Skyscrapers in London's Canary Wharf business district rise above a neighbouring housing estate. © Bloomberg/Getty

What we should really do about inequality

We need to tackle the very top and bottom, and drop our preoccupation with the Gini coefficient and moralising about victimhood.
April 22, 2015

Inequality has replaced house prices as a fashionable topic for discussion. But anyone looking for a serious treatment of the problem, rather than just a dinner party conversation, should turn to these books by eminent economists who have made the study of inequality their life’s work. They complement each other: Anthony Atkinson focuses on rising inequality in post-1980 Britain, while François Bourguignon analyses global inequality.

Both writers balance their diagnoses with concrete proposals for achieving a more equitable distribution of wealth and income. Bourguignon, a former Chief Economist at the World Bank who now teaches at the École des Hautes Études en Sciences Sociales in Paris, makes what is perhaps the most important point: that the same forces of economic globalisation that are rapidly reducing inequality between countries are increasing it within them. Atkinson, a professor at the London School of Economics who has a measure of inequality (the “Atkinson index”) named after him, laments the “turn to inequality” that occurred in the United Kingdom after 1980. However, globally during the same period we have seen a remarkable “turn to equality.” The inexorable rise in global inequality of the past two centuries has been reversed. So much so that the credible future dystopia is no longer Brave New World or 1984, it is Dubai—where the super-rich rub shoulders with the super-poor or, more accurately, have their shoulders rubbed by them.

Inequality is an emotive term for a slippery concept. A classic dispute is whether what matters is equality of outcomes or equality of opportunities. Looming technological changes may make these increasingly incompatible. But what struck me most forcibly from reading these analyses is that what economists mean by inequality (and what their various formulae measure) is not what most non-economists have in mind when they say that they are concerned about it. To achieve a significant reduction in inequality as measured by economists, incomes in the central range of the distribution must be compressed: bus drivers must become better off relative to headteachers. But what people actually worry about are the tails of the distribution: children without life chances and the undeserving super-rich. As Jonathan Haidt has recently argued in his book The Righteous Mind, modern social science is radically out of touch with popular morality.

Let’s begin, though, with Atkinson’s agenda for the UK. This, surely, is the book Ed Miliband has been waiting for. It sets out a range of policies for bringing about a significant reduction in inequality as defined by the Gini coefficient (the more the distribution diverges from a state of perfect equality, the higher its Gini coefficient will be.)  Among the 15 proposals Atkinson makes is the renewal of social security and welfare provision, “raising the level of benefits and extending their coverage.”

His case is strong: targeted, means-tested benefits, such as child tax credit, may be cheaper, but they are demeaning to their recipients and often do not reach the people who need them most. Contrast the success of France’s universal pre-school programme of publicly provided écoles maternelles, to which all young children are sent, with Britain’s complex patchwork of schemes and subsidies for nurseries and childminders. Atkinson also favours ending the incentives that have created the buy-to-let sector. Again the case is strong: these incentives have simply enabled the affluent retired to outbid young couples, so that people who, in the 1970s, would have been first-time owner-occupiers are now tenants.

Atkinson’s most interesting and original suggestion is that the direction of technological change should be an explicit concern of policymakers, “encouraging innovation in a form that increases the employability of workers.” This builds on an economic theory he first developed in the 1960s: how national income is distributed among the population reflects the way in which the dispersion of individual abilities interacts with technological opportunities that make some of them more valuable economically than others. Basic manufacturing technology levels the playing field: working at a conveyer belt, people need neither brains nor brawn to be productive. But in the case of computer programming, say, the consequences of seemingly small differences in ability are multiplied significantly—a good programmer is around 100 times more productive than an ordinary one.

Some technological progress has alarming implications for the distribution of income. Robot technology, for instance, may become so cost-effective that industry ceases to provide many jobs. This would be terrible news for poor countries, in particular, since job-generating industrialisation has, up to now, been the only reliable route out of national poverty. Such technology could also increase inequality in developed countries like the UK. Atkinson identifies driverless cars as an innovation likely to make thousands redundant. His proposal is to use public policy to skew technological research towards those innovations that are equalising. However, it is doubtful that governments are really capable of reshaping technical progress according to distributional concerns. I can well imagine taxi drivers lobbying successfully to hold back the introduction of driverless cars, as they have mobilised against the low-cost cab service Uber. Governments, easily intimidated by organised disruption, might end up inadvertently licensing such blocking tactics, rather than skewing discovery and innovation towards job creation. Also, as Bourguignon points out in another context, effective policy would need to be global rather than national, and there is no credible prospect of this.

