Other economics
Economists should get serious about inequality
Economists pay too little attention to wealth inequality. That’s bad, because distributional unfairness retards economic growth, and even the rich would like to see a more equal society.
I asked Google AI “what is economics?” and got an answer, that it would have gleaned from the hundreds of economics texts out there:
Economics is the social science that studies the production, distribution, and consumption of goods and services, focusing on how people and societies manage limited resources to meet unlimited wants and needs.
Not bad, and it’s heartening to see the word “distribution” in that list, but undergraduates who enrol in economics, or who take a basic economic unit as an elective or as part of another course, find that the question of distribution is left out. That’s a matter for politics, or for social security policy, the student is told.
That’s one theme in a recent episode of The economy stupid, in which Peter Martin discusses with Jenny Gordon of ANU, and Dan Ziffer of the ABC the great Australian wealth gap. They are particularly concerned that economists tend to see dealing with the distribution of income and wealth as topics outside their duty statement.
This neglect is not for a lack of evidence. Among the 20 highest-income OECD countries, Australia ranks at #7 in terms of income inequality, as shown in the graph below, which shows Gini coefficients of income for those countries (higher coefficient indicating more inequality).
Similarly for the same set of countries, Australia has a relatively high poverty rate.[1]
Income inequality in Australia has been widening only slowly, and former Treasurer Wayne Swan assures us that our government is doing much better than governments of other countries in ensuring that our economy delivers for everyone.
But income inequality is not our main problem. Decades of small growth in income inequality can lead to large and intractable disparities in the distribution of wealth, particularly in relation to housing, which corresponds to intergenerational inequality.
Few other than the occasional aged communist would argue that income and wealth inequality are always undesirable: most people with a sense of fairness would agree that equality of opportunity is a more worthwhile policy goal. Even hard-nosed economists, concerned only with economic growth, agree that when some are denied the opportunity to develop their capabilities, there is an opportunity loss to the economy.
Inequality of opportunity is hard to measure, but it comes about when some can draw on parents’ financial resources to extend their education, get established in a house, or start a business while others cannot, and when so many of life’s opportunities are distributed by postcode, particularly in relation to access to good schooling.
In the program there is discussion about the relationship between inequality and a country’s economic performance. They refer to the neoliberal view that inequality is a driver of growth, but the evidence is that if there is a causal relationship it runs in the other direction. In high-growth societies such as China, inequality is a result of that growth. When inequality becomes entrenched, and when whole groups feel left behind, there is a fraying of social cohesion, and a rise in the politics of resentment, both of which have their own costly consequences.
If we know how inequality is rising, and we know its economic consequences, what do we know about its causes?
On this Martin, Gordon and Ziffer come up with a list of some causes – the financialization of housing, the rise of the gig economy, the precarity of work in many industries, a lopsided tax system – and they also talk about the social determinants of inequality. Are universities still melting pots of social interaction between classes, where people from all classes meet, mix and mate? Are we reverting to a society of assortative mating that preserves social hierarchies? Are we becoming a society of oligarchs, or even plutocrats, who live in a world separate from the hoi polloi and have no shared interest in the wider society?
In this regard they refer to work by the Melbourne Institute of Applied Economic and Social Research, which suggests there is developing an other-worldly oligarchy, detached from the lives and shared experiences of most Australians. Research described in their paper Political polarization, wage inequality and preferences for redistribution reveals that most people are uncomfortable with income inequality in Australia, that they would like a more equal distribution, and that they underestimate the extent of income inequality. That means our society is more unequal than we would like it to be, and is even more unequal than we believe it to be.
For example, we believe that the pay of a CEO is about 7 times the average full-time worker salary (making it around $700 000) but that it should be should be only about 3 times ($300 000). In fact it is more like 100 times a worker’s salary ($10 million).
Their research reveals, predictably, that voters on the left are more in favour of redistribution than voters on the right. But the surprising finding is that voters on the far-right (the 20 percent most “right” on their scale) are likely to shift their views towards favouring more redistribution when they are informed of the true extent of inequality. At the same time providing such information has little effect on the attitudes of the other 80 percent of respondents. This holds most strongly in terms of the well-off agreeing with broad statements of values such as “Government should reduce inequality”, and less strongly, but still positively, for concrete statements such as “Raise inheritance taxes”, and statements about raising taxes on the top 10 percent and top 1 percent. (But do those in these exalted positions always realize that they are in the top 10 or 1 percent?)
Carl Rhodes of the University of Technology, Sydney writes in The Conversation that To become a fairer nation, Australia needs to set national inequality targets, in the same way as we set targets for Closing the Gap and our energy transition. He agrees that our achievements often fall short of targets, “but [targets] also create transparency, accountability and momentum for change – which we currently don’t have on economic inequality”.
To return to the theme of The economy stupid, must economists avoid questions of distribution when they teach undergraduates?
It hasn’t always been so. There was a time when undergraduates were presented with the Benthamite theory of diminishing marginal utility of income or consumption. This rests on the assumption that there is a higher improvement in human welfare when a single mother struggling to pay rent gets an extra $1000, than when that same $1000 goes to Gina Rinehart. But ostensibly in the interests of philosophical purity, those who set the curriculums asserted that different people’s utilities cannot be compared, and undergraduate economics resorted to taking questions of distribution as some exogenous factor, outside the scope of economics.
This shift in teaching coincided with the emergence of neoliberalism, and it exempted economists from becoming concerned with the erosion of progressive taxation, a policy rooted in Benthamite utility.
Economists, if they wish to be taken seriously, should welcome Jeremy Bentham back into the classroom.
1. No data for Sweden or Iceland. ↩
Business myths: small is beautiful and death is a tragedy
Researchers blow apart two common myths – that small business enjoys some intrinsic economic virtue and that every business closure is a tragedy.
There are two strong but highly questionable beliefs about businesses.
One is the almost sacred status of small business, which is given special treatment by Commonwealth, state and local governments, such as exemption from regulations applying to larger businesses, and payroll tax relief.
The other, amplified by media reports, is that every business closure is a tragedy. Boarded-up windows and padlocked factory gates make for good TV.
Research by Rachel Lee and her colleagues of the e61 Institute – New firms power Australia’s economy, while small old firms drag it down – addresses both myths. They summarize their findings on business size:
Small biz, Wellington NSW
… young firms (firm births and infant firms under five years old) consistently drive growth in headcount and value add. However, small, old firms are a net drag on both measures across all years. Large, old firms generally make positive contributions, though their impact fluctuates with the business cycle.
They also look at firm closures, pointing out that “not all firm exits are bad”. After all, turnover of firms is one of the basic dynamics of capitalism. They find that on average firms hang on too long in low-productivity activities before they eventually close, releasing real resources to be applied more productively.
Lachlan Vass of ANU, one of Lee’s collaborators, has a Conversation contribution providing more details of the work: Young businesses create 6 in 10 new jobs in Australia – far more than established firms.
He draws attention to data showing that the rate of business closures has been declining over time – a finding that government politicians would see as a positive development. He urges governments to consider policies that facilitate business exit:
Policies that remove impediments from orderly business closure, including supporting affected workers, would help workers and capital to be re-allocated to more productive and innovative firms.
That aligns with the thinking of public servants in industry departments, but their ideas rarely make it past Treasury, who are usually more concerned about the budgetary cost of supporting workers than with the allocative effect of deferring inevitable collapses. Such is the cost of fiscal policy having supplanted economic policy.