To Have And Have Not

The forthcoming International Review of Applied Economics (Vol. 23, n. 3, May 2009, Routledge) is a special issue on Mechanisms of Inequality, reporting on a research project undertaken at the Universities of Rome “La Sapienza”, Ancona and Urbino (Guest Editors Maurizio Franzini and Mario Pianta). The issue is still in proofs, but its contents were discussed two days ago at a Round Table at the Faculty of Economics of “La Sapienza”. The benefit of Round Tables, like that of Blogs, is that of helping – indeed forcing – one to formulate decisively one’s own convictions about the subject under consideration. This is what I propose to do here with regard to Income Inequality, while referring interested readers to that excellent special issue of the IRAE.

1. Market-determined income distribution. In a market economy personal income distribution is determined by 1) the distribution of the many productive factors and of financial claims; 2) the state and progress of technology; 3) the price of goods and services and therefore the derived prices for productive factors and financial claims, determined in their markets and therefore depending on the degree of competition in those markets ; 4) institutions and policies, in particular re-distribution policies.

2. Efficiency, equality, re-distribution. Under a number of highly restrictive conditions – that are frequently neglected and deserve a separate post of their own – market allocation will deliver economic efficiency [in a Paretian sense: no more output of anything can be produced without either less of some other output(s) and/or more of some other input(s); nobody can be made better off without having to make someone else worse off]. But nobody in his right mind has ever argued (or should ever have argued) that market-determined income distribution is necessarily desirable, and cannot be improved.

A democratically elected government can and does re-distribute a certain amount of income through taxation and budget transfers, usually in an égalitarian direction – though the recent global crisis, financial and real, has induced governments to make large transfers to cover the losses of unsecured creditors, shareholders and other unsuccessful investors, all largely belonging to richer income groups.

Governments are perfectly legitimate in their re-distributive measures, within the bounds of democratic consensus, even at the cost of resulting inefficiency in the allocation of resources, i.e. at the cost of a loss of output.

3. Efficiency and equality gains? There may be a range of possible re-distribution policies over which no such conflict arises between efficiency and equality. The market allocation may be inefficient to start with (some of the necessary conditions for efficiency not being satisfied); lower inequality may enhance cohesion and reduce losses from conflict; re-distribution from the rich to the poor may result in a higher level of activity. But re-distribution is bound to generate opportunistic behaviour (or “moral hazard”), which will reduce the net benefits of re-distribution even over the otherwise safe range. Sooner or later moral hazard will re-instate the conflict between efficiency and equality even if no other causes for such a conflict were present.

4. Countries and the world: income and wealth inequality. The most popular index of Inequality in the distribution of anything is the Gini coefficient, a measure of statistical dispersion taking the value zero for absolute equality between the members of the investigated population, and the value of one for a single member taking all. Inequality in the distribution of income in individual countries is relatively high and rising (see the UN-WIDER http://www.wider.unu.edu/research/Database/en_GB/database/). The current picture in the European Community is given in the Figure below http://www.poverty.org.uk/l14/index.shtm (click on it to enlarge):



Other sources give different coefficients, usually slightly higher. Throughout the world, Gini coefficients of income inequality in different countries range from around 0.25 in Northern Europe and Japan, to over 0.50 in Latin America, to peaks of over 0.60 in some African countries, where however measurements are less reliable and more volatile (up to 73.9 in Namibia in 1993, the last reported value of its coefficient).

Income Inequality world-wide, treating the world as a single country, naturally is much higher, with a Gini Coefficient of 65% (See Milanovic. 2005) [1]

Cornia and Court (2001)[2] consider the positive and negative impact of income inequality within a country. Extreme egalitarianism tends to reduce incentives, encourage free riding behaviour, involves high costs and corruption in the distributive system. Extreme inequality erodes social cohesion, raises social tension and conflicts, causing uncertainty in property rights. Both reduce the capacity to growth. The authors suggest a desirable range of Gini coefficients between 0.25 (typical of North European countries) and 0.40, lower than the Ginis of Russia, China and the USA, not to speak of Latin America and Africa. All the EU-27 countries fall within this range (Turkey being the only European country above 0.40, at 0.436). Cornia and Court (2001) call this the efficient inequality range, though there is considerable arbitrariness in the determination of the upper and lower bounds of the range.

