My interview with Goldman Sachs magazine Fortnighly Thoughts: Populism or plutocracy?

Branko Milanović is the visiting Professor at City University of New York Graduate Center and former lead economist at the World Bank’s research group, where he worked on the topics of income inequality and globalisation. He is the author of The Haves and the Have-Nots: A Brief and Idiosyncratic History of Global Inequality.

 

Hugo Scott-Gall: Is income inequality on the rise globally?

Branko Milanović: It is important to begin with a clear definition of global income inequality. The most commonly accepted use of the term refers to inequality in what all the individuals in the world earn, regardless of the country of origin. This form of global inequality has been slightly decreasing over the past 15 years or so. What is driving this decline is that large and relatively poor countries, particularly China and India, have been growing significantly faster than the rich countries, like the US. There are, of course, other countries apart from China, India and the US that feed into global income inequality levels, but this triangular relationship explains close to 50% of the variation in the recent decades.

Another definition that is also used to describe income inequality paints a contradictory picture and refers to developments on an intra-country basis, rather than a global level. On these terms, over the last quarter-century, there has been an increase in inequality in a majority of nations including China, US, Russia, UK and most of Europe.

In summary, by and large there has been an increase in national inequality levels, but if we aggregate populations from all countries, global inequality has slightly declined.

 

Hugo Scott-Gall: In practice, how do economists measure income inequality? And are there inherent difficulties arising from the quality of data?

Branko Milanović: There are two main methods employed to measure inequality, each with its own advantages and limitations. The first measures inequality using household survey data and the second looks at income concentration using filed tax returns.

Household surveys are used to get information on income levels from a sample of households, surveyed at regular intervals. These are produced by most countries. However, in some countries such as India and Indonesia, income surveys are not available and consumption surveys are used instead. These national surveys are then combined and adjusted for differences in purchasing power and prices between the countries in order to get a real worldwide distribution of incomes.

The second method draws on a country’s fiscal or tax data, and focuses on income concentration at the very top of the distribution.  For many countries, large segments of the population do not submit tax returns, and therefore capturing the entire distribution can be an impossible task. Fiscal data however are significantly more accurate at measuring incomes at the top percentiles compared to household surveys because rich people tend not to participate in surveys or underestimate their incomes. Obviously, the incentive to underestimate incomes exists in fiscal data too since such information provides the basis for taxation, but experience shows that, in rich countries at least, tax evasion is less of a problem among the rich than the sheer unwillingness to bother with surveys. Tax data are available for some two dozen countries only and they cannot be used to generate global statistics.    

It is also important to remember that focusing just on the top earners does not provide a complete picture of income inequality within a country. There are scenarios when there are income increases at the top and the bottom, but declines in the middle, and while the results obtained from top income shares only would imply further concentration of incomes, inequality measured by Gini coefficient might register a decline.  But over the past 30 years, in the US and elsewhere in the rich world, both top income shares and overall Gini have gone strongly up. So, the two methods come to the same result.

 

Hugo Scott-Gall: For countries that are rapidly developing, is higher income inequality a necessary consequence of growth?

Branko Milanović: From a historical perspective, there is evidence of a relationship between inequality and growth, drawing on periods such as the industrial revolution in the UK and the US. Inequality significantly increased during these growth phases. Peak levels of income inequality in the UK were reached around the 1870s, while in the US it was in the 1920s. The Kuznets curve, formulated in the 1950s, is based on the hypothesis that as an economy grows and industrializes, market forces at first drive increases in inequality, and after a certain income per capita threshold is reached, inequality begins to fall.

But the evidence has been mixed more recently. Although the Kuznets theory has not been rejected completely, it is perhaps too simple to conclude that inequality is a necessary condition that accompanies industrialization.  For sure, China’s growth phase has broadly conformed to this pattern as inequality has risen during the period over which real GDP per capita experienced a sixteen-fold increase (between 1980 and 2012). However, during Korea’s development phase, rapid growth was accompanied by reductions in inequality. So was it in Taiwan, which experienced land reform and equitable privatization after Japanese occupation.

The direction of causality between income inequality and economic growth, as well as whether the sign is positive or negative, continues to be one of the most hotly contested relationships in economics.  The Kuznets theory makes the case that the direction is from economic growth to the changes in inequality. But it is also possible to look at the reverse relationship, how inequality influences economic growth.

In the 1990s in particular there have been numerous studies that have looked at this relationship; some arguing that inequality has a positive impact on growth, while other found a negative influence. Classical economists would argue that there is a positive relationship, as those with higher incomes save more and these savings finance investment which lead to higher growth. At the other side of the spectrum, it is argued that inequality increases pressures for redistribution because with higher inequality there are more poor people and they have an incentive to vote for higher taxes simply because they gain more from social transfers than they pay in taxes. If you then also believe that higher taxes are bad for growth, there is a relationship from higher inequality to low growth. But neither of these approached found strong empirical support and this type of literature waned until very recently.

