Poverty and Inequality

January 22, 2014 6:30 PM

In December, President Obama defined economic inequality and reduced social mobility as one of the most important challenges of our days. Increasing inequality has become one of the fundamental points of the American political debate and was one of the arguments that helped elect Bill de Blasio as mayor of New York City.

The reduction of social mobility in the United States is becoming a serious problem. Today, a child born in a family within the top 20 percent of income distribution has a probability of over 60 percent of remaining as an adult in the top 20 percent. However, a child born into a family in the bottom 20 percent of income distribution has a probability of only 5 percent of progressing as an adult to the top 20 percent of the income distribution. The prevalent view in the United States has traditionally been that it is more important to increase the total amount of wealth than to divide that wealth more symmetrically. But as the distribution of wealth becomes ever more unequal, the debate is tilting toward improving the distribution without reducing the growth of wealth. The problem is, if a strategy to achieve this second goal fails, the next step will be to improve the distribution even if total wealth is reduced.

Economic theory suggests that the evolution of inequality should follow an inverted U: Technological progress initially benefits the richer, more skilled classes, increasing inequality. But after a stable period, it gradually starts benefiting the middle and lower classes, as the use of the new technologies is democratized. This inverted U appears in history: after the industrial revolution, inequality grew rapidly. It then stabilized and fell dramatically after the Second World War (mainly due to the destruction of a large part of the capital of the richer classes during the war).

After a period of stability, the inverted U began to reappear in the early 1970s, coinciding with the beginning of the decline of employees in the manufacturing sector (as the service sector allows for greater dispersion of wages) and the start of the secular reduction in the progressivity of taxation. The process of globalization, which doubled the workforce competing globally for the least skilled jobs, and the information technology (IT) revolution, which gradually eliminated jobs in low skilled sectors, added to the widening of income inequality.

A fundamental difference between the rich of the first inequality period and the rich in the second is that the former were mainly capitalists and entrepreneurs, while those of the second period are mostly salaried employees, but highly remunerated. The rapid increase in asset prices during the 1990s, combined with an increase in remuneration linked to asset prices for the most skilled jobs, contributed to this trend.

The recent economic and financial crisis has widened the income distribution and brought it to the foreground. After a brief initial contraction in inequality due to the sharp fall in asset prices, which always affect the rich disproportionately, the dispersion of income has increased and has reached record levels. Aside from the obvious moral aspects of the debate, the key question is whether it is sufficient to accelerate the economic recovery (in the expectation that the rising tide will lift all boats) or adopt policies to reduce inequality.

Using data from the Congressional Budget Office, Paul Krugman has argued that rising inequality has been more important than the weakness of the recovery in explaining the decline in middle class incomes since 2007. It is an open debate. The constellation of policies adopted to overcome the crisis, with fiscal adjustment and monetary expansion, initially benefits the owners of financial assets, which tend to be more concentrated in the upper classes. However, once the recovery is established, increased employment and wages should restore middle class income growth.

The obsession with deficit reduction, including the refusal to extend unemployment benefits and other social welfare spending cuts, could signal fiscal discipline or could be seen as disregard for the poorest cohorts of the population. The fact that the US Congress has an overrepresentation of millionaires (they amount to a majority of members of Congress, even if only 3 percent of the US population) has been discussed as an additional factor potentially explaining the lack of sensitivity to inequality.

Similarly, in Europe, the powerful influence of Germany—where employment is at record high levels—in the discussion of European economic policies likely helps explain the lack of decisive action to support the disadvantaged. Solutions such as increased taxation of capital present problems of implementation because of the mobility of capital and the possible negative impact on investment.

The poverty that this crisis has created cannot be ignored. The National Review recently published an article entitled "The White Ghetto," describing the situation of the poorest county in the United States, Owsley County, Kentucky, focuses on a place that is representative of Appalachia. The population is 98.5 percent white, so arguments typically used to explain the higher incidence of poverty among African Americans (such as the instability of family institutions and the high degree of incarceration of men) can't be used.

Nor is its crime rate higher than the US average. The explanation for this deep poverty seems quite simple: the lack of jobs. The article details how the citizens of Owsley behave when they get monthly food stamps. The money goes onto a debit card. As it arrives, most use the money to buy cases of Pepsi, which are then used as currency—for cash, often at a discount of 50 percent, or to buy painkillers, apparently one of the past-times of the area. It is a chilling description of an economy running a black market in bottles of Pepsi.

Let's not forget: This is acute poverty in one of the world's richest countries. Reducing poverty and inequality is not a matter of choosing between supply policies and incentives to resolve with reforms and reductions in subsidies. Nor is it a matter of choosing policies to stimulate demand. It requires both. In Europe we tend to forget the demand side. Let's not allow the timid recovery blind us to the need to spur demand.

Translated and adapted from "Pobreza y desigualdad: En EE UU, la reducción de la movilidad social se está convirtiendo en un problema muy serio," in El Pais, January 19, 2014.