The tame inequality debate

In: Uncategorized

3 Nov 2014

The extent to which inequality has come to be blamed for most of the world’s economic problems is astounding.

Will Hutton, principal of Hertford College, Oxford, summed up the charges in an Observer article earlier this year: “It’s inequality that is behind poverty, ill health and the growth of the welfare bill. It’s inequality propelling the escalating demand for credit. It’s inequality that has created our fragile banking system and its still feral proclivities. It’s inequality that has provoked the collapse in productivity and the stagnation in innovation and investment… This is the truth that cannot yet be spoken.”

Hutton has a left-wing reputation but of his questionable claims the most absurd is the last. Many senior figures from Barack Obama to the Pope and David Cameron to the head of the International Monetary Fund have condemned excessive inequality. They are not necessarily correct but it does indicate, contrary to Hutton’s claim, that such criticisms are thoroughly mainstream. Even the Guardian’s economic editor has belatedly acknowledged this is the case.

Indeed, I wrote a Fund Strategy cover story on the topic two years ago but have returned to it because it has become so prevalent. Several of this year’s most prominent economics books have covered it, including Thomas Piketty’s Capital In The Twentieth Century. Martin Wolf’s The Shifts and the Shocks blames inequality for weak demand and lagging educational standards. Atif Mian and Amir Sufi’s House of Debt links inequality to debt by arguing that borrowing by those with low incomes was a key cause of America’s recession.

There are many problems with these arguments but let us take three for now.

First, there are big issues with definition. What kind of inequality is being discussed? Wealth or income? If the latter, is it wages or entire income? And should the focus be on individuals or households?

The choice of definitions is not trivial. Although inequality has widened by many measures in many countries, it has not done so universally. For example, according to a study by the Institute for Fiscal Studies, the Gini co-efficient for income inequality in Britain is lower now than in 1990.

Next is the question of the appropriate measure of inequality. Perhaps the Gini co-efficient, the Theil index or a comparison of different percentiles?

And what about cause and effect? Just because inequality rose in the run-up to a crisis, it does not always follow that it is the cause. It could be that crisis tendencies caused a widening of inequality. Or it could be that a third factor caused both. Or it may simply be a coincidence.

In the hope of untangling these factors, I was interested to read a study by the Washington Center for Equitable Growth. Although the authors of How are Economic Inequality and Growth Connected? are partisan, it is a reasonably comprehensive literature review.

To its credit, it raises the question of causality but its conclusions are guarded, such as “more work is needed to fully understand the specifics of how inequality affects growth”. It notes most studies have argued there is a statistically significant negative correlation between inequality and growth.

To the extent there is an insight, it is that the relationship tends to hold over the long term rather than the short term. The study also argues that income growth is particularly disappointing for those not at the top. However, the paper comes nowhere near establishing that widening inequality causes low growth.

Finally, mainstream critics of inequality do not advocate equality of either income or wealth. On the contrary, they typically go to great pains to say they are not against inequality in principle – their concern is that the degree of inequality could be reaching extreme levels.

In many cases there is little emphasis on the redistribution of income. Their main concern is for more government regulation to mitigate the effects of widening inequality.

It is hardly a spectre that will haunt the rich and powerful.

A slightly abridged version of this article was published as my November Polemic column in Fund Strategy magazine.

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