QUES­TIONS FOR Branko Mi­lanovic

A lead­ing econ­o­mist ex­plains the cur­rent state of global in­equal­ity.

Rotman Management Magazine - - CONTENTS - In­ter­view by Karen Chris­tensen

De­scribe the dif­fer­ence be­tween wealth in­equal­ity and in­come in­equal­ity.

It’s use­ful to think about three types of in­equal­ity: Wealth in­equal­ity, in­come in­equal­ity and con­sump­tion in­equal­ity. Wealth in­equal­ity can be sim­ply de­fined as ‘dif­fer­ences in the to­tal amount of mar­ketable as­sets that peo­ple pos­sess’. Your wealth is cal­cu­lated as the to­tal amount of money that you would re­ceive if you sold all your as­sets — your house, car, fi­nan­cial as­sets, etc. It does not in­clude ‘ac­crued as­sets’, such as pen­sion rights, be­cause they can­not be sold. On the other hand, when we talk about in­come in­equal­ity, we gen­er­ally mean dif­fer­ences in dis­pos­able in­come — that is, af­ter­tax in­come.

The key dif­fer­ence be­tween in­come and con­sump­tion mea­sures is that lots peo­ple can have zero in­come over a par­tic­u­lar pe­riod, but your con­sump­tion can never be at zero — or you would not sur­vive. If you have zero in­come, there are other ways to fi­nance your con­sump­tion: Gov­ern­ment pro­grams pro­vide as­sis­tance to the poor, so con­sump­tion in­equal­ity is muted rel­a­tive to in­come in­equal­ity. Also, the rich can lend to the poor through the fi­nan­cial sys­tem, keep­ing the spend­ing of the poor (i.e. their con­sump­tion rate) rel­a­tively high, at least in the short term. In this sense, the num­ber of poor, ac­cord­ing to con­sump­tion mea­sures, is of­ten lower than ac­cord­ing to in­come mea­sures.

At the other end of the spec­trum are peo­ple with ex­traor­di­nar­ily high in­comes who are able to save a lot of their in­come, which in­crease their wealth. The im­pli­ca­tion is that in­equal­ity of con­sump­tion is al­ways less than in­equal­ity of in­come, and in­equal­ity of in­come is al­ways less than in­equal­ity of wealth.

Lots of peo­ple fo­cus on in­come in­equal­ity as the key is­sue to­day, but if you are try­ing to mea­sure fi­nan­cial well­be­ing, it is much more use­ful to look at house­hold wealth, which, as in­di­cated, is even more un­equally dis­trib­uted than in­come.

In­equal­ity of all types is ris­ing within many na­tions, while global in­equal­ity de­clines. Please de­scribe the sit­u­a­tion.

The rea­son in­equal­ity is go­ing down glob­ally is that very large, pop­u­lous and rel­a­tively-poor coun­tries like In­dia and China are grow­ing quickly. What is dif­fer­ent be­tween na­tional in­equal­ity and global in­equal­ity is that for global in­equal­ity, you have an el­e­ment to con­sider that is some­times for­got­ten: The rel­a­tive growth rates be­tween poor and rich coun­tries. For ex­am­ple, when China and In­dia grow faster (in per capita terms) than the U.S. and Europe, global in­equal­ity will tend to go down, even if in­equal­i­ties within coun­tries them­selves in­creases. Of course, in­creases in within-na­tion in­equal­i­ties ex­ert an off­set­ting ef­fect — push­ing global in­equal­ity up — and then the ques­tion be­comes, which of the two ef­fects (in­come con­ver­gence or ris­ing within-na­tion in­equal­i­ties) will be stronger? In the past 25 years, the for­mer has been stronger.

Who has gained the most from glob­al­iza­tion?

That is sim­ple to prove em­pir­i­cally: Dur­ing the pe­riod of high glob­al­iza­tion (1988-2008), peo­ple in the lower and up­per mid­dle classes in Asia gained the most. This is not sur­pris­ing, be­cause we know that Asian coun­tries — in par­tic­u­lar China, but more re­cently In­dia, In­done­sia, Thai­land and Viet­nam — have grown sig­nif­i­cantly, and they continued to grow dur­ing the global re­ces­sion.

The sec­ond group that has gained sig­nif­i­cantly from glob­al­iza­tion is the top 1%, both in rich coun­tries and in other na­tions. How­ever, their gains—and therefore their wealth — was re­duced some­what by the fi­nan­cial cri­sis.