Other of Atkinson’s proposals also gave me pause for thought. For instance, he wants the state to build “countervailing power” against business, specifically through legislation that strengthens trade unions. While there is certainly a need for countervailing power, it is not clear that this would be best achieved by boosting the unions and resurrecting the apparatus of a national incomes policy. Atkinson also wants guaranteed employment for all (though not through “workfare”-type schemes), with the public social sector serving as the employer-of-last resort. This is a terrible idea. A lack of unappealing job opportunities has not been Britain’s problem, while deeming the social sector sufficiently unimportant that it could take anyone on seriously devalues the contribution and status of those currently working in it.

Atkinson also proposes a massive transfer of incomes through large increases in taxes on income, property, wealth and inheritance. In his scheme, starting with incomes of £55,000, income tax would rise to 45 per cent, with further increases to 55 per cent above £100,000 and to 65 per cent above £200,000. In its own terms, Atkinson’s agenda is coherent. If Britain wants to reduce its Gini coefficient substantially, then these are practical options. But is this what really concerns people? Conventional measures of inequality show how income is distributed among the large majority who are neither remarkably wealthy nor desperately poor. This is where the weight of numbers lies: the bus driver versus the headteacher. In many countries in the Organisation for Economic Co-operation and Development (OECD), and certainly in Britain, this gap has widened over the past 30 years. In order to narrow these gaps significantly, tax rates on ordinary people would have to rise dramatically, as Atkinson acknowledges.

The basis for Atkinson’s analysis is a carefully constructed time series for inequality in postwar Britain. This shows that the golden age of low inequality was the late 1970s. Atkinson’s annus mirabilis is 1977, since when inequality has shot up. Reading his hymn to that golden age, I couldn’t help composing a variant on Philip Larkin’s famous paean to the year 1963:

So life was never better than In nineteen-seventy-seven. Inflation, taxes, unions: A veritable heaven!

In the 1970s, inflation slashed fiscal liabilities, strengthening the public sector balance sheet, taxes redistributed income from headteachers to bus drivers and unions provided countervailing power in abundance. I may have misread public opinion, but I rather doubt that many regard 1977 as the apogee of social justice. Indeed, judging by how people have repeatedly voted since, they appear to have seen the policies of the day, particularly high levels of personal taxation (in 1977, the top marginal tax rate was 83 per cent), as unreasonably penalising effortful aspiration. According to surveys of British social attitudes, fewer people today support higher spending on welfare benefits than think, as the Financial Times reported in March, that “many [of those] who get social security don’t really deserve any help.” Trade unions languish with the banks, low in citizen regard. A crusade to narrow differentials beneath the banner of social justice of the kind Atkinson outlines would meet enormous political resistance.

As I have already suggested, what most concerns people when they think about inequality are the tails of the distribution rather than the middle. Therefore, policy needs to address the excesses at the top and the misery at the bottom. The same is true of inequality between countries. The average Chinese is now considerably richer than the average Indian, and the average European remains much richer than the average Chinese. It will be a better world when the Indians have caught up with the Chinese, and the Chinese with Europeans, but I do not think that remedying these inequalities should be a priority. Here, too, policy should be focused on the tails of the distribution.

Conventional economic measures of inequality not only focus on the wrong thing, they also lack normative force beyond the mere fact of the income difference itself. The rich may have won their money on a horse, inherited it, slogged their guts out for it, stolen it or received it as the reward for something beneficial to the common good. The poor may have squandered an inheritance, or never had a chance. Seen through the lens of the Gini coefficient, it’s all the same—it is the inequality itself, not its cause, that needs correcting. But I suspect that most people are angered by the bankers and lawyers who receive but are perceived not to “earn” over £1m a year, rather than by headteachers, doctors and senior civil servants on generous but not stratospheric salaries. And globally they are angered by the rentier societies of the Gulf, rather than by Singapore which has grown equally rich by its own extraordinary efforts. In other words, at the top they are concerned about a lack of desert. Sadly, as opinion polls show, this concern applies to the bottom as well. Foreign aid programmes are similarly unpopular because the poorest countries are seen as having fouled their own nests through corruption and conflict.

Such harsh attitudes are, perhaps, a reaction against the left’s emphasis on “social justice.” The left insists that those at the bottom of the distribution—poor people or poor countries—are victims. But seeing things this way arguably undermines the case for action. Often, poor people and poor countries have made poor choices, although those choices themselves have explanations. What many poor families need is not simply more cash, but a feasible pathway into more purposeful lives. And what many poor countries need is not more aid, but a route into productive participation in the global economy.

