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Saturday 19 Aug 2017 | 02:55 | SYDNEY
Saturday 19 Aug 2017 | 02:55 | SYDNEY

The other income-equality debate



5 May 2014 10:31

Rock-star economist Thomas Piketty is getting headlines for his book on income distribution,  mainly focused on disparities within advanced economies. This might be the moment to ride the wave of attention and record something of the long-running parallel narrative on emerging economies.

If Piketty’s message is a sobering one of inexorable trends making the rich even richer, there is a good-news story happening at the other end of the income distribution spectrum in emerging economies. In the last couple of decades, a billion people have been lifted from abject poverty to a modest but more adequate standard of living.

This is the convergence story: the astonishingly speedy catch-up of quite a few economies, reducing income disparities between these countries and the advanced economies. It took a century for the now-advanced economies to raise living standards to a respectable level. Many emerging economies are doing it in a few decades.

This astounding success story coexists, however, with a theme which mimics Piketty’s: the rise in living standards has been accompanied by a marked worsening income distribution within these countries, with the position of the uber-rich even more offensive because they are in the midst of those who remain close to destitution and those who have risen only just above abject poverty.

Development economists have for decades grappled with a question Piketty largely ignores: is unequal income distribution necessary for growth, either to provide the required savings or to provide the incentives for dynamic entrepreneurship?

It is obvious to Piketty (and most of his readers) that the wealth disparities seen in advanced economies are not the essential drivers of growth. Patrimonial wealth is not more dynamic than earned wealth. And after all, the three decades after World War II were not only a time of greater equality; they were also a time of strong growth.

For emerging economies, however, the relationship between growth and income distribution has been much less clear-cut. 

The newly independent post-colonial governments often prioritised economic equality through state ownership, cooperatives and strong social programs. Whatever these approaches did for equality, they failed miserably in growth. Cuba illustrates the point. The response was a shift to more market-oriented arrangements, summarised in the Washington Consensus. The Consensus was often taken over by free-market ideologues with a conscious disregard for income-distribution. Their influence was, however, at the margin. The sensible middle ground has long accepted the importance of pro-poor policies and social programs to soften the sharp edges of the free market, even if this meant some cost in terms of slower growth.

Indonesia provides an example of this more nuanced debate. Three decades of 7% annual growth under Soeharto lifted a huge chunk of the population out of abject poverty (watch The Year of Living Dangerously to see what it was like in 1965). By accident or design, some elements of policy were hugely helpful for income distribution: for example, the emphasis on agricultural productivity, simple health facilities and family planning.

Subsequent governments have raised the level of anti-poverty rhetoric. According to the World Bank’s measure, poverty has halved over the last couple of decades. Sure, there is still a long way to go: more than 10% of the population is still below the poverty line and a further 40% teeters just a few cents above the cut-off.

Still, the emerging economy experience differs from Piketty’s. The rising tide has lifted nearly all boats.  Piketty's story is about the top 'one-percent'; the emerging economy central narrative is about the bottom half of the income distribution.

At the same time, however, at the other end of the income distribution, Piketty’s inequality symptoms are apparent. Through the first three or four decades of Indonesia’s economic progress, the Gini coefficient (one measure of inequality) remained pretty steady. But it has risen sharply over the past five or ten years. Judged by over-the-top conspicuous consumption, the deterioration has been going on much longer.

This has led some development economists to question the earlier view that some degree of income maldistribution is a necessary and acceptable price for strong growth. Perhaps inequality, rather than fostering savings and dynamic entrepreneurship, is just a manifestation of institutional failings which distort decisions and undermine growth. Established wealth seeks safety in traditional investment rather than funding innovation. Efforts are diverted into rent-seeking and influence-buying to preserve position. Because politics is an expensive business, the rich are able to buy influence in ways that are not only self-serving but also bad economics.

Piketty’s 700 pages represent just one more way-point in an unfinished journey. Even if the Piketty message is acknowledged in countries like Indonesia, fixing the problem is even more challenging than in advanced economies. It requires not just more efficient and progressive tax, but institutions which reduce the opportunities for rent-seeking and blatant misuse of position. In Indonesia, the post-1998 democracy has created huge opportunities for outright corruption and influence peddling. At the same time, it created powerful opportunities to combat these, via an open media and anti-corruption institutions. This narrative is currently being played out. It awaits the sort of data-driven analysis which Piketty provided for the advanced economies.

Image courtesy of Flickr user Le Rétroviseur.

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