Making A Difference

The Sun Used To Shine Here

Worsening income distribution hits all but the rich. It’s time to resurrect the welfare state

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The Sun Used To Shine Here
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Chasm At Our Feet

  • The growing income gap within countries, encompassing both the US and China, has been a damaging economic trend universally
  • The rapid increase in the income share of the richest one per cent results in a new class of have-nots
  • This was the result of three decades of erosion of belief in the policies of social equity

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The income gaps that separate the super-rich of the world from the middle classes of varying sizes, and from close to 1 billion people who still live on less than $1 a day, remain very large—in fact, outrageously large. According to World Bank economist Branko Milanovic, the 77 per cent of people in the bottom of the world income distribution receive 20 per cent of global income, the same as the 1.75 per cent richest people! Protests and unrest in Greece and Spain this autumn, as well as the ongoing ‘Occupy’, ‘Outrage’ and many other social movements, reflect the deep sense of social injustice that has taken hold around the globe.

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These gaps, or “global income disparities”, result from forces affecting income distribution within countries, and differing income levels among countries. Social class was the main determinant of income disparity as late as 1870, but location then took its place as the Industrial Revolution widened income gaps between developed and developing countries. Location still determines four-fifths of global income disparities. Where you live matters most today in determining your economic well-being.

But growing income gaps within countries—and, particularly, the rapid increase in the share of income of the richest one per cent and even the richest 0.1 per cent of households—has been the most damaging economic trend over the past three decades. It encompasses the US, historically regarded as the land of opportunity, as well as the world’s new powerhouse, China. As a result, a new world of have-nots has taken shape in wealthy countries. And while there may be fewer have-nots in the less wealthy countries that have grown rapidly, even there, people at the top have benefited disproportionally from stronger economies.

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According to economist Giovanni Andrea Cornia, 76 per cent of the world’s people live in countries where income inequality widened in the last decades of the 20th century—Russia and Britain join the US and China as leaders here—while only five per cent live where distribution improved, like South Korea. (The remaining 19 per cent live where there was no significant change.)

Things were somewhat better in the first decade of this century, thanks to improvements—or, in many cases, partial reversals—of adverse trends in some developing nations, particularly those in Latin America, with Brazil as an important example. Still, 60 per cent of the world’s people now live in countries where income distribution continued to deteriorate over the past 10 years.

The news isn’t all bad. For decades, living standards have risen in the two largest developing countries, China and India, and several other Asian economies. However, other regions continued to lag behind the developed world until the end of the 20th century. Since early this century, these spots have become brighter, as most developing countries grew faster in per capita terms than developed countries—in contrast to the past 200 years.

Is globalisation the culprit or the solution to income gaps that prompt public outrage around the world?

Economic historians refer to two eras of globalisation: The first started in the second half of the 19th century and ended with the Great Depression of the 1930s; the other began in the 1960s and continues to this day. Broadly speaking, both have been associated with greater income inequalities within countries. In between, a weakening of international ties greatly improved income distribution in the developed world. That was in part because of the rise of institutions and policies, like labour standards and a commitment to welfare state policies; many of those developments were, no doubt, related to the ideological confrontation of the Cold War.

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In recent decades, most of these policies and institutions have weakened, sometimes quite significantly. Talk of a “race to the bottom” has grown louder, spurred by the declining bargaining power of labour unions, reduced employment protection and weaker redistributive taxation. The social values associated with income equity have in turn been replaced in conservative circles by the view that income disparities contribute positively to innovation and growth. Welfare states have so far done better in avoiding these trends, but there is now the looming threat of significant cuts in welfare benefits in industrial countries undergoing austerity programmes (think Greece and Spain).

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Increased education everywhere has been a plus, but that has not been enough to counteract negative factors. In contrast, many economists argue that technology has contributed to rises in income inequality worldwide by generating a bias in favour of skilled workers. But this hypothesis is shaky on two counts: it is unclear why the tendency for this to happen has been stronger in some countries, like the US, than in others like Japan or Western European nations, or why technological change did not have a similar effect until the 1970s.

