(London Business School) Polarising prosperity
By Elias Papaioannou 17 January 2018
In recent decades, the rich have done well. The ultra-rich have done even better.
It is entirely understandable. Whether measured by wealth or by income, it is indisputable that those at the top have captured a far larger share of the economic cake than those further down the spectrum.
Look at figures for the US. There are various ways of cutting the data, but they tell broadly the same story.
The rich get richer
Take average pre-tax incomes adjusted for inflation. In 1980, the annual average for the bottom 50 percent of households was $16,000. By 2014, that had increased, but only marginally – to $16,200.
In 1980, the average income for the top 1 percent was $428,000 – already a very substantial sum. But by 2014, that had more than trebled to $1.3million. The gap between the lower half of the population and people at the top of the income scale had become a yawning chasm.
Now take a shorter time period – from 1993 to 2014. The US economy grew over that period and average wages went up by just over 25 percent.
But that average is virtually meaningless: it conceals huge differences.
Of the aggregate increase in the incomes of US citizens, more than half accrued to the top one percent. By 2014, the top one percent of households were receiving around one-fifth of the pre-tax incomes of the entire American population. The bottom half of the population were having to share less than 13 percent. (Even after taking taxes into account, the bottom half have still done badly in securing a decent slice of the economic pie: their share of total net incomes was less than 20 percent in 2014.)
All this is striking enough. But dig a little deeper, and the picture is even more dramatic. Certainly, those within the top one percent might consider themselves rich. But by the standards of those at the very pinnacle of the league table, they are little more than comfortably-off. Look at the one percent of the one percent – those who comprise the one in 10,000 at the top of the income ladder. Call them the ultra-rich, or the Ultras for short.
From the end of the Second World War until the mid-Eighties, the incomes that went into the pockets of this small group ticked along below one percent of the national whole. After that, the share of the total took off, and has continued to do so. By the middle of the current decade, this super-rich sliver of the population – just 16,500 families – was taking more than three percent of the entire national pie. Adding in capital gains, the share had grown to nearer five percent.
Not just rich; ultra-rich
By 2015 a family would need to have annual income including capital gains of at least $11.27million to make it into the 1-in-10,000 club. And even then, the family would scrape into the Ultras’ category only by a whisker. The average income of this one percent of the one percent was far higher – $31.6million.
Income equality in the US is not a new phenomenon. It was manifest in the 1920s, but was dented by the Great Crash of 1929, declined in the period of the New Deal, and remained low during and after the Second World War. Indeed, in the years from the end of the war to 1980, post-tax incomes for the top one percent of the US population actually grew more slowly than those of the remaining 99 percent.
It is only since 1980 that the rich – particularly the Ultras – have left everyone else behind. Between 1980 and 2014, post-tax incomes of the Ultras’ one percent of one percent club multiplied more than seven-fold.
This is not just a US phenomenon. Income distributions in Britain and Canada have shown a similar pattern: inequality showed a steady decline over the half century to the late Seventies, then reversed.
However, the same has not been true everywhere. France, Japan and most strikingly Sweden saw inequality lessen between the mid-Thirties and the end of the War. But since then – and even since the end of the Seventies – inequality has remained fairly constrained. Indeed, people the bottom 50 percent of the French population take roughly the same share of the country’s total income as they did four decades ago.
France, however, is an exception. The general point stands: in most developed economies, the distribution of incomes has become more and more stretched. Why?
An international market
Globalisation provides a partial explanation. Less-skilled workers are more likely to see their work outsourced to low-wage countries than was the case a few decades ago. And plenty of evidence suggests that since the 1970s, technology has been skill-biased, favouring those workers with high levels of education, while low-skill workers have been hit by automation, robots, and communication technology. At the top end of the spectrum, individuals with a specific and highly-valued talent operate in an international market: their skills can be the bid for by corporations around the world. With globalisation, markets for both goods and services have become larger: someone who can invent or develop a successful new product is going to be worth more to a company selling that product if it can be marketed worldwide rather than in a single country or region.
Tax rates for high earners have tumbled since the 1970s. (At various points in the post-War period, the top marginal rate of tax in the US, Britain France and Germany topped 70 percent.)
In the financial sector, it is probably no coincidence that pay, relative to other industries, has been highest during periods of deregulation. From the mid-Forties to the early Eighties, regulation was tight, and financial sector wages were only modestly higher than elsewhere in the economy. In the years both before that period and after, regulation was lighter touch and wages were higher.
And, as is common knowledge, the remuneration of people at the very top outside the financial sector – be it in the law, sport or in large non-financial corporations – has grown sharply over the past three decades.
All this concerns incomes. But what about wealth? While getting wealth estimates is tricky, recent research by Gabriel Zucman and Emmanuel Saez yield a broadly similar picture. Over the past 40 years, the richest people in the US have seen their share of total household wealth in the entire nation increase sharply. In the late 1970s, the top 0.1 percent – the richest one-thousandth of the population – was reckoned to control roughly 7 percent of total household wealth. By 2013, that had grown to more than 20 percent.
