Why canít 20th century tools be used to address 21st century income inequality?.
Roughly from the end of the Second World War to the early 1980s there was a remarkable period of reduced income and wealth inequality in the world’s rich countries. It relied on four pillars: Strong trade unions, mass education, high taxes and large government transfers.
Since the increase of inequality 20 or more years ago, the attempts to stem its further rise have relied on trying, or at least advocating, the expansion of all or some of the four pillars. These efforts have failed. In fact, none of them will do the job of reducing income and wealth inequality in the 21st century.
1. Weak trade unions
Why? Consider trade unions first. The decline of trade union density, present in all rich countries and especially strong in the private sector, is not the product of more inimical government policies only. These might have contributed to the union’s decline, but are not the main cause of it.
The real cause is that the underlying organization of labor has changed. The shift from manufacturing to services and from enforced presence on factory floors or in offices to remote work as well as the additional shift toward outsourcing has had a profound effect.
That has led to a multiplication of relatively small work units, often not located physically in the same place.
Organizing a dispersed workforce is much more difficult than organizing workers who work in a single huge plant and share a single interest.
Power of labor vis-à-vis capital
In addition, the declining role of the unions is a reflection of diminished power of labor vis-à-vis capital. This is due to the massive expansion of wage labor (that is, labor working under capitalist system) since the end of the Cold War as well as China’s re-integration into the world economy.
While the latter was a one-off shock, its effects will persist for at least several decades. And they may be reinforced by future high population growth rates in Africa, which keeps the relative abundance of labor undiminished.
2. Mass expansion of education
Mass education was a tool for the reduction of inequality in the West in the period when the average number of years of schooling went up from 4 or 6 in the 1950s to 13 or more today.
This led to a reduction in the skill premium, the gap between college educated and those with only high or elementary school, so much so that the famous Dutch economist Jan Tinbergen believed in the mid-1970s that by the turn of the century the skill premium will be zero.
But mass expansion of education is impossible when a country has reached 13 or 14 years of education on average simply because the maximum level of education is bounded from above. Thus, we cannot expect small increases in the average education levels to provide the equalizing effect on wages that mass education once did.
3. Taxes – high enough
In the past WWII era, high taxation of current income and high social transfers were crucial to reduce income inequality. But their further increases are politically difficult.
The main reason may be a much more skeptical view of the role of government and of tax-and-transfer policies that is now shared by the middle classes in many countries compared to their predecessors half a century ago.
This is not to say that people just want lower taxation or are unaware that without high taxes the systems of social security, free education, modern infrastructure etc. would collapse.
What it does say is that the electorate is more skeptical about the gains to be achieved from additional increases in taxes imposed on current income — and that such increases are unlikely to be voted in.
So if the high underlying inequality is a threat to social homogeneity and democracy, what tools should be used to fight it?
This is where we need to think not only out of the box in purely instrumental fashion, but to set ourselves a new objective: We need to shift toward an egalitarian capitalism based on approximately equal endowments of both capital and skills across the population.
To put it in simple terms: We need a capitalism that generates egalitarian outcomes even without relying on a large redistributionist state (as we have done in the past).
Consider this: If the rich have only twice as many units of capital and twice as many units of skill than the poor, and if the returns per unit of capital and skill are approximately equal, then overall inequality cannot be more than 2 to 1.
How can endowments then be moved toward greater equality? As far as capital is concerned, by de-concentration of the ownership of assets. As for labor, mostly through equalization of returns to the approximately same skill levels.
That means we need both the equalization of the stock of endowments, as well as the equalization of the returns to the stocks of education.
Let us start with capital. It is a remarkable fact, to which little attention has been paid: The concentration of wealth and income from property has remained at the incredibly high level of about 90 Gini points or more since the 1970s in all rich countries.
Reducing capital concentration
This is to a large extent the key reason why the change in the relative power of capital over labor and the increase in the capital share in net output was directly translated into a higher inter-personal inequality. Why was this obvious fact overlooked? Simply because it is so obvious.
We are used to thinking that as the capital share goes up, so must income inequality. This is true. But it is true because capital is extremely concentrated. Thus, an increase in a very unequal source of income must push overall inequality up.
But if capital ownership becomes less concentrated, then an increase in the share of capital that may be — let’s suppose — inevitable due to international forces such as the Chinese moving to capitalism, does not need to lead to higher inequality within individual rich countries.
The methods to reduce capital concentration are not new or unknown. They were just never used seriously and consistently. We can divide them into three groups.
Future options: Tax policies and worker ownership
First, we need tax policies that are favorable to small and medium shareholders (including a guaranteed minimum rate of return) to make equity ownership more attractive to them (and less attractive to big shareholders). That is notably a policy that is exactly the opposite of what exists today in the United States.
Second, increased worker ownership through Employee Stock Ownership Plans or other company-level incentives.
Third, we need to make much better use of inheritance or wealth tax as a means to even out access to capital.We should use the tax proceeds to give every young adult a capital grant (as recently proposed by Tony Atkinson).
In a rich and well-educated society, the issue is not just to make education more accessible to those who did not have a chance to study (although that too is obviously important), but to equalize the returns to education between equally educated people.
In today’s world, the most significant source of wage inequality is no longer the difference in the years of schooling (as it was in the past). Rather, it is the difference in wages (for the same number of years of education) that is based either on the perceived or actual difference of the quality of the schools attended.
The way to reduce this inequality is to equalize the quality of schools. This, especially in the United States, but increasingly in Europe as well, implies improvement in the quality of public schools.
This can be achieved only by large investments in improved public education and by the withdrawal of the numerous advantages (including tax-free status) enjoyed by private U.S. universities that command huge financial endowments.
Without the leveling of the playing field between private and public schools, income and wealth inequality will rise. A mere increase in the number of years of schooling or the ability of the rare child of lower middle class status to attend elite colleges (that increasingly serve only the rich) will not reduce inequality in labor incomes.
**Branko Milanovic is Presidential Professor at the City University of New York’s Graduate Center, as well as Senior Scholar at the Luxembourg Income Survey.
Previously, he served as lead economist in the World Bank’s Development Research Group and as a visiting professor at the University of Maryland.
During his 25-year career as an economist, his main area of research has been income distribution. This gap was the subject of his 2011 book, The Haves and the Have-Nots: A Brief and Idiosyncratic History of Global Inequality (Basic Books).
He likes to point out that his dissertation was on income inequality in the former socialist Yugoslavia, with the country disappearing four years after the dissertation was successfully defended. He moved on to studying income inequality during the transition in Eastern Europe, and with the integration of most of these countries into the European Union that specific topic disappeared as well.
After these projects, he dedicated himself to the study of income distribution on the worldwide level (as opposed to the distribution in one country or a group of countries).