Photo by Sarah Jamerson, via Flickr Creative Commons
Last month, the World Inequality Report (WIR) was released. Hundreds of the world’s leading economists contributed to the comprehensive report on the evolution of economic inequality since the 1980s. The report states that the poorest half of the world’s population has seen significant income growth over the past 40 years, but income inequality is rapidly increasing. In 1980, the US and EU were on a similar standing in terms of income distribution, but since then, the proportion of income captured by the highest earners has skyrocketed in the States, whereas it has stabilized in Europe. The key takeaway here is that economic inequality increases at different rates in different parts of the world. This suggests that institutions and policies matter in shaping inequality and different state-market relationships will produce different economic outcomes.
For example, the WIR determines that key factors in the US-EU disparity are the American education and tax systems. In the US, the price of education has reached unprecedented levels, and the American tax system is less burdensome to high income earners. While most of the press focuses on the dynamics of developed Western countries, they overlook the data trends in emerging countries such as China and India. Both countries have experienced rapid growth in the past four decades, but have seen dramatically different results in how that growth has been distributed.While India has experienced crucial growth within its middle class, lifting millions out of relative poverty, a substantial portion of its overall growth has been captured by its highest earners. The rural-urban divide is a considerable factor in this phenomenon. While market forces have favoured India’s large urban centres, the agricultural sector has not developed at the, excluding many from India’s high growth rates. Former Communist regimes and countries with strict economic regulations have reacted very differently to their integration into the global economy. China’s income inequality has been gradually increasing over the past 25 years but still lies well below that of Russia. Fire sale privatizations following the dissolution of the Soviet Union led to a radical spike in the concentration of wealth, along with the formation of the modern Russian Oligopoly. These examples reflect how different types of deregulation and liberalization policies have led to diverse outcomes in the domestic distribution of wealth.
Inequality and Capital
Thomas Piketty’s published Capital in the Twenty-First Century in 2014, an was subsequently launched into stardom. The book made waves in the field of international political economy with the simple equation r > g. That is, the relative rate of growth of wealth (r) is higher than that of income (g). This relationship predicts that rapid economic growth will diminish the significance of capital, and low economic growth will amplify it. In an era of low economic growth, Piketty’s conclusions have become all the more pertinent. For inequality to be curtailed, significant modifications must be made to the global economy. The WIR points to trends in the relative share of private to public capital as another driving force of increasing inequality.
Due to the r > g imbalance, the share of private capital will only continue to increase as its relative share becomes larger and larger in relation to its public counterpart. As the share of public capital decreases, democratic institutions have less financial control, and consequently less influence over the direction their economy takes. For this natural process to be curbed, mechanisms outside of to standard market processes must be involved. Piketty posits that a global tax on capital should be coordinated to control its dominating effects. Piketty emphasizes the importance of government’s fiscal involvement in markets in order to correct adverse imbalances that would otherwise be left unchecked. The WIR points to progressive taxation schemes as one of the most effective means to efficiently redistribute income. A progressive tax system, combined with the an efficient of a transfer payments scheme, can control the dense accumulation of private capital.
Globalization and Inequality
The liberalization of markets over the past half-century has led to some of the fastest economic growth in global history. Through the combination of rapid technological innovation and augmented global interconnectedness, globalization has launched both developed and developing countries into massive economic expansion. Globalization has proven to be the biggest enemy of global poverty, creating better living standards for hundreds of millions, mostly in South America and Asia. Substantial growth has taken place in the poorest half of the world, but the bracket that has seen the most growth is far from poor. Since 1980, the top 1% has captured 27% of the total gains in wealth. These facts are reflected in a graph called the ‘elephant curve’, coined by economist Branko Milanovic. This graph has since become a trending symbol for the consequences of globalization.
The middle portion of the graph (above) is the most interesting. Over the past 40 years, economic growth for the global middle class has stagnated, leaving millions without any significant gains in real income. This global middle class comprises of the bottom half of income earners in developed nations such as the US, Germany, and Canada, and the middle class of developing countries such as Brazil. Though globalization may on whole lead to a tide of economic growth, that tide has not risen evenly. One of the models that explains this phenomenon is the Hecksher-Ohlin theorem. The model’s basic claim is that in a globalized economic setting, “a capital-abundant country will export the capital intensive good, while the labour-abundant country will produce the labour intensive good.” This theory asserts that within a given economy, under import competition, sectors which have natural large endowments in particular resources will flourish relative to others. For Germany, this may be the capital-intensive auto industry and for China, the labour-intensive manufacturing industry. An excellent illustration of this theory is the evolution of the US economy over the past 50 years. Whereas a large portion of the US economy was historically dominated by industrial manufacturing, newfound global competition has lead countries such as India and Bangladesh to produce at more modest rates than the US. Thus, demand for unskilled labour has declined and capital intensive industry has instead flourished under current economic conditions.
“The Winner and Losers from trade between Germany and China”, courtesy of CORE-Econ.
The stagnation of the American industrial sector has created the “Rust Belt” in the Midwest. The economies of Ohio, Indiana, Michigan and upstate New York have all suffered heavily from increased global competition, leaving thousands without work and wages inert. Though this may seem like a relatively small portion of the US as a whole, its influence has proved decisive for American politics.
