Income Inequality in the United States Through the Lens of Other Advanced Economies

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1 Mia DeSanzo Wealth & Power Major Writing Assignment 3/3/16 Income Inequality in the United States Through the Lens of Other Advanced Economies Income inequality in the United States has become a political issue in this country, but it is a matter of both national and global importance. To the extent that income inequality is linked to high rates of poverty, it is a humanitarian issue. It is also an issue of stability; historically, high income inequality has been associated with political and social instability. As the world s largest economy, anything that is destabilizing in the US is a threat to global stability. (Bechtel 197) Inequality is rising across the board in advanced economies, but is rising higher and faster in the United States. The factors that have led to the current level of disparity between the top and the bottom income brackets in American society are present in other advanced economies as well, yet many of them do not have the same levels of inequality. In order to shed some light on how this came to be and what might be done to improve it, I will discuss the development of income inequality in the United States, and then compare and discuss income inequality across other developed economies, including factors that contribute to it and those that mitigate it. Before comparing the US to other countries, it is worth looking internally to see exactly how the current level of income inequality developed over the last few decades. According to Bryan and Martinez in On the Evolution of Income Inequality in the United States, most of the increase in income inequality has been in the top half of earners. This is to say that the income of the top is pulling away from the middle. Most of the labor income increases have been in the top ten percent, and most of that increase has been in the top one percent. ( ) There was also

2 an increase of inequality in the bottom half of earners during the 1980 s, attributed mostly to a decrease in real minimum wage. (103) These figures are for labor income. If nonwage income is included, such as insurance benefits and pensions, inequality is even worse than it appears in wages alone. (105) In Public Policy, Economic Inequality, and Poverty, Timothy Smeeding confirms these observations and points out that as of 2001, a 95 th percentile family had an income 3.2 times higher than a 50 th percentile family, around $164,100 compared to $51,400, and that 50 th percentile family had an income times higher than the 20 th percentile family, which made around $24,000. While the ratio of the 50 th percentile to the 20 th percentile hadn t changed much over the 54 years of data they looked at, they saw that since the 1970 s, the top end is running away from the middle. (963) Bryan and Martinez also looked at income inequality between the genders and between groups with different levels of education. Inequality among both males and females has been increasing, but the gap between males and females is closing as income for women has been rising. (106) In looking at educational levels, they considered both inequality between groups and within groups. Inequality has been rising within groups and between groups. Within groups, the pattern is similar to overall inequality, with the top pulling away from the middle. (107) The between-group inequality levels have been increasing as well, indicating an increase in the education premium: between 1963 and 2002, the median male income increased 78 percent for postgraduates, 41 percent for college graduates, 17 percent for some college, and 11 percent for high school graduates; it decreased 10 percent for high school dropouts. (108) Although there is some disagreement over it, it may be that this increase in the value of education is related to technological changes that demanded skills and education. (109) This point is reiterated by Max Roser and Jesus Crespo Cuaresma in Why is Income Inequality Increasing in The Developed

3 World?, where the rise in skill premiums is explained as a combination of changes in technology demanding high-skilled workers and the demand for low-skilled workers declining with the decline of manufacturing due to globalization. (7) With these internal developments in mind, we can compare the US to other advanced economies and consider what it is that makes the US stand out in income inequality. To generalize the findings, there is the least inequality in the northern European countries, including the Nordic countries, Belgium, and the Netherlands, somewhat more in central Europe, including Germany, Austria, and France, followed by the large Anglo-Saxon nations of Canada, Australia, and the United Kingdom, with the US having less equality than all of those. (Smeeding 959) Smeeding goes on to say that the US differs, above all, in the relative disadvantage of its poorest residents. Our poorest residents have incomes only 39 percent of the median; in other rich nations they are much higher. While inequality has been rising across advanced nations, and all advanced economies face the same pressures of technological change and globalization, the outcomes of inequality vary greatly from country to country. As previously mentioned, as technology has advanced, we have seen a shift toward demand for high-skilled labor and from an industry-based economy to a service economy across the advanced economies. At the same time, low-skilled, labor-intensive production jobs have moved to developing countries. Roser elaborates that as the prices of imported products fall, the wages in the import-competing sector also fall. In contrast, the rising prices of those goods that are exported cause higher wages in the exporting sectors of the economy. As advanced economies import labor-intensive goods and export skill- and capitalintensive goods, the effects of the shifting economy are magnified. (8) As Reuveny says in Economic Openness, Democracy, and Income Inequality, economic openness creates winners

