Friday, June 26, 2015

The Many Faces of Inequality and Poverty in Australia and the World

Introduction

Inequality matters. This is the consistent finding of a myriad of studies in recent times. Consequently, inequality has become an increasingly important concern for policy-makers, business people and societies throughout the world. We can attribute some of the increased interest in inequality to the success of Thomas Piketty’s book Capital in the Twenty-First Century. A more important factor, however, is the clear evidence that inequality is rising in many countries throughout the world. While Piketty’s major concern is with inequality in the developed world, it is clear that the rise of the developing world, particularly China and India has changed the global distribution of income and wealth. Complicating the analysis of inequality is the fact that rapid economic growth in these two giants has seen a massive reduction in global poverty and a small reduction in global inequality. The big winners from the globalisation of the world economy have been the middle classes of the developing world and the wealthy in the developed world.

Measurement Matters

How we measure inequality has a big impact on whether we conclude it has increased or decreased in recent years. Mostly we measure inequality in terms of income or wealth, but we could also consider other inequalities relating to gender, race, access to government services, education opportunities and many others. One important distinction that is often made is between equality of outcomes versus equality of opportunity, although the accumulation of wealth clearly brings with it increased opportunities. We can also contrast ‘market’ inequality with inequality after taxation and spending by governments. The United States, for example, has similar market inequality to other developed countries, but redistributes less through taxes and transfers,  leading to more unequal final outcomes.[1]

Inequality needs to be distinguished from poverty. It is possible for poverty to be in decline at the same time as inequality is on the rise. This would occur if incomes for the poor rose above a designated poverty line, while, at the same time, incomes for the rich increased at a greater rate.
Some writers and policy-makers contend that the focus of policy should be poverty reduction rather than inequality. Feldstein uses the Pareto principle, which states that that “a change is good if it makes someone better off without making anyone else worse off.” He contends that “if the material well-being of some individuals increases with no decrease in the material well-being of others, that is a good thing even if it implies an increase in measured inequality”.[2]

Such contentions rest on the idea that poverty is an absolute concept, while inequality is a relative one. Levels of inequality, however, shape how we perceive poverty. What is available to a majority of citizens shapes perceptions of deprivation and hence poverty. Poverty, even in an ‘absolute’ sense, is ‘relative’ over time and space. Poverty in Australia today is different to what it was in the 1960s. And poverty in Australia is clearly different to poverty in other parts of the world.

Rising inequality is a potential problem because it divides societies and opens up the possibilities of reactionary responses to economic and social problems as the poor increasingly support populist solutions. Some authors argue that rising inequality leads to an erosion of trust and to increases in anxiety and illness.[3] The OECD argues that rising income inequality “can stifle upward social mobility, making it harder for talented and hard-working people to get the rewards they deserve.”[4]
One measure of inequality that receives a lot of attention is the Gini Coefficient (GC). This measure is popular because of its simplicity and its applicability across countries. The GC represents a scale from zero to one, where zero represents a situation in which all households’ incomes are equal, and one represents a situation where one household has all the income to itself.  

Australia has a higher GC (0.33) than the OECD country[5] average (0.31). Iceland has the lowest GC (0.24), followed by Slovakia, Norway and Denmark. Caution is required with this measure as with any other measure of inequality. India’s GC, for example, was 0.38 making it a country of low inequality of income. This means that in India, despite some spectacularly wealthy people and a growing middle class, most people are poor and therefore relatively equal!

Table 1
Gini Coefficient 
Selected Countries


Gini coefficient
(disposable income,
post taxes and transfers)
Iceland
0.24
Norway
0.25
Denmark
0.25
Finland
0.26
Sweden
0.27
Germany
0.29
Netherlands
0.29
France
0.30
Korea
0.31
OECD
0.31
New Zealand
0.32
Italy
0.32
Canada
0.32
Ireland
0.33
Australia
0.33
Japan
0.34
Spain
0.34
United Kingdom
0.34
India
0.38
United States
0.38
Indonesia
0.38
Russian Federation
0.40
China
0.41
Mexico
0.47
Brazil
0.55
South Africa
0.70

Other ways of measuring inequality include comparing the share of the top 10 per cent of income earners versus the rest or between them and the bottom 10 per cent. Sometimes the focus is on the top 1 or even 0.1 per cent. In recent years, those at the very top of the income scale have increased their share.  Rising inequality sparked the creation of the Occupy Wall Street movement in the United States, which used the slogan “we are the 99 per cent”.

