Like cholesterol, inequality cuts both ways

Speaking of cholesterol...

SHOULD we worry about rising inequality? Protests across the United States under the Occupy Wall Street banner are in part a spontaneous outcry at the outrageous post-crisis salaries of Wall Street “bailoutees”. But they also find roots in a deeper, multi-decade trend of rising inequality in the US. As the stunningly successful catch cry “we are the 99 per cent” shows, this is a movement based on statistics as much as slogans.

Since the late 1970s, the share of US pre-tax income going to the top 1 per cent of American wage earners has grown from 8 per cent to 18 per cent, the online World Top Incomes Database shows.

Inequality of wealth is even more pronounced, with the top 1 per cent sitting on 35 per cent of the country’s net household worth, that is, assets, including housing, shares, trusts, deposits and pension accounts, minus debts.

Sympathetic Australians occupying Martin Place and Melbourne’s City Square have less cause for complaint, but inequality here is rising, too. Tax Office statistics show the share of taxable income earned by the top 1 per cent of Australian wage earners doubled from 5 per cent to 10 per cent over the past three decades.

But as long as incomes are growing for all, why should we care?

Some economists think we shouldn’t. So long as there is equality of opportunity and redistribution to alleviate poverty, they argue inequality is simply a fact of life, reflecting the disparate market value of the output of workers with varying levels of skill and ability.

This theory of wages does well to explain the pay gap between, say, computer software developers and retail assistants, but it struggles to explain the excessive multi-billion dollar salaries awarded to some chief executives.

Most economists also defend some degree of inequality on the basis that it provides useful incentives for all workers. We need to see that others are earning more than us to drive us to work harder, improve our skills and aspire to greater things.

But how much inequality is enough?

In a recently released book, The Haves and the Have-Nots, the World Bank economist and inequality expert Branko Milanovic argues that inequality is like cholesterol: “There is ‘good’ and ‘bad’ inequality, just as there is good and bad cholesterol. ‘Good’ inequality is needed to create incentives for people to study, work hard, or start risky entrepreneurial projects.”

But, he argues, economic efficiency is eventually undermined when a group of super rich devote their considerable resources to ensuring they get to keep all the best jobs and opposing economic reforms that would endanger their privileged positions. “Bad inequality starts at a point – one not easy to define – where, rather than providing the motivation to excel, inequality provides the means to preserve acquired position.”

Milanovic argues the global financial crisis is a direct result of this kind of “bad” inequality taking hold in the US. An excessive build-up of wealth and income in the hands of the financial elite meant they soon ran out of ways to consume it in caviar and champagne, meaning it needed to be invested in ever riskier vehicles.

Meanwhile, US politicians sought to hide the uncomfortable truth of declining middle and lower class wealth by turning a blind eye to a massive loosening of credit standards, which enabled people to borrow and feel rich, even as their incomes stagnated. A more equitable path of development “would have spared the United States and the world an unnecessary crisis”.

So, worth keeping an eye on, then.

THE IRVINE INDEX

$197,112
Minimum income you needed to earn in 2007-08 to make it into the top 1 per cent of Australians by income.

18%
Share of pre-tax income earned by the top 1 per cent of American workers in 2007, up from 8 per cent in 1977.

10%
Share of pre-tax income earned by the top 1 per cent of Australian workers in 2007, up from 5 per cent in 1977.

85%
Share of net worth owned by the top 20 per cent of US households.

35%
Share of net worth, including housing, shares, trusts, deposits and pension accounts, owned by top 1 per cent of US households

0.9%
Share of net worth owned by the bottom 20 per cent of Australian households.

62%
Share of net worth owned by the top 20 per cent of households in Australia.

9
Gross household income of the top 10 per cent of Australia’s top income-earning households as a multiple of the bottom 10 per cent.

49
Net worth of the top 10 per cent of Australia’s wealthiest households as a multiple of the bottom 10 per cent.

Sources: Facundo Alvaredo, Anthony B. Atkinson, Thomas Piketty and Emmanuel Saez, The World Top Incomes Database, g-mond.parisschoolofeconomics.eu/topincomes, accessed 21/09/2011; sociology.ucsc.edu/whorulesamerica/power/wealth.html; ABS Household Wealth and Wealth Distribution 2009-10; andrewleigh.org/pdf/TopIncomesAustralia.xls.

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2 Responses to Like cholesterol, inequality cuts both ways

  1. Magpie says:

    That is a balanced and fair view.

    Just two observations:

    “Bad inequality starts at a point – one not easy to define – where, rather than providing the motivation to excel, inequality provides the means to preserve acquired position.”

    If one thinks of the RSPT/Rudd demise case, the pokie machines, the environmental thing, and a host of other cases, wouldn’t Australia qualify for membership in the bad inequality club?

    I really don’t know how necessary is inequality “to create incentives for people to study, work hard, or start risky entrepreneurial projects.”

    Consider this: below a certain income level, you don’t really have much savings; and the dole is a bad joke: if you don’t work as hard as your boss feels you should, you risk losing your job. Believe me: that’s motivation enough to work hard. No need for inequality here.

  2. Magpie says:

    Well, young Econogirl, I know it’s bad taste to quote oneself (and particularly in a matter that — I believe — worries you all at Fairfax), but the current take over of Fairfax sounds a lot like these words:

    “If one thinks of the RSPT/Rudd demise case, the pokie machines, the environmental thing, and a host of other cases, wouldn’t Australia qualify for membership in the bad inequality club?”

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