But now I believe this type of research has just begun to explore new options as a result of access to much larger pools of data, and economists’ understanding is becoming far more nuanced than 15 or 20 years ago. Analysis today is no longer limited to looking at the relationship simply between an overall inequality index like Gini and the growth rate, but at pin-pointing the variety of impacts that inequality might have on different segments of the population, i.e. poor, middle class and rich. It is in my way a much more promising way to look at the issue. It would also take us away from the inconclusive black-and-white approach to inequality. For some things, and up to a certain point, inequality may be good. For other things, and beyond a certain point, it  may be bad.

 

Hugo Scott-Gall: What role does ageing demographics play in increasing inequality?

 

Branko Milanović: Demographics certainly plays an important part. In general, an ageing population means increasing demand for social transfers that redistribute income from those who are employed to those receiving pensions – leading to a reduction in inequality. From an accounting perspective, unless this transfer is accompanied by an increase in productivity, there is a reduction in growth.

However, demographic shifts take place slowly and are constantly offset by many other elements impacting the labour market.  For example, in countries such as Spain where unemployment levels are close to 25%, a return to higher employment would obviously increase incomes and may reduce income inequality.

 

Hugo Scott-Gall: Have we reached levels of income inequality where society’s tolerance level is being tested?

Branko Milanović: Increasing income inequality eventually leads to political pressures, but at present, I do think that people’s concerns that it might lead to dramatic political changes are exaggerated. I do not foresee catastrophic events. However, I believe that the current situation has led to two problems, which I call the tale of the two P’s. Both elements can be found in all democracies, but have become more prominent and corrosive in recent years.

The first is plutocracy, some of whose features are present particularly in the US.  The need for politicians to fund future campaigns has been met by monies coming from special interests. These relationships have led to the politicians being beholden to lobbies. As we know from Adam Smith, special interests are special because they never have interest of a community, but their own only, in mind. This however is not a new phenomenon and was seen in the US even in the 1920s. It is just worse now.

The second risk is greater populism, and this has manifested itself especially in relation to immigration policies in Europe. The response by European countries has been emblematic of lower economic growth experienced after the financial crisis. Post 2008, stagnant or declining incomes in most countries were  not accompanied by an even distribution of the loss. For example, Mediterranean countries such as Greece saw real incomes at the top 1% experience minimal changes at a time when GDP decreased by 15%, and when the poor and the middle classes lost even more. As a consequence, there has been a tendency for political systems to assuage the middle class by using immigrants as a scapegoat. These are indeed difficult challenges faced by the countries that are adjusting to a slower growth environment, and if they are unwilling or cannot go after some of their own rich, they go after the immigrants. The US has been slightly different because it has a long history of immigration, and despite the fact that there is an anti-immigrant movement there, it is not been as sharp as the one in Europe.

 

Hugo Scott-Gall: Has greater transparency enabled by widespread access to the internet changed attitudes?

Branko Milanović: I'm not going to exaggerate the importance of smartphones in revolutions, but there are many examples where technology has played a role in raising awareness of the extremes in inequality. The revolution that took place in Tunisia was triggered by WikiLeaks, which reported on the spending habits and luxurious lifestyle of the now deposed leader, Ben Ali. Even though people would have been aware of his extravagance, there is a difference in impact from being told this as a gossip to being discussed and reported all over the internet.

 

Hugo Scott-Gall:   What are the solutions available to leaders of Western countries who may have been mandated by the population to address inequality?

Branko Milanović: Unfortunately, I do not have a very strong or original  answer to this question. For example, although more widespread and better education is not a panacea, it is certainly a policy that boosts economic growth and helps address income inequalities. A broader-based educational system equipping the population with a wider set of skills creates a more productive and flexible labour market (this is, I know, somewhat of a cliché but may nevertheless be true). Also, a more educated population reduces the premium that very highly skilled individuals receive which creates a win-win proposition for both growth and inequality.

Taxation is another tool, but its impact on growth is much more ambiguous. Implementing tax policy change is constrained by the fact that capital is very mobile, and for a single country or even group of countries such as the OECD it is a difficult task to accomplish single-handedly.  This has been the underlying hurdle which has scuttled proposals for worldwide taxation on capital or the Tobin tax levied on financial trading for example.

Also, there has been an ongoing debate in the US on increasing the minimum wage. The US minimum wage in real terms is below the level it was in the 1960s, whereas GDP per capita has increased by almost 2.5 times.

 

Hugo Scott-Gall: Countries and cities  that are highly specialised in specific industries can witness large differences in incomes across the population. Is wider income inequality inevitable under these circumstances?

Branko Milanović:  I agree that there are many economies located across the globe that are highly geared to a specific sector and have been especially successful in attracting global talent. For example, the state of California ranks as one of the most unequal states in the US, but it is incredibly successful at bringing together highly educated individuals, as well as people from different portions of the income spectrum including low-skilled. I do believe that high inequality in technologically driven or other successful economies is acceptable to the extent that it allows for movements up and down the income ladder, within and across generations. But absent that high mobility, high inequality which carries over several generations, eventually leads to marked inequalities of opportunity and that is certainly undesirable.