the income inequality debateonline.sfsu.edu/jgmoss/pdf/635_pdf/no_101_articlesincomeinequali… ·...

The Income Inequality DebateAuthor: Steven J. MarkovichSeptember 17, 2012

Introduction

Rising U.S. Income Inequality

Globalization and De-Unionization

Education and Technological Change

Income Tax Rates

Social Program Support

Bred for Success?

Political Impact

Introduction

In September of 2011, the Occupy Wall Street protests began in New York and quickly spread across

the globe. Its "We are the 99 percent" slogan encapsulated popular angst over income inequality that

had been rising steadily over the years. Today, inequality in the United States, measured by the

standard Gini coefficient, is substantially higher than almost any other developed nation, and even

some developing countries such as Russia and India.

While income inequality can be summarized in a few words, its multiple potential causes are more

complex. Globalization and technological change have simultaneously led to greater competition for

lower-skilled workers--many of whom have also lost union membership--while giving well-educated,

higher-skilled workers increased leverage. Changes to tax rates, including favorable treatment for

capital gains, may also play a role.

Rising U.S. Income Inequality

Income inequality in the United States has been rising for decades, with the top echelon of earners

http://www.cfr.org/united-states/income-inequality-debate/p29052

rapidly outpacing the rest of the population. According to the Congressional Budget Office

(PDF), the average real after-tax household income of the top 1 percent rose 275 percent from 1979

to 2007. Meanwhile, income for the remainder of the top quintile (81stto 99th percentile) grew 65

percent. Income for the majority of the population in the middle of the scale (21st through 80th

percentiles) grew just 37 percent for the same period. And the bottom quintile experienced the least

growth income at just 18 percent.

Furthermore, in 1965, a typical corporate CEO earned more than twenty times a typical worker; by

2011, the ratio was 383:1, according to the Economic Policy Institute.

While many of the suspected drivers of rising income inequality—globalization, technological change

and the rising value of education—affect other nations as well, few have seen as stark a rise in

inequality. From 1968 to 2010, the share of national income earned by the top 20 percent rose from

42.6 to 50.2 percent, with gains concentrated at the very top. Meanwhile, the "middle class," the

middle 60 percent, saw its share decline from 53.2 to 46.5 percent. This increasing income inequality

is captured by the steady rise in the U.S. Gini coefficient, from 0.316 in the mid-1970s to 0.378 in the


late 2000s. Today, the U.S. income distribution is one of the most uneven among major developed

nations (PDF).

Income Inequality in OECD countries

Map data ©2012 MapLink, Tele Atlas

Source: OECD

Globalization and De-Unionization

Economic forces underlie the growth of income inequality. Highly skilled workers have greatly

benefited from worldwide opportunities, from the star actor whose movies reach a global audience to

the entrepreneur who can quickly and cheaply bring a new product to market through Chinese

contract manufacturing (Forbes).

Meanwhile, globalization has brought tough competition to other American workers who have seen

jobs move overseas, wages stagnate, and unions decline. The median union member earns roughly a

quarter more than a non-union counterpart. Forty years ago, a quarter of private sector workers were

represented by unions, but today it is only 6.9 percent. Despite a workforce one-fifth of the size, the

public sector has more union members (PDF).


Immigration likely pays a role in stagnant wages, especially among workers without a high school

degree, of which immigrants make up about half. One study found that a 10 percent increase in the

local immigrant population correlated with a 1.3 percent decline in the price of labor-intensive

services, but it is difficult to disentangle this competitive effect from others on the labor market

(PDF).

A noted free trade advocate, Alan Blinder, said that while beneficial for the United States as a whole,

the increased labor competition from globalization will be painful for many Americans. He advocated

for helping displaced workers through a stronger safety net, reforming education, and encouraging

innovation and entrepreneurship (WashPost). Fellow Princeton economist Paul Krugman

believes that "we need to restore the bargaining power that labor has lost over the last thirty years, so

that ordinary workers as well as superstars have the power to bargain for good wages" (NYT).

Education and Technological Change

Most high wages come from high-skill jobs that require a commensurate level of education. After

decades of gradually narrowing, the college wage premium has grown dramatically since 1980, as the

annual growth in the college educated workforce (2 percent) failed to keep pace with rising demand

(3.27 to 3.66 percent) driven by technological change. In 2011, the median earnings of a worker

with a bachelor's degree were 65 percent higher than a high school graduate's; holders of professional

degrees (MD, JD, MBA) enjoyed a 161 percent premium. Higher educational attainment correlates

both with higher earnings and lower unemployment.

However, college degrees do not guarantee good jobs. Falling communication and computer costs are

leading to the offshoring and automation of some jobs that were once the purview of well-paid

professionals, from scientists in pharmaceutical labs to finance and accounting jobs

(Businessweek). There is a widening wage premium between those with advanced degrees and

those with a bachelor's degree only. Since the 2000s, the wage premium for those with only a

four-year degree has remained flat, while for those with advanced degrees it has continued to

grow.

