different groups of Americans have different levels of opportunity. Those born to the middle class have about an equal chance of moving up or down the income ladder, according to the Economic Mobility Project. But those born to black middle-class families are much more likely than their white counterparts to fall in rank. The children of the rich and poor, meanwhile, are less mobile than the middle class’s. More than 40% of those Americans born in the bottom quintile remain stuck there as adults. (source)

The Ethics of Human Rights (29): Should Taxation Be a Tool For Economic Efficiency or For Social Justice?

Taxation is a recurring theme in political discussions between people of the left and right. People of the left see taxation as a tool for social justice. They tend to prefer rather high taxation rates and a progressive taxation system:

  • High taxation rates bring in revenues that are large enough to enable the government to spend on programs and transfers that are designed to promote social justice: unemployment benefits, poverty reduction policies, education, healthcare etc.
  • Progressive taxation rates are just because they impose relatively (and not just absolutely) higher taxes on people who are more able to pay, and, in addition, reduce income inequality and hence realize another goal of social justice.

People on the right usually favor low tax rates and a non-progressive taxation system (either a proportional system in which everyone pays the same share of their income, or a regressive system in which everyone pays more or less the same amount in taxes). Rather than on social justice, they focus on the economic effects of taxation.

  • They reject high taxation rates because they claim that these high rates discourage people and are a disincentive to hard work, effort and investment. Because high rates limit effort and investment, they also limit productivity, innovation, international competitiveness and job creation.
  • They also reject progressive tax rates because high tax rates for high incomes discourage those people who work relatively hard (they work hard supposedly because they earn a lot) and who are most likely to innovate, to be productive and competitive and to create jobs.
  • However, they don’t necessarily favor regressive taxes because they are equally hostile to high tax rates for low income people, albeit for other reasons. High taxes for low income people discourage them from entering the labor market and hence inflate unemployment. Still, they claim that the worst damage is done by high taxes on the higher incomes, which is the reason they reserve particular scorn for progressive taxation systems. Because high tax rates for the wealthy punish the most productive elements in a society, the whole of society suffers. More productive people will limit their productivity because they don’t want to fall into a higher tax bracket, and the money they pay in taxes can’t be invested in the economy. High tax rates, especially for the rich, have an unacceptable cost in terms of economic efficiency. Keeping taxes low, on the contrary, and allowing wealthy people to use their money in the economy, will ultimately benefit everyone (this is the so-called Trickle-Down theory).

Of course, this distinction between left and right is a caricature. Most people on the left are also concerned about economic efficiency, and most on the right are not insensitive to questions of social justice. The extremes are hardly ever encountered in real life: no one wants to limit taxes to such an extent that economic efficiency is promoted but no money is left for justice, and no one wants to put tax rates at such a high level that there is ultimately no more economy to tax. (The latter concern is expressed in the famous Laffer Curve arguing that beyond a certain level of tax rates government revenues in fact decrease instead of increase. At very high rates there is no longer any incentive for a rational taxpayer to earn any income and hence tax revenues will decline while tax rates increase. However, it isn’t clear what “very” in the previous sentence actually means and where exactly the tipping point is situated).

Personally, I believe that the concerns of both right and left are justified and need to be balanced, and that too much focus on either the element of efficiency or justice is detrimental to the other element. On the one hand, there’s only so much money a government can raise without wrecking the economy, and justice isn’t only about spending money (there can even be perverse effects such as unemployment traps, welfare dependency etc.). On the other hand, there’s only so much an efficient economy can do to realize social justice all by itself and quasi-automatically (remember the invisible hand…). To quote Matthew Yglesias’ sarcastic comment on the skyrocketing incomes of the U.S. top 400 earners in the decades leading up to the 2009 recession:

As is well-known, the Top 400 are considerably more talented than the rest of us. And [the] decline in their tax rates has created exciting new incentives for them to apply their talents. And that, in turn, is why the 2000s were a so much more economically successful decade than the 1990s, not just for the Top 400 but for the rest of us as well. Thanks to their skyrocketing incomes and falling tax rates, we’re currently [during the 2008-2009 recession, FS] all enjoying the fruits of prosperity, rapid growth, and low unemployment. Thanks rich guys! (source)

A similar sentiment is expressed in this clip from the Daily Show (skip to the 4th minute or so).