4 and losers in a society (578) and this can be addressed through policies that compensate the losers from trade openness. (594) We see that some countries do a better job of mitigating rising inequality and helping their poorest residents. After strongly stating the need to reduce income inequality in the US and China the world s biggest economies, both with extreme income inequality Bechtel goes on to say that European institutions and norms do set a 21 st century standard for reduced income inequality. (212) What is it that European countries are getting right the United States is getting so very wrong? According to Kollmeyer in Income Inequality in Advanced Capitalism: How Protective Institutions Can Promote Egalitarian Societies, there are three main institutions that work in more egalitarian societies: a large public sector economy, strong collective bargaining institutions, and the dual income family. (425) Additionally, the US spends less on cash and near-cash transfer programs for the nonelderly than other advanced economies. (Smeeding 970) The first of these protections is a large public sector. Kollmeyer tells us that quantitative studies show that public spending in democratic countries reduces income inequality because those countries get revenue from progressive taxation and spend the resulting resources to benefit the population across the social hierarchy, effectively redistributing wealth from the top to the bottom. (As a side note, he also points out that this does not hold for non-democratic countries, where larger public spending is often associated with more inequality, attributed to those funds being spent on the narrow interests of the elite, rather than in the broad public interest.) (426) Roser also notes the connection between the public sector and a decrease of income inequality in another way; increases in the tax share of GDP is strongly associated with decreases of inequality. He notes that rising tax revenue is likely associated with an increase in the number of public sector employees, which probably contributes to reductions in overall

5 income inequality because the income inequality in the public sector is lower than in the private sector. Cheol-Sung Lee suggests in The Limit of Equality Projects: Public-Sector Expansion, Sectoral Conflicts, and Income Inequality in Postindustrial Economies that policymakers would do well to consider possible unintended negative consequences of using public sector expansion to promote income equality,, such as worse macroeconomic performance in some countries, but admits that it has achieved its promise for gender equality, income equality, and full employment at a large scale for several decades. Perhaps the American voter who is concerned with income inequality would do well to weigh these ideas when listening to politicians who want to take a slash-and-burn approach to the public sector, in terms of both spending and public sector employment. The second protective institutions identified by Kollmeyer are trade unions and collective bargaining structures. There are at least three ways that trade unions may contribute to lower overall income inequality. First, in increasing the bargaining power of workers, they increase labor s share of the income so that more money goes into wages rather than profits. Second, unions tend to reduce the gap between high- and low-income workers. Third, social norms are affected to influence wage inequality in non-unionized sectors. Additionally, some countries have more centralized wage setting in which decisions are made at the national level and then implemented by employers and unions, while others, including the US, have a decentralized system in which unions negotiate directly with employers at the local level, having little impact on national economic policy. ( ) Further, in discussing the tax share of GDP, Roser notes that high tax share is also strongly correlated with regulation of the labor market, such as minimum wage laws and stronger labor protection. Unemployment benefits are also likely to be higher in states with a larger tax share of GDP. These tend to be the kind of benefits that trade

6 unions fight for to benefit their membership, and also reduce income inequality across the board. (On unemployment benefits, Roser cites Koeniger s findings that more generous unemployment benefits in fact lower income inequality. ) Roser also speaks directly to the issue of trade unions, noting that higher levels of wage coordination lower inequality. Again, the equality-minded American voter would do well to consider this in an age of politicians bragging about union busting. The third protective institution identified by Kollmeyer is the family, an important institution because it allows for the pooling of incomes among multiple income earners and the redistribution of income from working to non-working members of society. There have been changes, positive and negative, to the way that families buffer against. The increasing participation of women in the workforce is generally an equalizing force, spreading income more widely across society and adding income to many lower-income families. On the other hand, the rise of households headed by single mothers contributes to inequality because they have fewer resources than dual income families, the gender gap in pay means that they generally make less than their male counterparts, and in the US, single mothers tend to be less educated than other women. ( ) Again, many European countries have policies favorable to families and to women, such as paid maternity leave, that are not guaranteed and often unavailable in the United States. This is yet another angle the equality-conscious voter in the United States might want to consider before casting a ballot. Beyond Kollmeyer s protective institutions, there is the matter poverty and social safety net programs. As previously mentioned, Smeeding points out that our poorest residents are at relative disadvantage compared to the poorest in other rich nations. He says that this reflects relatively low wages at the bottom of the distribution in the United States compared to other

