Inequality And Its Discontents

The gap between the incomes of the rich and poor has grown. But those who blame inequality for Tunisia and Egypt's revolutions and the United States' economic woes are wrong. The real problem is that consumption has become more ostentatious, and, thanks to globalization, everyone -- from middle class westerners to Africans living on one dollar per day -- is able to compare him or herself to the richest of the rich

By Branko Milanovic

Inequality in Tunisia, Egypt, and the United States 1975-2010   As income inequality increased in the past quarter century in most parts of the world, it was strangely absent from mainstream economic discussions and publications. One would be hard-pressed, for example, to find many macroeconomic models that incorporated income or wealth inequality. Even in the run-up to and immediate aftermath of the 2007–2008 financial crisis, when income inequality returned to levels not seen since the Great Depression, it did not elicit much attention. Since then, however, the growing disparity in incomes between the rich and poor has taken a place at the top of the public agenda. From Tunisia to Egypt, from the United States to Great Britain, inequality is cited as a chief cause of revolution, economic disintegration, and unrest. This feeling that the incomes of the rich and the poor have diverged in part reflects reality: between the 1980s and mid-2000s, income inequality rose significantly in countries as diverse as China, India, Russia, Sweden, and the United States. The Gini coefficient, a measure of economic inequality that runs from zero (everyone has the same income) to 100 (one person has the entire income of a country), has risen from around 35 to the low 40s in the United States, from 32 to 35 in India, from 30 to 37 in the United Kingdom, from less than 30 to 45 in both Russia and China, and from 22 to 29 in famously egalitarian Sweden. According to the OECD, during the same time frame, the Gini coefficient increased in 16 out of 20 rich countries. The situation was no different in the emerging market economies: in addition to in India and China, it rose in Indonesia, South Africa, and all the post-Communist countries. For the poor, the gap has been palpable. In much of the world, the size of the economic pie has been shrinking, and the poor’s relative slice has been getting smaller. The poor’s actual income thus declined on two accounts. Despite large increase in global mean income between 1980 and 2005, excluding China, the number of people who live -- or, rather, barely subsist -- on an income below the absolute poverty line (1 dollar per day) remained constant, at 1.2 billion. In many countries, however, it appears that perceptions of inequality outstripped even these large and very real increases. In three latest World Values Surveys (conducted in early 1980s, 1990s, and 2000s), when given the choice between more freedom and more equality, respondents around the world increasingly selected the second in later surveys. Even when controlling for the changing composition of countries over the past three decades, that result remains constant. Public perception of inequality was behind the curve for over two decades, it seems to have now leaped ahead of it. Even in countries that have not shown any significant change in the reported gap between the rich and poor, moreover, citizens believe it has grown. This could be correct; measurement problems could have led to faulty data. Commonly used household surveys, from which data on inequality are extrapolated, might have become less reliable in capturing the incomes of the rich, for example. In greater numbers than before, they are thought to decline to participate in surveys or not truthfully report their incomes. India has become something of a cause célèbre of this problem. Since the country’s economic reform in the early 1990s, its GDP per capita has risen by an average of almost five percent per year. But per capita consumption, as calculated from household surveys, grew only slightly, at one percent per year. Some of the discrepancy is due to the declining share of personal consumption in India’s GDP, but some is thought to have been caused by the low “capture” of the incomes of the rich. In other words, the mean income rose because the rich got richer but did not report it, while the poor and the middle class earned only moderately more income, which was well reported in the surveys, and did not consume significantly more. Perhaps the rich are undersurveyed. Have our statistical tools thus become much less reliable guides both to income distribution and for conducting policy? Probably not. Wealthy people’s evasion has been a problem since household surveys were first conducted seriously more than half a century ago, and there is no reliable evidence that the problem has become systematically worse. Moreover, statistical instruments that, in principle, should be harder to falsify -- for example, individual IRS reports -- paint the same picture as household surveys. In the United States, both agree on the extent of rising inequality since the 1980s. Exaggerated perceptions of wealth disparity do not lie in the arcana of survey techniques or the wiliness of the rich but in a combination of domestic and global factors. As an example, consider the recent revolutions in Tunisia and Egypt, which were blamed on inequality. In fact, in neither country had economic growth slowed or inequality risen in recent years. In the last decade, Egypt’s per capita income grew at the respectable rate of 2.6 percent per year and Tunisia’s grew at 3.4 percent. The growth rate of both countries exceeded that of the eurozone (which was just under one percent) over the same period. The fruits of this higher growth did not go exclusively to the rich. In Tunisia, inequality declined in the 1980s, increased in the 1990s, and has been constant since. In Egypt, it has been on the decline. Just before the revolutions, the level of inequality was high but not outrageous in both countries: in Tunisia, it was almost the same as in the United States, and in Egypt, it was lower. Broadly constant Gini coefficients meant that everyone’s income increased by about the same percentage -- the rising tide lifted all boats. This is not the situation typically associated with widespread disenchantment and imminent revolution The origins of the anger that developed into the Arab Spring must be sought elsewhere -- in the feelings of injustice that the existing distribution of income had generated, and the perception that inequality was higher than it really was. Feelings of injustice are driven by domestic factors. When combined with corruption and persistently high unemployment, inequality is transmuted into inequity in people’s minds. In both Egypt and Tunisia, the top of the income pyramid was composed of people who acquired their wealth through corruption. The jobless saw their problems as resulting directly from the way the rich amassed their fortunes. Indeed, fraudulent enrichment, unlike wealth gained from increased entrepreneurship, inventiveness, or harder work, is