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Protests like Occupy Wall Street have renewed focus on equality. (Photograph by Marcus Yam)

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Growing trade integration may have had adverse effects on developed countries, forcing them to compete with goods produced by low-paid workers in less developed nations. Still, that doesn’t explain why trade growth has also been associated with worsening income distribution in many developing countries. Immigration may have a slight effect on low-income workers in developed countries, but for the most part immigrant workers there occupy jobs local workers are unwilling to fill.

Economists across the ideological spectrum, including Nobel Prize winner Joseph Stiglitz and former imf chief economist Raghuram Rajan, have suggested that the stagnation or even regression of median incomes in the US contributed to the current crisis through increased household debt. A recent Brookings Institution study of income inequality in the US suggested that a growth in demand, key to a strong economic recovery, would remain weak if income distribution continues to deteriorate thus. Along that line of thought, one could argue that the best way to rebalance European economies would be to increase wages in Germany and the Netherlands, which export more than they import, and not only to reduce them in periphery countries, like Greece and Spain, which face deficits. However, global integration and fears of Chinese competition limit willingness to increase wages.

Conventional economic thought argues that global integration and the accompanying wider trade, mobility of capital and transfer of technology leads to more equal income levels among countries. Yet income gaps between developed and developing countries widened until the last decade of the 20th century, as did income disparities between developing countries. Explanations for the recent narrowing of income gaps between developed and developing nations must, therefore, lie elsewhere.

One prominent cause is the strong upward trend—the “super-cycle”—of commodity prices unleashed by the rise of China since 2004. Chinese growth has benefited the many developing economies in Africa, South America, the West Asia and Central Asia that are based on the sale of natural resources like oil, copper or soybeans. Chinese investments in infrastructure and mining have also helped many developing countries seize the opportunities generated by the rise of the Asian giant. Another positive factor has been the increased commitment to development assistance made at the 2002 United Nations Conference on Financing for Development, which benefited many of the world’s poorest countries.

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Within countries, the most likely culprits behind greater income inequality are the weakening of institutions and policies that help combat economic inequalities: political commitment to the welfare state; redistributive taxation; employment protection (including minimum wages); strong labour unions; and placing equity at the centre of the social contract—that is, valuing more equitable societies and a large and prospering middle class as great social achievements. A first step in treating the pandemic of inequality would be to restore belief in these institutions and policies, and concomitantly, government commitment to them.

The economic crisis will continue to weaken commitments to the ideals of the welfare state, and the ranks of the have-nots in the developed world may thus increase. Gaps in income levels among nations, however, are likely to continue narrowing, for both a positive reason: the dynamism of the “global South,” particularly China; and a negative one: the deep crisis that developed countries, particularly in Europe, face.

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Some of the benefits unleashed by China’s growth, such as high commodity prices, may soon end, however, and China itself may slow down due to its own structural imbalances—particularly the abnormally high share of investment in domestic demand, and the equally abnormally low share of consumer spending. The global crisis is already reducing developed countries’ financial assistance to developing nations. More importantly, perhaps, the crisis is likely to affect developing countries in varied ways, deepening the diversity among them.

This mixed prognosis is why it makes sense to place better global income distribution at the centre of international policy commitments, in particular those that will succeed the UN’s Millennium Development Goals after 2015. To do this, strong international cooperation is needed in at least four areas: funding for development assistance; raising education levels; strengthening social protection; and increasing tax cooperation to limit the race to the bottom in redistributive taxation.

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National governments should favour policies that improve income distribution: investments in education; upholding the ideals of the welfare state; supporting institutions that protect workers; redistributive taxation; and overall social and political values that again place equity at the centre of the social contract.

This agenda may appear over-optimistic at a time when governments, businesses and people around the globe struggle for economic survival. The world may in fact be heading in the opposite direction. But many political and social movements are putting equity back on the agenda, and the voices of their adherents are growing louder. The ongoing crisis may, in the end, redirect the focus of domestic and global policymakers toward a world of more haves, and fewer have-nots.

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Ocampo, a former Colombian minister of finance, is a professor and member of the Committee on Global Thought at Columbia University

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