I believe taxes in the U.S. are relatively low and can be raised without too much harm to economic efficiency. The resulting government revenues could then be spent on improving the social safety net and promoting social justice. It’s difficult to imagine for a European that a country such as the U.S. doesn’t offer health insurance to millions of its citizens. Also, unemployment benefits are quite stingy in the U.S., both in terms of eligibility and duration: only one third of the unemployed qualify for benefits and only for 26 weeks (extendable during recessions if the Republicans don’t object, as they infamously did beginning of 2010).

The system of unemployment benefits could easily be improved without perverse effects or harm to economic efficiency. And there are other areas of possible improvement as well.

However, as a European in Europe, I think there’s a strong argument that the social safety net in Europe (at least in some countries) has harmed European competitiveness, labor market participation and innovation.

Still, is there evidence of this? What do the data say about high tax rates harming economic efficiency, in Europe and in general? Is the conservative case against taxes as strong as it seems? I’m afraid not. There’s some evidence that the effect of reasonably rather than extremely high rates on economic efficiency is minimal at best. Here’s more evidence from Lane Kenworthy about the U.S. and other affluent countries (always keeping in mind that correlation doesn’t imply causation and that the absence of a large negative effect of high taxes doesn’t preclude the possibility that lower taxes would have had a large positive effect). One measure of economic efficiency is economic growth. If we plot economic growth rates for the U.S. against tax rates for the wealthy we see that higher tax rates lead to more growth. But of course there can be catch-up effect: higher rates producing their effects only years later. That’s taken into account in these graphs, which also show that an international comparison doesn’t prove that countries with higher tax rates have lower growth.

If we have a look at the data about the effect of high tax rates on unemployment (another conservative concern), we also see that we shouldn’t panic about taxes.

Now, if there is no good reason not to tax at a moderately high level, based on concerns about economic efficiency, the question remains whether there is a good reason to tax based on social justice reasons. Given the caveat that social justice isn’t all about government spending (I argued <a href="http://here that it is primarily about something else) and that such spending can in some cases have perverse effects (see above), I do believe that some spending is necessary in some cases, and that relatively high tax rates are necessary to produce the revenues required for this spending.

Again following Kenworthy, I believe that relatively high tax rates are acceptable and even necessary to create the revenues required for social justice policies, but that progressive tax rates in themselves don’t do the job of reducing income inequality, contrary to what is often claimed as a justification for progressive rates. That doesn’t mean that we shouldn’t reduce income inequality (it’s quite high in the U.S.) – there are good reasons to try. It just means that progressive taxation in itself won’t do the job. The important thing is to have high tax revenues which can then be spent in transfers and services that reduce income inequality and achieve other goals of social justice. Yet, I still think a progressive system is required, not because of its supposed effects but simply because it is just in itself, compared to proportional or regressive systems. A person with more income can afford to pay, not merely more in an absolute sense but more in the sense of a larger share of his or her income.

Measuring Equality of Opportunity

People on opposite sides of political debates often agree on very little, but they do agree on the importance of equality of opportunity. There is almost universal agreement that people should have at least a starting position that guarantees an equal chance of success in whatever life projects one chooses, for those willing to invest an equal amount of effort. More specifically, equality of opportunity is often defined as an equal likelihood of success for all at age 18 (in order to factor in possible inequalities of opportunity determined by education).

Equality of opportunity is by definition an impossible goal. The lottery of birth means more than being unable to choose to be born in a wealthy family with caring parents who can finance your education and motivate you to achieve your goals. It also means that you can’t choose which talents and genes you are born with. Genetic differences are no more a matter of choice than the character and means of your parents. And genetic differences affect people’s talents, skills and maybe even their capacity to invest effort. So, as long as we can’t redistribute beneficial genes or disable harmful ones, and as long as we don’t want to intervene in people’s families and redistribute children, we can’t remove the impact of genes and parents.

However, we can do something. Equality of opportunity may be impossible but there is less or more inequality of opportunity. Or concern should be to provide as much equality of opportunity as possible, and to expand opportunity for those who are relatively less privileged. This means removing things that hold some people back (e.g. discrimination, unemployment, bad schools etc.), and – more positively – helping people to cultivate their capabilities and expand their choices.