And strikingly, the sources of wealth of the very richest in the US have changed significantly. Look at the individuals who make it into the Forbes 400 – the list of America’s wealthiest individuals. Back in 1982, the majority came from “old money”: they were born rich and they stayed that way. Fast forward three decades to 2011. It was individuals who had come from only modestly wealthy backgrounds or indeed had started with nothing who made up the majority of the list of elite billionaires.
Isn’t this something to be celebrated? Doesn’t it indicate that the American dream is indeed still very much alive and well – that someone can start with nothing and by their own efforts become rich?
Born rich, stay rich
International comparisons are instructive here – although it is always tricky to compare nations that differ across many dimensions. Return to incomes and look at the countries where inequality is greatest – Britain and the US. In these countries, there is actually less mobility between generations than elsewhere. People with rich parents are likely to stay rich, and people from poor backgrounds are likely to remain poor. It is in those countries where the gap between the well-paid and the badly-paid in relatively small – places such as Norway, Denmark and Finland – that people are most likely to move into a different income bracket from their parents’.
Put this all together. Over the past few decades, the distribution of both incomes and wealth has become increasingly stretched. On the one hand, we have the rich, the very rich and ultra-rich: they have done exceptionally well. The remainder – and particularly those in the less well-off half of the population – have not.
If we think this is a problem that should be addressed, how to do so?
Executive pay could be capped. Controls could be imposed on devices such as incentive schemes and share option schemes that have made a few people very wealthy. Company boards and regulators could be given more powers to curb what they perceive to be excess.
All of that may sound superficially appealing. But such measures would be effective only if applied everywhere. Otherwise, there could be a competition between countries to make their regulatory regimes lighter – and thus more attractive to internationally mobile capital and individuals – than those of their rivals.
What about higher taxes? Again, the mobility of capital and people across borders is an issue: the lowest-tax environments will be the most attractive. If very talented people leave a country because they feel too highly taxed, productivity in that country may suffer. The temptation to use tax havens and straightforward evasion becomes greater.
And conventional wisdom has it that high taxes discourage work and impede business creation. Well, maybe. But don’t forget that in what are now thought of the bad old days of the 1960s when tax rates around the developed world were high, growth was generally stronger than has been the case in the recent past.
Remember the 99 percent
Do not think that income inequality is just about the financial success of the top one percent (or 0.1 percent or 0.01 percent) compared to others. It is not. Inequality outside these elite groups – within the remaining 99 percent – has also increased markedly.
Between 1963 and 2012, pay for American men with a degree above bachelor level almost doubled in inflation-adjusted terms. In contrast, the incomes of men graduating from high school, but with no further education, increased by little more than 10 percent. Average pay for high school drop-outs was actually lower at the end of the period than at the start. In other words, the premium put on skill went up. And the financial penalty for being badly educated became harsher.
Those at or near the bottom of the pile have felt the effect of reductions in the real value of the minimum wage. Union power has declined. Tax changes have favoured those at the top: they no long face high marginal rates.
Automation, global outsourcing and competition from developing countries which has increased as tariffs and quotas have been dropped – all these factors have combined to undermine the market for low-skill work at home. Excluding the agricultural sector, manufacturing accounted for almost one-third of US jobs in the late 1940s. That share is now less than 10 percent.
The impact of China’s joining the World Trade Organisation in 2000 has been a huge factor. It has become the workshop of the world. At the start of the millennium, its share of global manufactured exports was around five percent. It is now nudging 20 percent.
This is about more than pure economics. In the US, it has had profound political implications, too. This was shown in last year’s presidential election. Donald Trump’s anti-China rhetoric resonated most strongly in US states whose industries have been most severely hit by Chinese competition. It was in these places that the Republicans did best. And even in the years preceding the 2016 US Presidential Elections, there has been growing political polarization with Congressmen taking more extreme positions – on issues such as gun control, LGBT rights, immigration, abortion – and less willing to “cross the aisle”.
And income inequality matters when it comes to a nation’s health. In the US, a child from a poor background in its first year is about twice as likely to die than is the case in Finland, where health and welfare policies provide a far more comprehensive safety net. As recent influential work by Anne Case and Nobel Laureate Angus Deaton show, adults are impacted, too. On average, an American male in the bottom one percent of the income distribution is likely to die before his 73rd birthday; a man in the top one percent can expect to last to age 87. And the gap has been growing: it is people at the top of the income scale who have seen their life expectancy increase; those at the bottom have not. One group has seen mortality in middle age actually increase: a poorly educated white American is now significantly more likely to die between the age of 50 and 54 than was the case at the turn of the millennium.
Furthermore, the US as a whole does badly when measured against life expectancy in other developed countries. And even within the US, there are differences: states with welfare safety-nets that are close to European standards show much better mortality rates than elsewhere, particularly among the very poor.
So inequality matters in politics. It matters in health. And because America’s elite earners have taken so huge a share of the nation’s increased income, there has been little left to share out among the remainder of the population. Of people born in 1940, more than 90 percent would end up earning more than their parents. Of those born in the early 1980s – people now in their thirties – scarcely more than half are likely to be better off than the generation that preceded them.
So should we be surprised at the swelling up of populist movements that have challenged the decades-old political consensus? No. Should we be surprised that inequality has become a topic? No. Should we be concerned? Emphatically yes.