THE FOURTH ANNUAL OXFORD FULBRIGHT DISTINGUISHED LECTURE ON INTERNATIONAL RELATIONS CAUSES AND CONSEQUENCES OF GROWING INEQUALITY and what can be done about it Professor Joseph E. Stiglitz Friday 23 May 2014 Hosted by the University of Oxford in association with the US-UK Fulbright Commission, the Embassy of the United States of America, Pembroke College and the Lois Roth Endowment Pembroke College Embassy of the United States of America, London
I. Inequality has been growing within most countries around the world But the level of inequality differs markedly And there are some countries in which inequality is decreasing Economic forces are global, affecting similarly situated countries similarly Differences in outcomes suggests that the level of inequality is greatly affected by policy and politics US has highest level of inequality among advanced economies Countries that have emulated US model are seeing increases in inequality
Increase in share of top 1%: Piketty and Saez data Top 1% Income Share 1913 1918 1923 1928 1933 1938 1943 1948 1953 1958 1963 1968 1973 1978 1983 1988 1993 1998 2003 2008 25% Top 1% US Pre-Tax Income Share, 1913-2012 20% 15% 10% 5% 0% T. Piketty and E. Saez, "Income Inequality in the United States, 1913-1998" with Thomas Piketty, Quarterly Journal of Economics, 118(1), 2003:1-39, updated to2011. Series based on pre-tax cash income including realized capital gains and exluding government transfers.
Increase in share of top 1%: Piketty and Saez data Top 1% of U.S. income earners take home 22.5% of income Late 2000s and early 2010s highest levels since before Great Depression Top 0.1% take home 11.3% of income Top 0.01% take home 5.5% of income
Stagnation: U.S. median household income (constant 2012 US$) 60,000 55,000 50,000 45,000 2012: $51,017 40,000 35,000 30,000
Decline in median income of U.S. full-time male worker Median income of a full-time male worker lower than 4 decades ago Median income of a full-time male worker with only a high school education 47% below 4 decades ago Low labor force participation rate of 62.8% -- lowest since 1978
Decline in median income of full-time male worker Real median income of full-time male workers, 1964-2012 55,000 50,000 45,000 40,000 35,000 30,000 Real median income of full-time male workers
Labor force participation at 1978 level
Increasing gap between productivity and wages Source: Washington Post citing data from the Bureau of Labor Statistics and from the Heritage Foundation.
Disparity between top and rest shows that trickle-down economics doesn t work Never was good theory, no evidence behind trickle-down economics Old version: need to give more money to top to enhance savings Modern version: need to give more money to top because they are job creators
Recession made matters worse Those at the bottom hurt thrice over Directly by unemployment Shifting distribution of income Cutbacks in public services Again, it s politics and policies: how we responded to the crisis made matters worse
Recession made matters worse In US, 95% of increase in income went to upper 1% between 2009-2012 Median wealth fell by 40%, back to level of early 90 s Poverty is up
Many dimensions to inequality Income Wealth Health Greater in US than other advanced countries, partly because of lack of access to health care But evidence that inequality may even have adverse effect on top Exposure to environmental hazards Access to justice In US, treatment of homeowners, bankers in mortgage crisis (where homeowners who owed no money were thrown out of their homes, but bankers who lied to court were not prosecuted) raises questions about if the US can be said to have a rule of law Inequalities in many of these areas are greater than in income
Many aspects of inequality More of income, wealth going to the top Hollowing out of the middle class in many advanced countries More people in tails of distribution Increases in poverty in some advanced countries Can t summarize income distribution in a single number But whatever way one looks at it, things are getting worse in most countries
This is even true of the so-called successful countries In Germany, from mid 1990s to 2008 the bottom three deciles showed negative growth in real disposable income
Inequality of opportunity For most people, even more important than equality of outcomes Large differences among countries: Many advanced countries do much more poorly than is widely recognized; some (Scandinavian) do much better than others. Again, it s not just economics, its policies and politics that seem to matter most Surprising comparison: US among least mobile No single number that can summarize mobility matrix Conventional measure: Correlation between income/education of child and that of parent Inequality of outcomes and inequality of opportunity are closely linked
Prospect of decreasing equality of opportunity Because inequality of outcomes and inequality of opportunity are closely linked Increases in inequality of outcomes today suggests that in the future there will be decreases in equality of opportunity Increasing importance of inequality of (inherited) wealth suggests that we are creating a new plutocracy
Contribution of Piketty s recent book Confirms patterns of increasing inequality in incomes focusing on the top Argues that period after WWII was an historical anomaly Refuting Kuznets curve hope that with development inequality would be reduced Suggests that there will be increasing inequality of wealth (and income) unless there are policy changes Success of book in US highlights growing concern about inequality
II. Causes of inequality Each aspect of inequality has its cause Causes are interrelated hard to parse Social, economic, political