Changes over time reveal whether inequality (as per the measurement) is increasing or decreasing. In OECD countries, income inequality has been increasing over the past 30 years and in some countries, it has reached historic highs. In the 1980s, the richest 10 per cent earned 7 times the poorest 10 per cent. In the 1990s, it was 8 times and in the 2000s it was 9 times. Today the ratio between earnings of the richest 10 per cent is 9.6 times the earnings of the poorest 10 per cent. Inequality increased in the good economic times before the crisis and in the bad times afterwards. As the OECD points out:
Much of the recent debate surrounding inequality has focused on top earners, especially the “top 1%”. Less well understood is the relative decline of low earners and low-income households – not just the bottom 10% but the lowest 40%.[6]

Measuring income inequality, however, only gives us a partial understanding of economic inequality. To get a more accurate picture we need to supplement income data with an analysis of wealth inequality.

Thomas Piketty’s basic contention is that wealth has consistently grown faster than economic output since the industrial revolution, with the exception of the first three-quarters of the twentieth century. The relationship between wealth and growth is captured by the expression r > g, where r is the rate of return on capital (wealth) and g is the rate of economic growth. If the rate of return on capital (r) continues to outpace economic growth (g) then countries will continue to become more unequal.
According to the OECD, “wealth distribution is much more concentrated than the income distribution. 

On average, the top 10% (of households) accounts for about 50% of total household wealth, while the top 10% (of individuals) accounts for about 25% of total household income.”[7] Wealth is often very concentrated in the top 1 per cent and especially the top 0.1 per cent of the income distribution. The top 1 per cent in OECD countries own 18 per cent of total wealth, while the bottom 60 per cent owns 13 per cent of total household wealth. High income and wealth shares for the top of the income distribution are common across all countries, but in recent years, rapid growth in many developing countries has seen the middle increase their share.

The Developed and Developing World

From the beginning of the industrial revolution, inequality between countries increased enormously. This phenomenon is often called the “great divergence”, with Europe and then the United States increasing their share of world output at the expense of Asia.[8] As chart 1 shows, since 1950 and especially since the 1990s, the world has experienced a great re-convergence. While inequalities between countries are still very large, they are decreasing.

Chart 1

The Distribution of World Output 1700-2012

The economic rise of China and India has had an enormous impact on global income distribution and poverty reduction. In China, for example, 660 million people have been raised from poverty. According to the World Bank, “income per capita increased from $320 in 1980 to about $5,500 in 2012, and the number of people living on less than $1.25 a day declined from 85 percent of the population in 1980 to 11 percent by 2012”.[9] This poverty reduction, however, occurred alongside significant increases in inequality. China has gone from one of the most equal societies in the world to one of the most unequal. Such a contention exposes the contradictions between economic growth, poverty and inequality. Despite the problems associated with rapid growth, such as environmental damage, it would be hard to make a case that China was better off in the past with less inequality, but more poverty. Over coming years, however, increasing inequality will no doubt create rising tensions China if it is not addressed.  

To assess the progress or otherwise of developing and developed countries, we can measure inequality within countries, between countries, or by considering the world as a single entity. If we imagine the world as one country and assess people’s income as individuals rather than as country averages, we get a better idea about real global inequality. If measured in this way, it appears that global inequality (measured by the Gini coefficient) went into decline between 2002 and 2008. It is too soon to tell what the long-term impact of the global economic crisis will be and whether this decline will continue, but if so it would be the first time since the industrial revolution that global inequality has declined.[10]