How doe we measure if these interventions are successful? It seems very difficult to measure equality of opportunity. All we can do is measure some of the elements of opportunity:

  • We can measure unequal income and infer unequal opportunity from this. People with low income obviously have less opportunities than other people. However, not all opportunities can be bought and maybe low income isn’t the result of a disadvantaged upbringing or bad schools, but of bad choices, or even conscious choices. Can we say that a child of a millionaire who chose to be a hermit suffered from unequal opportunity? Don’t think so.
  • We can measure unequal education and skills (educational attainment or degrees, IQ tests etc.). However, someone who comes from a very privileged family but with low or alternative aspirations may score low on educational attainment or even IQ.
  • We can deduce unequal opportunity by the absence of opportunity enhancing government policies and legislation. The Civil Rights Act was self-evidently a boost for the opportunities of African-Americans.
  • We can measure social mobility and assume, correctly I think, that very low levels of mobility indicate inequality of opportunity.
  • Etc.

Whatever actions we take to enhance opportunity, it will probably always be relatively unclear what the net outcome will be on overall equality of opportunity. Of course, that doesn’t mean we shouldn’t do anything. And when we do something, we should also distinguish clearly between things we can do and things we can’t to, or things we feel are immoral (e.g. genetic redistribution or child redistribution). We know that parental attitudes, genetics, talent, appearance, networks and luck have a huge impact on individuals’ chances of success, but those are things we can’t do anything about, either because it’s impossible or because it’s immoral. But we can teach people skills and perseverance, to a certain extent. We can help the unlucky, for example with unemployment benefits. We can regulate firms’ employment policies so as to counteract the “old boys networks” or racism in employment decisions. We can impose an inheritance tax in order to limit the effects of the lottery of family. Etc etc.

Income Inequality (21): And Economic (In)Efficiency

Standard economic theory suggests that these problems created by income inequality are a necessary price to pay for economic efficiency: unequal rewards – however unpleasant they are and whatever consequences they have – incite those with talents, skill and perseverance to innovate and be productive. Ultimately, this serves the welfare of the whole of society. Reducing inequality means taking away incentives for doing well, and results in economic inefficiency.

Sam Bowles has argued that the opposite is true:

Inequality breeds conflict, and conflict breeds wasted resources … in a very unequal society, the people at the top have to spend a lot of time and energy keeping the lower classes obedient and productive.

Inequality leads to an excess of what Bowles calls “guard labor”. In a 2007 paper on the subject, he and co-author Arjun Jayadev, an assistant professor at the University of Massachusetts, make an astonishing claim: Roughly 1 in 4 Americans is employed to keep fellow citizens in line and protect private wealth from would-be Robin Hoods.

The job descriptions of guard labor range from “imposing work discipline”—think of the corporate IT spies who keep desk jockeys from slacking off online—to enforcing laws, like the officers in the Santa Fe Police Department paddy wagon parked outside of Walmart.

The greater the inequalities in a society, the more guard labor it requires, Bowles finds. This holds true among US states, with relatively unequal states like New Mexico employing a greater share of guard labor than relatively egalitarian states like Wisconsin.

The problem, Bowles argues, is that too much guard labor sustains “illegitimate inequalities,” creating a drag on the economy. All of the people in guard labor jobs could be doing something more productive with their time—perhaps starting their own businesses or helping to reduce the US trade deficit with China. (source)

I must say I’m not entirely convinced. Income inequality creates a lot of problems, but economic inefficiency isn’t the most important one. Justifications for the fight against inequality based on efficiency look a lot less promising than justifications based on justice and fairness.

The Causes of Wealth Inequality (5): Globalization

Globalization is supposed to have lowered the earnings of less-educated workers by putting them in direct competition with low-wage workers around the world. This competition put pressure on wages through international trade in goods and services; through the relocation or threat of relocation of production facilities to overseas locations; through competition with immigrants in local labor markets; and through other channels. …

U.S. and European workers are told that … our societies can no longer afford a generous welfare state. …

Contrary to the standard framing, which presents globalization as something that no nation can escape or even attempt to shape, we can choose the terms under which we integrate capital, product, and labor markets across countries. Over the last 30 years we have indeed “chosen” a particular form of globalization in the United States – a form that benefits corporations and their owners at the expense of workers and their communities. If we had chosen globalization on different terms, however, economic integration would not have required rising inequality. Another globalization is possible. (source, source)

So globalization, as it has occurred and is occurring, causes higher inequality in the West in two ways:

  • The direct competition with overseas workers who can produce at lower wages puts downward pressure on wages in the West, especially for low-skilled workers at the wrong end of inequality.
  • Governments in developed countries react to this competition by restricting social safety nets because the taxes necessary for the funding of these safety nets hurts the competitiveness of local businesses, a competitiveness already under pressure from low-cost labor in the developing world. Less generous safety nets obviously also have a negative effect on inequality.