Gary S. Becker and Kevin M. Murphy of the University of Chicago see education as the major driver

of rising income inequality. "In the United States, the rise in inequality accompanied a rise in the

payoff to education and other skills. We believe that the rise in returns on investments in human


capital is beneficial and desirable, and policies designed to deal with inequality must take account

of its cause" (TheAmerican). To address income inequality, they argue for policies that would

increase the percentages of American youth who complete high school and college, and against

making the tax code more progressive.

In a recent survey, 80 percent of economic experts agreed that a leading reason for rising U.S.

income inequality was that technological change has affected workers with some skill sets differently

than others, but not all prominent economists agree. James K. Galbraith believes that "the skills bias

argument--the notion that inequality is being driven by technological change and education and the

supply of skills--is comprehensively rebutted by the evidence." He argues instead that the credit cycle

has concentrated income in specific sectors, such as finance, tech and real estate (WashPost).

Income Tax Rates

One tool for addressing income inequality is a more progressive tax code (PDF). While some

argue that shifting some money from the rich to the poor means that money can be used to create

more social utility—the economic concept of declining marginal utility—other see this shift as

unfair and unwise because it reduces the ability of more productive citizens to re-invest in the skills

and businesses responsible for their higher relative income, thus retarding overall growth. While

economic models and theories can attempt to quantify the relationship between inequality and

growth, the optimum balance cannot be empirically determined.

The United States has generally cut top income tax rates over the past half century. When John F.

Kennedy entered the White House in 1961, the top ordinary income tax bracket--applied to wages

and savings interest--was more than 90 percent. Ronald Reagan slashed the top rate from 70 percent

in 1981 to 28 percent after 1986. Tax increases under the first President Bush and President Clinton

brought the top rate to 39.6 percent, but tax cuts signed by President George W. Bush and

reauthorized by President Obama set it to 35 percent.

Tax rates on investment income in the form of capital gains taxes and dividends have also declined,

with the current rate of 15 percent the lowest since 1933. Investment income ultimately is derived

from the after-tax profits of corporations, whose tax rate has also declined since the Eisenhower-era,

from more than 50 percent to today's marginal rate of 35 percent. Corporate income tax has

declined steadily as a share both of corporate profits and as a percentage of GDP over the past half


century.

The Social Security payroll tax, which funds both old age pensions and Medicare, is regressive

because it is a flat rate that only applies to the first $110,100 of wages, in 2012. On the other

hand, roughly half of U.S. taxpayers pay no additional federal income tax.

A Tax Policy Center analysis of all federal taxes found overall progressive taxation, with each quartile

paying a successively higher rate and the top 0.1 percent paying an effective rate of 30.4 percent.

While higher than the 14.1 percent borne by the middle quartile, 30.4 percent is lower than the

historical rates paid by this small group, which is earning its largest share of national income

since the Great Depression.

Social Program Support

The poverty rate tends to generally follow the economic cycle (PDF). As the economy reached new

heights in 2000, the poverty rate fell to 11.1 percent--a rate not seen since 1973—but in 2010 the

poverty rate had jumped back up to 15.1 percent.

Under President Lyndon Johnson's Great Society, most assistance was in the form of cash benefits to

needy families. Through the 1970s and 1980s, non-cash benefit programs were created or

accelerated, including college grants, food stamps, and housing assistance. The 1990s ushered in

welfare reform, replacing federal cash assistance with TANF block grant to states (PDF), with

work requirements and time limits. The refundable earned income tax credit, (created in 1975) was

greatly expanded at this time, providing extra cash to workers in an effort to "make work pay."

Today, record numbers receive food stamps, though one in five Americans struggle to afford food

(Stateline). The number of Social Security Disability Insurance recipients has surged by more than

22 percent since the recession began, as that program effectively acts as a long-term

unemployment benefit for some (Bloomberg).

From Medicaid to unemployment benefits, many social support programs are driven by decisions at

the state level. States have less flexibility to run deficits and many have cut programs to needy

citizens. Pennsylvania recently joined other states in eliminating its general assistance

program (Stateline). One caseworker observed: "My clients have lost an important source of funds


for life's necessities, while they face longer waitlists for job training programs."

Bred for Success?

A longer-term source of income disparity is strengthening: It is increasingly difficult to reach a higher

economic status than your parents. Many Americans take pride in the belief that everyone has a

chance to "make it big" and rags-to-riches stories are almost legends. But today, more than 40

percent of those born into the lowest income quintile will stay there, and less than 30 percent will

make an above-average income.

Among developed countries, only the United Kingdom has less class mobility; in 2006, the Brookings

Institution found that 47 percent of U.S. parents' income advantages are passed to their children,

greater than in France (41 percent), Germany (32 percent) or Sweden (27 percent). The countries

with the highest mobility were Canada, Norway, Finland and Denmark, where less than 20 percent of

economic advantages are passed to children (PDF).