unproductive -- the result of a zero-sum game. Meanwhile, exaggerated perceptions of inequality are driven by two global factors: the ethos of today’s capitalism and globalization. Success in today’s world is celebrated immoderately. The new capitalist society -- ushered in by the Thatcher and Reagan revolutions in the United Kingdom and the United States in the 1980s -- is winner-take-all. Worse, the winner wants everybody to know he is the winner. Extravagant consumption, displays of political power, and ostentatious living are used to validate success. About a century ago, in The Economic Consequences of the Peace, John Maynard Keynes described the West’s pre–World War I capitalist society. It was the opposite of today’s: Society was so framed as to throw a great part of the increased income into the control of the class least likely to consume it. The new rich of the nineteenth century were not brought up to large expenditures, and preferred the power which investment gave them to the pleasures of immediate consumption. In fact, it was precisely the inequality of the distribution of wealth which made possible those vast accumulations of fixed wealth and of capital … which distinguished that age from all others. Herein lay, in fact, the main justification of the Capitalist System. If the rich had spent their new wealth on their own enjoyments, the world would long ago have found such a régime intolerable. Keynes thought that the long-term survival of capitalism depended on maintaining this particular structure, in which the rich are receptacles for savings, not engines for extra consumption. Asceticism was the key ingredient of Keynes’ “spirit of capitalism.” He would be perplexed by today’s version. On the one hand, communism and fascism no longer threaten its survival as they did during the inter-war period. But on the other, modern capitalism’s winner-take-all design is so far removed from industrial capitalism that Keynes had in mind that it is hard to believe that he would have been sanguine about its sustainability. Today’s economic ethos is magnified by a media that focuses only on lifestyles at the top -- those of the richest, the most beautiful, the most successful. Of course, the media does not choose its stories arbitrarily; it is driven by public preferences as much as it shapes them. And people want to know about the top. The difference in skill between the world’s number one tennis player and its hundredth, for example, is minimal, but the difference in the endorsements they receive is huge. Today, it is no longer only the “physical” marginal product (the quality of one’s play) that determines income but also the image of being successful. No one wants to wear a shirt advertised by player number 78 in the rankings.  Thanks to globalization, this ethos has become universal. With this decade’s spread of the Internet, cell phones, and social media, people everywhere have come to know about the lifestyles of the richest of the rich, both domestic and international, and to compare themselves to them. What Marshall McLuhan famously termed the “global village” has come to pass. Carol Graham, a senior fellow at the Brookings Institution, and Stefano Pettinato from United Nations Development Program, have shown that it is not only the global poor who increasingly feel left behind, but also what she termed “the frustrated achievers” -- those who have done well in real terms but feel deprived because others have done even better. According to Graham, the more the frustrated achievers knew about those who did better, the worse they felt about themselves. China is perhaps the best example of this phenomenon today. While China’s overall living standards have improved massively in recent decades, World Values Survey data show an equally large decline in life satisfaction. Researchers credit this unhappiness to ballooning income differences, especially as ostentatious consumption has became more visible. The current process of globalization is not much different from what happened in the 1700s and 1800s, when nation-states in Europe were born of disparate villages and townships that had previously been ignorant of the lifestyles of their neighbors. Political consolidation, improved transportation, and greater contact made the differences between people much more obvious. It was often unhappiness resulting from the knowledge of these differences that forced governments to try to reduce the gaps between classes and regions -- that is why French aristocrats lost all their feudal rights during the revolution, and Giuseppe Mazzini’s Italy tried to “Italianize” the Mezzogiorno. Of course, the globalized world lacks a central authority that could do something about income gaps. Globalization has no “closure”: income differences are exposed and feelings of deprivation grow, but there is no outlet for them nor solution to them. So how should the world deal with the age of “want more”? Solving the problem through remedial action at the global level -- for example, transfers of wealth from the rich to the poor -- is inconceivable. Total official development aid to poor countries is less than three out of every thousand dollars the rich world earns. The current financial crisis is likely to depress that figure further. And such small amounts cannot make a serious dent in absolute poverty across the world, much less in feelings of deprivation. Modern capitalism’s ethos will also not change overnight; anyway, there are no dour Calvinists ready to replace our happy, globe-trotting millionaires. To jettison globalization is not only impossible, it would be outright foolish. Globalization brings enormous economic and cultural benefits; the last twenty years have seen a jump in income that rivals the increase between 1914 and 1980. Equally foolish would be a Luddite reaction to new technologies or attempts to censor what people can write about themselves or read about the outside world. The only solution to modern capitalism is modern capitalism, but with high -- very high -- and equitable growth, which is akin to a high tide that not only lifts all boats but also covers the rocks of corruption. The recipe for social instability is low growth, high inequality, high unemployment, and high corruption. Egypt and Tunisia scored high on the last two. Inequality, even if not excessive by world standards, was perceived as inequity, and growth was not a sufficient emollient for corruption. Inequality has won a spot on the top of the world’s agenda because of its objective long-term increase, the ethos of the new rich, and the forces of globalization. The three factors are not independent. Globalization contributed to the increase in inequality. The ideology of those who became rich justified it. But their behavior made these inequalities more glaring and open to questioning. It ultimately undermined the economic order from which they benefited the most. -This article was published in The Foreign Affairs on 12/08/2011 -BRANKO MILANOVIC is Lead Economist in the World Bank research group and a visiting professor at University of Maryland School of Public Policy