If these effects are real, perhaps they can explain the decline of manufacturing in many developed countries.

However, I’m not sure this pressure on wages is real and significant (I’ll try to find some data), and we also shouldn’t dismiss the benefits for low-wage workers in the West of cheaper products. This particular result of globalization can offset the possible negative wage effects of wage competition.

Also, I’m not sure governments in the West are actively attacking safety nets (here it says they haven’t during the last decades, but it seems that the recent economic crisis has convinced some to start cutting benefits). And finally, we should remember that inequality isn’t just a national problem. The inequality between countries is just as, if not more, important. And globalization has had a beneficial effect on inter-country inequality because it has redistributed wealth from rich countries to poor countries. For example, it’s hard to imagine how China could have had the same success in poverty reduction without globalization. The question is of course whether this redistribution had to come from low skilled workers in the West, rather than from their more wealthy fellow citizens. The fact that it did come, however, was undoubtedly beneficial to the poor in the receiving development countries.

Economic Human Rights (32): The Economic Cost of Taxing the Rich

Taxation is linked to human rights in several ways:

I personally belief that a progressive tax is best in light of the last two concerns. In a progressive taxation system, higher earners pay a larger percentage of their income on taxes. Compared to a regressive taxation system (people with higher incomes pay less in percentage of their income, as in the case of a consumption tax or VAT) or a flat tax (the tax percentage is the same for all income groups), a progressive tax reduces income inequality: it makes incomes more equal in a direct way because it reduces the income of higher-earning families by a larger percentage than the income of lower earning ones; but also in an indirect way because this system – under certain conditions – yields more tax revenues which can then be spent on poverty reduction and the safety net. Also, it seems to be a good example of a just and fair system. The strongest shoulders should carry the most heavy burden. Someone earning a low income can end up in poverty after paying a small percentage in taxes; a wealthy person will perhaps not even notice paying a relatively large sum in taxes.

The counter-narrative states that high tax rates discourage people; they are a disincentive to hard work and effort. High tax rates for high incomes discourage people who work relatively hard (they work hard supposedly because they earn a lot). Because high tax rates punish the most productive elements in a society, the whole of society suffers. More productive people will limit their productivity because they don’t want to fall into a higher tax bracket, and the money they pay in taxes can’t be invested in the economy. Taxing the rich therefore has an unacceptable economic cost. Conversely, low tax rates for the rich produce benefits for all (this is trickle down economics, read also about the Laffer curve).

But this narrative doesn’t quite stand the test of data. As is clear from this link, high tax rates don’t slow down economic growth, and low tax rates don’t speed it up. This paper also supports the claim that moderate, as opposed to dramatic, increases in marginal rates don’t have any impact on the willingness of the wealthy to participate in the economy. They won’t go Galt. Atlas won’t shrug, except to signal indifference.

The top income tax rate was 91% (beginning at taxable income of $400,000) … [in] the period from 1951 through 1963. Those were the golden years of the U.S. economy, in which the average annual rate of productivity growth was 3.1% (compared with about 1.5% after 1981). Of course, the growth might have been even faster had the marginal tax rates been lower, but the coincidence of high rates and high productivity raises challenging questions for those who believe that high marginal tax rates carry an unacceptable cost. (source)

To be fair, marginal tax rates are a crude measures of tax burden. There’s a difference between marginal tax rates and effective tax rates.

  • A marginal tax rate is the tax rate that applies to the last dollar of the tax base (taxable income or spending, usually income). It’s not the rate at which all your dollars are taxed. It’s the maximum rate you’re paying on any of your dollars of taxable income.
  • An effective tax rate refers to the actual rate, i.e., the rate existing in fact, for the entire income, after tax deductions and credits and taking into account lower rates for lower income brackets (see here). It’s your total tax obligation (including your income tax and any other additional taxes and/or credits), divided by your total taxable income.

But even if we look at the effective tax rates of the rich, we see that this has steadily decreased over the decades, with little or no positive effect on overall economic performance.

And when there’s no positive effect of decreasing tax rates, there’s probably also no negative effect of increasing tax rates. To the extent that the wealthy (and productive, although those groups obviously don’t overlap completely) respond to changes in the tax system, their responses focus not on increased/decreased labor, productivity or investment, but on tax avoidance (see here).

