In this post, I will discuss the drivers of income inequality that were expositioned by Chrystia Freeland in her sagacious text entitled "Plutocrats: The Rise of the New Global Super Rich and the Fall of Everyone Else". The central aim of this post is to illustrate the complexity of inequality and how fiscal policy is ill-equipped to eradicate it.
I will start by illustrating the regions of the world that risk being destabilized by growing income inequality, after which I will use the example of Egypt, during the Arab Spring, to briefly discuss the triggers of social unrest in regions with high income inequality. I will then discuss the drivers of income inequality and propose policy measures that could be implemented to tackle each driver.
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If the assertions of Chiffrephiles (i.e. historians who use a few key numbers to understand the world) and practitioners of Cliodynamics (i.e. historians who use mathematical modelling techniques to analyze history) are anything to go by, a Gini coefficient of 0.4 or greater is a reliable predictor of social unrest.
Illustration 1, below, shows the Gini coefficients of most of the nations on this planet:
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| Illustration 1 (click on illustration to zoom in) |
The nations and regions that have the blue overlay (i.e. practically the whole world) have got Gini coefficients of 0.4 or greater; i.e. they may experience varying types and degrees of social unrest in the near future. This begs the question of when.
According to the International Labour Organization, high inequality results in social unrest when it is a concomitant of high (youth) unemployment. In my opinion, this is an over-simplification.
The admixture of high income inequality and high unemployment does not always culminate in social unrest. By and large, the masses do not hate disproportionately successful people. According to David Carr, everyone loves inequality because we all believe that it will favor us disproportionately "one day"; i.e. we all hold the belief that we are superstars-in-waiting, and we see our future selves in disproportionately successful people. However, as Charlie Munger observed, what people generally have disdain for is unearned or undeserved success; it gives them feelings of inequity. Hence, what contributes to social unrest is not high income inequality per se, but feelings of inequity.
From the preceding two paragraphs, Illustration 2 can be derived:
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| Illustration 2 (click to zoom in) |
...The Arab Spring: Egypt
What triggered the mass-protests that culminated in the deposition of Mubarak? Was it:
- A Gini coefficient that had rocketed past the 0.4 threshold? Or,
- A stratospheric and rising youth unemployment rate? Or,
- Both?
Surprisingly, Illustration 3 below shows that Egypt's Gini coefficient was below the 0.4 threshold for social unrest; it was actually on a downtrend before the mass-demonstrations occurred:
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| Illustration 3 (click on illustration to zoom in) |
Further, as Illustration 4 below shows, Egypt's youth unemployment was, like the Gini coefficient, also on a downtrend:
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| Illustration 4 (click on illustration to zoom in) |
Therefore, what fuelled the unrest in Egypt?
Rising food prices
When the Arab Spring occurred, Egyptians spent approximately 38.3% of their annual income on food. To put this into context, around that time Finnish people spent 12.1% of their annual income on food and Singaporeans spent 8.1% of their annual income on food; Egyptians were spending too much on food. As for the other countries that were affected by the Arab Spring, the proportion of annual income that was spent on food was close to the Egyptian figure: Tunisia - 35.8%, Algeria - 43.8%, Morocco - 40.3% and Jordan - 40.8%.
When wheat (an Egyptian staple) prices increased between late 2008 and 2010, as is shown in Illustration 5 below, the proportion of annual income that Egyptians spent on food rose:
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| Illustration 5 (click on illustration to zoom in) |
Rising fuel prices
In 2008, fuel prices spiked sharply, as is shown in Illustration 6 below, and this, according to the World Bank, reduced economic activity in Egypt:
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| Illustration 6 (click on illustration to zoom in) |
Other Factors
These weren't the only factors that triggered social unrest in Egypt. According to social commentators, the following factors also played a role in spawning the Egyptian iteration of the Arab Spring:
- Increasing perceived weakness of the Egyptian government: the perceptions stemmed largely from rumors of Mubarak's failing health and an impending political transition.
- Social networking: According to David Kirkpatrick, Facebook allowed discontented masses to connect and voice out their concerns to like-minded individuals (and to mobilize).
- Contagion: civil unrest in Tunisia started it all.
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| Illustration 7 (place a mirror perpendicular to your screen) |
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...What are the drivers of Inequality?