1. All the laws and regulations help shape the degree of inequality Markets don t exist in a vacuum Decisions about enforcing anti-trust laws can affect monopoly rents Decisions about enforcing predatory lending laws can affect well-being of those at the bottom Bankruptcy laws Derivatives given priority in bankruptcy US introduced partial indentured servitude in 2005 bankruptcy law Students could not discharge debt
Corporate Governance Firms have used their managerial discretion to seize a larger fraction of corporate rents Sometimes in the name of incentive pay But incentives have actually been perverse
2. Macroeconomic and especially monetary policy Focusing on inflation rather than employment Response to crisis illustrates potential distributional effects Lowering interest rates hurt retirees Focus was on restoring stock market values, increasing consumption of the rich Low cost of capital encourages innovation that is capital using and labor saving Unintended (?) consequence of Fed policy Creating a jobless recovery Increasing inequality Indirect help for housing market (through banks) rather than direct assistance Increasing concentration in sector meant that benefits of lower interest rates were not fully passed on Little attention to SME lending, local and regional banks Echoing biases in IMF/US Treasury policies in earlier crises
3. Underlying economic forces Increasing disparity in endowments Wealth inequality Inequality in human capital In US related to increasing economic segregation, decreasing access to higher education Momentum for increasing wealth inequality High savings of wealthy, high after tax returns Especially given opportunities for tax avoidance Especially given preferential treatment Increases in assortive mating Complementarity between wealth and returns to wealth
Some dampening effects but these may be getting weaker Division of wealth among heirs Primogeniture designed to prevent Smaller families Regression towards mean Rags to riches and back again in three generations In general, there exists equilibrium wealth distribution What we are observing today is a movement towards a more unequal equilibrium wealth distribution
Other market forces contributing to Increasing inequality of income Changes in market prices of endowments Skilled-biased technical change Not consistent with timing of increase in wage inequality Not consistent with growth in inequality in recent years Globalization Decreasing share of labor With capital more unequally distributed than labor Result of increasing K/L and elasticity of substitution greater than one (?) Or increasing appropriation of income by rent seeking
But even market forces are affected by policy Incentives for different kinds of innovation Rules of the game Tax policies New proposed trade agreements may make things worse Scope for rent seeking
Rent seeking vs. Marginal Productivity Theory Latter suggests that those at the top contribute more have made the size of the economic pie bigger Former says that those at the top have excelled in their ability to get a larger share of the pie Markedly different implications for acceptability of inequalities Markedly different views of consequences of tax policy
Many forms of rent seeking Getting public resources at low prices Natural resources Privatizations spectrum Selling to government at high prices Military contracts Drugs Corporate welfare Hidden (and not so hidden) tax provisions Open subsidies
Marginal productivity theory suggests inequality just rewards for wealth creation No one is self-made Disagreements about relative role of luck, contributions of others Widespread market failures Whenever there is market failure, private rewards and social returns differ Agency issues (corporate governance) Externalities (imposing costs on others) Monopolies (major source of inequality)
Rent seeking more plausible explanation Obvious importance in many developing countries that are characterized by rent seeking But also true in advanced industrial countries Example: large bonuses, incomes of corporate executives Bearing little relationship to private contributions, even less to social contribution Evidenced in Great Recession Exploiting deficiencies in corporate governance
Large numbers of those at the top have fortunes that are associated with rent seeking If those at the top made the economic pie bigger, would expect that as their incomes increased, others would also there would be trickle-down economics Evidence is to the contrary Experiment: Increase tax rates at the top If inequality is largely associated with rent seeking, would not expect to see much effect on growth confirmed by data
Multiple social forces shaping inequality Weaker unions Related to politics, globalization, changing structure of production Changing social mores Willingness of top management to take larger fraction of corporate rents Markedly different at other times and in other countries Legal framework provides them scope
Multiple social forces shaping inequality Social conventions and customs Changes in marriage and family structure Discrimination Particularly adverse effects on the bottom Clear evidence in labor market Clear evidence in housing and mortgage markets Becker suggested that in competitive market couldn t persist Game theoretic models show that it can persist Evidence is that it does persist Statistical discrimination But with imperfect information, existence of statistical discrimination can lead to differential outcomes even when ex ante groups are identical
