The best argument against Australian inequality

http://www.theguardian.com/commentisfree/2015/may/27/the-best-argument-against-australian-inequality

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Inequality has reached the point where even billionaires are worried about it. In an open letter to “my fellow zillionaires”, American dot-com entrepreneur Nick Hanauer warns that rising inequality is making his country “less a capitalist society and more a feudal society”. Hong Kong billionaire Li Ka-shing, the 15th richest person in the world, says that his concerns about widening polarisation are keeping him awake at night: “… why am I sleepless in Hong Kong? I fear that widening inequality in wealth and opportunities, if left unaddressed could fast become ‘the new normal’.”

Related: Don’t blame rising inequality on technological change | Owen Jones

In a world where worsening inequality is widespread, Australia is still managing to pull away from the pack. Compared to the average for OECD countries, income inequality is growing significantly faster in Australia. The Productivity Commission, in a study of how the economic gains from 1988 to 2010 had been distributed among workers, found that they disproportionately accrued to higher-paid workers.

In comparison with other prosperous countries, Australia has generally had much more targeted redistributive programs. For access to many benefits Australia relies much more on means-testing than European countries do, and Australia’s income taxes for low- and middle-income earners are quite progressive. But these redistributive measures have become less effective in recent years as more tax breaks have gone to high-income earners.

Over time, income disparities lead to wealth disparities. This is perhaps starkest when viewed from a global perspective: as of 2013, the wealth in the hands of the entire bottom half of humanity was equal to that owned by the world’s 85 richest people. But it is also clearly apparent at a national level. Some may recall the headlines in 1978 when for the first time a Sydney house, a mansion on the harbour, sold for more than $1m dollars. A million dollars in 1978 equates to about $5m now, but in 2013 it took a sale of $50m to merit a story in Sydney’s newspapers.

Until recently the mainstream of the economics profession stood aside from questions of redistribution. Common sense may suggest that taking $1,000 from a mining magnate and giving it to a struggling single mother would cause her more than enough happiness to offset any pain to the mining magnate (assuming he or she noticed it missing), but many economists tend to avoid such comparisons, based on the assumption that happiness, wellbeing and welfare are highly personal, and there is no rational, objective way to weigh up such additions and subtractions.

By such logic, all that can be said is that everything is fine so long as none are worse off as a result of any economic arrangement. By the same token it’s ok to give the mining magnate another $1,000, provided that the single mother is not disadvantaged. This parsimonious principle (the “Pareto principle”) tells us that a distribution can be said to be beneficial only if some people are made better off while no one is made worse off.

It is possible for an economics lecturer to posit a situation in which some do very much better than others and there are no losers. Such situations, however, exist only in the abstract world of diagrams on university whiteboards. (We look forward to the day a university vice-chancellor dares to test this theory by giving all academics other than economics lecturers a pay rise, or to when corporate CEOs refrain from using the pay of CEOs in other corporations to justify their own remuneration.)

The problem is that inequality, and the processes by which inequality arises, do matter. When some do better than others there is inevitably a reallocation of what economists call “positional goods”, and in this process there are losers. Positional goods are goods in short supply, and likely to remain that way. Plots of land on Sydney Harbour are the clearest examples. So too are the best teachers and surgeons, who have gifts and dedication that others can never quite match, who will be drawn into providing priority services for the well-off, effectively denying their services to others. When people can afford to cut themselves off from shared services, such as public schools, public hospitals and national parks, they have a smaller stake in supporting them.

Related: Why is Thomas Piketty's 700-page book a bestseller?

When the rich and poor live in separate worlds, one result is a tax revolt. If the well-off come to believe they gain no benefit from shared public goods, and that they have achieved their own fortune purely through their own effort and discipline, rather than through luck, inheritance or political influence, then they will react strongly against paying taxes to provide for others. Their support for social insurance falls because they believe, rightly or wrongly, that they themselves will never need to draw on it. Research on beliefs about how people derive their income finds that in societies with low social mobility people are more inclined to believe that high incomes came about through effort or virtue, rather than through luck. In other words, in places where more people have faith in the rags-to-riches myth, it is harder for the ragged to get rich.

It is possible that the huge changes in fortunes that accompanied the wars and depressions between 1890 and 1945 helped dispel such false-assuredness, but the generation that experienced these dislocations has largely passed away. The generations now coming of age in the old “developed” countries, however, may likewise be losing faith in the connection between contribution and reward. Just over a quarter of Australians believe that those who have become rich have got there through hard work. Even among those who are reasonably well-off, only a third believe that hard work is the path to material prosperity.

The long period of economic growth leading up to the global financial crisis bred complacency both among the public and policymakers. This was particularly so in Australia, which from 1992 enjoyed the benefits of the structural reforms of the 1980s, and in the new century enjoyed the peak of the mining boom with high commodity prices and strong foreign investment. The GFC seems to have resurrected interest among academic economists and policymakers in the fundamental dynamics of capitalist economics.