The Causes of Wealth Inequality (4): Technology

[T]he diffusion of computers and related technology in the early 1980s steadily increased the demand for skilled workers relative to less-skilled workers, driving up the wages and incomes of more-educated workers and depressing the wages and incomes of less educated workers…

However, the technological explanation removed policy, politics, and power from the discussion of inequality, by attributing rising economic concentration to “technological progress,” a force that could be resisted only at our peril. (source, source)

Indeed, taken in isolation, this explanation obscures more than it reveals. To the extent that it reflects reality – and I think to some extent it does – we’ll still have to ask ourselves why there’s such a wide and growing distance between people with and without skills: why can’t we educate more people so that they can enjoy the wage premium of high-tech labor? Inequality isn’t just the outcome of technology but of choices regarding education, personal ones but also social and political ones.

And there’s another problem with the technological explanation of income inequality. It’s undoubtedly true that higher levels of technology increase demand for higher skilled people, and hence increases their wages (and vice versa for lower skilled people). When you combine this with the disappearance of a high number of jobs at the lower end of the wage sprectrum that are automated and replaced by computers, you end up with a strong push towards more inequality. However, this can’t explain the relatively large increase in income inequality in the U.S. and the U.K. when compared to other countries that are equally technologically advanced.

And neither can it explain why inequality is so top-heavy, in other words why the increase in income is concentrated in a tiny minority of individuals (the top 1% in the U.S.) whose skills aren’t that much different from those just below in the income distribution, if at all. Alex Tabarrok offers an interesting explanation of the fact that income inequality seems to be driven by very high earnings in the very top of the distribution. It also has something to do with technology, but not necessarily with skills:

J.K. Rowling is the first author in the history of the world to earn a billion dollars. … Why? Consider Homer, he told great stories but he could earn no more in a night than say 50 people might pay for an evening’s entertainment. Shakespeare did a little better. The Globe theater could hold 3000 and unlike Homer, Shakespeare didn’t have to be at the theater to earn. … By selling books Tolkien could sell to hundreds of thousands, even millions of buyers in a year … And books were cheaper to produce than actors which meant that Tolkien could earn a greater share of the revenues than did Shakespeare … Rowling has the leverage of the book but also the movie, the video game, and the toy. And globalization, both economic and cultural, means that Rowling’s words, images, and products are translated, transmitted and transported everywhere …

Rowling’s success brings with it inequality. Time is limited and people want to read the same books that their friends are reading so book publishing has a winner-take all component. Thus, greater leverage brings greater inequality. The average writer’s income hasn’t gone up much in the past thirty years but today, for the first time ever, a handful of writers can be multi-millionaires and even billionaires. The top pulls away from the median.

The same forces that have generated greater inequality in writing – the leveraging of intellect, the declining importance of physical labor in the production of value, cultural and economic globalization – are at work throughout the economy. Thus, if you really want to understand inequality today you must first understand Harry Potter.

More on inequality.

Income Inequality (20): Social Mobility in Anglo-Saxon Economies

I know that talking about national or international economic models should be avoided because it’s highly simplistic, but I’ll do it anyway because I want to show that people who do sincerely talk about such models make some assumptions about them that are, in my view, incorrect. The Anglo-Saxon economic model, when compared to the mainland European model, is believed to focus more on individual responsibility than on social support. It imposes lower taxes and delivers a less developed social safety net. It’s more “liberal” (in the European sense of the word, meaning less social) and free market oriented. (Anglo-Saxon means English-speaking countries such as the United Kingdom, the United States etc. but there are large differences between the UK and the US, the UK being less “Anglo-Saxon” than the US; and some mainland countries – like some Eastern European countries – are more “Anglo-Saxon” than they are “mainland”. This goes to show that we’re being simplistic; see also here).

The mainland model is often believed to be better at poverty reduction, job security, social services, and income equality. The Anglo-Saxon model on the other hand is said to be more flexible, less state dependent and more competitive (because of lower taxes and less labor regulation) and suffers less unemployment (because of the less generous social safety net; see also here).

For the same reasons, the Anglo-Saxon model is also believed to be less equal and more open to social mobility – social mobility being defined as the difference between the socioeconomic status of parents and the status their children will attain as adults. When the focus is on individual responsibility and when people can keep a larger share of their income after taxes, they are incited to do well, to work hard, to develop their talents, and to innovate. This not only creates a more competitive economy, but also one in which people can be socially mobile and rise in status and wealth. Countries that impose high taxes and offer generous safety nets don’t give the same incentives.

