Too much inequality will kill you
While Thomas Piketty is reaching rock star status, not many people will read the almost 700-page book. Economic geographer Ton van Rietbergen walks us through the details of Piketty’s work, and asks the basic question: why is inequality actually a problem?
By Ton van Rietbergen
“Almost all the problems that are more common at the bottom of the social ladder are more common in more unequal societies – including mental illness, drug addiction, obesity, loss of community life, imprisonment, unequal opportunities and poorer well being for children”
On Wednesday the 5th of November Thomas Piketty visited the Dutch parliament. It was not his first meeting with politicians. Ever since his book, Capital in the Twenty First Century, was published in English it has gotten a lot of attention. Almost every newspaper has featured an article on Piketty and lots of TV shows have been fighting to have him. The NRC Handelsblad published a test on ‘How Piketty are you?’ with questions like ‘how much social inequality is justified’ and on the sports pages we read that the results in the Champions League prove that Piketty is right: it is always the same rich clubs that reach the finals. That Piketty has shot to rock star popularity for a 685-page book with 18 tables and 97 figures is slightly surprising. It is a great achievement in this day where books are considered to be out of fashion and stuffy, though I do wonder how many of his fans have actually read the book. Why is Piketty’s book such a success while a similar book by former World Bank boss Joseph Stiglitz remains largely undiscovered? It might have something to do with the spirit of the times and the fact that middle class incomes have decreased more than other groups.
Very unequal societies have numerous social problems
Before going into the details on Piketty’s work, I would like to start with a more basic question: How harmful is inequality? For a clear answer to this question, go and watch Richard Wilkinson’s TED Talk on YouTube, and see his book with Kate Pickett, The Spirit Level: Why More Equal Societies Almost Always Do Better. In this book, published in 2009, they show quite convincingly that unequal societies have lower scores on all indicators of social well-being. They first tried to find a statistical relationship between wealth, GDP per capita, and social well-being. To their own surprise they did not find one. This changed radically when they used inequality data instead and found an effect at all levels. So, unequal countries have lower scores than more equal countries, and the same goes for states and cities. In other words, there are enormous differences between Canada and the USA but the differences between American states are just as profound. In the more equal states there is more trust in other people (varying from only 15% in unequal countries to 65% in more equal ones) and less crime. At the neighbourhood level, the harmfulness of inequality shows itself in the average life expectancy. People in poor neighbourhoods in the UK have an average life expectancy of 72 while in the rich areas it is almost 80 years. Or as Wilkinson, put it on his website: “As we looked at the data, it became clear that, as well as health and violence, almost all the problems that are more common at the bottom of the social ladder are more common in more unequal societies – including mental illness, drug addiction, obesity, loss of community life, imprisonment, unequal opportunities and poorer well being for children. The effects of inequality are not confined to the poor. A growing body of research shows that inequality damages the social fabric of the whole society”. Figure 1 shows that unequal societies do worse on a cocktail of indicators for social well-being. The most striking example in Wilkinson and Pickett’s work, which is still not really explained, is the fact that an unequal society like the UK has higher rates of infant mortality than more equal Sweden in all income categories. This leads them to the conclusion that redistribution of income is a good thing even for the rich.
The most frightening aspect of Wilkinson and Pickett’s analysis is that inequality also prevents social mobility. The more inequality there is in a society, the less social mobility there is: inequality is inversely proportional to social mobility. A method to measure this is called ‘intergenerational elasticity of income’, which measures to what degree the father’s income predicts that of the son. For Sweden this number is 0.21, whereas it is 0.48 in America (Brunori et al, 2013). This means that only 21% of the son’s wealth is inherited while in the USA it is 48%. This leads Wilkinson to conclude that: “If Americans want to live the American dream, they should go to Denmark”.
Figure 1: Health and social problems are worse in more unequal societies
Structure-Agency debate
Within science and politics, there is usually a distinction made between people who support structuralism and those who support liberalism. The first group thinks that everything can be explained by the division of power. People are unemployed because either they did not have the chance to get an education or they cannot enter the labour market because they do not fit in socially or racially. The actor, or liberal-oriented, approach thinks that this is nonsense and that individuals, if they work hard, are capable of attaining whatever they want. ‘Success is a choice’ is a slogan that suits them well.
