We cannot reason inequality away

Thanks to the unprecedented attention that Thomas Piketty’s Capital in the 21st Century has received from thought-leaders, newspaper columnists and research economists, inequality is in vogue.

It is beyond dispute that extreme poverty, defined as the percentage of population living on less than $1.25 per day, has been on the decline globally over the last few decades. From over 40 per cent of the world population in 1980 it is now down to around 15 per cent. This remarkable achievement has, however, occurred in tandem with a steady and alarming rise in inequality. While we have celebrated the decline in poverty, the rise in inequality was until recently all but ignored.

That we needed this prodding for global inequality to command public attention is a surprise. The occasional facts that appeared every now and then were alarming enough. The 10 richest people in the world have roughly the same income as the population of Ethiopia; the total wealth of the 85 richest individuals equals the wealth owned by the poorer half of the world’s total population.

One must appreciate the hard work on the part of market-fundamentalist thinkers to make all this appear natural and inevitable. The skewed incomes, we were told, represented a just division of spoils between the hard working and the lazy. In other words, what the poor were losing out in terms of money they were making up in terms of leisure and sleep. What the free market, unhindered by the state, delivered was efficient and fair.

These myths are now crumbling. Attributing today’s large inequality to people’s choice between hard work and leisure is patently false because a substantial part of the inequality manifests at birth. There are children in slums who are born doomed to destitution. There are other children born into so much wealth that it is virtually impossible for them to become poor. The economist Miles Corak recently demonstrated with big data that for the superrich there is a “glass floor.” Since it is a bit of a stretch to attribute a newborn’s poverty to his or her taste for leisure, much of today’s inequality is evidently unfair.

The question that naturally arises from this is: what are the policies needed to counter extreme inequality and promote the well-being of the poor?

An easy way out is often taken by citing some studies that show that three-quarters of all variations in recent growth of the income of the poor occurred because of variations in overall income growth. This fact has been seized upon by ideologues to argue that the best way to help the poor is to just let growth happen.

There are two mistakes with this argument. First, the fact that growth was the main driver of well-being of the poor in the past does not mean that it is the most effective driver. It could simply be that little else was tried in the past. The mistake is analogous to an economist analysing labour data in the USSR in the 1970s and 80s, noting the state’s overwhelming presence and concluding: “We have to rely on the government to create all future jobs because my study shows that all past jobs were created by the government.”

Secondly, new research (by Roy van der Weide and Branko Milanovic at the World Bank) shows that the relation between growth and inequality is more complex than earlier supposed. Analysing micro-census data from US states from 1960 to 2010, they find that there is an association between inequality and growth, but it is different for different segments of the population. Higher initial inequality in a society is associated with lower growth for the bottom 25 per cent of the population and higher growth for the top 10 per cent. We do not know the causal basis of this but it certainly throws a wrench into analyses which try to establish a uniform relation between inequality and growth.

Another strategy used to stall policy action, within a nation or globally, is to point to Adam Smith’s idea of the invisible hand and to argue that the market, left to itself, will eventually lead society to optimal conditions.

This argument errs by treating two sets of collectivities of individuals contradictorily. When “corporations” pursue profits to the exclusion of all else, it justifies this by saying, “this is what corporations are meant to do.” But the actions of governments are treated as aberrations. The mistake is the failure to realise that government is also nothing but a collection of individuals. A clever, kleptocratic government can navigate this objection by simply renaming itself. Nicaragua’s Anastasio Somoza could have changed the name of his government to Somoza and Sons, Inc. Given Somoza’s single-minded pursuit of money, it would not be too hard to think of his government as a for-profit corporation. And by this simple ploy he would have got around the ideological argument, thereby revealing that the argument was spurious in the first place.

Just as we have had some success in reducing extreme poverty, we now need policy interventions at the level of the nation and the world to combat the scourge of extreme inequality.