Political Impact


The growing gap between the rich and poor may exacerbate political disunity. Economist Joseph E.

Stiglitz of Columbia University examined this in his recent book, The Price of Inequality, and argued

that no one has an interest in stark inequality. "The rich do not exist in a vacuum. They need a

functioning society around them to sustain their position. Widely unequal societies do not function

efficiently and their economies are neither stable nor sustainable" (Vanity Fair).

The Pew Research Center found increasing anxiety among America's middle class, with 85 percent

expressing greater difficulty in maintaining their standard of living. While a majority of

Americans see income inequality as a big problem (TheHill), polls also show more desire for

economic growth and greater equality of opportunity (Gallup).

During the debate in late 2010 over whether to extend the Bush-era tax rates, influential behavioral

economist Richard H. Thaler asked "whether we want a society in which the rich take an

ever-increasing share of the pie, or prefer to return to conditions that allow all classes to anticipate an

increasing standard of living" (NYT). The former chairman of Bush's Council of Economic

Advisers, N. Gregory Mankiw, argued that raising his marginal tax rate would lead him--and many

others--to work less (NYT). This tension between equality and growth is likely to remain

unresolved for the foreseeable future.

Finally, an August 2012 paper by the Hoover Institution of Stanford argued that income inequality

is not rising. Their analysis considered after tax income and added in non-cash benefits from

employers and government programs, and calculated a decline in the U.S. Gini coefficient from 1993

to 2009. The authors argued that reducing income inequality would not improve economic

well-being, and policymakers should instead target opportunity inequality.


SEPTEMBER 21, 2012, 6:00 AM

Income Inequality and Educational OpportunityBy LAURA D'ANDREA TYSON

Laura D'Andrea Tyson is a professor at the Haas School of Business at the University ofCalifornia, Berkeley, and served as chairwoman of the Council of Economic Advisersunder President Clinton.

A core American value is that each individual should have the opportunity to realize his orher potential. Birth needn't dictate destiny. Education has been the traditional Americanpathway to opportunity and upward mobility, but this pathway is closing for a growingnumber of Americans in low- and middle-income families.

And the failure to provide all Americans with the educational opportunities to realize theirpotential not only harms them; it harms the nation.

Educational attainment levels rose rapidly throughout much of the 20th century, with thecollege completion rate quadrupling for those born between 1915 and 1975. But it has beenlargely stagnant since.

The slowdown in college attainment levels has been most pronounced for individuals fromlow-income families. At the same time, the economic benefits of higher education haverisen. In 1979, the average college graduate made 38 percent more than the average highschool graduate. The comparable figure today is more than 75 percent.

During the last three decades the gap between the educational attainments of childrenraised in rich and poor families has widened dramatically, and it reveals itself remarkablyearly in children's lives.

According to the most recent census report, about one-quarter of children under the age of6 live in poverty. Recent research shows that early childhood poverty has negative effects onbrain development. At the age of 3, children in poverty have smaller vocabularies than theirpeers and a harder time sorting and organizing information and planning ahead.

Children in poor families are also less likely to have access to early-childhood educationprograms. Such programs have a proven record of raising future educational attainmentlevels, especially for poor children. Sadly, many states are slashing such programs, despitethe fact that the funds dedicated to them earn an annual real rate of return of 10 percent orhigher.

http://economix.blogs.nytimes.com/2012/09/21/income-inequality-and-educational-opportunity/?pagewanted=print

Disparities in educational achievement among children from different income groupsincrease with age. Such gaps are larger in fifth grade than they are in kindergarten, and theycontinue to grow as children move through primary and secondary school.

As a result of residential segregation, children from low-income families are more likely tohave classmates with low achievement levels and behavioral problems than children fromaffluent families. Poor children are also disproportionately situated in schools that oftenfind it difficult to attract and retain skilled teachers. And as the Chicago teachers' strikereminds us, poor children are often hungry, depending on their schools rather than theirhomes for breakfast and lunch.

The United States is caught in a vicious cycle largely of its own making. Rising incomeinequality is breeding more inequality in educational opportunity, which results in greaterinequality in educational attainment. That, in turn, undermines the intergenerationalmobility upon which Americans have always prided themselves and perpetuates incomeinequality from generation to generation.

This dynamic all but guarantees a permanent underclass. Indeed, the process is alreadyunder way: An American child's future income is already more dependent on his or herparents' income than a child born in most other developed countries.

Demographic trends are aggravating this vicious cycle. More than half of all births in theUnited States now occur out of marriage, and incomes for single-parent families are lowerthan for married families. That's one reason that family incomes have been declining formore than 50 percent of all children during the last 40 years.