A clear example of the first direction is the geographer David Harvey, who sees the neo-liberal turn as a project to restore the power of the economic elite. According to him and other supporters of the structural approach, the Washington Consensus was a reaction to the fact that income inequality was at its lowest point in the Western world at the end of the seventies, with the top 1% of the earners falling from a pre-war high of 16% the total income to around 8%. According to Harvey (2007), Ronald Reagan and Margaret Thatcher were not pleased with the redistribution of wealth and deliberately restored the differences by liberalizing the financial markets and limiting the power of the public sector.
People with a more liberal orientation have a different interpretation of what happened. They say that economic growth was very low at that time and removing barriers was just an attempt to stimulate the economy. This worked well for a few years but also resulted in more inequality since some people were more capable of profiting from the new possibilities that technology offered. The internet, in particular, provided a lot of opportunities for those able to grasp them. Whatever the reason behind the change of policy, Figure 2 (from Piketty) illustrates the rise in inequality that Harvey references. It is shocking to see that the long-held consensus that capitalism only increases differences shortly after its introduction and that these differences would disappear in the long run (as predicted by Kuznets) seems not to be true. Piketty’s conclusion that Kuznets was perhaps wrong and that the increased equality was only caused by the combination of two World Wars and a crisis and as such was a historical anomaly, is even more alarming.
Figure 2: Inequality in the USA, Share of top decile in the national income
A special element in Piketty’s work is that he did not only look at income but also at the growth of wealth, or capital. In fact, he showed that capital grows more rapidly than income, or in his own words: “When the rate of return on capital significantly exceeds the growth rate of the economy, as it did through much of history until 1920 and as is likely to be the case in the twenty-first century, then it logically follows that inherited wealth grows faster than output and income.” (p. 26). His formula, r>g, is as popular as Einstein’s famous e=mc 2 at the moment. The r stands for the average annual return on capital, including profits, dividends, interest, rents and other income from capital as a percentage of its total value. The g stands for the rate of growth of the economy expressed in annual increase in income or output. Figure 3 (from Piketty) illustrates this. It shows “the total value of private wealth in real estate, financial assets, and professional capital, net of debt in Britain, France and Germany, expressed in years of national income, for the period 1870-2010.” (p. 25) The figure shows quite clearly that the best way to get rich is to marry a wealthy person – much more profitable than working day and night.
Figure 3: Market value of private capital (% of national income)
Lessons to be learned
There are numerous lessons to be drawn from Piketty, though his analysis and his data gathering are perhaps better than his policy advice. But first, about reactions to his work. It is quite obvious that people with a more structural vision of the economy (SP, GroenLinks and the left wing of the PvdA) agree with Piketty’s figures. The more liberal or conservative parties (VVD, D66, CDA, SGP) immediately start to doubt them and say that the Netherlands is one of the most egalitarian countries in the world and that more taxation would hamper innovation and entrepreneurship.
Though figures in the field of taxation are incredibly difficult to interpret, especially in the Netherlands with all its special allowances, some conclusions can be drawn. The income inequality in the Netherlands is relatively modest internationally (see Figure 1) but it is also rising slightly. However, as in France and the UK, the inequality in wealth is very high in the Netherlands. The trend is also the same: while in 1900 almost 80% of the wealth was concentrated in the hands of the richest 5%, this decreased to only 48% in 1980, and then, just as in other countries, rose to almost 60% today. In this time, the political climate changed. In the sixties and seventies, there was a general attitude that large differences in wealth should be corrected and that high incomes could be charged a 70% tax rate. Now, the general reaction is that this would be unfair to these hard working and innovative people and that it is just a matter of jealousy. Of course, this change in attitude has something to do with the current message that globalisation means that we are all in competition with each other and that people and companies can go wherever they want.
Having said this, the conclusions and policy advice I would draw from Piketty would be:
*Start taxation on fast moving portfolio investments. A very small tax on this fast moving capital (as suggested by Tobin and Piketty) will not only create less damage to poor countries but will also create a fund to invest in more sensible and more sustainable things. That a considerable amount of money is used to speed up these types of transactions is very harmful to the economy, as we saw in the financial crash of 2008. The fact that the famous Chinese Walls do not really seem to exist within financial institutions makes this step even more necessary.