However, we see that the UK and the US aren’t characterized by relatively high levels of social mobility:

A father’s income determines his son’s to a greater extent in Britain than in any other wealthy nation, with half of a high earner’s “economic advantage” being transmitted to their children, a study by the Organisation for Economic Co-operation and Development has found. … In Britain … background determines a person’s success to a far higher degree than in almost any other rich country. “Education is not as important for social mobility in Britain as for other countries. Class, to be honest, is the most likely explanation,” said Romain Duval, head of division in the Paris-based OECD’s economics department. (source)

Something similar is the case for the US.

It appears that the United States has less intergenerational social mobility than many other industrialized countries. (source)

It’s true that the UK and the US (especially the US) are highly inegalitarian, and increasingly so, but high levels of income inequality do not necessarily go hand in hand with high levels of social mobility. In fact,

social mobility between generations tends to be lower in more unequal societies. (source)

So if you care about social mobility – and I think you should because high levels of social mobility indicate equality of opportunity, something no one objects to – then you should care about reducing inequality rather than promoting it through “Anglo-Saxon” tax and welfare systems (to the extent that there is something like it in the real world).

Measuring Poverty (2): Some Problems With Poverty Measurement

The struggle against poverty is a worthy social goal, and the absence of poverty is a human right. But poverty is also an obstacle to other social goals, particularly the full realization of other human rights. A necessary instrument in poverty reduction is data: how many people suffer from poverty? Without an answer to that question it’s very difficult to assess the success of poverty reduction policies (such as development aid).

And that’s were the problems start. There’s some uncertainty in the data. The data may not reflect accurately the real number of people living in poverty. There are definition issues – what is poverty? – that may reduce the accuracy of the data or the comparability between different measurements of poverty (or between different measurements over time), and there are issues related to the measurements themselves. I’ll focus on the latter for the moment.

Poverty is often measured by way of surveys. These surveys, however, can be biased because of

  1. sample errors: underreporting of the very rich and the very poor (more on sample errors here), and
  2. reporting errors: failure of the very rich and the very poor to report accurately.

The rich are less likely than middle-income people to respond to surveys because they are less accessible (their houses for instance are less accessible). In addition, when they respond, they may tend to underreport a larger fraction of their wealth as they have more incentives to hide (for tax reasons for example).

The very poor may also be inaccessible, but for other reasons. They may be hard to interview when they don’t have a fixed address or an official identification. In poor countries, they may be hard to find because they live in remote areas with inadequate transportation access. And again, when they report, it may be difficult to estimate their “wealth” because their assets are often in kind rather than in currency.

Because we can have underreporting of the two extremes on the wealth distribution, we believe that income distribution is more egalitarian than it really is. Hence we underestimate income inequality and relative poverty.

But apart from relative poverty we also underestimate absolute poverty since we’re often unable to include the very poor in the reporting for the reasons given above. By “cutting off” the people at the poor end of the distribution, it seems like most people are middle class and society largely egalitarian.

However, absolute poverty can also be overestimated: if the poor respond, we may fail to accurately assess their “wealth” given that much of it is in kind. And it’s unlikely that these two errors – underestimation and overestimation – cancel each other out.

These and other problems of poverty measurement make it difficult to claim that we “know” more or less precisely how many poor people there are, but if we make the same errors consistently we may be able to guess, not the levels of poverty, but at least the trends: is poverty going up or down?

Income Inequality (19): What To Do About It?

What to do about income inequality? Assuming of course that you agree that income inequality is a problem. How can we do something about the problem without destroying the incentives behind economic growth (assuming that much of economic growth is driven by financial rewards for effort, creativity, innovation etc. and that taking away resources from wealthy successful people takes away their will and creativity, hence driving down growth and making everyone, including the poor, worse off).

One thing that everyone thinks of is taxation, more precisely <a href="http://progressive taxation: this reduces the income of higher-earning families by a larger percentage than the income of lower earning ones. “Spreading the wealth around”, if you want. This makes incomes more equal in a direct way, but also in an indirect way because the tax revenues can be spend on poverty reduction (unemployment benefits, healthcare or education subsidies etc.). (An inheritance tax can also help, because it promotes social mobility and discourages income inequality that is not the result of economic incentives, and because a lack of social mobility is correlated with income inequality).