Robert Reich, professor of public policy at the University of California, Berkeley, and former US secretary of labor, points out that the American economy, so dependent on domestic consumption, is faltering because incomes are too low to provide secure markets for American industries. Former World Bank chief economist Joseph Stiglitz points out that economies with lower concentrations of income and wealth are less subject to economic volatility than those where wealth is in the hands of the few.

Those who are not so well-off tend to be steadier in their spending patterns, while the rich, particularly the super-rich, use their wealth for financial speculation, fuelling real-estate and equity booms and busts. People with modest incomes in socially useful trades and professions don’t spend their days gambling with other people’s money or engaging in high-frequency share trading.

A 2014 study by the International Monetary Fund confirmed Stiglitz’s theory: countries with lower inequality tend to have faster and more durable economic growth. That same study also confirmed earlier work by Harvard’s Dani Rodrik and Alberto Alesina, who found that as a result of widening income disparities countries with neoliberal policies had to spend more on redistributive welfare than those countries that kept a rein on the excesses of unregulated markets. That finding is initially counter-intuitive but, as Rodrik and Alesina point out, much of the rise in redistributive welfare spending in Britain and the United States in the 1980s was driven by the inequality resulting from the neoliberal “small government” policies of Thatcher and Reagan.

Hard evidence that inequality is costly is also provided in a major study by Richard Wilkinson and Kate Pickett. Their work, The Spirit Level, compares different nations and states within the US, showing that higher levels of inequality in a society are associated with higher incidences of violence, suicide, obesity, mental illness, imprisonment and diminished life expectancy. Their findings are not entirely new; it has long been known that poverty and poor health are related, but the direction of causality has been disputed – does poverty result in poor health, or does poor health result in poverty? The evidence in their work suggests strongly that inequality is a major causal factor contributing to these costly outcomes. Also, and perhaps counter-intuitively, they find that whole societies, including the well-off, are adversely affected by inequality.

Related: Joseph Stiglitz: ‘GDP per capita in the UK is lower than it was before the crisis. That is not a success’

Emerging now is a wide body of study on the economics of fairness. That research finds that while people accept some level of inequality, this acceptance has firm limits. People are particularly concerned with how inequality comes about. It is more likely to be accepted when it comes about through effort, creativity, innate ability or pure chance in situations akin to unbiased lotteries. When it comes about through exploitation of monopoly power, inside knowledge, favours granted by the powerful, denial of opportunity, or breach of social norms, people are understandably resentful. And when people believe that the fruits of their efforts will be disproportionately enjoyed by others, they lose motivation – a sullen and angry workforce is not a productive workforce.

When inequality involves humiliation, or comes about through processes that people perceive to be unfair, there is another cost, because people don’t like unfairness, and that dislike, whatever we call it – moral revulsion, envy, anger – is itself a detriment to people’s well-being. Inspired by the extravagances of the late 19th century – an era, like now, when the über-rich let it all hang out in vulgar displays of opulence – Thorstein Veblen wrote The Theory of the Leisure Class. In it he analysed the phenomenon of “conspicuous consumption” – behaviour designed to demonstrate one’s place in the pecking order. Those at the top can enjoy inequality a little more if they can demonstrate their superior position to an audience.

When inequality gets to the point that there is a significant very prosperous class, problems that were widespread in societies such as England in the nineteenth century re-emerge. Thomas Piketty has added urgency and many more hard numbers to this debate. He shows mathematically that wealth accumulation and concentration are almost inevitable processes of market capitalism, and therefore, by implication, inequality must be addressed by government policy. Only in periods of very high economic growth, such as the postwar reconstruction period in “developed” countries, is some closing of inequality likely. He warns that a class living off inherited wealth becomes parasitic rather than productive.

Even if one generation has become wealthy through their own effort and creativity, there is a strong possibility that the next generation will blow their inheritances – on $50m mansions, slow horses and fast cars – rather than on prudent investments. But in general great wealth passes from generation to generation, either through inheritance or through privileged access to education and job opportunities, while at the other end of the spectrum disadvantage passes from generation to generation. Social mobility is blocked, and there is a consequent waste of human capabilities.

Ian McLean adds to Piketty’s warnings in his book, Why Australia Prospered. Drawing on comparisons between Argentinian and Australian economic history, he shows how a wealthy elite uses its political power to shape a nation’s policies, thus reinforcing a skewed distribution of income and wealth. The land-owning classes of Argentina had no interest in developing or nurturing institutions, such as universal education, that would make for national prosperity. (The distinction between Argentina and Australia is not dissimilar to the distinction in the US between the former slave states and the more industrialised states.) As the IMF’s Christine Lagarde says, “excessive inequality makes capitalism less inclusive. It hinders people from participating fully and developing their potential”. Talent and ability are widely spread throughout society. Without inclusive institutions much of that talent and energy goes to waste.

Related: Inequality harms all of us | Lesley Riddoch

This is perhaps the most compelling economic argument in favour of tackling the growing gap between rich and poor in Australia. It is impossible to fully insulate the political process from the influence of economic power. If wealth were less highly concentrated, we might find our governments to be less vulnerable to capture by a narrow elite, and that more Australians really would find themselves in a position to “have a go”.