We should acknowledge, however, that the world is still a fundamentally unequal place and the small improvement in recent years does not change this fact. The Gini coefficient for the world is about 0.7. According to Milanovic:
One way to look at it is to take the whole income of the world and divide it into two halves: the richest 8 per cent will take one half and the other 92 per cent of the population will take another half. So, it is a 92–8 world. Applying the same type of division to the US income, the numbers are 78 and 22. Or using Germany, the numbers are 71 and 29 … Global inequality is much greater than inequality within any individual country.[11]
Over the 20 year period from 1988 to 2008 the global poor from developing countries experienced considerable income growth, with the new ‘middle classes’ of Asia doing particularly well. The biggest losers have been the working and lower middle classes in the developed world.[12]  Chart 2 shows the growth of income for all percentiles of the global income distribution from 1988-2008. Growth has been strongest in the middle (e.g. the Chinese middle class) and the very top (e.g. the rich in the developed world). Those at the 80th percentile of the global income redistribution (e.g. the lower middle class in the United States) have experienced the least growth. As Milanovic points out: “It is between the 50th and 60th percentiles of global income distribution that we find some 200 million Chinese, 90 million Indians and about 30 million people each from Indonesia, Brazil and Egypt.”[13] Many Africans – represented by the bottom 5 per cent of the distribution – have missed out on these improvements.

Chart 2

Real Income Growth at Various Percentiles of Global Income Distribution
1988-2008 (in 2005 PPPs)


The very rich in the developed world have experienced the biggest growth in income as chart 3 shows. More than 50 per cent of the increases in income between 1988 and 2008 went to the top 5 per cent of the global income distribution.

Chart 3 
Distribution of the Global Absolute Gains in Income 
1988-2008


Australia

The very rich have increased their share in Australia as well. According to Atkinson and Morelli, the share of total wealth of the top 1 per cent in Australia was 34 per cent in 1915, falling to 6.3 per cent in 1968, and rising again to 16 per cent in 2006. After the GFC, their share fell to 11.4 per cent.  With the increase in asset prices since 2010, it is probable that the share has risen once again. The income share of the top 1 and top 0.1 per cent in Australia has grown in recent years after declining for most of the twentieth century. In the United States, top income shares have grown more than twice as large as Australia.

Chart 4

Share of Top 1 per cent and Top 0.1 per cent in Gross Income 
Australia and the United States

Source: Atkinson and Morelli (2014) Chartbook of Economic Inequality <http://www.chartbookofeconomicinequality.com/>.

Australia’s Gini coefficient shows that inequality has worsened since the 1980s. On most measures of inequality and poverty, outcomes have deteriorated.  Australia avoided the worst effects of the economic downturn following the global financial crisis and, consequently, inequality has not risen in Australia as much as it has in many other developed countries.  In countries hardest hit by the crisis, poorer households experienced substantial falls in income, with rising unemployment a major factor. In Australia, employment has remained high and the poor have increased their incomes. In the United States, stagnating incomes for the majority of the income distribution have accompanied rising inequality. In Greece, while inequality has slightly declined, so too have living standards for all parts of the income distribution. To get an indication of progress, therefore, we need to consider living standards as well as inequality. [14]

The major factors restricting the growth of inequality in Australia in recent years have been the long period of growth and government redistribution through taxing and spending. As argued above, analyses of inequality and poverty must include the impact of public services or so-called non-cash benefits. They also need to consider the impact of regressive indirect taxes such as the GST. While governments have tightly targeted direct government assistance to the unemployed in Australia, the significant rise in family payments has meant that wealthier families have increased their share of government redistribution. Wealth in Australia benefits from low levels of taxation, which helps to entrench inequality. There are no capital gains taxes on the family home or any wealth or inheritance taxes, and there are generous tax concessions for wealthy superannuants, property owners and investors.

Conclusion

For most people’s lived experiences, what matters most is within country inequality, rather than global inequality. For developed countries, growing inequality could lead to growing dissatisfaction with economic globalisation. While globalisation brings many benefits, it must create benefits for the poor and the middle if it is to be sustainable over the longer term. Reactions against globalisation in the major developed economies could lead to protectionism and xenophobia.

