What’s driving our inequality?


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good economics : actual economics

If there was a one line answer for why inequality is growing, someone would have said it elegantly a long time ago. It seems the answer is a mix of systemic, economic and political factors, which I will wade through somewhat inelegantly below.

Trends – Global and Local

The Economist ran a feature late last year looking at the dynamics of income distribution. They point out that up until the 1970s, inequality within countries was largely falling, while inequality between countries grew. Globalisation and technological advancement since then have served to enrich the rich in developed countries (as their companies become global in scale), and the rich and middle class in developing countries (as markets open and jobs are outsourced); while hurting the poor and middle class in developed countries (whose jobs disappear overseas) and leaving the poor in the developing world largely unaffected. The result is a decrease in inequality between countries, and an increase in inequality within countries.

One of the key dynamics that comes into effect as we globalise is that of “superstar economics”: The argument that the best in any given field will earn disproportionately more than the second best in a globalised, technologically enabled set up. Nassim Nicholas Taleb describes this effect in his hugely insightful book “The Black Swan.” The argument goes that a hundred years ago, a modestly talented footballer could earn a good living as local people would be willing to pay to see them play. Nowadays, everyone can tune in to Barcelona v Real Madrid to watch the best in the world. This crowds the averagely talented player out of the market, while grossly inflating Christiano Ronaldo’s pay, as his audience grows exponentially.

The sectors that have become less equal are the same ones that are growing the quickest. Urbanisation and industrialisation (particularly in the developing world) mean that more and more people are working in a winner-takes-most “extremistan” environment. In an argument first put forward by Simon Kuznets in 1955, this sectoral change in itself has become a driver for increased inequality.

One of the most headline-friendly modes of discussion of inequality is around CEO compensation. There is ample evidence of CEO pay mushrooming in the last thirty years, with a growth rate 127 times greater than the US industrial average since 1978. This idea of superstar economics goes a good way to explaining why: Intuitively, CEOs run much larger organisations. Interestingly, looking at their pay compared to their next two most senior lieutenants, they have risen from 40% higher in the 1980s to 150% higher by 2000. This suggests the same dynamic dictates the relationship between the 99% and the 1% as the relationship between the top 1% and the top .1%.

And the politics

In 1955, Simon Kuznets was confused as to why inequality was falling. The industrialisation of society mentioned above, combined with disproportionately large returns on capital (held by a small proportion of society) should have seen inequality growing. One of the key mechanisms for inequality falling that he proposed was the flow of political power from the super-rich to the urban poor.

To quote fully:

“In democratic societies the growing political power of the urban lower income groups led to a variety of protective and supporting legislation, much of it aimed to counteract the worst effects of rapid industrialisation and urbanisatuion and to support the claims of the broad masses for more adequate shares of the growing income of the country” (Kuznets 1955: p17)

Can anyone seriously say today that political power has continued to flow from the wealthy to the urban lower income groups? At a time when Barack Obama, campaigning for the Presidency in 2012, can overtly state that “We can be outspent and still win — but we can’t be outspent 10 to 1 and still win”?

At a time when Saez and Pickety have demonstrated that 93% of the money from the economic recovery in the US between 2008-2011 went to the top 1%; with 33% going to the top 0.01%?

Whether pursued consciously or not, it is impossible to avoid the conclusion that inequality within countries is growing today; and the forces pushing it – be they globalisation, urbanisation, market-based compensation or a shift in political power toward the super-wealthy, are not dissipating any time soon.