I am currently taking a class called “Global Inequality and Growth”, taught by Gabriel Zucman, a very accomplished economist who wrote, “The Hidden Wealth of Nations“. As you may know, (socio)economic inequality is a cause I really care about. This class is also really special to me because I’ve taken a class with Emmanuel Saez, almost met Thomas Piketty, and now I’m taking a class with Gabriel Zucman. To me, these three (French) economists are at the frontier of economic research about inequality, pushing the way we think about wealth and income in the 21st century.
Inequality is also becoming more and more important to the public. Inequality is one the topics that is driving Bernie Sanders’ presidential campaign. Inequality is so important, especially in a developed economy because it’s basically making a statement about relative poverty.
So, I’ve hit the trifecta!
(And I’ve also taken a class on Wealth & Inequality with Robert Reich, so quad-fecta?)
I’m not an expert in inequality, but I do want to highlight some facts.
- The economic academic realm today, inequality is actually not fully understood. It’s a relatively new economic concept, highly complex, and we don’t really have good data on the true levels of inequality that exists. The data is getting better and more comprehensive but as inequality is a phenomenon that must exist over long periods of time, good data about today cannot totally tell us what happened a decade ago, five decades ago, a century ago, more than a century ago. Which goes into my next point:
- Inequality is a phenomenon that that has come to exist over time. It is pretty much impossible for the top 1% to own about 42% of the entire nation’s wealth (2012, United States) in a span of a few years. They must have been accumulating wealth and saving for many years before that. It’s important to look at inequality in the past so we can understand the causes of it.
- Rising inequality is a phenomenon that is occurring in many developed nations in the world, but the extreme level at which inequality rises is unique to the United States (and arguably, to a certain extent, other Anglo-Saxon countries).
- Note: we only have relatively good data for rich developed nations, so the information here is not externally valid to developing nations.
- The relationship between inequality and economic growth is ambiguous.
- There are two types of incomes:
- Labor income, which is comprised of earnings, salaries, wages, etc. The money that you earn through your labor.
- Capital income, which is comprised of rents, dividends, interests, capital gains, etc. The money that you earn through capital.
- The combination of labor income inequality and capital income inequality (or wealth inequality) make up overall income inequality.
- So, when we talk about “income”, it’s technically more than just the wage people earn. But, in public discourse, addressing labor income inequality is much more popular.
- Income is a flow and wealth is a stock.
- Capital income is related to wealth through assets (eg. houses, equities, pensions, stocks, inheritances, and other business assets)
- For example, you own a home and you rent it to out to tenants. Say, you bought the home for $1 million, and your tenants pay $1000. Your house is your asset, so your wealth stock is worth $1 million, but your capital income is $1000.
- Another example, you have $10,000 in your savings account with an interest rate of 5%. Your wealth is the amount on your savings, $10,000. Your capital income is the $500 you will earn from interest. Then, the next time your interest is compounded, your wealth actually increased to $10,500, and the $525 you earn through interest is capital income.There are two types of inequalities: income inequality and wealth inequality.
Now, with some fundamentals in place, I’m going to turn my attention to the United States (I had previously written about inequality broadly in regards to Vietnam and other things), and income and wealth inequality in the US.
- Note: The mechanisms that caused labor income inequality are totally different from those that caused capital income inequality. Therefore, the mechanisms to address the two inequalities must also be different.
Let’s talk about labor incomes first. In the US, the top 1%’s share of labor income has increased over time. They have captured most of the income growth since the Recession.
Addition to that, the minimum wage in real terms (adjusted for inflation) is lower today than it was in 1968. This means that while labor incomes at the top are increasing, the labor incomes at the bottom are remaining stagnant or even decreasing. The purchasing power of the bottom is declining, so people cannot survive solely on their wages. Then, we have examples like Walmart, where Walton family is ultra-super rich, while many of their workers are on welfare (another one of Bernie’s causes, and we’re not even going to start talking about corporate welfare). This is also a reason why our discussion about UNemployment should also include discussion on UNDERemployment and wages.
That’s a very brief picture of labor income inequality, and things that drive rising labor income inequality has to do with earnings, wages, and salaries. Therefore, things to address labor income inequality would be things like the minimum wage, labor unions, and taxes. It makes sense that there are campaigns like “Fight for $15” and raising the marginal tax rate. These initiatives would assist in making sure that people are earning living wages as well as taxing the super-high incomes of the rich, closing the rich-poor gap.
Now, let’s talk about wealth inequality. Wealth inequality is driven by capital income, which is driven by the wealth you already own. You can’t receive any capital income if you don’t own any capital, right?
Looking at the shares of wealth by percentage (Table 2), the top 1% owns about 40% of all the wealth in the US and the bottom 90% owns only 23% of the wealth. Inequality becomes more stark when I tell you this generalization: If you say that the middle class is represented by people between the 50th to 90th percentile, the middle class owns about 23% of all the wealth. This leaves the bottom 50% with 0% of the wealth. Zero. (Keep in mind that net wealth = assets – liabilities, so people in the bottom can own wealth – usually in the form of housing or pensions, but high levels of debt offset that wealth).