The question for the future is whether growing inequality in the developed world is inevitable. Analysing the differences in inequality between countries at similar levels of development shows that politics and policy can and do make a difference. Governments and societies that aim to do something about inequality generally achieve better outcomes than those that believe that the costs of lowering inequalities come at the cost of economic growth and productivity.[15]

Contrary to the arguments of many economic liberals, globalisation and the pursuit of economic growth do not undermine the ability of governments to promote egalitarianism; instead, egalitarianism helps to support a globalising, dynamic economy. As Peter Lindert points out in his authoritative two volume study on social spending and economic growth since the eighteenth century:
There is no clear net cost to the welfare state, either in our first glance at the raw numbers or in deeper statistical analyses that hold many other things equal … It turns out there are many good reasons why radically different approaches to the welfare state have little or no net difference in their economic costs. Those reasons … boil down to a unified logic: Electoral democracy, for all its messiness and clumsiness, keeps the costs of either too much welfare or too little under control.[16]
Lindert also points out that ‘the history of economic growth is unkind’ to those with a suspicion that higher taxes and social spending are bad for productivity. Beyond this basic fact is another unpleasant one for those who argue that the welfare state must be cut in the interests of growth or productivity: ‘people in the countries with higher social budgets get to enjoy more free time every year and retire earlier’. Well educated, healthy workers are more productive workers. Parents with access to childcare and leave can continue careers sooner or later and maintain their productivity. Providing even more options in this area enhances the productivity of a large section of the population with parental responsibilities.  

Australia’s vulnerabilities and the need to improve social outcomes should not encourage a shift away from globalisation towards protectionism. Far from it. Globalisation, liberalisation and engagement with Asia have increased prosperity. Sustaining these benefits, however, requires governments to increase opportunities, spread the benefits of prosperity, and share the costs of adaptation. In sum, maintaining support for openness requires governments and societies to do something about inequality. 



[1]       For a critique of this contention, see Paul Krugman (2015) “Explaining US Inequality Exceptionalism”, New York Times, 4 May <http://krugman.blogs.nytimes.com/2015/05/04/explaining-us-inequality-exceptionalism/?_r=0>. 
[2]       Martin Feldstein (1999) “Reducing Poverty not Inequality”, The Public Interest, No. 137, Fall.
[3]       Kate Pickett and Richard Wilkinson (2009) The Spirit Level: Why Greater Equality Makes Societies Stronger, London, Allan Lane.
[4]       OECD (2015) In it Together: Why Less Inequality Benefits All, Paris, OECD Publishing <http://www.oecd.org/social/in-it-together-why-less-inequality-benefits-all-9789264235120-en.htm>..
[5]       OECD or Organisation for Economic Cooperation and Development is a grouping of 34 countries committed to democracy and free markets. It is often used as a description of developed or advanced countries, although it also includes emerging economies such as Mexico, Chile and Turkey.  See OECD <http://www.oecd.org/about/membersandpartners/>. 
[6]       OECD (2015) In It Together. 
[7]       Fabrice Murtin and Marco Mira d’Ercole (2015) Household Wealth Inequality across OECD Countries: New OECD Evidence”, OECD Statistics Brief, June <http://www.oecd.org/std/household-wealth-inequality-across-OECD-countries-OECDSB21.pdf>. 
[8]       Kenneth Pomeranz (2000) The Great Divergence: China, Europe and the Making of the Modern World Economy, Princeton, Princeton University Press.
[9]       Serhan Cevik and Carolina Correa-Caro (2015) Growing (Un)equal: Fiscal Policy and Income Inequality in China and BRIC+, IMF Working Paper 15/68 <http://www.imf.org/external/pubs/ft/wp/2015/wp1568.pdf>. 
[10]     Branko Milanovic (2013) “Global Inequality in Numbers: In History and Now”, Global Policy, 4(2).
[11]     Ibid.
[12]     Branko Milanovic (2014) “The Tale of Two Middle Classes”, Yale Global, 31 July <http://yaleglobal.yale.edu/content/tale-two-middle-classes>.
[13]     Milanovic,“Global Inequality in Numbers”.
[14]     Max Roser, Brian Nolan, and Stefan Thewissen (2015) Inequality or Living Standards: Which Matters More? The Institute for New Economic Thinking Blog, 9 April <http://ineteconomics.org/ideas-papers/blog/inequality-or-living-standards-which-matters-more>. 
[15]     Tom Conley (2009) The Vulnerable Country: Australia and the Global Economy, Sydney, University of New South Wales Press. 
[16]       Peter H Lindert (2004) Growing Public: Social Spending and Economic Growth since the Eighteenth CenturyCambridgeCambridge University Press, p. 6.