Poverty rates are much higher in single-parent households than in married households.According to the most recent census numbers, 11.8 percent of all families, 6.2 percent ofmarried families, 31.7 percent of single-parent families headed by a female and 15.8 percentof single-parent families headed by a male were living in poverty in 2011. About 48 percentof children in single-parent households headed by women were living in poverty, comparedwith about 11 percent of children in married households. And poverty claimed a staggering57 percent of all children under the age of 6 in female-headed households.

Researchers at the Hamilton Project have found a strong correlation between earnings andmarriage rates. While marriage rates have declined across the board, the drop has beenlarger for middle- and low-income groups, especially for men with a high school degree orless. This group has experienced a large secular decline in real earnings during the last 30years. A provocative new book posits that women are increasingly dominant in work andeducation and celebrates the growth of female-headed households as a sign that patriarchyis giving way to matriarchy.

But there is another, less sanguine way to regard these trends. The rise of single-parenthouseholds headed by women may reflect the fact that women do not want to get marriedor stay married to such men or that men with weak earning prospects would rather drop


Copyright 2012 The New York Times Company Privacy Policy NYTimes.com 620 Eighth Avenue New York, NY 10018

out of the labor force altogether and avoid marital responsibilities. In either case, the newsis not good for children and their educational opportunities and attainments.

Meanwhile, college-educated men and women are more likely to marry - most often topeople with similar education levels - less likely to divorce and less likely to have childrenoutside of marriage. Marriage and stable two-parent households are becoming marks ofprosperity. These trends spell even greater income inequality and even greater inequality ofopportunity for children in the future.

What can the federal government do to mitigate these trends? First, the progressivity of thefederal tax and transfer system should be strengthened. The United States has one of themost unequal income distributions in the developed world, but its tax and transfer systemis among the least progressive.

Tax expenditures that disproportionately benefit high-income families should be limited,while the earned-income tax credit that benefits working families should be expanded. Thetax rates on capital gains, dividends and carried interest, most of which go to top incomeearners, should be increased as part of a multiyear deficit reduction plan.

Such a plan should also include more means-testing of entitlement programs and adequatefunds for programs like food stamps, Head Start and Medicaid that address the needs oflow-income families.

Second, the investments championed by President Obama to enhance educationalopportunities - the $4 billion Race to the Top program to reward states for school reforms;the increase in the number and size of Pell grants; the tuition tax credit; the reformedstudent loan program; federal support for partnerships with community colleges - must besustained. Deficit reduction must not be at the expense of these investments. Because theyare investments, not handouts, they will end up paying for themselves.

Providing all Americans with the opportunity to realize their potential, regardless of theirorigins, is a core value. It is also a wise down payment on the nation's future prosperity. "Amind is a terrible thing to waste" is more than a clever slogan.


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Cues from Egypt - Income inequality and inequality ofopportunityTuesday, 16 October 2012 14:03

On October 8, President Mohamed Morsi issued a decree pardoning all "ArabSpring" political prisoners. While the decree, if implemented, marks a milestonein Egypt’s hard-fought 21-month-long revolution, the quotient of inequality thatcontributed to setting it off still remains.

From the Arab Spring to Occupy Wall Street, inequality has risen to the top ofsocial agenda. However, our measures of inequality are often limited to finaloutcomes, such as income, wealth, and educational achievement, which do notdistinguish between the impact on inequality of personal responsibility and thatstemming from factors beyond the scope of individual responsibility.

Across the ideological spectrum, there is a role for personal responsibility andthat hard work and wise choices ought to be rewarded. On the other hand,inequality that arises from differences in circumstances outside an individual’scontrol, such as race, gender, ethnicity, family background and birthplace, isgenerally viewed as unfair. There are two important implications from suchdistinction. The first is that while there may be arguments for and againstinequality in final outcomes, there tend to be no disagreements about individualshaving equal opportunity at achieving them Income inequality arising fromdifferences in individual efforts, as long as there is a level playing field, maygenerally be considered acceptable. To the extent that final outcomes differbased on effort, it may even be argued to provide incentives for greater effort.Likewise, there are arguments against high income inequality, includingassertions that it may reduce growth and hinder poverty alleviation efforts and bea cause for crime, violence and conflicts. The second implication is that thedistinction would allow economic and social policies to compensate for factorsbeyond the control of individuals, while letting individuals bear the consequencesof factors for which they can be held responsible.

So what type of inequality might have been a factor in Egypt’s Arab Spring?Quantitative data from pre Arab Spring Egypt indicate that measures of incomeinequality in Egypt were moderate by international standards. According to arecent household data, income inequality, as measured by Gini coefficient, wasabout 31% in 2009. While this figure is higher than in the most egalitariancountries, it is not at a level that would contribute to the setting off massiveuprisings witnessed during the revolution. Similarly, the World Value Survey(WVS) conducted in about 70 countries during 2005-2008 show that the publicperceptions of income inequality in Egypt are low (Figure 1). While more than12% of all WVS respondents agreed that “incomes should be made more equal,”the corresponding figure for Egypt was 3%. About 30% of Egyptians felt that “weneed more income differences as incentives for individual efforts”, compared to

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16% for all participating countries. Finally, nearly all respondents from Egypt(97%) agreed with the statement “if someone worked harder, it is fair for him orher to be more rewarded”, compared to 78% for all participating countries.