The problem, however, is that taxation is hardly ever progressive, even if it looks like it is:

Taxation in affluent countries does little to alter the market distribution of income. The reason is that taxes on income and corporate profits-which are progressively structured, reducing the incomes of high-earning households by a greater percentage than those of low-earning ones-are only part of the tax system. [But] their progressivity tends to be largely offset by the regressivity of payroll and consumption taxes. … Payroll and consumption tax rates usually are “flat”: the rate is the same regardless of individual or household income. Payroll taxes tend to be regressive because they apply to earnings rather than income, and wealthy households tend to get a smaller share of their income from earnings than do most households in the middle of the distribution. Also, payroll taxation often features a cap; in the United States, for instance, earnings above roughly $100,000 are not subject to the social security payroll tax. Consumption taxes apply to spending rather than income. They are regressive because lower-income households by necessity spend more of their income than their higher-income counterparts, so more of their income is subject to the tax. Lane Kenworthy (source)

Redistribution, then, does not occur through or because of the tax system itself, but through the systems of public spending.
Some interesting graphs
here. So it’s the amount of taxes, rather than the system of taxes, that enables governments to redistribute and reduce income inequality.

The Causes of Poverty (30): Lack of Economic Growth

When a country achieves a certain level of economic growth – or, more precisely, rising levels of GDP per capita because economic growth as such can be the result of rising population levels – it is assumed that this reflects a higher average standard of living for its citizens. Economic growth is therefore seen as an important tool in the struggle against poverty. If a country is richer in general, the population will also be richer on average. On average meaning that GDP growth isn’t necessarily equally distributed over every member of the population. That is why GDP growth isn’t sufficient proof of poverty reduction. Separate measurements of poverty and inequality are necessary.

So in theory, you can have GDP growth and increasing levels of poverty, on the condition that GDP growth is concentrated in the hands of a few. However, that’s generally not the case. GDP growth benefits to some extent many of the poor as well as the wealthy, which is shown by the strong correlation between poverty reduction and levels of GDP growth (always per capita of course). It’s no coincidence that a country such as China, which has seen strong GDP growth over the last decades, is also a country that has managed to reduce poverty levels substantially.

Unfortunately, growth isn’t a silver bullet. Poverty is a complex problem, requiring many types of solutions. Promoting economic growth will do a lot of the work, but something more is required. In a new paper, Martin Ravaillon gives the example of China, Brazil and India. The levels of poverty reduction in these three countries, although impressive, do not simply mirror the levels of economic growth. Although half of the world’s poor live in these three countries, in the last 25 years China has reduced its poverty level from 84% of the population in 1981 to just 16% in 2005. China is exceptional, but Brazil also did well, cutting its rate in half over the same period (8% of Brazilians still live on less than $1.25 a day). Regarding India, there are some problems with its statistics, but whichever statistic you use, there’s a clear reduction.

Ravaillon points out that the intensity of poverty reduction was higher in Brazil than in India and China, despite lower GDP growth rates.

Per unit of growth, Brazil reduced its proportional poverty rate five times more than China or India did. How did it do so well? The main explanation has to do with inequality. This (as measured by the Gini index, also marked on the chart) has fallen sharply in Brazil since 1993, while it has soared in China and risen in India. Greater inequality dampens the poverty-reducing effect of growth. (source)

Which is rather obvious: lower levels of income equality means a better distribution of the benefits of growth. So the “pro-growth strategy” against poverty is important but not enough, and should be combined with Brazilian type anti-inequality measures (focus on education, healthcare and redistribution).

The Causes of Wealth Inequality (3): Marital Homogamy and Declining Manufacturing & Unionization

Part of the increase [in inequality during the last decades, particularly in the U.S. and the U.K.] stems from declining manufacturing employment, part from shrinking unionization and fragmenting collective bargaining, part from heightened immigration and other aspects of globalization, and part from technological change. … [A]nother source of the rise in inequality: changes in household size and composition. Due to later marriage and more prevalent divorce, more and more households have just one adult, and hence only one potential earner. At the same time, coupling between people with similar education and thus similar earnings potential (“marital homogamy”) has increased, and the share of highly educated women who are employed continues to rise. The result of these developments is that many countries have more two-adult households with high earnings and more one- or two-adult households with low earnings than used to be the case. Lane Kenworthy (source)

