Persistently high rates of income or wealth inequality are bad for social cohesion, political inclusion and crime. The evidence for this is overwhelming. Often, stubbornly high income inequality partly reflects deep historical injustice. Fortunately, history also provides some clues to how we might tackle it.
In some Western advanced countries income inequality is a lot higher than it was 37 years ago. In 1980 it had been stable and low in the UK for three decades . The period after World War II was one of inclusive economic growth. This Golden Age of low inequality is a reference period for many of us: it is when we grew up. But few can now remember the times that lead to it. The 1930s are too long ago.
The statistical record on inequality before the 1950s is quite thin, though research is continuing to improve it. We are fairly certain that income inequality fell and stayed low in most Western countries roughly between 1910 and 1980. What made it fall? Of course there was more than one cause, and surely different causes in different places. But some common features are present.
War and wages
In the earlier years of the 20th Century there was a clear trend of state intervention in the economy, albeit institutionalized differently across countries. It was generated by a mix of factors: social solidarity engendered by the wars, wartime experience of governing the economy, unemployment in the 1930s and the rise of socialist ideas. It accelerated for a decade or so after World War II.
Key features were nationalization, increased provision of welfare, public health and education, and the development of public amenities. Scholars have discerned regional variants: the Nordic Model, Rhine capitalism and so on. Arguably the most important aspects that directly affected income inequality were state involvement in wage setting and redistributive taxes and transfers.
In many countries there were moves to centralize collective bargaining over wages and conditions of work. In the UK, Wages Councils which controlled wages in low pay sectors were introduced in 1909, and national wage setting was introduced during both world wars. From 1945, government-imposed ceilings on pay rises, agreed with unions and employers, were in place much of the time until 1979.
In other countries the process was different. In Sweden, national level bargaining between employers’ federations and unions was agreed initially in 1938 to avoid government intervention. In West Germany after World War II, employers’ confederations and unions were restructured along industry lines and wage bargaining took place nationally, by industry. In France, unions and employers organizations, together with government, were brought together in Le Conseil Economique in 1946.
Mood shift
You are getting the picture by now. Even in the US, the Treaty of Detroit of 1945 created a tripartite system aimed at maintaining industrial peace. Moderation and duty were virtues to be applauded. Historians record how in the 1960s the White House might publicly criticize executives granting themselves large pay rises. In the 1970s this interventionist tendency was criticized, with some justification, as being a partial cause of the stagflation of that decade. By the mid-1980s the political mood had shifted, particularly strongly in the UK and US.
The new mood in those countries was anti-interventionist, especially in industrial relations. Both President Ronald Reagan and Prime Minister Margaret Thatcher faced down unions rather than seeking compromise. In Britain the institutions of consultation were wound up. In the US, minimum wages were allowed to fall against average earnings.
Inequality in labour earnings rose quickly though the 1980s in both countries. The trend was slower in the rest of Western Europe where, mainly, the wage setting institutions remained more intact. Most commentators argue that the inequality rise was due to the slow-moving forces of technological change and globalization which favoured skilled and educated workers. But in the UK and US the shift in political climate meant that the wage setting institutions no longer worked to moderate those forces.
Taxation was changing as well. In most Western countries, income tax became a major revenue source in the early 20th Century. As the political tide changed, both Reagan and Thatcher heavily reduced the progressivity of income tax – the extent to which the rate of taxation increases with income.
The Organisation for Economic Co-operation and Development (OECD) calculates the extent to which taxes and transfer payments moderate income inequality in its member countries. Their calculations illustrate what economic historian Peter Lindert calls the Robin Hood Paradox, which is that the highest levels of redistribution occur in countries with the least pre-tax inequality. For instance, among OECD countries, the highest levels of redistribution occur in the Scandinavian countries and the lowest in Mexico and Chile.
Fashion statement
Can we infer from this that redistribution works? Could the Mexican government eliminate massive inequality with deep historical roots simply by increasing the progressivity of taxes and transfers? Their Progresa and Prospera programmes have made cash transfers to the poor conditional on them ensuring their children attend school and that the family receive preventative health care. Analysis of these programmes tell us they work well.
There is also international evidence that increases in tax and transfer progressivity do reduce income inequality directly. My own calculations have shown that changes in progressivity and changes in income inequality across the OECD countries 2007-2014 are strongly negatively correlated.
This message of the last 100 years is unfashionable. In Britain and the US few political parties today with serious electoral ambitions would embrace a collectivist approach to the setting of wages and salaries or increasing tax and transfer progressivity. Even fewer would speak out against high salaries. Fashions do change, though.
How to use this editorial-
The editorial gives a specific time frame – When inequity fell, why it fell and why it is rising now, and this time frames can be used in your answer.
