Economic inequality in West developed, economist warns

Isaac James, who cannot find a job, eats lunch at the Central Park United Methodist Church which has a soup kitchen and food pantry on Oct 20 in Reading, Pennsylvania. AFP photo

Inequality is in the news a lot right now. How should we be thinking about it and trying to get our heads around it?

Inequality is one of the things that has changed quite a lot in the United States and other economies over the last three decades or so. A lot of things don’t change radically, but inequality has. Understanding why that has happened and what it implies for our society is important. So it’s a good thing that it’s in the news, it’s an important topic and there is no reason for it to be taboo. Having said that, there is no broad consensus among social scientists about how to talk about inequality, and the average economist probably thinks about it very differently than the average layman. I’m not saying one is right and one is wrong, but the conversation needs to be expanded to bring these different viewpoints to the table.

What’s the economist’s view?

The default position of economists is that inequality reflects the unequal human capital or productive capabilities of different workers. If you start with that premise – that what people earn is commensurate with their contribution to their employer, and also perhaps to society – then greater inequality tells you something about how people’s productivity has evolved over time. This is by no means what every economist believes, but it’s a common view. Economists have cut their teeth on inequality by looking at things like the increase in the college premium over the last 30 years in the U.S. and other economies, as well as the increase in the gap between relatively high earners – the 90th percentile of income distribution – versus the bottom 10th percentile. 

So if a chief executive officer is earning $5 million a year, is that because he deserves that $5 million?
That’s why I put emphasis on the 90th versus the 10th percentile, because once you get to that very high level, the story becomes a little harder to swallow. Economists have, for the most part, not focused on the CEOs for two reasons. This is changing, but one reason is that most of the publicly available data sources don’t have information on CEOs. That’s because there are not that many CEOs, or multimillionaires. So when you take a sample – for example, a 1 percent sample of all the U.S. households – you’re not going to get many of them. Secondly, data are top coded. You don’t actually see people’s exact earnings. You see that they are at the very top, which might be $250,000, but you don’t see if they’re making $25 million. For that reason, a lot of the labor economics literature has focused on things like, do people with college degrees earn more than high school graduates? Do postgraduates earn more? What has happened to earnings inequality among lawyers or doctors or among production workers?

What do non-economists think, in your view?

My caricature of a layman’s view is that inequality is an indication of something that is failing in society. If a group of people used to earn twice as much as another group of people, and then, over 20 years, that ratio increases to four, that’s something that is concerning and might indicate a failure of social policy. My own view is a mixture of the two. 

If you’re looking at the average college graduate versus the average high school graduate, or the 90th versus the 10th percentile, then the things economists have emphasized – technology, globalization, offshoring and outsourcing, changes in the supply of skills, et cetera – have played a major role and probably tell the bulk of the story. But if you want to understand the top inequality, why the top 0.1 percent – even more than what the 1 percent Occupy Wall Streeters are talking about – have been earning such huge amounts, then really you have to think about the social policy aspects of it and the politics of it. There is perhaps some sort of failure in how our system is working.

In terms of the actual figures, how bad is inequality in the U.S. and, say, the U.K.?

Based on the work of Thomas Piketty and Emmanuel Saez, if you look from the 1950s up to the end of the 1970s, the share of total national income in the U.S. earned by the richest 1 percent was about 10 percent. If you look at the 2000s, it’s well over 20 percent. It rose up to nearly 25 percent and then came down. In the U.K. it’s at about 15 percent, up from 7 percent or so. The trend toward inequality over the last 50 years has been very similar in the Anglo-Saxon economies, though it’s important to say that it’s not just an Anglo-Saxon phenomenon. There are similar trends in many economies, though there are a few that haven’t experienced it to any notable extent.

This recent interview by Sophie Roell appeared on thebrowser.com.