Thomas Piketty's Capital in the Twenty-first Century put inequality centre-stage in the economic debate. But the topic has been around for a long while. Brookings has recently republished Arthur Okun's 40 year-old Equality and Efficiency: The Big Trade-off, The launch was an opportunity to bring it up to date.
Okun set out the arguments which became the mainstream among economists for the next three decades, up until the global financial crisis of 2008. The key idea was that there was an trade-off between growth and equity. If you imposed high marginal tax rates on entrepreneurs, or set the minimum wage too high, or tried to fix inequality using the 'leaky bucket' of government tax-and-redistribute policies, you would pay a substantial price in terms of lower growth. In poorer countries, some would get rich while others lagged behind, but too much concern about how the national-income pie was sliced up would result in a smaller pie.
The failure of socialism, notably the collapse of the USSR, lent support to these views.
What's changed in four decades? First and foremost, the equal distribution of income in many economies, notably America, has become much worse. 40 years ago the consensus opinion was that income distribution was fairly constant, and rises in living standards had to come from growth rather than redistribution.
That's not how it has turned out. [fold]
In America, the share of income received by the top 1% has gone from 8% in the 1970s to 20% today. It gets worse right at the top of the pyramid: the top 0.01% got 1% of the income while today they get 6%. As one analyst has said:
Okun pondered a trade-off between equality and efficiency just when those at the top of the wealth and income ladder began hauling off all the gains of economic growth.... When Okun was writing, the typical CEO earned about 25 times the typical worker. How could he know that today, they earn nearly 300 times the typical worker?
The wealth distribution has shifted even more than the income distribution:
Okun writes that the richest one percent of American families have about a third of all the wealth, and the bottom half hold about five percent.... [Today] the richest one percent have over 40 percent of the wealth, and the bottom half have only one percent.
This unpalatable reality is not all that's changed since Okun wrote. We have taken a more comprehensive view about what drives growth. There is now greater recognition that if substantial sections of the population are poorly equipped for the modern economy – either through poor education or constraints on social mobility – then the outcome will be low growth. It's all very well to make sure the top entrepreneurs have incentives, but when those lower in the distribution have no clear path for advancement, their incentives are damaged and growth suffers.
Others have been more pointed – and more political – in their criticism of how the rich got to be at the top of the pile. The free-market, regulation-reducing, tax-lowering policies begun in the Thatcher/Reagan period have boosted inequality more than growth. The economic elite have turned rent-seeking into an art form, exploiting the many distortions and monopolies in the economy. They have buttressed their favoured position by manipulating the political process. Their share of national income reflects their power rather than their productivity.
As if on cue, the OECD has produced another fascinating study contributing to the inequality debate: Why Less Inequality Benefits All (try the OECD's online survey to see how well you know the equality position in your own country). This focuses on the growth-constraining effects of leaving the poorest 40% of the population without adequate opportunities to realise their potential. Greater participation in the workforce by women has substantially helped income distribution, but there is a long way to go. Freeing up the labour market through more 'non-standard' jobs (ie. not a full-time permanent job) has created opportunities but also inequalities.
The power of the OECD report is its international comparisons. When senior officials say we need to lower tax rates to foster growth, the refutation is in the counter-examples overseas.
What to do? We should accept that Okun identified issues which are still relevant today:
- Confiscatory rates of tax will dampen entrepreneurship and encourage capital and skills to move to lower-taxed jurisdictions. But the Scandinavian countries have demonstrated that it is possible to have high taxes and good growth. As a result, they lead all the indices of equality set out by the OECD.
- It is possible to seriously damage an economy with excessive minimum wages, as we did in Australia in the 1970s. But Australia's current minimum wage is around twice America's, and so far this has been consistent with good growth and greater equality. Larry Summers notes that the US minimum wage in real terms is lower now than when Okun wrote his book.
- While entrepreneurship needs to be fostered, it's hard to argue that the rewards needs to be as big (or as widely spread) as they have become. Salaries for top business people and financiers are more a reflection of relative pecking-order rather than necessary to reward talent. Again, Scandinavia shows the way.
- The leaky bucket of government redistribution can be addressed intelligently, through focusing on social mobility (especially through education) and encouraging labour-market participation.
As well, there are clearly many opportunities to help both growth and equality at the same time. Better public transport is one example. While Piketty (and also Anthony B Atkinson) sound unworldly in their advocacy of 'tax-and-redistribute' policies, addressing tax evasion should not remain forever in the policy-makers' 'too hard' basket.
So much for the gloomy story of income distribution within countries. In the emerging economies, where income distribution is typically bad, the overall rate of growth has lifted a billion people out of abject poverty, with the process of convergence still leaving room for much more reduction in income inequalities between countries.