Both Atkinson and Bourguignon are concerned not just about unequal incomes, but also about inequality of opportunity. Bourguignon rightly notes that unequal abilities to borrow are not only regressive but inefficient, while Atkinson takes as his core example of social injustice the privileged youth who gets an inside track to a valuable employment opportunity (Ed Miliband, perhaps?). As he suggests, greater inequality of outcomes inevitably intensifies  concern about unequal opportunities. A book whose message was somewhat drowned out by the extraordinary reception given last year to Thomas Piketty’s Capital in the Twenty-First Century is The Son Also Rises by the economist Gregory Clark. By tracing rare surnames over several generations, Clark was able to measure inter-generational social mobility in a number of different societies. He found that mobility was surprisingly low, and that it was low in societies that had followed very different social policies, such as Sweden, China and the United States. Clark’s conclusion was that a sustained high level of social mobility was infeasible. This may even be a good thing. Except in the wholly exceptional circumstances of the postwar west, which experienced an unrepeatable expansion in professional jobs, rapid upward mobility would entail equally rapid downward mobility. Yet a well-researched feature of people’s preferences is “loss aversion”—they hate going down much more than they enjoy going up. A society with high social mobility, therefore, might be a rather unhappy one.

This does not mean that we should be relaxed about inequality. But it does mean that we should focus rigorously on raising those at the bottom and curbing the undeserving rich, both within countries and between countries. This gives us four target groups: those at the bottom of the national and global distributions, and those at the top. I will examine each of them in turn, starting with what I regard as the most urgent challenge we face: helping the poorest countries to converge on the rest of us.

Bourguignon shows that while globalisation is working well for the majority of countries, it is not working at the bottom. During the boom in commodity prices over the past decade, he argues, the evidence for this claim was obscured because many of the poorest countries are resource-exporters. Now that the boom is over, Bourguignon expects the poorest countries to fall behind again because they did not manage to diversify their economies into the global markets for industry or services during the good times. While I am less pessimistic about the prospects for these countries, I agree that we cannot rely upon globalisation to solve this problem. Bourguignon suggests we could do much more to harness the opportunities presented by global markets. He proposes trade preferences, to which one might add investment incentives and security assistance. The OECD needs to make a commitment like the one made by Mario Draghi, President of the European Central Bank, at the height of the eurozone crisis to do “whatever it takes.”

Doing everything we can to help the poorest societies to catch up is both a moral and a practical imperative—a billion frustrated lives hang in the balance, and we know the costs incurred when societies implode. But in order to help those countries which are not on track catch up, we need to put aside the fantasy that it is our responsibility to “address global poverty.” Britain is no more responsible for the poor of China or India than for the poor of America: these societies are rich enough (or soon will be), to look after their own poor should they choose to do so. Malawi, Chad, Sierra Leone, Mali and many more are not. Atkinson, unlike Bourguignon, is only peripherally concerned with global poverty. His proposal that Britain increases its aid commitment from the UN target of 0.7 per cent of GDP, which has just been reached, to 1 per cent merely adds to the “back to the 1970s” flavour of his book. As a development strategy, such a move would be an anachronism.

What about policies to improve the lot of those at the bottom of the British income distribution? After the Second World War, thanks to improvements in state education and healthcare, new opportunities opened up and many people took them. I was one of them. My parents had led frustrated lives, leaving school at the age of 12 and finding themselves trapped in manual work. My lot was very different: when I was seven, NHS penicillin saved my life. Aged 11, I won a place at a grammar school that would eventually propel me to Oxford. As for the families left behind during this period of possibility, some of them no doubt now in a third generation of worklessness and dependency, they need more money, but money is not the core problem. They will not gain self-respect robed either as society’s victims or as its feckless—yet these have been the two roles on offer. They need a lot of patient, practical assistance. For example, their children need to be coaxed into literacy, while the adults need to be coaxed into work. Yes, benefits need to be redesigned to avoid the “benefit trap,” but financial incentives are only part of the solution, which has little to do with the Gini coefficient.

Now to the undeserving rich. This is not about headteachers, or indeed university professors like Atkinson, many of whom command substantial salaries. Nor are today’s undeserving rich 19th-century-style rentiers, living off accumulated capital, of the kind Piketty claims are making a comeback. In the UK at least, there are two kinds of rentier or undeserving rich.

The first kind derive their incomes from working in those organisations which have managed to capture massive rents as a result of their market power. The average senior banker, say, or a partner in a City law firm will be getting over £1m per year, often a lot more, and this is decidedly not a premium on exceptional personal ability. There are thousands of these people, and they are unlikely, on average, to be smarter or more hard-working than the few dozen people who have reached the apex of the major professions—top academics, civil servants, military leaders and medical consultants, who earn much less. One of Atkinson’s most important arguments is that it is control rather than ownership that confers the biggest rents. Via your pension fund, you may own shares in these organisations, but the rents accrue to the few thousand who control them, not to the millions who own them.