Illustration 8, below, expositions the drivers of inequality that I distilled from Chrystia Freeland's text entitled "Plutocrats: The Rise of the New Global Super Rich and the Fall of Everyone Else". The drivers that are colored black dominate the public discourse, while the drivers that are colored white are seldom discussed:
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| Illustration 8 (click on illustration to zoom in) |
The overlapping drivers will each be discussed below:
1) Skills-biased Technological Change
Illustration 9, below, demonstrates that the integrated circuit supplanted the transistor as the dominant paradigm of computing in 1970:
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| Illustration 9 (click on illustration to zoom in) |
When this shift occurred, most of the people who worked in the upstream of transistor supply chains and in transistor manufacturing factories lost their jobs.
People who possessed skills that were not immediately demanded by other industries needed to retrain to gain employment. This didn't pose much of a problem for the young people who were just starting-off their careers; but for older people who were approaching the end of their careers, this shift meant either:
- Early retirement. If their pensions were underfunded they would need to go on the dole.
- Finding employment in unskilled occupations that paid less.
Moving forward: The integrated circuit marked the dawn of the information age (and the "de-materialization" of the global economy). Between 1970 and 2008, the global Services sector contributed increasing value to global GDP growth, while the contribution of the Manufacturing sector and Agriculture declined (see Illustration 9). This suggests a growth-bias towards the Services sector.
Because of this growth-bias towards the Services sector, the people who were employed in this sector generally earned increasingly higher median wages than the people who were employed in Manufacturing and Agriculture. Hence, this created income inequality among people from these groups.
As Ray Kurzweil demonstrated, the pace of technological change is increasing exponentially. Therefore, in the future it is reasonable to expect more and more people to be displaced by emergent technologies, and, for income inequality to continue to rise because of this growing displacement. To remedy this, It is imperative for governments to implement the most feasible combination of any of these policy measures:
- Give companies generous tax credits for maintaining employment and retraining workers. Such tax credits could incentivize companies to find ways of redeploying workers with redundant skills.
- Fund the retraining of workers who would have been made redundant by emergent technologies (through grants and low interest student loans).
- Exclusively recruit civil servants from retrained pools of displaced workers.
- Assist displaced workers with emigration procedures. The adoption of technology across the globe is generally asymmetrical; workers who may be displaced in advanced markets may be able to find employment in less advanced markets.
2) Globalization
The word "Globalization" implies:
- Increasing competition as countries relax barriers to trade. When this happens, competitive local industries would win a growing share of foreign markets, and their revenues and profits would increase. Conversely, uncompetitive industries would lose their domestic market share, and, their revenues and profits would decline. The net effect: the investors and employees of competitive industries would experience growing incomes and wealth, while the investors and employees of uncompetitive industries would experience dwindling incomes and wealth. In short, income inequality would increase. Interestingly enough, the recommended policy fixes for Skills-biased technological change that were discussed elsewhere could be employed to assuage the pain of the displaced employees.
- Increasing competition from foreign labor as companies outsource processes and offshore operations to countries with lower factor costs. When this happens, workers from outsourced divisions (or offshored operations) would become jobless; they would experience a loss of income, while the incomes of the equity-holders of the firms that would have outsourced (and offshored) would grow (owing to increased cost efficiencies and profitability). Succinctly, there would be a disparity between the incomes and wealth of capital owners and those of labor. This could, in theory, be remedied through the tax code by: 1) giving tax credits to the companies that maintain domestic production facilities and jobs, and; 2) increasing the corporate tax rate of the companies that drastically reduce employment beyond a "reasonable" level.
3) Declining Union Power
Unions play a constructive role in forestalling the growth of income inequality. They increase the bargaining power of "labor" in wage negotiations with "capital providers".
As I have demonstrated elsewhere, globalization and technological progression have made it easier for capital owners to substitute technology (and cheaper foreign labor) for expensive domestic labor. This has, in turn, increased the bargaining power of capital providers vis-a-vis the bargaining power of unions.
Ceteris Paribas, this implies that unions would increasingly become wage takers as technological progression increases. Owing to this shifting balance of power, the incomes of capital providers vis-a-vis the incomes of labor would increase, which would, in turn, increase income inequality.
I am not entirely sure of how declining union power could be addressed through policy measures.