Figure 1: Perceptions of Income Inequality and Fairness in Egypt

A recently completed World Bank study that drew on the methodology developedin the recent literature of inequality of opportunity (e.g., John Roemer, 1998; 2006WDR) shows that Egyptians’ ability to achieve life goals depends to a largedegree on circumstances beyond their control. The findings are enlightening:despite moderate income inequality, there are larger and growing disparities indevelopment opportunities because of circumstances beyond control (Figure 2).Inequality of opportunity, measured by dissimilarity index, ranges from 6.5percent in access to nutrition during the early years to 42 percent in acquiring awell-paid job by aspiring young females. Two important cautionary remarks are inorder to help better understand these numbers. First, since it is impossible toaccount for all circumstances, the figures should be taken as a lower bound andthe actual inequities could be considerably larger. Second, a relatively lowdisparity in access to early nutrition does not suggest a low prevalence ofmalnutrition in Egypt, rather it is indicative of the phenomenon affecting manychildren regardless of their circumstances.

From the very start, circumstances influence a child’s probability of healthcareand nutrition services that are necessary to succeed in life. Family background,especially parental education and wealth, and geographic factors are key factorsin children’s access to basic services. Later on, the disparities in children’seducational outcomes (such as test scores) are reinforced by these exogenouscircumstances. Afterwards, during the individual’s early working years,productivity levels, probability of obtaining a well-paid job, and earnings sufferprogressively more.

What do the findings mean for Egypt and its new government?Egyptians’ ability to achieve life goals to a large extent depends oncircumstances beyond their control. Inequality of opportunity, presentsubstantially early in most Egyptians’ lives, tends to increase over time resultingin poor outcomes - at a time crucial for shaping their financial freedom and civicparticipation. While these findings shed light on some of the underlying causes ofthe uprising, they also provide insights on important social and economic policiesthat the new Government can focus on.

How can the Bank support the new government in this effort?To help focus the attention on these underlying issues, the World Bank isorganizing a policy workshop in Cairo in November 2012. Among other things,the findings of this study will be shared with policy-makers and otherstakeholders. As we prepare to present these findings, we look forward tohearing your suggestions and ideas.

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Lire Ersado is a Senior Economist with the Human Development Unit of theMiddle East and North Africa Region (MNA), the World Bank. Currently hemanages social protection analytical and lending activities and policy dialogue inEgypt, Jordan, and Yemen. Previously, Lire was with the Human DevelopmentEconomics group in the Europe and Central Asia Region (ECA), where he wasprogram leader for the South Caucasus regional and programmatic povertyassessment and statistical capacity building; was a core member of ECA’s globaleconomic crisis monitoring team; and led the World Bank’s social protectionsector policy dialogue and lending operations in Armenia. Prior to joining theWorld Bank, Lire, an Ethiopian national, was a postdoctoral fellow at InternationalFood Policy Research Institute (IFPRI) and has taught at Alemaya University. Hisareas of research and publications include: poverty and policies for fighting it;inequality of opportunity; social safety nets; work disincentives in cash transferprograms; household consumption and saving behavior; rural vulnerability andrisk; income diversification; child labor and schooling; public investments andhealth; and agricultural technology adoption. Lire’s work has been published inseveral journals, such as World Development, American Journal of AgriculturalEconomics, Journal of Development Studies, and Economic Development andCultural Change. Lire holds a Ph.D. in economics from Virginia Tech. (© 2012The World Bank Group, All Rights Reserved.)

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Oct 13th 2012 | from the print edition

Special report: The world economyIn this special reportFor richer, for poorerAs you wereLike a piece of stringLike father, not like sonThe rich and the restMakers and takersCrony tigers, divided dragonsLessons from PalanpurGini back in the bottleThe new modelHaving your cakeA True ProgressivismSources & acknowledgementsReprints

For richer, for poorerGrowing inequality is one of the biggest social, economicand political challenges of our time. But it is not inevitable,says Zanny Minton Beddoes

IN 1889,AT theheight of

http://www.economist.com/node/21564414/print

America’s first Gilded Age, George Vanderbilt II, grandson of the originalrailway magnate, set out to build a country estate in the Blue Ridgemountains of North Carolina. He hired the most prominent architect ofthe time, toured the chateaux of the Loire for inspiration, laid a railwayto bring in limestone from Indiana and employed more than 1,000labourers. Six years later “Biltmore” was completed. With 250 roomsspread over 175,000 square feet (16,000 square metres), the mansionwas 300 times bigger than the average dwelling of its day. It had centralheating, an indoor swimming pool, a bowling alley, lifts and an intercomsystem at a time when most American homes had neither electricity norindoor plumbing.

