Inequality is not what people think it is

There was much consternation in December when the OECD, the club of rich nation states, came out with the statement that western world economies would be very much larger than they currently are if only inequality hadn’t risen.

The consternation arose from the fact that we’re all aware of people who would prefer there wasn’t so much inequality, but not really familiar with any economic theory that directly links too much with less growth. In the wake of Thomas Piketty, of course, there are a number of people looking for one but that’s something rather different.

Those who want there to be such a link were of course delighted with this OECD report.

Those of us rather more connected with reality went and actually read the paper and found something rather different in it. There was an assumption made that rising inequality reduced the growth of the economy. They then measured how much inequality had risen and this gave them their answer of how much growth had fallen.

That your model is internally logical, that your result matches your assumptions, is useful but it’s not really a finding about the real world. If I insist that one particular book is the way we must all live and we should stone to death any who does not, then I am being consistent with my model when I stone the unbelievers.

I’m not actually addressing the question of whether people should be killed with rocks.

What raised more eyebrows was that the report itself didn’t actually include any proofs of that essential contention. It was more of a press release stating it and then having a quick scribble in the margins trying to quantify the effect as above. The U.K. economy is now, according to this scribble, 20 percent smaller than it would have been at earlier levels of equality.

What makes all this so wearisome is that there has been considerable research into the effects of inequality upon growth. And the most basic finding is that it’s, to some level at least, essential for there to be growth. Or if not that, then at least an inescapable outcome of there having been some.

For if outcomes for individuals are going to be equal then who will strive to create the new? Who would undertake a 10 year training to do a job if the income were to be the same as the person who had three-hours training on how to use a shovel?

If we have an economic system that is to depend upon incentives in any manner then there will have to be an inequality of rewards to provide those incentives.

And we have had a number of attempts to create societies that don’t use either markets or rewards from them as incentives and we usually regard them as the worse horrors of the 20th century.

Perhaps it is possible that “too much” inequality reduces growth. Yet even here what is alleged isn’t borne out by other research. For example, how much of the economy is taken by the 1 percent (or the 0.1 percent) does not have any effect that anyone has measured.

We can see interesting things where there’s a wide or rigid division between the middle and the bottom, that’s true, but the thing that everyone’s worrying about today, that 1 percent, seems to have no effect that we can discern.

What’s worse about the OECD report is that it then goes on to insist that reducing inequality will bring back the lost growth. Yet that other rich nations club, the IMF, recently reported on exactly this point, where they pointed out that modest attempts to redistribute income did not hold back economic growth. This immediately led to shouts that redistribution did not, which seems to be where the OECD is. But as the perceptive will note, rather a lot rests on that value of “modest” there.

And the IMF answer was that trying to move the Gini (a measure of inequality, 0 being equal incomes, 100 being where one person has all the income of the society) by 13 or so points was the limit of “modest”. To give a couple of examples, the U.K. moves before tax and benefits Gini by about 14 points to the post tax and benefits one. The U.S. by a more modest 11 or 12 points. The other European countries by rather more and they are thus reducing growth through immodest redistribution.

That the modest attempts do not reduce, might even increase, growth seems reasonable enough. That the poor are not scavenging in the streets could be said to be advantageous as an example. That there’s a security net so that people are willing to be flexible, try new things, start new companies would also help.

That there’s a top end to attempts being useful would also seem logical. We don’t have to entirely buy the caricature of Art Laffer that all tax cuts pay for themselves via increased growth to be sure that very high tax rates do curb growth. So there is that top limit on what can be taken from the rich to be awarded to the poor by the political class.

Moving away from excited press releases, the actual state of knowledge is that some inequality is beneficial, too much might not be, modest attempts at redistribution through the tax and benefits system seem at least not to be harmful and large ones are. Meaning that in terms of public policy the socially democratic states of Europe should probably do a little less to reduce inequality and the U.S. and U.K. are, on this one measure, about where everyone should be.

Not that this would appeal to our other excitable reporters on such matters. Just before the Davos meeting Oxfam released a report stating that soon the 1 percent would own 50 percent of everything.

Wealth, which is of course different from income, was so concentrated that 80 people owned as much as the bottom 50 percent of the world and that 1 percent were about to cackle over half of it all.

Quite why this was such a surprise to anyone is difficult to understand. Wealth distributions are always much more unequal than income ones for the simple reason that it’s possible to have negative wealth.

Pretty much any student fresh out of college will have less than nothing for example. Student loans and no assets is negative wealth in the way we measure because we don’t include human capital (that sheepskin) in our measure of wealth. So we actually find that the majority of our bottom 10 percent of the wealth distribution is in the rich countries.

Because that’s where there’s a financial system that enables you to go into debt to finance improving yourself. Third World farmers aren’t as poor as that: simply because no one ever lets them borrow much money.

Another reason why this shouldn’t be a surprise is that it’s is pointed out in the literature. Saez and Zucman, collaborators at times with Piketty, repeatedly point out in fact that the bottom 50 percent of any wealth distribution simply won’t have much wealth.

Much of this is simply that lifecycle thing. Barring inheritance we’re all with less than nothing at some point in our lives, then we buy houses, start pensions and by the time we retire we’re up in that global 1 percent.

To get to the top in that wealth distribution, you need some $800,000. So anyone who has paid off the mortgage on a modest house (or even apartment) in London or a major U.S. city and also has a pension organized will be there in that 1 percent. The plutocratically wealthy end up not being quite so plutocratic really.

Another illustration of the same point is that the Walton family, who own some 50 percent of Walmart between them, are richer than the bottom 30 percent of all Americans put together. This is true. But it becomes less impressive when you realize that if you have a $10 bill and no debts then you are richer than the bottom 25 percent of Americans. Not just each of them, but all of them cumulatively.

At which point perhaps we should return to the idea of income inequality. For again there has been an outburst about how the global 1 percent gain too much.

Which rather deflated when it was pointed out that if you’re on something just above mean average income (£26,000/$38,800) in the U.K. then you are part of that global 1 percent. And being on minimum wage puts you in the top 6 percent.

Approximately the same is true for the U.S. And, as another comparison, the average income for the bottom 10 percent of Americans is higher than the average income for the top 10 percent of Indians.

Which leads us to an interesting thought for those people at Oxfam complaining so vociferously about inequality. Absolutely everyone who works for them at home base is in the global top 6 percent by income, all of their senior people are in the top 1percent.

And given that some of them are middle aged, with houses and pensions, there’s almost certainly more people working for Oxfam in that top 1 percent of wealth in the world than there are actual billionaires on the planet. Inequality is just not what people think it is.



The Favela da Rocinha slum in Rio de Janeiro with skyline of the city behind.
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Michael Klein
Michael Klein Editor Pinnacle Media Group Ltd. PO Box 1365, Grand Cayman, KY1-1108, Cayman Islands T: 345-326-1720C: 345-815-0064 E: Michael is a financial journalist and copywriter.  In the past he has been responsible for the Risk Management and Corporate Finance sections of a British monthly Corporate Treasury publication.  He has written various financial handbooks, notably on European Banking and Cash Management and the Debt Capital Markets.   In addition he has worked as a copywriter for banks and investment funds and served as corporate communications consultant to US and European blue chip companies.   Michael holds an MA in Political Science and International Law from the University of Bonn in Germany. 

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