Time trends of Gini coefficients are complex to identify in different periods, countries, country groups: data differ for sources and methods and are not directly comparable over time. The IMF World Economic Outlook of October 2007 confirm that “Inequality has risen in all but the low-income country aggregates over the past two decades, although there are significant regional and country differences... While inequality has risen in developing Asia, emerging Europe, Latin America, the NIEs, and the advanced economies over the past two decades, it has declined in sub-Saharan Africa and the Commonwealth of Independent States (CIS)...Among the largest advanced economies, inequality appears to have declined only in France” (p. 140). The next figure (http://en.wikipedia.org/wiki/File:Gini_since_WWII.gif) also suggests that by and large, with a few exceptions especially in initially very unequal countries such as Mexico, in the last 20-30 years there has been a visible increase in income inequality as measured by Gini coefficients (click on the Figure to enlarge).

A first estimate of the world distribution of household wealth has been provided by Davies et al. (2008) [3]. They find that “… the distribution [of wealth] is highly concentrated—in fact much more concentrated than the world distribution of income, or the distribution of wealth within all but a few of the world’s countries. While the share of the top 10 per cent of wealth-holders within a country is typically about 50 per cent, and the median Gini value around 0.7, our figures for the year 2000 using official exchange rates suggest that for the world as a whole the share of the top 10 per cent was 85 per cent and the Gini equalled 0.892. By comparison, Milanovic (2005) estimates that the world income Gini was 0.795 in 1998… Roughly thirty percent of world wealth is found in each of North America, Europe, and the rich Asian-Pacific countries. These areas account for virtually all of the world’s top 1 per cent of wealth holders”[4]

5. Technology and Macroeconomics. Some explanations of income distribution are rooted in the nature of technology and of technical progress; another explanation is rooted on macroeconomic, allegedly Keynesian foundations. Both refer primarily to the income shares of wages and profits, but in general we can expect a lower share of wages to be associated with a more unequal distribution, given that capital is much more unequally distributed than labour (except that employment trends may offset this factor, as observed by my colleague Francesco Farina at the Rome Round Table). Both explanations seem to be very unsatisfactory.

In its extreme formulation, the impact of technology is formalised under the guise of a production function, whereby national income depends on the amount of aggregate capital and labour in existence. Under a few assumptions about the mathematical properties of that function, and factor prices corresponding to the marginal productivities of factors and exhausting the product, the relative income shares correspond to the elasticities of national income with respect to the two factors. “Income distribution – Joan Robinson used to say of this approach – depends on god and the engineers”.

There is no denying that technology has an influence on distribution; for instance it is plausible to conjecture that recently an increasing skill-intensive bias in technical progress may have raised the degree of inequality. But there are too many problems in attempting to isolate the impact of technology on distribution: the aggregation of capital, the divergence between capital measurements at historical cost, at current prices and at replacement cost; the varying degree of capacity utilisation; the separation of increasing returns to scale from technical progress; and many others. Such problems arise even in less aggregate formulations of this approach.

The impact of macroeconomic accounting, also in its extreme formulation, establishes a link between profit share and investment share in income, given the respective propensities to save of profit earners and wage earners. Suppose wage earners do not save; if they do, they get the same profit rate on their investments, and the respective saving propensities differ according to income category not class. In that case the share of profit will be equal to the share of investment divided by the saving propensity of profit earners (presumed to be constant and equal to the marginal propensity). The alleged Keynesian connection is in the driving force of investment. But relationships based on average propensities hold always necessarily ex-post, while average propensities are not necessarily behavioural parameters, constant and therefore equal to marginal propensities. The approach has little explanatory let alone predictive value. [5]

The highly unequal distribution of wealth, documented above, by itself generates unequal distribution of income, and thereby unequal distribution of savings out of income and investments that unequally raise total wealth, preserving and probably augmenting the inequality in the distribution of wealth. It is conceivable but unlikely that the distribution of new investments might be less unequal than the distribution of the wealth from which they originate, for this would involve the wealthy saving proportionally less than the less-wealthy-but-still-fairly-wealthy. The preservation of wealth inequality preserves income inequality which in turn preserves or enhances wealth inequality.

This applies not only to financial capital but also to human capital. One of the more disturbing results reported in the May 2009 issue of the IRAE is the high correlation between one’s income class and educational achievements and those of one’s parents, even in countries usually characterised as socially mobile like the US [6].

The persistent combination of 1) a high inequality of income and 2) a much higher inequality of wealth has a devastating corollary, namely the persistence of social classes. The gradual abolition of classes – which many predict or even regard as a fait accompli, would require workers to command increasing, though still below average, shares of capital. In that case, over time both income distribution and wealth distribution would become more equal, and the gap between wealth inequality and income inequality would narrow. This is the opposite of what we observe: classes are still with us and are here to stay.