A bit over a century later, America’s second Gilded Age has nothingquite like the Vanderbilt extravaganza. Bill Gates’s home near Seattle isfull of high-tech gizmos, but, at 66,000 square feet, it is a mere 30times bigger than the average modern American home. Disparities inwealth are less visible in Americans’ everyday lives today than theywere a century ago. Even poor people have televisions, air conditionersand cars.

But appearances deceive. The democratisation of living standards hasmasked a dramatic concentration of incomes over the past 30 years, ona scale that matches, or even exceeds, the first Gilded Age. Includingcapital gains, the share of national income going to the richest 1% ofAmericans has doubled since 1980, from 10% to 20%, roughly where itwas a century ago. Even more striking, the share going to the top0.01%—some 16,000 families with an average income of $24m—hasquadrupled, from just over 1% to almost 5%. That is a bigger slice ofthe national pie than the top 0.01% received 100 years ago.

This is an extraordinary development, and it is not confined to America.Many countries, including Britain, Canada, China, India and evenegalitarian Sweden, have seen a rise in the share of national incometaken by the top 1%. The numbers of the ultra-wealthy have soaredaround the globe. According to Forbes magazine’s rich list, America hassome 421 billionaires, Russia 96, China 95 and India 48. The world’srichest man is a Mexican (Carlos Slim, worth some $69 billion). Theworld’s largest new house belongs to an Indian. Mukesh Ambani’s


27-storey skyscraper in Mumbai occupies 400,000 square feet, makingit 1,300 times bigger than the average shack in the slums that surroundit.

The concentration of wealth at the very top is part of a much broaderrise in disparities all along the income distribution. The best-known wayof measuring inequality is the Gini coefficient, named after an Italianstatistician called Corrado Gini. It aggregates the gaps between people’sincomes into a single measure. If everyone in a group has the sameincome, the Gini coefficient is 0; if all income goes to one person, it is 1.

The level of inequality differs widely around the world. Emergingeconomies are more unequal than rich ones. Scandinavian countrieshave the smallest income disparities, with a Gini coefficient fordisposable income of around 0.25. At the other end of the spectrum theworld’s most unequal, such as South Africa, register Ginis of around 0.6.(Because of the way the scale is constructed, a modest-soundingdifference in the Gini ratio implies a big difference in inequality.)

Incomegapshavealsochangedtovaryingdegrees.

America’s Gini for disposable income is up by almost 30% since 1980,to 0.39. Sweden’s is up by a quarter, to 0.24. China’s has risen byaround 50% to 0.42 (and by some measures to 0.48). The biggestexception to the general upward trend is Latin America, long the world’smost unequal continent, where Gini coefficients have fallen sharply overthe past ten years. But the majority of the people on the planet live incountries where income disparities are bigger than they were ageneration ago.

That does not mean the world as a whole has become more unequal.


Global inequality—the income gaps between all people on theplanet—has begun to fall as poorer countries catch up with richer ones.Two French economists, François Bourguignon and Christian Morrisson,have calculated a “global Gini” that measures the scale of incomedisparities among everyone in the world. Their index shows that globalinequality rose in the 19th and 20th centuries because richereconomies, on average, grew faster than poorer ones. Recently thatpattern has reversed and global inequality has started to fall even asinequality within many countries has risen. By that measure, the planetas a whole is becoming a fairer place. But in a world of nation states itis inequality within countries that has political salience, and this specialreport will focus on that.

From Uto N

Thewideningofincomegaps is areversalof thepatternin muchof the20th century, when inequality narrowed in many countries. Thatnarrowing seemed so inevitable that Simon Kuznets, a Belarusian-bornHarvard economist, in 1955 famously described the relationshipbetween inequality and prosperity as an upside-down U. According tothe “Kuznets curve”, inequality rises in the early stages ofindustrialisation as people leave the land, become more productive andearn more in factories. Once industrialisation is complete and better-educated citizens demand redistribution from their government, itdeclines again.

Until 1980 this prediction appeared to have been vindicated. But thepast 30 years have put paid to the Kuznets curve, at least in advancedeconomies. These days the inverted U has turned into something closerto an italicised N, with the final stroke pointing menacingly upwards.


Although inequality has been on the rise for three decades, its politicalprominence is newer. During the go-go years before the financial crisis,growing disparities were hardly at the top of politicians’ to-do list. Onereason was that asset bubbles and cheap credit eased life for everyone.Financiers were growing fabulously wealthy in the early 2000s, butothers could also borrow ever more against the value of their home.

That changed after the crash. The bank rescues shone a spotlight on theunfairness of a system in which affluent bankers were bailed outwhereas ordinary folk lost their houses and jobs. And in today’s sluggisheconomies, more inequality often means that people at the bottom andeven in the middle of the income distribution are falling behind not justin relative but also in absolute terms.