7 developed nations, but it also reflects the relative weakness of the income support system for families with children and for the low-income elderly in the United States. (969) He also explains that, while every nation has its own mix of benefits and policies to fight poverty, other advanced democracies do a better job of reducing poverty than the US does, even with the Earned Income Tax Credit counted as social assistance. Countries such as Sweden, Belgium, and Germany, who have generous social insurance programs, such as unemployment, workers compensation, disability benefits, and paid family leave, find that those programs reduce poverty by over seventy percent. Targeted social assistance programs in countries such as Finland and the United Kingdom have large effects there, and smaller effects in the aforementioned heavily insured nations, where the heavy lifting has already been done by those programs. (974) In contrast, in 1999 (the latest comparable year available at the time Smeeding was writing in 2005), the United States spent less than three percent of GDP on cash and near-cash assistance for the nonelderly, or less than half the amount spent by Canada or the UK; less than a third of spending in Germany, the Netherlands, or Belgium; and less than a quarter of the amount spent in Finland or Sweden. (970) Lee, while warning about the pitfalls of relying on a large public sector, also makes an argument for generosity of social benefit programs that increase equality through progressive taxation and generous social transfers : This has been the single most important determinant for reducing inequality across advanced industrial democracies, even since the 1980 s, when the public-sector employment strategy began to show its adverse effects in some liberal and social-democratic countries. Welfare states role in protecting citizens vulnerable to rapid technological innovations and intensified global competition through generous transfers and entitlements should not be discounted. (118) When an American politician suggests that we are spending too much on programs for the poor and it is a huge

8 burden for the taxpayer, a wise voter with an eye toward reducing poverty and increasing equality should take those claims with a grain of salt. We have seen how the US differs from other advanced economies, especially those in Europe, and have also seen some of the ways those countries differ from one another. I have chosen to compare and contrast other countries with the US in order to answer the question of how and why income inequality varies across countries with advanced economies because the inequality in this country is so alarmingly out of line with other wealthy nations, including the other liberal democracies such as Canada and the United Kingdom. This largely seems to be a matter of the political culture in the US and the kind of policies that it engenders. As I have suggested throughout the discussion of the institutions and policies that reduce inequality, the solution for the inequality problem may lie in the ballot box. Large amounts of income inequality have been associated with social, political, and financial upheaval, so our national stability may depend on addressing this issue. Further, because of our special position as the world s largest economy, global stability may depend on it.

9 Works Cited Bechtel, Gordon G. "Does Globalization Mitigate Income Inequality?". Journal Of Data Science 12.(2014): Academic Search Premier. Web. Bryan, Kevin A., and Leonardo Martinez. "On The Evolution Of Income Inequality In The United States." Economic Quarterly ( ) 94.2 (2008): Academic Search Premier. Web. Kollmeyer, Christopher. "Income Inequality In Advanced Capitalism: How Protective Institutions Can Promote Egalitarian Societies." Comparative Sociology 13.4 (2014): Academic Search Premier. Web. Lee, Cheol-Sung, Young-Bum Kim, and Jae-Mahn Shim. The Limit of Equality Projects: Public-sector Expansion, Sectoral Conflicts, and Income Inequality in Postindustrial Economies. American Sociological Review 76.1 (2011): Web. Reuveny, Rafael, and Quan Li. "Economic Openness, Democracy, and Income Inequality: An Empirical Analysis". Comparative Political Studies 36.5 (2003): Web. Roser, M. and Cuaresma, J. C., Why is Income Inequality Increasing in the Developed World?. Review of Income and Wealth, 62: 1 27 (2016). doi: /roiw Smeeding, Timothy M. "Public Policy, Economic Inequality, And Poverty: The United States In Comparative Perspective." Social Science Quarterly (Wiley-Blackwell) 86.(2005): Academic Search Premier. Web.