Consequences of Income Inequality

In a world of weak demand and oversavings, the last thing we need are policies that encourage income inequality. The people who benefit most from income inequality will use their political power to continue the process. It will eventually will hurt them as well

I live in a small city in New England south of Boston. The town of Newport  in the 18th century was once one of the largest cities in the American colonies. Today the town is not known for its large in tact collection of 18th century houses. Instead it is usually identified with another time in American history, the Gilded Age.
 
The Gilded Age occurred in the late 19th and early 20th centuries. It was a time of great economic growth. It was also dominated by some famous names such as Rockefeller, Carnegie and Vanderbilt. Many of these so-called robber barons took their enormous wealth and built huge summer houses in Newport. So as not to be ostentatious, they referred to them as ‘cottages’.
 
The largest of these cottages is called the Breakers. The house was finished in 1895. It has 70 rooms and cost $150 million in today’s money. It appears as a symbol not only of extravagance, but also of income inequality. The fabulously wealthy could build palaces, because the top 1% had managed to corner 18% of the country’s wealth.
 
But times change, or do they? Today the wealthiest 1% of Americans have managed to even out do the robber barons. They now own 24% of the nation’s wealth.
America is not alone. Throughout the world income inequality is a major problem and growing. Is this simply a question of unfairness? Yes, but is it more than that. It threatens not only social stability, but also economic growth.
 
The good news is that the rapid economic growth in China and other developing countries has made the world a more equal place. Over the past 30 years literally billions of people have been lifted out of absolute poverty. The Asian Development Bank (ADB) defines the demarcation line between the poor and the middle class as those living on more or less than $2 a day. In 1981 58% of global population lived below that line. Only 20% or 930 million lived above it. This group is defined by the ADB as ‘middle class’. They earned between $2 and $10 a day.
 
Today that middle class has grown substantially. Today 2.8 billion people or 40% of the world’s population live on between $2 and $10 a day. This is exceptionally encouraging, but there is a down side. Although almost 2 billion people have climbed out of absolute poverty, few people make it beyond the middle class and the margins to slip back into poverty are very narrow.
 
Part of the problem is that as the world became wealthier, the wealthy did much better than anyone else. The GINI index measures the disparity of wealth. It is a scale of 0 to 1.0. The lower the number, the more equal the country is. If the GINI coefficient was 0 all people would have the same wealth. If it is 1.0 just one person owns everything. In Asia the GINI index rose about 1% per year throughout the 1990s and 200s.
 
Part of this trend has to do with urbanization.  People in urban areas have more opportunities than subsistence farmers. Urban areas also grow faster. So as countries develop and urbanize inequality grows. But this is not the whole story. This is particularly true in China where the gap between the urban population and the countryside rose. In contrast in India inequality has risen sharply among urban populations.
 
Rising inequality though is not just a problem for the developing world. It is interesting to note that the United States and China have similar numbers.  According to the World Bank the GINI coefficient for the US is 45 and 47 for China. This compares rather unfavorably. The numbers for Germany and France are 28 and 32 respectively. India and Indonesia are both about 34.
 
The inequality in both the US and China are based on the legal infrastructure. The US as Warren Buffet famously pointed out taxes him less than his secretary. Investment and speculation are taxed at half the rate of earned income. The finance industry makes up 8% of the US GDP, but generates 29% of the profits. The Federal Reserve has been exceptionally helpful by providing extra  money to spur the speculation Not surprisingly talent and political power have gravitated to finance.
 
The costs of elections in the US have been skyrocketing. The total cost of the 2012 elections, including congressional races, topped $7 billion. The money has to come from somewhere and its not given for free. The US Supreme Courts’ recent decisions haven’t helped.
 
But the US politicians pale besides their Chinese counter parts. The 50 richest members of the US Congress control $1.6 billion. The 50 wealthiest delegates to China’s congress control $15 billion.  
 
But so what? Does inequality slow growth? The answer is an unequivocal yes. It reduces demand by forcing down consumption. The obvious point is that the poor have to spend more of their incomes than the rich and the rich save more. If you take purchasing power out of the hands of mass consumers, then it decreased demand. Without demand the rich have fewer reasons to justify reinvestment in productive ways such as new plants.

We are seeing this in the US. Corporations are sitting on huge piles of uninvested money. In China they keep investing, but in unproductive ways such as new uninhabited cities and over capacity. Since households retain an ever-smaller share of the total amounts of goods and services, it is hardly surprising that they also consumed an ever-declining share of GDP.
 
Income inequality is not a natural form of capitalism. It is not a prerequisite for growth. It is a choice. It is often a choice of those entrenched interests who benefit by it. But in a world of weak demand and over savings, the last thing we need to are policies that encourage income inequality. Yet the sad fact is that the people who benefit most from income inequality will use their political power to continue the process. Tragically it eventually will hurt them as well

(William Gamble is president of Emerging Market Strategies. An international lawyer and economist, he developed his theories beginning with his first-hand experience and business dealings in the Russia starting in 1993. Mr Gamble holds two graduate law degrees. He was educated at Institute D'Etudes Politique, Trinity College, University of Miami School of Law, and University of Virginia Darden Graduate School of Business Administration. He was a member of the bar in three states, over four different federal courts and speaks four languages.)

Comments
Ramesh Poapt
1 decade ago
Good,analytical article!Not many serious readers to appreciate?
SuchindranathAiyerS
1 decade ago
The Monopoly "end game". I remember that after the players were reduced to just two who owned all the sites and hotels and all the others were bank rupt, the winners would distribute all the money in the Bank (equitably) to all the players to prolong the game and the joy of winning. Provided the other players were young and naive enough. Like stealing candy from babies! The next revolution will come when the "divine rights" of "capitalism" are exorcised from the minds of the Great Unwashed of the West as the "Divine Rights" of feudal Lords was not so long ago, and the "Divine Rights" of Commissars and Neta-Babus are being questioned as we speak.
SuchindranathAiyerS
1 decade ago
The Monopoly "end game". I remember that after the players were reduced to just two who owned all the sites and hotels and all the others were bank rupt, the winners would distribute all the money in the Bank (equitably) to all the players to prolong the game and the joy of winning. Provided the other players were young and naive enough. Like stealing candy from babies! The next revolution will come when the "divine rights" of "capitalism" are exorcised from the minds of the Great Unwashed of the West as the "Divine Rights" of feudal Lords was not so long ago.
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