The Occupy Wall Street campaign proved incoherent and ephemeral, butinequality and fairness have moved right up the political agenda.America’s presidential election is largely being fought over questionssuch as whether taxes should rise at the top, and how big a rolegovernment should play in helping the rest. In Europe France’s newpresident, François Hollande, wants a top income-tax rate of 75%. Newsurcharges on the richest are part of austerity programmes in Portugaland Spain.

Even in more buoyant emerging economies, inequality is a growingworry. India’s government is under fire for the lack of “inclusive growth”and for cronyism that has enriched insiders, evident from dubiousmobile-phone-spectrum auctions and dodgy mining deals. China’sleaders fear that growing disparities will cause social unrest. WenJiabao, the outgoing prime minister, has long pushed for a “harmonioussociety”.

Many economists, too, now worry that widening income disparities mayhave damaging side-effects. In theory, inequality has an ambiguousrelationship with prosperity. It can boost growth, because richer folksave and invest more and because people work harder in response toincentives. But big income gaps can also be inefficient, because theycan bar talented poor people from access to education or feedresentment that results in growth-destroying populist policies.

The mainstream consensus has long been that a growing economyraises all boats, to much better effect than incentive-dulling


redistribution. Robert Lucas, a Nobel prize-winner, epitomised theorthodoxy when he wrote in 2003 that “of the tendencies that areharmful to sound economics, the most seductive and…poisonous is tofocus on questions of distribution.”

But now the economics establishment has become concerned about whogets what. Research by economists at the IMF suggests that incomeinequality slows growth, causes financial crises and weakens demand.In a recent report the Asian Development Bank argued that if emergingAsia’s income distribution had not worsened over the past 20 years, theregion’s rapid growth would have lifted an extra 240m people out ofextreme poverty. More controversial studies purport to link wideningincome gaps with all manner of ills, from obesity to suicide.

The widening gaps within many countries are beginning to worry eventhe plutocrats. A survey for the World Economic Forum meeting atDavos pointed to inequality as the most pressing problem of the comingdecade (alongside fiscal imbalances). In all sections of society, there isgrowing agreement that the world is becoming more unequal, and thattoday’s disparities and their likely trajectory are dangerous.

Not sofast

That istoo

simplistic. Inequality, as measured by Gini coefficients, is simply asnapshot of outcomes. It does not tell you why those gaps have openedup or what the trend is over time. And like any snapshot, the picturecan be misleading. Income gaps can arise for good reasons (such aswhen people are rewarded for productive work) or for bad ones (ifpoorer children do not get the same opportunities as richer ones).


from the print edition | Special report

Equally, inequality of outcomes might be acceptable if the gaps arebetween young people and older folk, so may shrink over time. But insocieties without this sort of mobility a high Gini is troubling.

Some societies are more concerned about equality of opportunity,others more about equality of outcome. Europeans tend to be moreegalitarian, believing that in a fair society there should be no big incomegaps. Americans and Chinese put more emphasis on equality ofopportunity. Provided people can move up the social ladder, they believea society with wide income gaps can still be fair. Whatever people’spreferences, static measures of income gaps tell only half the story.

Despite the lack of nuance, today’s debate over inequality will haveimportant consequences. The unstable history of Latin America, long thecontinent with the biggest income gaps, suggests that countries run byentrenched wealthy elites do not do very well. Yet the 20th century’sfocus on redistribution brought its own problems. Too often high-taxwelfare states turned out to be inefficient and unsustainable.Government cures for inequality have sometimes been worse than thedisease itself.

This special report will explore how 21st-century capitalism shouldrespond to the present challenge; it will examine the recent history ofboth inequality and social mobility; and it will offer four contemporarycase studies: the United States, emerging Asia, Latin America andSweden. Based on this evidence it will make three arguments. First,although the modern global economy is leading to wider gaps betweenthe more and the less educated, a big driver of today’s incomedistributions is government policy. Second, a lot of today’s inequality isinefficient, particularly in the most unequal countries. It reflects marketand government failures that also reduce growth. And where this ishappening, bigger income gaps themselves are likely to reduce bothsocial mobility and future prosperity.

Third, there is a reform agenda to reduce income disparities that makessense whatever your attitude towards fairness. It is not about highertaxes and more handouts. Both in rich and emerging economies, it isabout attacking cronyism and investing in the young. You could call it a“True Progressivism”.


October 16, 2012

Income Inequality May Take Toll onGrowthBy ANNIE LOWREY

WASHINGTON — Income inequality has soared to the highest levels since the GreatDepression, and the recession has done little to reverse the trend, with the top 1 percent ofearners taking 93 percent of the income gains in the first full year of the recovery.

The yawning gap between the haves and the have-nots — and the political questions that gaphas raised about the plight of the middle class — has given rise to anti-Wall Street sentimentand animated the presidential campaign. Now, a growing body of economic research suggeststhat it might mean lower levels of economic growth and slower job creation in the years ahead,as well.

