Closing the gap on inequality

Opinions

Social inequality has become the focus of political interest in the wake of the financial crisis.

The costs are primarily borne by medium to low wage earners, especially in those countries in which strict austerity measures have been adopted.

Expert economists like Joseph Stiglitz regard stagnating salaries for the masses on the one hand in conjunction with increasing assets on the other as the cause of the debt-driven, speculative growth, which preceded the collapse of the financial bubble.

The consequences include high levels of unemployment, falling actual earnings, and a long-term recession.

Now that the casino has reopened for business and the stock markets are once again booming with the aid of the central banks, inequality is increasing almost everywhere.

And it is not only progressive and left-wing pundits, who are raising concerns about the consequences of increasing inequality.

Christine Lagarde, Managing Director of the International Monetary Fund (IMF), warned that: “Rising inequality can damage economic growth and social ties, and may also cause political instability”.

And the authors of the 2014 Global Risks Report, published by the World Economic Forum (WEF) in Davos, regard the growing gap between rich and poor as the greatest risk for the global economy.

 

Income and wealth distribution trends

The triumph of neo-liberalism in the 1980s has resulted in a significant change to incomes and in the distribution of wealth around the world to the detriment of the less privileged.

Although many states, particularly in Asia, are in the process of catching up with the West, there too it is primarily the economic and social elites (i.e. the top 10 per cent), and to a lesser extent, a new middle class, who are profiting.

The lowest 40 per cent on the income scale, by contrast, are getting very little benefit from it.

According to some estimates the wealthiest 20 per cent of the global population earn some 50 times more than the poorest 20 per cent.

There are three distinct trends involved in growing income inequality.

Firstly there has been a global change in terms of income distribution between wages and profits to the detriment of wages. Whilst investment incomes have frequently achieved double-figure growth rates, average actual earnings have stagnated.

In this context there is also a further significant factor at work: whilst salaries for workers in jobs regulated by collectively bargained agreements have continued to grow, the rapidly increasing number of workers in precarious or atypical employment situations has been obliged to accept reductions to their actual earnings.

On the other hand it has been actors within the finance sector who have profited most on the capital investment side. Since the 1980s, investment income has been growing faster than the corresponding economies within the member states of the Organisation for Economic Co-operation and Development (OECD).

The result has been wealth concentration in conjunction with a shrinking middle class.
Secondly there have been some dramatic increases in earned income spreads. Back in 1970 top managers in the USA were earning 30 times the average worker salary.

Today that has risen to 300 times or more. In the UK in 2013 CEOs in the companies listed in the FTSE 100 Index were bringing home 120 times more than the average salary of their employees.

In many places economic growth has been decoupled from the material prosperity of the majority of the population.

Since 2009, 95 per cent of all income growth in the USA has gone into the pockets of the most affluent one per cent of the population. The same trend can be observed in other OECD member states.

Thirdly, tax and social transfer policy has had less of a corrective influence on income distribution than in the past. In many countries progressive taxation has been significantly decreased over the past few decades.

The fact that investment income is taxed less than earned income almost everywhere is an extremely undesirable development. In Germany, for example, capital gains tax currently stands at 25 per cent, whilst the top taxation bracket for earned income is 42 per cent.

Latin America is among those regions in which economic inequality has not increased over the last two decades. Despite the fact that it remains one of the regions with the highest levels of income inequality, the level actually decreased in 14 out of 20 South American states between 1990 and 2013.

There are three factors that account for this: better secondary school education; active state-led minimum wage policies; and state-led wealth transfer programmes in favour of the poor.

The unequal distribution of wealth is far greater than of income. Almost half of all asset holdings are owned by the richest one per cent.

But there is yet another statistic that is more repugnant still. The richest 85 people in the world currently lay claim to more combined wealth than the poorest half of the entire global population.

That is primarily due to the logic of financial capitalism, but also to a plethora of existing tax evasion and tax fraud opportunities. A significant proportion of the assets held by the rich is currently hidden away in so-called tax-havens. According to some estimates, some US$18.5 billion are currently languishing in off-shore accounts where they cannot be taxed.