7. Primitive accumulation. Some of the largest fortunes, like that of Bill Gates, are built from zero with the foundation and growth of a successful company. But among the rich there are also many beneficiaries of what Karl Marx called primitive or original accumulation (ursprungliche Akkumulation, Das Kapital, Vol. I, ch. 26), i.e. conquest, robbery and theft rather than thrift. Primitive accumulation, from which further accumulation originates from profit reinvestment, is not only an inheritance from the past, but a continuous occurrence in today’s economies. It takes the form of fiscal evasion, corruption, crime, international trade of arms and drugs, monopoly profits of all kinds, reciprocal salary and bonus fixing by the managerial class, the conquest of Iraqi oil, the procurement contracts of Halliburton, fraudulent Ponzi schemes like the large scale swindle by Bernie Magdoff, the looting of government resources by subjects undertaking risky ventures on the expectation of public rescue in case of failure, the appropriation of national wealth by the beneficiaries of privatisation in states divesting of social assets, like the UK and the post-socialist countries, particularly the appropriation of Russian natural resources by “oligarchs”. The adverse impact of post-socialist transition on income distribution, without any justification on efficiency grounds, through privatisation but mostly through price liberalisation (and globalisation, see below), is well documented in one of the essays in the IRAE May 2009 issue.[7]

The notion that wealth is simply the result of frugality has no more credibility today than it did in Marx’s time. If there are objections to the re-distribution of income and wealth on grounds of presumed efficiency a lot more needs to be done to prevent immoral and illegal enrichment and entitlement.

8. What is the impact of globalisation on income distribution? There are two contrasting views, both originating in IMF publications. The first is put forward in the World Economic Outlook, on Globalisation and Inequality, October 2007. “The analysis finds that increasing trade and financial globalization have had separately identifiable and opposite effects on income distribution. Trade liberalization and export growth… are found to be associated with lower income inequality, whereas increased financial openness is associated with higher inequality. However, their combined contribution to rising inequalityhas been much lower than that of technological change, especially in developing countries” (p.136). In sum, financial globalisation and FDI raise demand and therefore wages for skilled labour relatively to the unskilled.

The second view put forward in the World Economic Outlook, on Spillovers and Cycles in the Global Economy, April 2007, notes the rising globalisation of labour: in 1985-2005 global labour supply has increased by only about 60%, but the “effective” labour force – i.e. labour weighed by a country’s exports to GDP ratio – has increased by about 360%. Labour globalisation by means other than foreign trade, that is immigration and off-shoring, by comparison is almost negligible (respectively about 5% on average and at most 2% of the labour force). This stunning rise in labour competition has been accompanied by a significant fall in the wage share in GDP in advanced countries. Over the period 1980-2005 in which the labour share has fallen: “The decline in the labor share since 1980 has been much more pronounced in Europe and Japan (about 10 percentage points) than in Anglo-Saxon countries, including the United States (about 3–4 percentage points)…Within Europe, the strongest decline is observed in Austria, Ireland, and the Netherlands. Further, most of the decline in the labor share can be attributed to the fall in unskilled sectors, which was more pronounced in Europe and Japan than in the Anglo-Saxon countries. This decline reflects a combination of the reduction in the within-sector labor share and the shift of output from unskilled toward skilled sectors” (p. 166). In Europe, the United States, other Anglo-Saxon countries, Japan, the labour share has fallen from a range of 65%-73% in 1980 to a range of 58%-66% in 2005.

Clearly - as already noted above - there is no necessary one to one correspondence between growing inequality in personal distribution and falling wage shares, but over the long run it is reasonable to presume a connection between the two. In any case, globalisation has winners and losers – lowering tariffs in one sector damages domestic producers to the advantage of foreign exporters – and even if there were net advantages to be reaped the problem would remain of actually (over)-compensating the losers, for we know that potential over-compensation is not sufficient to establish an unambiguous gain from globalisation. Moreover, another essay from the IJAE May issue, by Serranito, establishes that “the positive effect of a decrease in tariffs on growth depends on the level of development; for the majority of the developing countries included in our sample a decrease in tariffs will have no effect on growth”. [8]

9. Other aspects of inequality. All the propositions listed above only scrape the surface of the issue of inequality. Gini coefficients are often ambiguous in ranking degrees of inequality (unless their respective Lorenz curves do not cross). Inequality within country groups (Europe, the world) is much greater than in individual countries. There are many alternative indicators, which may give different results; the choice among them is largely arbitrary. Countries differ not only by indicator but also by the selected dimension of inequality. Both persistence and turning points in inequality time patterns are difficult to explain. Besides household average income we should consider intra-household income distribution, in order to take into account the specific position of children, women and the aged. Access to medical care and education, and indications of life expectancy should be specifically considered, together with the inter-generational distribution of income and wealth. There are not only profits and wages but also rents, central to the classical tradition and largely neglected today. Beside distribution, i.e. relative poverty, there is the issue of absolute poverty – which we have chosen not to discuss at all in this post.

