In the last of three postings on wealth distribution, we ask who benefits from the relentless rise of the rich.
Even in the world of high-flying soccer salaries, the deal announced late this summer between Real Madrid and Welsh player Gareth Bale was eye-popping – £85 million (about $120 million). The 24-year-old will now earn at least 10 times more in a week than the average British worker earns in a year.
Mr Bale is rich – not Bill Gates-rich – but rich. He’s also typical of many of today’s high-earners in that he’s making his own money. In previous centuries, high incomes typically came from inherited wealth. That’s why so many of Jane Austen’s characters never seem to work – they don’t need to: Their wealth is invested instead in government bonds that reliably pay an income of between 4 and 5% a year. In Pride and Prejudice, a would-be suitor reminds Elisabeth Bennet that unless she marries, her wealth will produce an income of only £40 a year: “… one thousand pounds in the 4 per cents, which will not be yours till after your mother’s decease, is all that you may ever be entitled to.”
If she were alive today, Lizzy Bennet might be running her own business and earning her own money. In that, she would be a typical member of today’s set of top earners – the 1% – which as Chrystia Freeland has written, “consists, to a notable degree, of first- and second-generation wealth. Its members are hardworking, highly educated, jet-setting meritocrats who feel they are the deserving winners of a tough, worldwide economic competition …”.
Over the past few decades, these winners have done quite nicely for themselves, most notably in English-speaking countries: In 1980, the top 1% of income recipients in the U.S. earned 8% of all pre-tax income; by 2008, their share had risen to 18% and it rose in many other OECD countries too. Several factors have worked in their favour: lower taxes; technological advances that reward skilled workers; the emergence of a global market for talent; and rising executive salaries.
But here’s a question: Are all these jet-setting meritocrats really worth it?
Historically, various justifications have been offered for income inequality – in other words, people earning more than others. As Branko Milanovic notes in The Haves and the Have-Nots, J.M. Keynes retrospectively justified 19th century inequalities by arguing that the rich had not wasted their money on fripperies but, instead, “like bees, they saved and accumulated”, so providing capital for investment, which ultimately benefited everyone.
Arguments today aren’t all that dissimilar. T.J. Rodgers, founder of Cypress Semiconductors, recently defended his own wealth by pointing to the money he had reinvested in his own firm and in new businesses, such as a restaurant in his home town that created 65 jobs. “How much more do I need?” he asked. “How many more jobs do you want?”
In essence this is an appeal to the idea of “economic efficiency” – inequality may not always be popular, the argument goes, but it ensures a society’s economic resources are put to their best use. The most influential thinker in this area was probably the economist Arthur Okun, who in the 1970s argued that there was a “big trade-off” between equality and efficiency: Reduce the wage gap by raising taxes or minimum wages and you kill people’s incentives to work hard and risk losing some of that tax money in the “leaky bucket” of government.
That argument still appeals to many, but it has its detractors. Based on an analysis of growth patterns in a number of countries, IMF economists Andrew Berg and Jonathan Ostry concluded that “when growth is looked at over the long-term the trade-off between efficiency and equality may not exist.” While some inequality is necessary to ensure markets run efficiently, the economists argue, too much can destroy growth.
Among the downsides of rising inequality, they say, are that it may pave the way for financial crises, as many argue it did in the run up to the 1929 Wall Street Crash; it may also fuel political instability, as in Brazil earlier this year; and it “may reflect poor people’s lack of access to financial services, which gives them fewer opportunities to invest in education and entrepreneurial activity.”
Indeed, that last point is increasingly invoked. As Joseph Stiglitz has written, “growing inequality is the flip side of … shrinking opportunity,” a view echoed earlier this year by Alan Krueger, then-chairman of the U.S. President’s Council of Economic Advisers: “In a winner-take-all society, children born to disadvantaged circumstances have much longer odds of climbing the economic ladder of success.”
But if we accept the idea – and not everyone does – that too much inequality benefits the rich and hurts the poor we’re left with another question: How much inequality is “too much” inequality? Economists may have their own views but, ultimately, that’s a question only politicians and societies can answer.
Previous articles in Rich Man, Poor Man:
Reducing income inequality while boosting economic growth: Can it be done – from the OECD’s Going for Growth 2012
Incomes, by Peter Hoeller (OECD, 2012)
Divided We Stand: Why Inequality Keeps Rising (OECD, 2011)
OECD work on income inequality