Greater par­tic­i­pa­tion of women in the work­force re­duces in­equal­ity be­tween house­holds.

Are the gains of Asia’s mid­dle class di­rectly re­lated to the losses of the lower mid­dle class in the rich world?

If you’re ask­ing, Can we show that the gains of one group are caused by the losses of an­other group?, that is a very dif­fi­cult propo­si­tion to prove, even in spe­cific in­stances like ‘China vs. the U.S.’ or ‘Asia vs. Europe and the U.S.’ As a re­sult, there have been very few stud­ies of this. How­ever, there have been a num­ber of stud­ies look­ing at the role of Chi­nese-im­port pen­e­tra­tion on U.S. wages, and my read­ing of that lit­er­a­ture is that there is sig­nif­i­cant cor­rob­o­ra­tion that Chi­nese im­ports have had a long-term neg­a­tive im­pact on wages in sec­tors that com­pete with these im­ports. Many peo­ple have ei­ther lost their jobs or their long-term wages have been re­duced, and in this sense, there is some causal­ity be­tween the two.

Even if causal­ity ex­ists, it doesn’t mean that we should re­ject glob­al­iza­tion, be­cause it has de­liv­ered many more gains than losses. The sit­u­a­tion sim­ply calls for poli­cies that take into ac­count who the ‘losers’ will be. The fact is, glob­al­iza­tion is not a win/win for ev­ery­body: Some groups will lose, while many more gain.

Re­search shows that women’s in­creased par­tic­i­pa­tion in the labour force has re­duced in­equal­ity by some 19 per cent. Why would this be the case?

That came out of an OECD study that looked at 25 rich coun­tries. What gen­er­ally hap­pens is, when you have greater fe­male par­tic­i­pa­tion in a labour force, women are mostly at the lower end of the wage scale — and this ef­fect is en­hanced by the 20 per cent wage gap that ex­ists be­tween men and women. Es­sen­tially, the mid- and lower-wage seg­ments of earn­ers have a lot more peo­ple in them than high-wage seg­ments, and as a re­sult, over­all in­equal­ity goes down.

More im­por­tantly, women’s par­tic­i­pa­tion in the work­force in­creases to­tal house­hold in­come, and we mea­sure to­tal in­come dis­tri­bu­tion at the level of house­holds. If you have more house­holds with two earn­ers, over­all in­equal­ity goes down — and this is true de­spite the ten­dency of rich male and fe­male wage earn­ers to marry and/or part­ner with each other. The bot­tom line is that greater par­tic­i­pa­tion of women in the work­force re­duces both wage in­equal­ity

among wage earn­ers and in­equal­ity of dis­pos­able in­come among house­holds.

The ‘Kuznets hy­poth­e­sis’ [that in­equal­ity is low at very low in­come lev­els, then rises as an econ­omy de­vel­ops, and even­tu­ally falls again at high in­come lev­els] is quite dif­fer­ent from Thomas Piketty’s view [that cap­i­tal­ism it­self yields ris­ing in­equal­ity]. Do you agree with ei­ther of them?

Both Piketty and I are big ad­mir­ers of Kuznets’. Piketty makes many ref­er­ences to Kuznets in Cap­i­tal in the 21st Cen­tury, but he re­jects one im­por­tant hy­poth­e­sis: The so­called in­verted U-curve.

Kuznets ar­gued that at the very early stages of eco­nomic de­vel­op­ment, in­equal­ity is low. As a so­ci­ety in­dus­tri­al­izes, in­equal­ity grows, and then, as the so­ci­ety be­comes ma­ture, it should go down again. That hy­poth­e­sis made a lot of sense un­til 1980 — but since then, we have seen an in­crease in in­equal­ity in the rich world, which seems to dis­prove Kuznets’ hy­poth­e­sis.