The Causes of Poverty (28): Family Structure

Almost 30 percent of children [in the U.S.] now live in single-parent families, up from 12 percent in 1968. Since poverty rates in single-parent households are roughly five times as high as in two-parent households, this shift has helped keep the poverty rate up; it climbed to 13.2 percent last year. If we had the same fraction of single-parent families today as we had in 1970, the child poverty rate would probably be about 30 percent lower than it is today. Isabel V. Sawhill and Ron Haskins (source, source)

These numbers seem to correspond to intuition. It’s harder for one person to raise children than it is for two. And the risks of ending up in poverty are therefore higher. However, some caution is needed when linking poverty to family structure. Also, perhaps family structure isn’t so much the cause of poverty as its effect. And then there’s the fact that some countries, such as the Nordic European ones, have low marriage rates and high out-of-wedlock birthrates, yet they are much more egalitarian and have lower poverty rates than the U.S. (source). Part of the reason for this is the more generous welfare systems (and higher taxes ) in Nordic countries. Another part is the fact that

in the Nordic countries it’s quite common for committed couples raising children to just not be married. In the US a child whose mother isn’t married is typically growing up without his or her father being present, which isn’t the case in Sweden or Norway. (source)

“Born out of wedlock” doesn’t necessarily imply “single parent”. It’s family structure, and the presence of two parents – not necessarily “biological parents” or parents of a different sex – that helps families and children avoid or escape poverty, not formal or legal marriage status.

Unmarried biological parents in northern Europe are more likely to stay together to raise the kid than married parents in the US. (source)

This quote isn’t intended to imply that unmarried couples are better than married ones. Again, what matters isn’t marriage as such but family structure. And the focus on family structure isn’t intended to imply that all single parents are bad. Even if there’s only one parent, descent into poverty isn’t destiny. It also depends on the parent. Poverty isn’t a mechanical result of a certain family structure, but family structure does count in many cases (a poor single mother, even with the best intentions and efforts, will perhaps do worse than a celebrity divorcee). Having two parents is extremely helpful.

Yet we shouldn’t forget that poverty has many causes and family structure is just one of them, and most likely not the most important one. Hence it’s very well possible that a society with extremely high rates of single parents and births out of wedlock experiences less poverty (including child poverty) than another society where the large majority of children are raised by two biological parents and the large majority of marriages doesn’t break down.

Here‘s a graph indicating that living with only one parent certainly doesn’t condemn children to poverty.

Lies, Damned Lies, and Statistics (21): Misleading Averages

Did you hear the joke about the statistician who put her head in the oven and her feet in the refrigerator? She said, “On average, I feel just fine.” That’s the same message as in this more widely known joke about statisticians drowning in a pond with an average depth of 3ft. And then there’s this one: did you know that the great majority of people have more than the average number of legs? It’s obvious, really: Among the 57 million people in Britain, there are probably 5,000 people who have only one leg. Therefore, the average number of legs is less than 2. In this case, the median would be a better measure than the average or the mean.

But seriously now, averages can be very misleading, also in statistical work in the field of human rights. Take income data, for example. Income as such isn’t a human rights issue, but poverty is. When we look at income data, we may see that average income is rising. However, this may be due to extreme increases at the top 1% of income. If you then exclude the income increases of the top 1% of the population, the large majority of people may not experience rising income. Possible even the opposite. And rising average income – even excluding extremes at the top levels – is perfectly compatible with rising poverty for certain parts of the population.

Averages are often skewed by outliers. That is why it’s necessary to remove outliers and calculate the averages without them. That will give you a better picture of the characteristics of the general population (the “real” average income evolution in my example). A simple way to neutralize outliers is to look at the median – the middle value of a series of values – rather than the average (or the mean).

An average (or a median for that matter) also doesn’t say anything about the extremes (or, in stat-speak, about the variability or dispersion of the population). A high average income level can hide extremely low and high income levels for certain parts of the population. So, for example, if you start to compare income levels across different countries, you’ll use the average income. Yet country A may have a lower average income than country B, but also lower levels of poverty than country B. That’s because the dispersion of income levels in country A is much smaller than in country B. The average in B is the result of adding together extremely low incomes (i.e. poverty) and extremely high incomes, whereas the average in A comes from the sum of incomes that are much more equal. From the point of view of poverty average income is misleading because it identifies country A as most poor, whereas in reality there are more poor people in country B. So when looking at averages, it’s always good to look at the standard deviation as well. SD is a measure of the dispersion around the mean.

More posts in this series.