Will the recent return of inequality outweigh its long-term decline?

In the long run, is inequal­ity rising?

Daniel Walden­ström. When we look back over the whole of the last cen­tury, the answer is no. With the intro­duc­tion of demo­cracy, redis­tri­bu­tion, the shocks of wars and oth­er eco­nom­ic crises, the 20^th Cen­tury has been an era of strong equal­isa­tion in west­ern soci­et­ies. How­ever, if we con­sider the last four dec­ades there is more of a debate with lar­ger dif­fer­ences across coun­tries. The 80s were a glob­al low in inequal­ity reduc­tion. But since then there has only been a mild increase in most European coun­tries with a lar­ger increase in the United States.

That being said, there are many nuances to these developments.

First, we need to bet­ter under­stand inequal­ity reduc­tion in the post-war era. Some deep trends have had a struc­tur­al effect, like edu­ca­tion attain­ment, with more edu­cated people who became more pro­duct­ive. Moreover, a large part of the inequal­ity reduc­tion observed was due to a one-time move­ment of women join­ing the labour force. Reduc­tion in inequal­ity was per­haps not primar­ily due to taxes redis­trib­ut­ing incomes, but to new income earners. By the 80s that equal­ising force had played out.

A second nuance is that we should not only look at how the cake is dis­trib­uted, but also its size, that is, the growth in nation­al income. This fun­da­ment­al per­spect­ive is some­times miss­ing from the dis­cus­sion around inequal­ity. Why do we care about inequal­ity? Is it not in part because we care about people who don’t have enough resources to live a good life, which is basic­ally the ques­tion of poverty? Research shows that poverty is much more about the size of the cake than its dis­tri­bu­tion, and this points to ques­tions about eco­nom­ic devel­op­ment, entre­pren­eur­ship growth and so forth. We star­ted get­ting large struc­tur­al prob­lems with those things in the 70s, and the new eco­nom­ic policies imple­men­ted in the 80s were first and fore­most a way to solve these problems.

Around this peri­od, West­ern coun­tries suffered from a struc­tur­al crisis in pro­ductiv­ity, espe­cially com­pared to Asia. Our eco­nom­ies were heav­ily reg­u­lated, with high taxes on large groups. To break this situ­ation and improve the rewards for work­ing, mov­ing, and tak­ing ini­ti­at­ive, we began strength­en­ing incent­ives for people to edu­cate them­selves, work longer hours and work harder. The cake even­tu­ally grew big­ger; growth picked up. A side effect of reward­ing suc­cess­ful people is that it increases income inequal­ity, but note that lower incomes were raised too: today, poor people are much bet­ter off than they were in the 80s.

Some of your col­leagues argue that the major inequal­ity is not so much about income, but about wealth.

Let me first say that I do not fully agree with that. I think that incomes are more rel­ev­ant than wealth for assess­ing people’s wel­fare or what the mar­ket eco­nomy is cur­rently reward­ing. That said, the trends in income and wealth inequal­ity look fairly sim­il­ar. If any­thing, the equal­isa­tion of wealth own­er­ship over the 20^th Cen­tury has been even stronger than what we see for incomes. A large share of the pop­u­la­tion basic­ally owned noth­ing a cen­tury ago when the cap­it­al was in the hands of a few indus­tri­al­ists, fin­an­ci­ers and landed aristocracy.

Over the past cen­tury, there has been a dra­mat­ic struc­tur­al change in wealth own­er­ship. As demo­cracy brought more secure prop­erty rights, labour rights, and bet­ter edu­ca­tion for most people, people got more pro­duct­ive and bet­ter paid. This means that, togeth­er with a more developed bank­ing sys­tem, nor­mal people could start to invest in homes and save for their pen­sions. In oth­er words, ordin­ary people could now accu­mu­late wealth for the first time in his­tory. Today, most assets are owned by the middle class unlike a cen­tury ago when they were mainly owned by the elite. This is also why asset price increases in hous­ing and the stock mar­ket after the 1970s bene­fit­ted not only wealthy people but quite broad lay­ers in the population.

But tan­gible wealth isn’t everything. Most people are also part of col­lect­ive pen­sion sys­tems in which assets are prom­ises about future income streams on which people have draw­ing rights. Note that these pen­sion assets are impli­cit. They are not money on a bank account that one can take out and use to buy a car. For this reas­on, some people have excluded these unfun­ded pen­sion assets when meas­ur­ing wealth, mak­ing middle-class people in Europe quite fin­an­cially poor since they have not saved privately for their pensions.

But it is pos­sible to estim­ate the present value of these pen­sion assets. If we include them in the wealth port­fo­lio, the pic­ture changes. Wealth con­cen­tra­tion num­bers fall dra­mat­ic­ally. Research show that the top one per­cent wealth share drops by half both in Sweden and in the United States when includ­ing unfun­ded pen­sion wealth.

Still, quant­it­at­ive eas­ing policies imple­men­ted by cent­ral banks in the wake of the Fin­an­cial Crisis could be con­sidered a game changer, with a surge in fin­an­cial and hous­ing mar­kets that cre­ated a gap between own­ers and non-owners.

Quant­it­at­ive eas­ing seems to have had a huge impact on asset prices. When we relate this to the wealth dis­tri­bu­tion, this does not primar­ily affect the inequal­ity among wealth hold­ers. Instead, the gap has widened between those who own ­– homes, shares, mutu­al funds – and those who do not own any­thing. For example, I would guess that the dis­tance for young people to get into the hous­ing mar­ket has gone up. No one has looked at this sys­tem­at­ic­ally, I think, but that would be inter­est­ing to study. Do we see such a struc­tur­al gap in the mak­ing? The jury is still out.

If it were the case that a wealth gap between the haves and the have-nots is mount­ing, there might be a role for eco­nom­ic policy to do some­thing about it. How­ever, some policies should be avoided. For example, there are politi­cians and even some eco­nom­ists who are talk­ing about rein­tro­du­cing wealth tax­a­tion for this. I think that this is quite a naïve view. That tax has been tried and it did not work. It is dif­fi­cult to design, it cre­ates liquid­ity prob­lems for firms, and it will be incon­sist­ent across assets depend­ing how easy it is to meas­ure their prop­er val­ues. The way tax­a­tion can help solve inequal­ity is rather to gen­er­ate rev­en­ues that can be spent on wel­fare ser­vices that are rel­at­ively more import­ant for poor people: health care, eld­erly care, edu­ca­tion. That’s the most effi­cient way of redis­trib­ut­ing via taxes. And for that, we need low mar­gin­al tax rates but broad tax bases that togeth­er gen­er­ate a lot of rev­en­ue – quite the oppos­ite of taxes on wealth, that don’t gen­er­ate enough rev­en­ue and send a neg­at­ive sig­nal to investors. Redu­cing inequal­ity has always been done most effect­ively by rais­ing the income and wealth floor from below: help more people get an edu­ca­tion, access the job mar­ket, own their own home and save for their pensions.