There is the question on what makes high degrees of inequality acceptable: whether ideological propaganda, or the willingness to risk destitution for a small chance of riches, or reliance on unconditional solidarity in case of failure. And what makes inequality intolerable, either to the masses, or to the ruling élite out of concern for sustainability (after all, the Bismark-style welfare state is not a revolutionary conquest but a concession induced by such a concern, as argued by my colleague Anna Simonazzi at the Rome Round Table).

One question that has began to be considered only recently is the relativity of both inequality and poverty with respect to relative prices. An apparently rising income inequality may be – partly, or totally, or more than – counterbalanced by a change in relative prices adverse to the richer income groups; the reverse may also happen, inequality falls counterbalanced by, say, the rise in the price of foodstuffs like those taking place in 2007 and 2008. Moreover, even for the same categories of goods, the rich do not necessarily pay the same price as the poor. The poor buy worse quality food, in smaller quantities and therefore more expensively, and receive lower quality public services – enough to induce the World Bank in 2008 to revise upwards the poverty line and recognise the existence of 400 million more poor than previously believed, a rise of 40% at a stroke.

10. What is the impact of the global crisis – financial and real – on income and wealth inequality? There can be no doubt that the crisis will raise the numbers of the poor, no matter how defined. The order of magnitude of stock exchange falls of one half or more in 2008 is bound to have reduced the inequality of wealth distribution both within countries and worldwide. It is possible – though we will not know for sure until some time after the end of the crisis – that the rich will also suffer a proportionately greater fall in income – though not as much in consumption – than the poor; except that many of the poor might suffer a total loss of income, thus tipping the balance towards greater income inequality. But even if a more equal wealth and income distribution resulted after the crisis, most people would regard the corresponding increase in poverty an intolerably high price to pay for more equality.

This does not mean that the converse is true, i.e. that an increasing inequality is necessarily an acceptable price for poverty reduction. It is not just a question of the actual trade-off on offer between inequality and poverty. Many, perhaps most of us, may simply not be prepared to entertain a trade-off between the two, and regard achieved levels of poverty and inequality as ceilings, beyond which there can be no sustainable welfare improvement.

[1] Branko Milanovic. Worlds Apart, Measuring International and Global Inequality, Princeton University Press, 2005.
[2] Andrea Cornia and Julius Court, Inequality, Growth and Poverty in the Era of Liberalization and Globalization, WIDER Policy Brief No. 4, Helsinki, 2001.
[3] James B. Davies,1 Susanna Sandström, Anthony Shorrocks, and Edward N. Wolff, The World Distribution of Household Wealth, UNU-WIDER Discussion Paper No. 2008/03, February 2008, http://www.wider.unu.edu/publications/working-papers/discussion-papers/2008/en_GB/dp2008-03/.
[4] Davies et al, 2008, who also discuss the appropriateness of using actual instead of PPP exchange rates. They add that “About 34 per cent of the world’s wealth was held in the US and Canada in the year 2000, 30 per cent was held in Europe, and 24 per cent was in the rich Asia-Pacific group of countries. Africa, Central and South America, China, India and other Asia-Pacific countries shared the remaining 12 per cent. The location of top wealth-holders is even more concentrated, with North America hosting 39 per cent of the top global 1 per cent of wealth-holders, and Europe and rich Asia-Pacific having 26 per cent and 32 per cent respectively. The high share of top wealth-holders in North America is particularly disproportionate, as this region contains just 6 per cent of the world population”.
[5] On both approaches see Geoff Harcourt, Some Cambridge Controversies in the Theory of Capital, CUP, Cambridge, 1972 (critical of the first approach, supportive of the second); Luigi L. Pasinetti, Keynes and the Cambridge Keynesians, CUP, Cambridge, 2008.
[6] Maurizio Franzini and Michele Raitano, Persistence of inequality in Europe: the role of family economic conditions, IRAE May 2009.
[7] David Barlow, Gianluca Grimaldi and Elena Meschi, Globalisation versus internal reforms as factors of inequality in transition economies, IRAE May 2009.
[8] Francisco Serranito, Trade, catching up and divergence, IRAE May 2009.