My ar­gu­ment is that we should in­stead think about ‘Kuznets waves’. The first wave that Kuznets de­scribed hap­pened from the late 19th cen­tury un­til ap­prox­i­mately 1980. Then, the tech­no­log­i­cal rev­o­lu­tion oc­curred in the 1990s, along with glob­al­iza­tion, push­ing us into a sec­ond Kuznets wave. Re­mem­ber, Kuznets wrote in the 1960s, so he saw the first wave, but he could not have imag­ined — for ob­vi­ous rea­sons — that it would be suc­ceeded by other waves. We now have his­tor­i­cal data that he didn’t have in the 1960s, show­ing that sim­i­lar waves did oc­cur in the past. By the way, some fol­low­ers of Piketty do not ac­cept my wave ar­gu­ment. They main­tain that there are strong forces within cap­i­tal­ism that push in­equal­ity up — obviously not for­ever, but cer­tainly to the lev­els that it at­tained in rich coun­tries some one hun­dred years ago.

I con­sider the cur­rent in­crease in in­equal­ity over the last 25 or 30 years to re­flect the sec­ond tech­no­log­i­cal rev­o­lu­tion, struc­tural trans­for­ma­tion of the econ­omy away from man­u­fac­tur­ing jobs and into ser­vices, and glob­al­iza­tion. There are strong sim­i­lar­i­ties to the first up­swing of the Kuznets wave, be­cause you can ar­gue (as Kuznets did) that it was the prod­uct of the In­dus­trial Rev­o­lu­tion and struc­tural change away from agri­cul­ture and into man­u­fac­tur­ing.

In the 20th cen­tury, in­equal­ity was re­duced by forces in­clud­ing in­creased tax­a­tion and so­cial trans­fers, hy­per­in­fla­tion, union­iza­tion, ed­u­ca­tion and wars. Will these same things be re­quired to re­duce in­equal­ity in the 21st cen­tury?

I di­vide the forces that re­duce in­equal­ity into ma­lign and be­nign forces, and the prin­ci­pal ma­lign force in the mod­ern era is war. It has re­duced in­equal­ity not only through the de­struc­tion of phys­i­cal as­sets but also through the in­creases in tax­a­tion that were nec­es­sary to fi­nance war ef­forts. And sadly, in to­day’s en­vi­ron­ment, we can­not rule it out.

The key be­nign forces that re­duced in­equal­ity in rich coun­tries be­tween the end of World War II and the 1980s were mass ed­u­ca­tion, trade unions, so­cial­ist po­lit­i­cal par­ties, high taxes and so­cial trans­fers, and tech­no­log­i­cal progress (where it helped low-skilled labour more than high­skilled labour).

I don’t think many of these forces will re­main op­er­a­tive in the near fu­ture. Trade unions have been pretty much dec­i­mated, not only by anti-labour leg­is­la­tion but also by the move­ment away from the mas­sive fac­to­ries that brought large num­bers of work­ers to­gether in one place. Mass ed­u­ca­tion will not play a big role ei­ther. It was a force for equal­iza­tion when rich coun­tries moved from an av­er­age of six or seven years of ed­u­ca­tion to to­day’s av­er­age of 13; but we are not go­ing to see a mas­sive move from 13 to 20 years of ed­u­ca­tion. That is why the qual­ity of ed­u­ca­tion, rather than a fo­cus on mass ed­u­ca­tion, is cru­cial to­day.

Fi­nally, I do not think that higher taxes and trans­fers are ac­cepted any longer by the ma­jor­ity of the elec­torate, and that may be due to the skep­ti­cal view that to­day’s cit­i­zens have of gov­ern­ment’s abil­ity to use money ef­fec­tively.

What is the most pow­er­ful be­nign force to re­duce in­equal­ity?

In my view, we should be fo­cus­ing on the equal­iza­tion of

At least half — and pos­si­bly more — of your in­come is de­ter­mined by where you live.

en­dow­ments. This means first, bet­ter ac­cess to high-qual­ity ed­u­ca­tion for all, so that the re­turns to ed­u­ca­tion be­come more equal, and sec­ond, what I call ‘de-con­cen­tra­tion’ of cap­i­tal own­er­ship. That means tax in­cen­tives to pro­mote wider own­er­ship of cap­i­tal and in­cludes greater par­tic­i­pa­tion in Em­ployee Stock Own­er­ship Plans.

If wage gaps be­tween work­ers de­crease and dis­tri­bu­tion of in­come from cap­i­tal be­comes more equal, then you can achieve rel­a­tively equal out­comes even with­out a greater gov­ern­ment role in the redis­tri­bu­tion of cur­rent in­come. If this is not done, the dan­ger is that with the heav­ily-skewed dis­tri­bu­tion of prop­erty that ex­ists to­day in the rich economies, any in­crease in the cap­i­tal share of na­tional in­come trans­lates di­rectly into greater in­equal­ity in per­sonal in­comes. Then you ei­ther let in­equal­ity get worse or you need to in­crease redis­tri­bu­tion of cur­rent in­come — for which, as I men­tioned, there is lit­tle po­lit­i­cal ap­petite. You will be thus left with­out in­stru­ments to off­set un­der­ly­ing in­creases in in­equal­ity.