“Growth becomes more fragile” in countries with high levels of inequality like the UnitedStates, said Jonathan D. Ostry of the International Monetary Fund, whose research suggeststhat the widening disparity since the 1980s might shorten the nation’s economic expansionsby as much as a third.

Reducing inequality and bolstering growth, in the long run, might be “two sides of the samecoin,” research published last year by the I.M.F. concluded.

Since the 1980s, rich households in the United States have earned a larger and larger share ofoverall income. The 1 percent earns about one-sixth of all income and the top 10 percent abouthalf, according to statistics compiled by the respected economists Emmanuel Saez of theUniversity of California, Berkeley and Thomas Piketty of the Paris School of Economics.

For years, economists have thought of such inequality in part as a side effect of policies thatfostered the country’s economic dynamism — its tax preferences for investment income, forinstance. And organizations like the World Bank and the I.M.F., which is based inWashington, have generally not tackled inequality in the world head on.

But economists’ thinking has changed sharply in recent years. The Organization for EconomicCooperation and Development this year warned about the “negative consequences” of thecountry’s high levels of pay inequality, and suggested an aggressive series of changes to tax

http://www.nytimes.com/2012/10/17/business/economy/income-inequality-may-take-toll-on-growth.html?pagewanted=print

and spending programs to tackle it.

The I.M.F. has cautioned the United States, too. “Some dismiss inequality and focus insteadon overall growth — arguing, in effect, that a rising tide lifts all boats,” a commentary by fundeconomists said. “When a handful of yachts become ocean liners while the rest remain lowlycanoes, something is seriously amiss.”

The concentration of income in the hands of the rich might not just mean a more unequalsociety, economists believe. It might mean less stable economic expansions and sluggishgrowth.

That is the conclusion drawn by two economists at the fund, Mr. Ostry and Andrew G. Berg.They found that in rich countries and poor, inequality strongly correlated with shorter spellsof economic expansion and thus less growth over time.

And inequality seems to have a stronger effect on growth than several other factors, includingforeign investment, trade openness, exchange rate competitiveness and the strength ofpolitical institutions.

For developing economies, the channels through which inequality might drag down growthseem clear. Inequality might foster political instability and lead to violence and economicdestruction, for instance, a theme that fits for Arab Spring countries, like Egypt and Syria.

For the United States, such channels are now the subject of intense research interest, witheconomists examining whether and how the gap between the rich and the poor fueled therecession and what it might mean.

In the last few years, research by the Brookings Institution, the I.M.F. and dozens ofeconomists at top research universities has started to coalesce into a compelling narrative.

Starting in the 1970s, earnings were squeezed for low- and middle-income households. Theyborrowed to improve their standards of living — buying bigger houses than they could affordand using those houses as piggy banks. Families bet that housing prices would keep rising,making a three-bedroom outside Phoenix a safe store of wealth. But the housing bubblecollapsed, and took the rest of the economy with it.

Research by Raghuram Rajan of the University of Chicago has also underscored theimportance of deregulation. “Starting in the early 1970s, advanced economies found itincreasingly difficult to grow,” he wrote this year. “The shortsighted political response to theanxieties of those falling behind was to ease their access to credit. Faced with little regulatoryrestraint, banks overdosed on risky loans.”


Thus, inequality might help explain the recession and the sluggish recovery after it. But now,economists and policy experts are facing the thorny and politically freighted question of whatthe United States’ inequality might mean over the next several years.

The recession seems to have cemented the country’s income and wealth inequality, notreversed it. The top 10 percent earn a larger share of overall income than they have since the1930s. The earnings of the top 1 percent took a knock during the recession, but have bouncedback. In contrast, the average working family’s income has continued to decline through theanemic recovery.

The distribution of wealth has become more concentrated as well. The lower income a familyearns, the more wealth they tend to hold in their housing. Housing values have plummeted,and are not expected to recover for years if not decades. At the same time, many bond priceshave soared and stock prices have performed well, aiding the upper-income households thattend to hold investments.

A new study by the left-of-center Economic Policy Institute, a research group in Washington,has found that the top 1 percent of households now hold a larger share of overall wealth thanthe bottom 90 percent does.

Policy experts and politicians across the political spectrum — including President Obama andMitt Romney — argue that restoring the middle class will be crucial to driving growth. Butthey disagree sharply on the proper policies to do so, particularly when it comes to taxes andgovernment transfer programs.

“What worries me is the idea that we’re in a vicious cycle,” said Joseph E. Stiglitz, a Nobellaureate in economics who has studied inequality extensively. “Increasing inequality means aweaker economy, which means increasing inequality, which means a weaker economy. Thateconomic inequality feeds into political economy, so the ability to stabilize the economy getsweaker.”

Rea S. Hederman, an economist at the right-of-center Heritage Foundation, a Washingtonresearch group, said that “the problem is that the policies that encourage growth alsoencourage inequality,” citing the preferential tax rates for investment income as an example.“That means redistributing income is going to restrict growth.”


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