*Even Morgan Stanley, not really a socialist club, pointed to the fact that labour has lost ground compared to capital so the position of labour should be improved. The fact that purchasing power in the Western countries has not grown for the last twenty years fits into this picture.
*A small rise in inherited wealth tax would certainly stimulate the economy because more people would need to work to improve their income. A lot of the entrepreneurial billionaires doubt whether passing on their capital to the next generation is sensible as it could make their children lazy and aimless.
However, many of these measures are only possible if we consider the political context. In 2011, the famous Turkish economist Dani Rodrik wrote The Globalization Paradox, a fascinating book in which he puts forward his so-called political trilemma. This means that you can have only two of these three things: hyperglobalization, the nation state and democratic politics all together. So if you want to have hyperglobalization and a nation state you have follow the strict rules of international capitalism and limit democracy. If you want to have a nation state and democratic politics you have to intervene with Bretton Woods-like measures. The most favourable option is where hyperglobalization and democratic policies find each other in a kind of world government. Looking at all the regional conflicts in the world today, this is, however, not very realistic. What Rodrik teaches us is that we have to make choices, and that institutions are important in doing so. That opinion is shared by James Robinson, the most serious opponent of Piketty’s work. The political economist from Harvard criticizes Piketty for making a general global model without taking the role of institutions seriously. And these institutions can really make a difference, as Robinson shows, making a comparison between South Africa and Sweden.
Given the inequality we see today and the problems it causes society and citizens, there is work for politicians all around the world. They should take what they learn from Piketty, Rodrik and Robinson and make the world a better place!
Ton van Rietbergen is economic geographer at Utrecht University.
Dit artikel verscheen in Idee nr. 6 2014: A Divided World.
Structure-Agency debate
Within science and politics, there is usually a distinction made between people who support structuralism and those who support liberalism. The first group thinks that everything can be explained by the division of power. People are unemployed because either they did not have the chance to get an education or they cannot enter the labour market because they do not fit in socially or racially. The actor, or liberal-oriented, approach thinks that this is nonsense and that individuals, if they work hard, are capable of attaining whatever they want. ‘Success is a choice’ is a slogan that suits them well.
A clear example of the first direction is the geographer David Harvey, who sees the neo-liberal turn as a project to restore the power of the economic elite. According to him and other supporters of the structural approach, the Washington Consensus was a reaction to the fact that income inequality was at its lowest point in the Western world at the end of the seventies, with the top 1% of the earners falling from a pre-war high of 16% the total income to around 8%. According to Harvey (2007), Ronald Reagan and Margaret Thatcher were not pleased with the redistribution of wealth and deliberately restored the differences by liberalizing the financial markets and limiting the power of the public sector.
People with a more liberal orientation have a different interpretation of what happened. They say that economic growth was very low at that time and removing barriers was just an attempt to stimulate the economy. This worked well for a few years but also resulted in more inequality since some people were more capable of profiting from the new possibilities that technology offered. The internet, in particular, provided a lot of opportunities for those able to grasp them. Whatever the reason behind the change of policy, Figure 2 (from Piketty) illustrates the rise in inequality that Harvey references. It is shocking to see that the long-held consensus that capitalism only increases differences shortly after its introduction and that these differences would disappear in the long run (as predicted by Kuznets) seems not to be true. Piketty’s conclusion that Kuznets was perhaps wrong and that the increased equality was only caused by the combination of two World Wars and a crisis and as such was a historical anomaly, is even more alarming.
