Global Inequality – Branko Milanovic

Global inequality is composed of inequality between countries and inequality within countries.  We can describe inequality within countries by “Kuznets waves”.  Inequality first rises as a country grows richer and when it has achieved a certain income level, inequality gradually decreases.  The theory fails to explain though why inequality has risen in developed countries since 1990, notably in the US, but also in Europe.  Milanovic introduces the concept of Kuznets cycles, rather than waves.  Benign and malign forces drive inequality up or down. High inequality is unsustainable and creates the seeds for destructive events that reduce it, but in their wake also destroy much else.
Forces that push inequality up are:
  • higher returns on capital than labour (Piketty factor)
  • high incomes from labour and capital are increasingly concentrated in the same peoplez
  • technological innovation that favours the rich (capital rents, higher wage dispersion)
  • decreasing power of unions (due to changing labour markets)
  • high availability of labour (opening up of China, India and USSR in 1990s)
  • increasing scalability and emergence of more winner-takes-all markets (e.g. education)
  • capture of political process (democracy) and media by the rich
  • monopolisation of sectors
Forces that reduce inequality are (malign or benign)
  • investment in public education
  • redistribution of wealth through progressive taxes or social programmes
  • wars, epidemics and natural disasters (World Wars or the Plague in medieval times)
  • scarcity of labour (can be reduced by immigration)
  • technological innovation that favours the poor (speculative)
Although inequality has been rising in developed countries, at the global level it has been decreasing for quite some time.  This is mainly due to the rise of China and, to a lesser extent, other Asian countries (India, Indonesia, Vietnam, Thailand).  This has come mainly at the expense of the lower middle class in Western countries.  The figure below shows how the 99th percentile (global plutocrats) and 50th-60th percentile (upper middle class in Asia) has done well during the last 20 years, whereas the 80th-90th percentile saw its income stagnating.  He notes that, as China grows richer, it will in the near future contribute to global inequality, rather than being a reducing force.

Lower inequality between countries reduces the “citizenship rent”, the importance of where one is born for whether will be rich or not. This does not mean that the “lottery of birth” becomes less important, as social mobility within countries has been decreasing.  However, in our (Western) discourse about rising inequality, it is important to note that on a global level, inequality is actually going down.  The decrease is mainly due to the rise of Asia, Africa is not contributing at all.
Milanovic discusses some of the consequences of high inequality.  On migration, which he sees as an inevitable consequence of globalization, he advocates (as Collier does) for limited access to citizenship rights (temporary worker status, higher taxes) to compensate for their higher productivity as a result of migration and access to a superior social model.  On politics, he sees plutocracy (the US option) and populism (the EU option) as consequences of high inequality and the reduced size of the middle class. A smaller middle class results in lower support for public services such as health and education and more attention for internal security and defense.  The slide away from democracy is masked by shifting attention to issues such as nationalism and identity and by overestimating social mobility.  He refers to the work of Jan Tinbergen who showed how returns on education are highest in poor countries, where few people have access to higher education.  In developed countries, access to education is widespread, the return decreases, but connections and sheer luck determine who gets access to well-paying jobs.
Milanovic present an impressive range of data and charts to make his case.  It is not an optimistic book, as he doesn’t see many benign forces that are strong enough to reduce inequality, especially in the US.

Piketty and Inequality in South Africa

Every month, hundreds of children are fleeing abject poverty in Zimbabwe and heading to South Africa. It’s a dangerous journey, but many take the risk in the hope of a better life. But once on the other side, there is help. With the support of UKaid from the Department for International Development, there is food, shelter and the chance to go to school. Find out more in our feature: Africa is a very unequal country.  It has one of the highest Gini coefficients in the world, in particularly since various Latin American countries managed to bring their coefficients down in recent years.  It should be noted that the Gini coefficient is an indicator of inequality in income, not in wealth.  However, given South Africa’s history of Apartheid and colonialism, including wealth into the equation is not likely to reduce inequality.  Conceded, the Gini coefficient also ignores progress that has been made in the provision of basic services to the poor in housing, electricity provision, healthcare delivery and education infrastructure.

Why does inequality matter? A certain degree of inequality may well be positive for society.  It stimulates people to find their talents and get the best out of them.  However, too much inequality poses various problems.   It’s morally indefensible that some people earn orders of magnitude more than others, whatever their skills. There’s also research that points to negative political effects of high inequality.  In unequal societies democracy tends to be hollowed out as decision processes are captured by a tiny elite, the masses are powerless and become disentangled and the social state is dismantled.  No longer “having skin in the game”, they vote for extremists.  Economically, high inequality reduces consumption, compared to a more even distribution of means.  High inequality also reduces social mobility, wasting talent.

Economists disagree on the evolution of inequality.  Kuznets argued that in the initial stages of development, a country becomes more unequal.  Some people move from poor to rich and compared to (almost) everyone being poor, this constitutes more inequality.  As more people grow rich, inequality would drop.  This view was challenged by Piketty in his book Capital.  Piketty’s central thesis is that inequality naturally rises within a capitalist system, because the rate of return on wealth exceeds that of income (or economic growth).  Rather than focusing only on equality of opportunity, Piketty shows that we should also worry about the inequality of outcomes.  Piketty’s thesis has drawn both praise and criticism.  Most critics acknowledge that inequality is rising, but dispute whether it’s an inherent characteristics of capitalism or whether they are other factors at play, such as globalisation and its tendency for delocalisation and winner-takes-all markets and automation, threatening many low-skilled and medium-skilled jobs.  Piketty favours the ‘utopian’ solution of a global, progressive wealth tax. Awaiting utopia, progressively taxing income and property may help.  Piketty argues that insufficiently progressive tax rates are at the basis of skyrocketing top wages.

How relevant is Piketty’s analysis of inequality for developing countries?  South Africa, with 1% of the population earning 15% of total labour income and with two thirds of the population living in poverty, seems like a good illustration of Piketty’s thesis.  Economic growth has been anaemic for years, whereas income from property and assets have been rising.  High youth unemployment and lack of unemployment benefits are one driver of inequality.  A second is the high wage gap within the workplace.  The low quality education system churns out too many unqualified people and too few qualified ones. For maths, only 3% of Grade 9 learners achieve a score higher than 50% at the latest Annual National Assessments (ANAs) and 90% remain stuck in the lowest category, which indicates a total lack of basic numeracy.  As a result, skilled people can command a premium and the former remain stuck in menial, poorly-paid jobs.  High inequality gradually erodes democratic institutions and public services are steadily privatized.

In other developing countries the situation is opposite. High inequality in countries such as Cambodia is rather the result than the cause of weak public institutions.  An effective administration to collect taxes, regulators to deal with monopolies and anti-corruption watchdogs, an impartial justice system are absent favouring a corrupt elite.  In this case, taxing the rich more will not help. Only building more effective institutions can address this.  This extends beyond nation states.

Solutions need to be found on a global scale.  Unfortunately, global governance institutions such as the WTO, WHO and the IMF provide global public goods, but suffer from a lack of democratic legitimacy, especially in developing countries.  Strengthening legitimate and global governance may help to address global inequalities.

Piketty’s book focuses on advanced countries, but the wealth of discussion it has triggered includes plenty of analysis of its relevance for developing countries.  Rising inequality within and between states is one of the defining themes of our times, partly causing and caused by Piketty’s work.

More information on the relevance of Piketty’s book for resp. developing countries and South Africa in particular can be found here and here.  Both articles are well recommended.

The picture at the top of this post is courtesy of DFID and is released under an Attribution-NonCommercial-NoDerivs 2.0 Generic license.