Vignettes on Inequality

Op-ed in El Pais

May 31, 2015

The Labour Party's overemphasis on inequality and redistribution ultimately led to its defeat in the recent British elections. The absence of a coherent message about an economic model that would create growth and a chance for the less fortunate to advance proved disastrous among "aspirational" voters. It is a lesson political leaders, especially in countries with high disparities such as Spain, will need to internalize as they go into the next general elections, lest they confuse anger with corruption and bad management with the absence of a desire to grow and progress.

Inequality has become a hot topic in the economics profession, but it has not always been so. The main economics textbooks devote little space, if any, to dealing with inequality and poverty. There are economic schools of thought that argue that the study of inequality can be counterproductive because it diverts attention from creating wealth and increasing growth.

Anthony Atkinson, the global leading researcher in inequality and a professor at the London School of Economics, has just published a treatise on inequality (Inequality—What Can Be Done? Harvard University Press) that should be required reading for everyone regardless of ideologies. Professor Atkinson discusses in detail why income distribution is important, how to measure it properly, what factors drive inequality, and how economic policies can change these factors. Economic inequality not only affects people psychologically but also, according to both the International Monetary Fund (IMF) and the Organization for Economic Cooperation and Development (OECD), hinders growth: Increased poverty reduces human capital and often creates political instability that reduces investment. By requiring more redistribution, inequality increases the use of distortionary taxes that can harm growth. The OECD estimates that rising inequality has shaved nearly 5 percentage points off of GDP growth in OECD countries in the last 20 years.

Inequality also makes growth more fragile. It was a factor in the last financial crisis, especially in the United States, where the poorest had to increase their leverage to buy houses that were increasingly out of reach. Inequality is also persistent. The children of the poor are born with a tremendous handicap that drags down their economic progress; the performance of a generation sharply limits the opportunities for the next generation. Inequality is the result of a combination of many factors, notably globalization and technological progress. But limiting the study of inequality to these two factors is dangerous, as this gives the impression of an inevitable and unstoppable trend of increasing inequality.  That the composition of taxes and government spending are as important as these two trends and they must be acknowledged. So, too, must disparities within democratic institutions be recognized: The more the composition of the government and Congress differs from the general population, the greater the economic inequality in the country.

On the other hand, there is some hypocrisy in this recent emphasis on inequality in the rich world, especially the anti-immigration policies that some populist politicians propose to counter it. The developed world holds only 15 percent of the world's population but accounts for 40 percent of global consumption. It is the moral obligation of the developed world to help those who lost in the lottery of the birthplace. Fortunately, the same factors that have contributed to increasing inequality in the developed world, globalization and technological progress, are reducing global inequality. In the last decade, hundreds of millions of people, especially in sub-Saharan Africa, have abandoned extreme poverty and have joined the ranks of the working poor, where they can now enjoy basic consumer goods. My colleagues Paolo Mauro and Tomas Hellebrandt at the Peterson Institute for International Economics forecast that global inequality will continue to decline in coming decades, enabling hundreds of millions of people (especially in India) to access consumer durables, such as cars and refrigerators, and hundreds of millions more (especially in China) to reach levels of consumption similar to those of the middle classes in advanced economies. Capitalism is becoming a great success.

Professor Atkinson's book argues that employment is not enough to escape poverty. If the pay is low, employment is not enough. In the United States, in 2014 it was impossible to pay the rent of a two-bedroom apartment working 40 hours at minimum wage and limiting payments to 30 percent of income. The minimum number of hours per week to make such rent payments ranged from 69 hours in Arizona to 138 hours in Maryland. But this problem is not limited to the United States, where the minimum wage is widely recognized as insufficient. In the vast majority of OECD countries employment of 40 hours a week at the minimum wage is insufficient to jump above the poverty line (defined as 50 percent of the median net family income in each country). In the four worst cases, the Czech Republic, Estonia, Spain, and the Slovak Republic, it takes more than 70 hours a week at minimum wage to escape poverty.

Yes: 72 hours per week at minimum wage is what it takes escape poverty in Spain, one of the most unequal and least redistributive countries in the OECD, especially after the financial crisis. Since 2008, the income of the poorest 10 percent of its population has fallen by 13 percent, four times the drop in the country's average income. As a result, the average income of the richest 10 percent is 14 times that of the poorest 10 percent. This ratio averages nine times in the OECD, and only six times in the Nordic countries. Spain is not a poor country, but it has too many poor people.

This is an ethical issue, which goes beyond economic arguments about the impact of minimum wages on employment. A job of 40 hours a week should be enough to ensure a decent standard of living. But this does not necessarily imply a much higher minimum wage. There are more efficient or complementary ways to promote adequate income levels, such as earned income tax credits, which in addition to increasing net incomes improve the incentives for job search. Promoting the increase of the size of firms, so that they become more productive and pay more, would also reduce income inequality. Atkinson goes much further and proposes a participation income, guaranteed to all who participate in society. The problem, as always, is how to finance it.

Inequality will be the organizing principle of economic policy in this decade. The debate has just started. Read Atkinson's book. In order to opine, one first has to be well informed.