Piketty, Stiglitz and Our Renewed Interest in Inequality

The publication in 2014 of Thomas Piketty’s Capital in the Twenty-First Centurybrought inequality to the center of the public policy debate.

Looking at lots of historical data, he finds that the return on capital is always higher than economic growth. That means that those who own capital will do better than the rest. The rich will not just get richer, but they will also get richer than everyone else. In capitalism, if governments do nothing, wealth is bound to concentrate among the few.

This argument has attracted many followers. Joseph Stiglitz, a Nobel laureate, has just published The Great Divide, a kind of application of Piketty to the United States. (Disclaimer: when Stiglitz presented his book last April in Washington, I chaired the event.) But there are also many would-be debunkers — one of them has shown that wealth does not concentrate as much if you take housing out of the data.

For most economists, all this is puzzling — the study of inequality has been going on forever. To give you an idea, the index used to measure how unequal the distribution of income is — the “Gini Coefficient” — was invented a century ago. So, why the sudden interest? Why worry now about something that has been the fodder of academics, politicians and the media for so long?

Here are four likely reasons:

First, we still don’t know how much inequality we should live with. While most people detest extreme inequality, most people also detest extreme equality. No one likes to hear that the world’s richest one percent will soon be wealthier than the rest of us put together — yes, it is that bad. But no one really wants to see governments forcing us to own or earn the same whatever our efforts or talents are. How equal should societies be? Economics provides only part of the answer.

Research shows that countries where inequality is rampant tend to grow more slowly in the long-run, and to recover more slowly after a recession. And we suspect that there is a direct link between large income differences and political instability, civil conflict, populism, and criminality — none of which is costless. But economists cannot settle what is, in essence, a matter of social choice. At least in democracies, voters can choose how much inequality they are willing to tolerate by picking a leader that represents their views. The problem, as Stiglitz will rightly tell you, is that inequality can ruin democracy itself: the rich elite just captures the politicians. Ergo: Social policy rarely reflects social preferences.

Second, we may be worrying about the wrong problem. The current debate is about inequality of outcomes among adults, that is, how much wealth, income, land, or education each of them should get. In that, there is no agreement. But there is agreement about inequality of opportunity among children — there should be none. A child’s success in life should not depend on her birthplace, gender, race, family’s worth, or any other personal circumstance over which she has no control or responsibility. This is held true across the political spectrum — for the left as a matter of social justice, and for the right as a matter of individual merit. Unfortunately, it was not until 2008 that the first “Human Opportunity Index” was constructed and published, applied to Latin-America — a region where inequality is rife. Few countries currently use it to guide social policy and public expenditures — Colombia has been a leader in this. That will change over time.

Third, we are focusing on radical rather than practical solutions. Piketty suggests a global tax on capital — wherever your wealth sits, it would be taxed at the same rate. Good idea in theory. But, if taxes are difficult to agree on inside a single country, how likely is an agreement among the 196 countries of the world? Stiglitz and others propose free public services for all — things like healthcare, college education, and transport. Taken literally, this would only make inequality worse because it would take money away from programs that could benefit the poor — imagine spending scarce public dollars on paying for rich kids to get a university degree. In fact, the opposite may be better — governments should focus more of their spending on those in need and away from the well-off.

Take fuel subsidies. In the average developing country, two-thirds of gasoline subsidies go to the rich — they have the cars — and only three percent go to the poor — they rely on public transport, where it exists. Something similar happens with electricity and natural gas — who owns the larger houses? This is a fiscal aberration that can be corrected. The technology to identify and transfer money to the poor — and only to the poor — exists and is cheap. What is lacking is political will.

Finally, we may be perpetuating inequality with our own behaviors. There is growingevidence that, in increasing numbers, people marry people like themselves. This “sorting” is based mostly on education — think of Ivy-leaguers marrying only other Ivy-leaguers, and high-school drop-outs marrying only high-school drop-outs. The educated choose the educated, and so do their kids. Contacts, jobs and assets then get trapped into classes. Serious scholars have found that, if marriages had occurred at random across educational levels, the distribution of household income in the U.S. today would not be much different from what it was in the 1960s, that is, before the “Great Divide” opened up.

For now, most of the research comes from developed countries, but the findings probably resonate if you live in Africa, South Asia, or Latin-America. Can governments change our social attitudes? Not easy. Perhaps our newly-found obsession with inequality is a reflection of a collective sense of guilt.