So, wealth inequality is much more unequal than labor income inequality. In other words, wealth is much more concentrated than labor income, and this inequality becomes more of a problem because the bottom 50% don’t own any wealth. So, how do we address this? Things that contribute to capital income are capital gains (from the sale of a property or investment), rents (from housing), dividends (from stocks), interest rates (from savings), and returns (on equities and bonds and other assets). So, some discussion to tackle wealth inequality suggest taxing capital gains. Or, maybe increasing opportunities for the middle class to purchase housing?
But, is that all?
To back track, I want to repeat that you can only have a capital income if you have capital, if you have wealth. So, how do people get wealth? Wealth can be self-made, people work hard and save their incomes, buy housing, and/or use their incomes to invest in stocks or bonds. Wealth can also be inherited, meaning you don’t need to do any any work to be wealthy.
So, in addition to capital gains taxes, we can also address wealth inequality through inheritance taxes, estate taxes, and wealth taxes. The thing is, in the US, capital gains are generally taxed at lower than labor incomes, there isn’t wealth tax, and very few people are eligible to pay inheritance and estate taxes. Therefore, at the present moment, wealth inequality is what is driving what overall income inequality looks like in the US.
One thing I would like to mention is that addressing labor income inequality is much easier to address than wealth inequality. This is why, for politicians especially, addressing income inequality is usually more about labor incomes, not capital incomes and wealth. There are many reasons for this:
- How much people earn is much easier to know than what people own. We all have to file for income tax, and there are pretty good national accounts to tell us about what people’s salaries are. But, the data is not that great for wealth, especially since the US doesn’t have a wealth tax (unlike many European countries). We just don’t understand wealth inequality as well as labor income inequality.
- Labor income has more utility. You spend your labor income. A majority of people rely on only their labor to survive. Like I previously stated, the bottom 50% of the population own no wealth. In extension to that, some people require a good labor income in order to get wealth in the first place.
- Wealth is an accumulation of capital that occurs over time. It generally doesn’t happen that you are poor one year and exorbitantly wealthy the next (unless you inherit your wealth); that’s probably more likely to happen more for labor income. This would mean that even if we put in effective policy to address wealth inequality, it’s not going to be more equal overnight. It’ll take time.
Actually, the last time Europe had a pretty equal distribution of wealth was when it was basically all destroyed during the First and Second World Wars. But, I don’t think we want to start a world war just to redistribute wealth.
- In relation to that, it’s harder to redistribute wealth (unless you’re in 1950s Vietnam) because that might mean that the government seizing your assets (ie. eminent domain), which we don’t agree with, right? So, all we can do is tax the income that you get on your assets (which will slow your accumulation of wealth and is also controversial, depending on how you gain that wealth, but we’re not going to go there). In relation to politicians, their campaigns are appealing if they can propose solutions to problems that are tangible and practical (Immigration, a problem? Build a wall, right?). The public won’t support a candidate if he/she is promising something that is vague or doesn’t seem attainable.
So overall, we just don’t really understand what inequality is – data isn’t perfect – and what do about it. We know it exists, and we know that it’s probably going to increase within the next few years. We know that wealth inequality is more much unequal than labor income inequality. But, no one is really sure what the solutions should be.
So these days, we’re talking a lot about inequality. We’re talking about it because there’s a feeling of injustice that in a meritocratic society, people are working hard yet are not experiencing a lot of gains. That most of income that is being created actually goes towards the top. That one person at the top is making 300 times than his median worker – sure, he should make more than the worker, but that much more? That the bottom 50% of the population essentially own no wealth. That just doesn’t seem right. And what studies are also showing is that in countries that are more unequal, there’s a correlation with lower levels of social mobility. In other words, a good predictor of what you will earn in the future is what your parents earned, meaning that if you want to be rich, it’s becoming more important to be born in a rich family than it is to work hard. And what kind of meritocracy is that?
Over and out.
PS. There are definitely many more economists that are doing important research on inequality right now – Paul Krugman, Raj Chetty, David Autor, etc. – but the three that I’ve mentioned have made the biggest impact on my understanding of inequality.
Update (13 April 2016): Boom! One day after I posted this, there was a leak of the “Panama Papers“. 11.5 million documents from Mossack Fonseca, a Panama-based firm, were leaked. Panama is a site for tax havens! People are still in the process of going through the papers, but it caused quite a stir in Europe! This is important because the Papers suggest that many powerful political figures have been involved in hiding their wealth in tax havens (in order to evade taxes?).
Also, since I also talked about where wealth comes from, I just want to share an article I found claiming that “Most Billionaire Wealth is Unearned“. Enjoy!