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Why is social inequality increasing in the 21st Century?

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

Richard Robert, Journalist and Author
On February 9th, 2022 |
4 mins reading time
2
Will the recent return of inequality outweigh its long-term decline?
Daniel Waldenström
Daniel Waldenström
Research Fellow at the Institute for Industrial Economics Research (IFN)
Key takeaways
  • The 20th Century as a whole has been an era of strong equalisation in western societies. But there is more of a debate if we consider the last four decades.
  • By rewarding success and increasing income inequality western societies have managed to solve their efficiency crisis and make everyone better off.
  • Some economists point out an increasing inequality in wealth. But there are debates about both the measure and the distribution of wealth. Most people are part of collective pension systems in which they don’t “own” assets but have drawing rights on future income streams.
  • In recent years the central banks’ quantitative easing policies might have created a wealth gap between the haves and the have-nots: redistribution policies are back in the agenda.
  • Reducing inequality has always been done most effectively by raising the income and wealth floor from below.

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.