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 20th 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 20th 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.