Political Effects of Inequality
Some, including McGill Economics professor William Watson, argue that economic inequality may not be such a bad thing after all. The argument is that energy directed toward reducing inequality should be redirected toward fighting poverty, and that by resisting the inherent forces of capitalism, we are actually waging an ineffectual war against the single largest emancipatory force of extreme poverty. He claims in his book The Inequality Trap (2015), “We should worry less about inequality, which is a distraction from what ought to be our true targets, poverty and privilege.” This argument holds water if we consider that some inequality is in fact deserved, that some people have worked harder for their fortunes than others. While we could spend significant amounts of time considering the merit of these arguments, Watson omits an important consideration in his argument: inequality has created a host of issues which challenge the social fabric of our society.
Scholars have pointed to economic inequality as one of the fundamental forces behind the recent wave of populism which has swept over the Western world. In the US, Donald Trump’s victory was largely attributed to the frustration of the middle class with decades of ineffective economic policies implemented by Democrat and Republican administrations alike. Trump’s campaign was successful because a significant part of the US population felt alienated by the mainstream politicians, turning towards unorthodoxy and unconventional rhetoric, provided graciously by the prolific New York real-estate magnate. In the EU, France has seen the rise of the populist Front National lead by Marine le Pen, a party which has been accused of spreading xenophobic rhetoric and supporting illiberal policies. For the first time since the 1940s, a far right party now has representation in the Bundestag in Germany. In the UK, the United Kingdom Independence Party (UKIP), led by Nigel Farage, managed to rally enough support in the 2016 ‘Brexit’ referendum to succeeded in their goal of inducing a withdrawal from the European project.
“In the US, during the economic recovery between 2009-2012 there was a healthy 6% rise in real GDP. However, the growth was incredibly uneven. The top 1% income bracket grew by 31.4%, capturing 95% of total growth while the remaining 99% grew by only 0.4%”
This phenomenon can also be examined through the lens of a post-2008 financial crisis world. During the crisis, the top income bracket was hit disproportionately hard by the initial shockwaves of the crisis. During the recovery, the opposite was true. In the US, during the economic recovery between 2009-2012 there was a healthy 6% rise in real GDP. However, the growth was incredibly uneven. The top 1% income bracket grew by 31.4%, capturing 95% of total growth while the remaining 99% grew by only 0.4%. The common denominator in each of the aforementioned political developments is the voter base that supports them. More than ever, voters are looking for radical alternatives to the mainstream political tradition. Political frustration has stemmed from a feeling being excluded from the benefits of the Western liberal project. The ‘squeezed middle class’ of the elephant curve feels that the present arrangement of the global economy does not benefit them, only those at the top. For us to survive this wave of populism, we must better understand the origins of this trend and actively work to reverse them.
Additionally, the ramifications of rising inequality in the developing world are equally grave. The post-Cold War era amounted to significant economic growth in the developing world, helping pull out millions of out of poverty. But in the last decade, the momentum of global economic growth has considerably slowed down. At the same time, institutional fallacies in developing states has resulted in a rapid rise of inequality. This could potentially adversely affect the social contract in many of these developing states. Inequality in itself is a major concern for any polity, but it becomes all the more contentious in a world of sub-par economic growth. High economic growth, where all sections of society continue to become a little more well-off, makes inequality more politically manageable. But as growth loses steam, inequality could potentially lead to political disruptions. We see evidence of this even a stable state such India, which has recently been marked by multiple identity-based protest movements. While the protests were blamed on identity grievances, the impacts of rising inequality and poor prospects of employment cannot be ignored as an important factor.
The WIR reiterates time and time again that state institutions play an instrumental role in how economic inequality evolves. Different government policies will necessarily lead to different economic outcomes, creating a self-determined mechanism to avoid adverse effects. Most notably, equitable education systems and progressive income tax schemes are both shown to have the largest positive effects on reducing the long-term inequality.
The WIR points to the policies of some of the EU member states as a good example of how inequality should be handled. Long-term public investment in healthcare, education and infrastructure are necessary for empowering future generations and providing more universal access to salubrious public resources. One of the challenges faced by almost all countries is that of tax evasion, a phenomenon whose depth has recently been brought to light by leaks such as the Paradise Papers. While massive sums of wealth continue to remain illegally withheld from public use, it becomes more difficult gauge the effects of tax policy and finance public projects. Reforms in this realm are possible, but require a significant overhaul of how fraud is dealt with on an international scale. The silver lining here is that there are plausible and effective means of tackling current trends of inequality. While there is no immediate quick-fix solution, the WIR has laid out comprehensive steps for how governments should move forward. The only thing left to decide is whether we will incorporate these policies into the 21st century economy.
All graphs are taken from the World Inequality Report Executive Summary available at http://wir2018.wid.world/ with the exception of ‘The winners and losers of trade between China and Germany’ which has been taken from ‘CORE-Econ’ http://www.core-econ.org/.
The opinions expressed in this article are solely those of the author and they do not reflect the position of the McGill Journal of Political Studies or the Political Science Students’ Association.