The world is facing an inequality crisis

A man from the small Western Pennsylvania town of Windber where 11.1% of the population live below the poverty line, with a median household income of $23,261. Photo: Mark Makela/ Getty Images.

Inequality around the world is growing.

Just look at the chart from AMP Capital below as evidence.

Source: AMP Capital

This demonstrates rising inequality, showing what’s known as Gini coefficients for individual developed nations and emerging nations since the early 1980s.

It’s a scorecard on how equally income is distributed among a nation’s residents. A score of 0 indicates that income is equally distributed whereas a score of 1 is the opposite.

Essentially, 0 means all residents get the same income while 1 means that one person, or household, gets everything.

As the chart shows, income inequality has been on the rise, with an increasingly small percentage of population receiving more of the income pie.

And, compared to many European nations, income inequality is particularly acute in the US, UK, New Zealand, Spain and Australia.

Source: AMP Capital

So why has inequality risen over the past four decades, and perhaps more importantly, why has it suddenly become an issue?

To Shane Oliver, chief economist at AMP, there’s not been one signal factor to explain the deterioration, but many.

Here’s his assessment on the main four factors that have contributed to the increase in inequality:

  • The rise in the profit share of GDP from its lows around the early 1980s in developed countries likely benefitted higher income earners who derive a greater share of income from profits via higher levels of company ownership either directly or via shares.
  • Technological innovation has likely boosted inequality as it has boosted demand for skilled workers at the expense of unskilled workers, supplanted middle income jobs in more recent years and has contributed to a “superstar economy” in which a few “winner-take-all” firms and app designers can earn super normal returns globally without generating the jobs and incomes that the technologies of the past might have.
  • Globalisation, by supplanting low income jobs in advanced countries, may have contributed to increased inequality.
  • Rapid economic development in emerging countries at a time when their progressive taxation systems are not fully developed likely benefitted higher income earners more than lower income earners in these countries, even though living standards rose across the board.

So a combination of technological change and globalisation has eliminated many low-skilled jobs, especially in developed nations, has been a factor, along with a lack of tax reform in emerging nations.

And increasing levels of corporate profitability has, over time, also benefited higher income households more than most.

While this process has been ongoing for some time, Oliver says the reason income equality has suddenly come to the fore is because now, as opposed to prior periods, it’s becoming apparent to an increasing number of people that they’re going backwards.

“Prior to the GFC, rising levels of inequality were likely masked as either wages were rising solidly people were able and willing to take on more debt. When your own income or at least your living standard is on the rise, you are less likely to take note of those better off than you are. But when your income growth slows and you are less able to take on more debt to make up for it, how the ‘better off’ are doing becomes a bigger issue,” he says.

He says that heightened levels of job insecurity in the post GFC-era is likely adding to anxiety and tension around the issue of rising inequality.

As we’ve all seen recently, the lift in income equality has left its mark on politics around the world.

Populist policies are unlikely to deliver long-term benefits

The UK “Brexit” outcome last year in June was one notable surprise, as was the election of Donald Trump as US president some five months later — both outcomes were seen as highly unlikely by many pundits before they occurred.

Instead, the people spoke, delivering a strong message to policymakers that they were fed up with the status quo. They saw themselves being left behind, and they acted decisively, stunning the establishment.

While not to the same scale, there were similar outcomes seen in recent French and Australian parliamentary elections.

This backlash against the establishment has, understandably, caught the attention of those already in power, and has seen the debate over ways to address rising inequality come to the fore, including increasing taxation on the wealthy.

To Oliver, while these populist policies may deliver short-term political gains, in the long-run the benefits are likely to be outweighed by the costs.

“The danger is that such a focus may lead to a return to economic policies, such as ever-higher top marginal tax rates, that discourage work effort, lead to a smaller national income base than would otherwise be the case, and a return to the worker versus boss confrontational environment that resulted in lower growth in productivity and living standards in the 1970s,” says Oliver.

“The risk is that rising inequality and a populist response to it help drive a shift away from rational economic policies, which ultimately leads to slower productivity growth and eventually rising inflation as the supply side of economies is damaged.

“A degree of inequality is essential in a free market economy to ensure there are incentives to be productive, invest and innovate.”

And there lies the centerpiece of the debate ahead — how can can inequality be addressed without discouraging people from attempting to get ahead?

Tax too much and the best and brightest will either leave or give up, creating even greater economic challenge that could amplify inequality further.

There’s no easy solution, but whatever solution policymakers come up with, it should be with the long-term picture in mind.

“The key for governments and policy makers in seeking to address the issue of rising inequality is to get the balance right between achieving an outcome which is fair and contributes to balanced sustainable growth but not going so far as to depress incentive and productivity,” says Oliver.