A poverty of fair wealth play

Rising income inequality in the US and UK is both unjust and inefficient. But what is driving the trend, and what can be done about it?

"The poor you will always have with you,” said Jesus. Despite vast rises in wealth, mainly over the last century, this remains true today because we define poverty relatively. Some object to this judgment: has destitution not disappeared from high-income countries and is it not diminishing in the developing world? The answer is: yes, although much poverty remains. But we are social animals. As stomachs fill, we wish to participate fully in our societies. But rising inequality is in the way.

As the US Congressional Budget Office noted in a fascinating recent study, for the 1 per cent of the population with the highest income, average real after-tax household income grew by 275 per cent between 1979 and 2007, reaching 17 per cent of the total. For the others in the top quintile of the distribution, average real after-tax household income grew by 65 per cent. For the 60 per cent in the middle (the 21st to 80th percentiles), the growth in average real after-tax household income was a little less than 40 per cent. For the bottom quintile, average real after-tax household income rose about 18 per cent. The Organisation for Economic Co-operation and Development states that "the wealthiest Americans have collected the bulk of the past three decades’ income gains”. Moreover, it notes, most of these gains accrued to executives and finance professionals.

An important question is whether similar shifts are happening – or are likely to happen – in the UK and other high-income countries. This was the theme of a discussion sponsored by the UK’s Resolution Foundation in November. The conclusion I drew was that, although the forces for greater inequality seen in the US were at work across the high-income countries – a point confirmed by the OECD’s recent analysis – outcomes differed in terms of levels and trends.

The UK has been similar to the US, in both respects, over the past two decades. Inequality is far lower in, say, the Netherlands and Germany and has hardly grown over the past two decades in, say, France. In 2005 the share of the top 1 per cent in pre-tax incomes varied from 5.6 per cent in the Netherlands and 6.3 per cent in Denmark and Sweden to 12.7 per cent in Canada, 14.3 per cent in the UK and 17.4 per cent in the US. Policies and social preferences – particularly the role of stock-driven rewards and of financial services, at the top – make a very big difference.

It is also important to distinguish what is happening among the bulk of the population from trends at the top. It is as important to distinguish levels from changes: the US has always been relatively unequal. But much of the rise in inequality dates to the last century. Stephen Machin of the London School of Economics noted at Resolution’s seminar that the ratio of earnings at the middle of the distribution to that at the bottom has stabilised over the past decade. Again, the share of the top 1 per cent in the US was already 16.5 per cent in 2000, close to the 17.7 per cent reached in 2008. In the UK it was already 12.7 per cent in 2000.

What is driving developments? The OECD concludes, surprisingly perhaps, that "neither rising trade integration nor financial openness had a significant impact on either wage inequality or employment trends”. Technological changes are almost certainly more important, though the two forces are hard to distinguish. There are also more single-headed households and a greater tendency for high-earning men and women to form couples. But the higher dispersion of male earnings is even more important.

People will disagree over why rising inequality matters and what should be done about it. I suggest it matters most, at least in the high-income countries because it both undermines hopes for any reasonable degree of equality of opportunity and cements the inequalities in power that have, in turn, allowed the preservation of a wide range of privileges, particularly in taxation.

These outcomes should matter even to those who have no concern for equality of outcome. I would add that some – perhaps a great deal – of the ultra-high incomes at the top are almost certainly the fruit of rent extraction facilitated by a breakdown in the control exercised by principals (outside investors) over their agents (corporate executives and financiers). Huge rewards then are both unjust and inefficient.

What is to be done? That demands a huge agenda. It must cover employment, education, corporate governance and financial reform and, however difficult, also elements of redistribution. It will be unavoidably divisive. So be it. This debate cannot be avoided if western democracies are to stay legitimate in the eyes of their peoples. That may not be true in the US. It is surely true in the UK. Warren Buffett has argued that "there’s been class warfare going on for the last 20 years and my class has won.” The remark has not made him popular with his peers. But he was surely right.

Copyright The Financial Times Limited 2011.

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