Multiple social forces shaping inequality Controversy over relative role of economic and social forces Timing of increase in inequality more consistent with social explanations Evidence in 1990 s suggested that trade is relatively unimportant More recent evidence suggests trade more important
III. Adverse consequences of inequality Undermines our democracy Divides our society Weakens our economy The effects are intertwined: societies in which many individuals believe that there are fundamental inequities that the system is not fair don t function well. Individuals and the economies suffer. One of reasons that health outcomes in the US may be so poor, even for those who can afford access to health care, has to do with inequality Inequality in health undermines economic performance
Adverse economic consequences of inequality We pay a high price for this inequality Could have more growth, more stability, and more equality This is a fundamental change in perspective: There need not be a trade-off This is in addition to the moral case for a more equal and fairer society
Adverse economic consequences of inequality Lack of opportunity means that we are not fully using human resources children of poor are not living up to their potential Rent seeking means that resources are diverted from wealth creation to rent seeking Political economy: more divided society has difficulty getting political consensus behind important public investments And top may use political influence to achieve legal frameworks which increase inequality and instability
Vicious circle More economic inequality leads to more political inequality More political inequality leads to rules of the game that amplify economic inequality and political inequality
Inequality and instability Inequality is associated with instability Instability has a direct cost, if individuals are risk-averse Instability also adversely affects growth Instability also contributes to inequality Vicious circle
Inequality and instability Empirical finding in IMF studies Consistent with recent downturn, Great Depression Not inevitable May be consequence of some forms of inequality more than others
Simple model Increased inequality lowers aggregate demand, in absence of countervailing government action Differences in MPC between the top and bottom If government responds by using monetary policy to stimulate the economy, in the presence of inadequate regulation, risks creating bubble The breaking of bubble leads to marked downturn Unlike standard DSGE models, bubble is endogenous There are alternative ways by which government could have responded (increased public investment), but in presence of high levels of political inequality, these are unlikely to be chosen
Poverty traps Low income people live in locations where: Their children do not get access to education Inequalities start pre-school, importance of pre-school education They have less access to jobs Especially important in absence of good public transportation They are exposed to more environmental hazards They even have less access to nutritional food Poverty limits ability to think long-term focus is on getting by In developing countries, nutritional poverty trap low income leads to poor nutrition
IV. Policy implications Every aspect of policy/legal/institutional framework has effects on inequality Bankruptcy law, competition law, corporate governance, financial sector regulation One can design policy/legal/institutional frameworks in ways which promote growth and equality (both of outcomes and of opportunities) One must remember: Growth doesn t necessarily benefit all. Trickle-down economics doesn t work. Taking account of inequality, broader measures of well-being give very different views of performance Main message of International Commission on the Measurement of Economic Performance and Social Progress
Multiple roles for government In changing distribution of income before taxes/transfers Innovations and investment that save the environment, rather than save labor Education Bankruptcy laws Laws affecting the scope for rent seeking In changing distribution of income after taxes/transfer Earlier discussion emphasized the interaction between the two Current tax system favorable treatment of capital gains (speculation)-- both distorts economy and increases inequality
Multiple roles for government US has high level of market inequality But highest level of inequality after taxes and transfers Role of government in redistribution diminishing Less progressive income taxes Special treatment of capital gains, dividends Weakened system of social protection
There needs to be a Comprehensive Agenda to fight inequality No magic bullets: problems have been long festering; won t be dealt with quickly Enhancing equality of opportunity Education Financial inclusion Inheritance taxes Promoting Full Employment End to austerity End to inflation targeting Discouraging rent seeking Making markets work like markets are supposed to work Industrial policies, including redirecting innovation
The problem is in the politics That s why the political agenda is so important We know what economic reforms that would promote growth and equality The question is how can we change the politics? Rules of game affect politics just as they affect economics Gerrymandering Campaign contributions (Citizens United) Compulsory voting Ease of registration, voting
In Europe The design of the euro-system makes redistribution more difficult race to the bottom More of the responsibility for creating a more equal society must lie at the European level
The Big Question Economies/societies can get trapped in a high inequality equilibrium But some economies/societies are seeming to escape this trap Will the US, UK, and other advanced countries be able to reverse direction