 

The causes and effects of economic inequality

Current levels of inequality are far in excess of what the majority of people in the world regard as fair, which raises serious issues in terms of justice, and also has ramifications in the economic, social, and political spheres.

Changes are currently taking place within the analytical discourse surrounding inequality.

A neo-classical paradigm has prevailed for decades in which a fundamental antagonism between economic growth and wealth distribution has been assumed.

For adherents to this view it is axiomatic that income distribution from the wealthy to the poor can only take place at the expense of economic growth.

Redistribution, they claim, acts as a disincentive to performance and productivity. Accordingly they go on to assert that, far from being a problem, inequality is a prerequisite for economic growth.

But in actual fact inequality can slow economic growth, for example when it impacts negatively on education and health care provision, or when social conflict destabilises the political status quo.

In addition such microeconomic analyses overlook the role of demand in market economies. Low wage earners inevitably spend a larger proportion of their income than high wage earners on the bare essentials.

The most recent financial crisis has changed the way many people think about inequality.

Rather than simply being regarded as a potential social problem, it is increasingly being thought of as an economic issue.

Thus a recent study by the IMF found that there is a global correlation between low levels of inequality and robust economic growth. A follow-up study also demonstrated that state-led redistribution policies have no negative effects on economic growth. On the contrary, on average it tends to promote economic growth

In their 2009 bestseller, The Spirit Level – Why More Equal Societies Almost Always Do Better, British epidemiologists Richard Wilkinson and Kate Pickett demonstrated the link between income inequality and social problems.

It impacts every kind of social issue ranging from mental health and life expectancy, to drug abuse, obesity, under performance in schools, and childhood pregnancy to murder rates.

According to this analysis, countries in which inequality is high, such as the USA and UK, must be struggling with far greater societal problems than countries like Japan or the Scandinavian states.

Non-equal societies are less considerate, socially colder and more brutal.

 

Policy approaches to combatting inequality

Proponents of the efficient market theory regard distribution results as positive only when they contribute to more equal access to the market. One example of this is investment in education and healthcare.

Access to high-quality educational and healthcare facilities, they argue, increases equal opportunities and social mobility for everyone and is therefore economically efficient.

But we also require short-term policy approaches that will shape the here and now.

On the one hand this does include direct intervention in market revenues, such as state-regulated minimum wages, measures aimed at reducing the gender pay gap and relative earnings ceilings for managers.

On the other hand the state can also contribute towards the reduction of inequalities through redistribution measures based on state revenues (taxes) and public spending.

Nevertheless international collaboration is also important in this context. This is particularly true in the case of cross-border capital flight and tax evasion undertaken by transnational corporations and wealthy individuals, both of which are significant factors in the increasing concentration of income and wealth.

Minimum wage tariffs, whether set by the state or linked to inflation or average income levels can reduce the income differential ‘from the bottom up’.

However the wage and salary structure also depends to a large extent on the role played by the unions. These are tasked with compensating for the lack of market power on the part of individual wage earners through the organisational and negotiating power of representative associations founded on the principles of solidarity and collective action.

Labour market policy instruments such as state-sponsored employment programmes can also improve income levels.

‘Top down’ inequality reduction can be achieved by setting upper limits for salaries, bonuses, severance packages, and pensions. Very little of this type of things has actually happened.

Ostensibly, the easiest way to bring about state-led redistribution is through the taxation regime. But by no means is it the case that all fiscal systems tax higher income earners more than low-wage earners.

Particularly in developing countries, whose state coffers are primarily replenished from purchase taxes and excises, the poor carry a proportionally higher tax burden than the wealthy. In addition, from the perspective of fair redistribution, investment income should not be taxed at a lower rate than earned income.

One element of a fair taxation regime of this kind would involve the requirement to capital gains tax on financial transaction profits. As it currently stands, this is one of the few economic transactions not, or only partially, subject to taxation in most countries.

Apart from the stabilising effect that this would have in the financial markets, in addition to the potentially substantial tax revenues it would generate, a tax on financial transactions would be one of the few indirect taxes involving a progressive rather than a regressive redistribution effect.

 

This is an abridged version of an article originally published on Progressive Alliance.