There are other tools that would help. For one, the tax­a­tion of wealth, in­clud­ing in­her­i­tance — which, strangely enough, has ac­tu­ally gone down re­cently. How­ever, I re­ally be­lieve that we should pay more at­ten­tion to equal­iz­ing the as­sets that peo­ple own. And redis­tri­bu­tion will re­main as an ex­tremely im­por­tant mech­a­nism, but I doubt that it can be sig­nif­i­cantly in­creased.

Talk a bit about the dif­fer­ence be­tween ‘lo­ca­tion-based in­equal­ity’ and ‘class-based in­equal­ity’.

It turns out that 50 to 60 per cent of in­come dif­fer­ences be­tween in­di­vid­u­als in the world to­day are due sim­ply to the mean in­come dif­fer­ences be­tween the coun­tries they live in. In other words, if you want to be rich, you had bet­ter be born in a rich coun­try — or em­i­grate there. The poor­est peo­ple in the U.S. have an in­come level that is equal to that of the lower mid­dle class in China and the up­per mid­dle class in In­dia.

Put sim­ply, at least half and pos­si­bly more of your in­come is de­ter­mined by where you live, which for 96 per cent of peo­ple in the world, is where they were born. Then, about 20 per cent is due to the in­come level of your par­ents. So, your cit­i­zen­ship plus your parental back­ground ex­plain around 70-80 per cent of your in­come. Obviously, if I had data for gen­der, race, eth­nic­ity and other things that are sim­i­larly ‘given’ to an in­di­vid­ual at birth, that per­cent­age would go up. But the lion’s share of it is due to cit­i­zen­ship, and as a re­sult, this is what I call ‘the cit­i­zen­ship pre­mium’ or ‘cit­i­zen­ship rent’.

Does in­equal­ity threaten the sus­tain­abil­ity of demo­cratic cap­i­tal­ism?

Yes and no. I wouldn’t say that it threat­ens the sta­bil­ity of cap­i­tal­ism as such, sim­ply be­cause there are no al­ter­na­tives. When you look at it ob­jec­tively, 50 years ago, slav­ery still ex­isted in some coun­tries and feu­dal re­la­tions were preva­lent in places like Afghanistan and in the early 20th cen­tury in Iran and (what is now) Pak­istan. But that is all prac­ti­cally gone. Things have be­come much more com­mer­cial­ized. We also faced the huge chal­lenge of so­cial­ism, with the na­tion­al­iza­tion of prop­erty, cen­tral plan­ning and so on; and that is also gone. So we re­ally have, for the first time in his­tory, the to­tal dom­i­na­tion of one mode of pro­duc­tion, and it doesn’t have any com­pe­ti­tion.

The is­sue is re­ally about demo­cratic cap­i­tal­ism, and that is a very dif­fer­ent propo­si­tion. Many regimes have been cap­i­tal­ist, but not demo­cratic: Spain, Greece, Chile, South Korea, Brazil and his­tor­i­cally, Ger­many, Aus­tria, Rus­sia and many oth­ers. The kind of dis­en­chant­ment with demo­cratic po­lit­i­cal pro­cesses that we are see­ing to­day is some­thing that might lead to the strength­en­ing of au­thor­i­tar­ian ten­den­cies or to ‘il­lib­eral democ­racy’, as it is called. I’m not sure that this is some­thing we will be able to avoid. There is no doubt in my mind that cap­i­tal­ism will re­main; but democ­racy is more ques­tion­able.

Branko Mi­lanovic is the au­thor of Global In­equal­ity: A New Ap­proach for the Age of Glob­al­iza­tion (Belk­nap Har­vard, 2016). He is on the fac­ulty of the Stone Cen­tre on So­cio-eco­nomic In­equal­ity, is a Vis­it­ing Presidential Pro­fes­sor at the Grad­u­ate Cen­tre, City Univer­sity of New York, and was for­merly a Lead Econ­o­mist at the World Bank.

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