Tackling this situation requires, as Atkinson says, a package of measures, of which high tax rates would be a part. I would reserve the highest rates for incomes above the top public-sector pay levels. In effect, the salaries of permanent secretaries and those at the top of other professions have been socially sanctioned. Above around £300,000, tax rates could indeed be set in the range 60-70 per cent. The point would not be to collect revenue but to discourage high pay, in part by signalling social disapproval. Another useful measure would be to ensure that the few thousand in senior corporate positions should not have the power to direct organisational rents to themselves. This would require broadening the control of firms. Atkinson has some useful suggestions here, but again they ring a little of the 1970s. The best recent contribution to the debate in this area is Colin Mayer’s book Firm Commitment, which argues for the adoption of the German model of supervisory boards with wide representation and legislated mandates for social benefit. The final part of the package would be to reduce the rents accruing to powerful firms through a mixture of regulatory change to force greater competition and corporate taxation that socialises the rent that accrues from market power.

Others are more subtly undeserving. In two of the sectors that generate the highest organisational and personal rents, wealth management and litigation, the social returns are far smaller than the private returns. This is because these activities are predominantly zero-sum games. The most brilliant wealth managers generate high returns by outwitting other less brilliant wealth managers—their gains are other people’s losses. And the most brilliant lawyers win litigation at the expense of the losing litigants. From the perspective of the person paying for these services, the most exceptional talents applied to wealth management and legal disputes fully earn their money. Correspondingly, from the perspective of the exceptionally talented professional, high earnings are warranted—these people would rightly be offended to be lumped in with the first group of rent-seekers who are lucky enough to be controlling rent-generating organisations.

Nevertheless, the social costs of such activities are high. Rare abilities that could be deployed in genuinely productive tasks such as innovation are diverted into these zero-sum activities. The market draws far too many resources into these sectors. Successful rent-seekers are not triumphant producers: they are hard working, brilliant parasites—and many of them know it. I recently gave a speech to the City elite in which I set out the distinction between productive business and rent-seeking. Public policy should be encouraging the former, I argued, and discouraging the latter. A member of the audience approached me afterwards and with quiet concern remarked, “but rent-seeking is what these people do.”

At the global level, rentier societies are those states with small populations and valuable natural resources—think of Qatar, for example. The international fawning bestowed on such states has led to major errors in foreign policy. Rather than courting them in an undignified scramble for investment dollars, the world’s developed economies should be cajoling these countries into being far more generous towards the global poor.

Both Atkinson and Bourguignon are hopeful about the future. Inequality, they argue, is not inevitable. But Atkinson’s near-exclusive focus on national-level policies is misplaced. The world has changed since the 1970s. As Bourguignon observes, globalisation has had profound consequences: capital is more mobile, companies and banks have been internationalised, as have the highly paid. Atkinson acknowledges these changes but his natural habitat is domestic policy. Much can be done to mitigate the worst effects of globalisation, but action will need to be internationally coordinated. Under the UK presidency in 2013, the G8 took important steps forward on this agenda. It agreed measures on corporate tax avoidance, which are being advanced by the European Commission and the OECD. The G8 also began a crackdown on secret bank accounts: globally there has been more progress here in the past two years than during the previous 20. It began the process of building strong international norms for the use of resource rents. The abuse of the rents from natural resources has contributed disastrously to inequality, both between countries and within them.

There is neither a national nor an international consensus for much of Atkinson’s agenda. But there could be a consensus for one more narrowly focused on the tails of the distribution. Ordinary Americans are not going to vote for socialism, or even mild social democracy, but they are understandably angry about the top 1 per cent—even leading Republican politicians are taking the problem seriously, now that the US government is losing about $60bn a year from corporate tax avoidance. At the bottom of society, the US faces the same problems as the UK. The political scientist Charles Murray has shown in chilling detail just how entrenched hopelessness is at the bottom of the income distribution. However, sophisticated techniques for carefully evaluated experimental interventions pioneered by American social scientists are helping us to see more clearly what works to lift people out of poverty. But if such experimental approaches are to be given a proper chance, we need to admit that moralising about either victimhood or fecklessness is bankrupt.

At the global level, Americans are never going to get worried about poverty in China, but half of all households made donations to the disaster relief fund after the earthquake in Haiti in 2010. So it should be possible to build a constituency for support for fragile states. Even craven deference to Saudi Arabia and other Gulf states is beginning to be questioned.

It is reasonable to hope that the scandal of gross inequality can be tackled. But I doubt that a preoccupation with the Gini coefficient will help us sort out the priorities for internationally coordinated action, while the kinds of prescriptions Atkinson makes are unfeasible for an economy as globalised as Britain.