Take the report and data and show which countries are doing better and why they are doing better in your answer. This can give your answer an objective approach rather than arguing subjectively on the basis of only statements without any data to vindicate your stand.
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Steve Ovett, the famous British middle-distance athlete, won the 800-metres gold medal at the Moscow Olympics of 1980. Just a few days later, he was about to win a 5,000-metres race at London’s Crystal Palace. Known for his burst of acceleration on the home stretch, he had supreme confidence in his ability to out-sprint rivals. With the final 100 metres remaining,
[wptelegram-join-channel link=”https://t.me/s/upsctree” text=”Join @upsctree on Telegram”]Ovett waved to the crowd and raised a hand in triumph. But he had celebrated a bit too early. At the finishing line, Ireland’s John Treacy edged past Ovett. For those few moments, Ovett had lost his sense of reality and ignored the possibility of a negative event.
This analogy works well for the India story and our policy failures , including during the ongoing covid pandemic. While we have never been as well prepared or had significant successes in terms of growth stability as Ovett did in his illustrious running career, we tend to celebrate too early. Indeed, we have done so many times before.
It is as if we’re convinced that India is destined for greater heights, come what may, and so we never run through the finish line. Do we and our policymakers suffer from a collective optimism bias, which, as the Nobel Prize winner Daniel Kahneman once wrote, “may well be the most significant of the cognitive biases”? The optimism bias arises from mistaken beliefs which form expectations that are better than the reality. It makes us underestimate chances of a negative outcome and ignore warnings repeatedly.
The Indian economy had a dream run for five years from 2003-04 to 2007-08, with an average annual growth rate of around 9%. Many believed that India was on its way to clocking consistent double-digit growth and comparisons with China were rife. It was conveniently overlooked that this output expansion had come mainly came from a few sectors: automobiles, telecom and business services.
Indians were made to believe that we could sprint without high-quality education, healthcare, infrastructure or banking sectors, which form the backbone of any stable economy. The plan was to build them as we went along, but then in the euphoria of short-term success, it got lost.
India’s exports of goods grew from $20 billion in 1990-91 to over $310 billion in 2019-20. Looking at these absolute figures it would seem as if India has arrived on the world stage. However, India’s share of global trade has moved up only marginally. Even now, the country accounts for less than 2% of the world’s goods exports.
More importantly, hidden behind this performance was the role played by one sector that should have never made it to India’s list of exports—refined petroleum. The share of refined petroleum exports in India’s goods exports increased from 1.4% in 1996-97 to over 18% in 2011-12.
An import-intensive sector with low labour intensity, exports of refined petroleum zoomed because of the then policy regime of a retail price ceiling on petroleum products in the domestic market. While we have done well in the export of services, our share is still less than 4% of world exports.
India seemed to emerge from the 2008 global financial crisis relatively unscathed. But, a temporary demand push had played a role in the revival—the incomes of many households, both rural and urban, had shot up. Fiscal stimulus to the rural economy and implementation of the Sixth Pay Commission scales had led to the salaries of around 20% of organized-sector employees jumping up. We celebrated, but once again, neither did we resolve the crisis brewing elsewhere in India’s banking sector, nor did we improve our capacity for healthcare or quality education.
Employment saw little economy-wide growth in our boom years. Manufacturing jobs, if anything, shrank. But we continued to celebrate. Youth flocked to low-productivity service-sector jobs, such as those in hotels and restaurants, security and other services. The dependence on such jobs on one hand and high-skilled services on the other was bound to make Indian society more unequal.
And then, there is agriculture, an elephant in the room. If and when farm-sector reforms get implemented, celebrations would once again be premature. The vast majority of India’s farmers have small plots of land, and though these farms are at least as productive as larger ones, net absolute incomes from small plots can only be meagre.
A further rise in farm productivity and consequent increase in supply, if not matched by a demand rise, especially with access to export markets, would result in downward pressure on market prices for farm produce and a further decline in the net incomes of small farmers.
We should learn from what John Treacy did right. He didn’t give up, and pushed for the finish line like it was his only chance at winning. Treacy had years of long-distance practice. The same goes for our economy. A long grind is required to build up its base before we can win and celebrate. And Ovett did not blame anyone for his loss. We play the blame game. Everyone else, right from China and the US to ‘greedy corporates’, seems to be responsible for our failures.
We have lowered absolute poverty levels and had technology-based successes like Aadhaar and digital access to public services. But there are no short cuts to good quality and adequate healthcare and education services. We must remain optimistic but stay firmly away from the optimism bias.
In the end, it is not about how we start, but how we finish. The disastrous second wave of covid and our inability to manage it is a ghastly reminder of this fact.