Figure 2: Inequality in the USA, Share of top decile in the national income
A special element in Piketty’s work is that he did not only look at income but also at the growth of wealth, or capital. In fact, he showed that capital grows more rapidly than income, or in his own words: “When the rate of return on capital significantly exceeds the growth rate of the economy, as it did through much of history until 1920 and as is likely to be the case in the twenty-first century, then it logically follows that inherited wealth grows faster than output and income.” (p. 26). His formula, r>g, is as popular as Einstein’s famous e=mc 2 at the moment. The r stands for the average annual return on capital, including profits, dividends, interest, rents and other income from capital as a percentage of its total value. The g stands for the rate of growth of the economy expressed in annual increase in income or output. Figure 3 (from Piketty) illustrates this. It shows “the total value of private wealth in real estate, financial assets, and professional capital, net of debt in Britain, France and Germany, expressed in years of national income, for the period 1870-2010.” (p. 25) The figure shows quite clearly that the best way to get rich is to marry a wealthy person – much more profitable than working day and night.
Figure 3: Market value of private capital (% of national income)
Lessons to be learned
There are numerous lessons to be drawn from Piketty, though his analysis and his data gathering are perhaps better than his policy advice. But first, about reactions to his work. It is quite obvious that people with a more structural vision of the economy (SP, GroenLinks and the left wing of the PvdA) agree with Piketty’s figures. The more liberal or conservative parties (VVD, D66, CDA, SGP) immediately start to doubt them and say that the Netherlands is one of the most egalitarian countries in the world and that more taxation would hamper innovation and entrepreneurship.
Though figures in the field of taxation are incredibly difficult to interpret, especially in the Netherlands with all its special allowances, some conclusions can be drawn. The income inequality in the Netherlands is relatively modest internationally (see Figure 1) but it is also rising slightly. However, as in France and the UK, the inequality in wealth is very high in the Netherlands. The trend is also the same: while in 1900 almost 80% of the wealth was concentrated in the hands of the richest 5%, this decreased to only 48% in 1980, and then, just as in other countries, rose to almost 60% today. In this time, the political climate changed. In the sixties and seventies, there was a general attitude that large differences in wealth should be corrected and that high incomes could be charged a 70% tax rate. Now, the general reaction is that this would be unfair to these hard working and innovative people and that it is just a matter of jealousy. Of course, this change in attitude has something to do with the current message that globalisation means that we are all in competition with each other and that people and companies can go wherever they want.
Having said this, the conclusions and policy advice I would draw from Piketty would be:
*Start taxation on fast moving portfolio investments. A very small tax on this fast moving capital (as suggested by Tobin and Piketty) will not only create less damage to poor countries but will also create a fund to invest in more sensible and more sustainable things. That a considerable amount of money is used to speed up these types of transactions is very harmful to the economy, as we saw in the financial crash of 2008. The fact that the famous Chinese Walls do not really seem to exist within financial institutions makes this step even more necessary.
*Even Morgan Stanley, not really a socialist club, pointed to the fact that labour has lost ground compared to capital so the position of labour should be improved. The fact that purchasing power in the Western countries has not grown for the last twenty years fits into this picture.
*A small rise in inherited wealth tax would certainly stimulate the economy because more people would need to work to improve their income. A lot of the entrepreneurial billionaires doubt whether passing on their capital to the next generation is sensible as it could make their children lazy and aimless.
However, many of these measures are only possible if we consider the political context. In 2011, the famous Turkish economist Dani Rodrik wrote The Globalization Paradox, a fascinating book in which he puts forward his so-called political trilemma. This means that you can have only two of these three things: hyperglobalization, the nation state and democratic politics all together. So if you want to have hyperglobalization and a nation state you have follow the strict rules of international capitalism and limit democracy. If you want to have a nation state and democratic politics you have to intervene with Bretton Woods-like measures. The most favourable option is where hyperglobalization and democratic policies find each other in a kind of world government. Looking at all the regional conflicts in the world today, this is, however, not very realistic. What Rodrik teaches us is that we have to make choices, and that institutions are important in doing so. That opinion is shared by James Robinson, the most serious opponent of Piketty’s work. The political economist from Harvard criticizes Piketty for making a general global model without taking the role of institutions seriously. And these institutions can really make a difference, as Robinson shows, making a comparison between South Africa and Sweden.
Given the inequality we see today and the problems it causes society and citizens, there is work for politicians all around the world. They should take what they learn from Piketty, Rodrik and Robinson and make the world a better place!
Ton van Rietbergen is economic geographer at Utrecht University.
Dit artikel verscheen in Idee nr. 6 2014: A Divided World.