4) Minimum Wage Decline
As Illustration 10 below shows, the U.S.'s inflation-adjusted minimum wage has been on a steady downtrend since 1968.
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| Illustration 10 (click on illustration to zoom in) |
This implies that unskilled workers, who receive the minimum wage, have increasingly become poorer. The minimum wage has been steadily decreasing because of the aforementioned forces, i.e.:
- Technological Progression - most low-skilled "high throughput" repetitive processes have been automated.
- Globalization - has increased the competition that low-skilled workers face from foreign labor.
5) Rising Higher Education Costs
Illustration 11, below, demonstrates that tuition fees in US institutions of higher learning have risen exponentially (since 1999).
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| Illustration 11 (click on illustration to zoom in) |
This uptrend of tuition fees has fuelled an exponential increase in student and household debt (as is shown in Illustration 11); students are increasingly funding their education with debt.
This implies the following:
- Generally, higher education attracts higher incomes; to break into the global elite that Chrystia Freeland wrote of in Plutocrats, one needs either a Master's degree, an MBA or a PhD from an elite institution. Highly-indebted older people, who need to advance their education, would be reluctant to attain higher education owing to fear of increasing their debt burdens. Hence, older people who have onerous debt burdens would have lower chances of breaking into the global elite, that Freeland discussed, than younger people who have lower debt burdens. This disadvantage would culminate in an increasing income disparity between the young-debt free people and the older-debt-laden people.
- Further, in times where skilled employment prospects are low, younger people would be less inclined to attain higher education because it would essentially entail increasing their debt burdens (while they forfeit the income that would have been otherwise earned in a secure lower paying job). When the economic outlook is uncertain, and better employment opportunities are scarce, this would not be a prudent course of action.
How this can be remedied: Targeted student debt forgiveness. In uncertain economic times, students who seek to further their education in areas of (national) strategic importance should be incentivized to do so by forgiving a certain proportion of their outstanding student debt.
Further, targeted grants and scholarships could be used to incentivize older debt-laden people to attain higher education.
6) Rent-Seeking
Generally, rent-seeking occurs when wealthy people get the three pillars of government to do their bidding and when they "knock down the ladder that they used to get to the top". Owing to this, they would become entrenched and, societal progression would be forestalled.
The net-effect of rent-seeking: growing inequality between the people who would have managed to hijack the system and everyone else.
In his book titled "The Price of Inequality", Joe Stiglitz basically asserts that inequality tends to be the by-product of the chain of causation in Illustration 12 below:
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| Illustration 12 (click on illustration to zoom in) |
From Illustration 12, it is apparent that rent-seeking behavior can be curtailed by:
- Having a tax code that is more progressive; i.e. a tax code that has an equalizing effect on wealth and political influence.
- Banning private funding of political campaigns and funding political campaigns through the treasury. This would free politicians from being beholden to "donors" who desire to be repaid "in the currency of legislative favors".
- Having a more transparent government; where all lobbying efforts are cast into the spotlight and discussed extensively with all key stakeholders. Transparency would make anyone think twice before he/she tries to hijack the system! (The main drawback of this approach is slower policy making, which would compromise a government's ability to adapt to a rapidly changing environment).
7) The Superstar Effect
The elements of the Superstar Effect that would be discussed include the Marshall Effect, Martin Effect and Matthew Effect:
7.1) The Marshall Effect
Illustration 9 showed that Services are contributing more value to global GDP than Industry and Agriculture. In the discussion that is immediately below Illustration 9, I stated that because of this, people who work in the Services sector would increasingly attract higher incomes than people who work in Agriculture and Industry.
What would the people in the Services sector do with a small proportion of their growing incomes? They would do what most wealthy people do: get dogs. Dogs need trainers, and, when the well-healed Service sector employees seek trainers for their pets, they would seek the best: Cesar Milan - The Dog Whisperer (i.e. one of the few trainers who can teach old dogs new tricks).
Thus, any surge in GDP would increase the number of dog owners who would require Cesar Milan's services, which would, in turn, bid-up Milan's wage labelled Ws in Illustration 13 below. Unfortunately, the wage of the second best dog trainer, labelled Wa in Illustration 13 would not register much of a change because every new dog owner would, as I stated before, would only want to work with the best trainer: Cesar Milan. Such Darwinian winner-take-all scenarios are known as scenarios in which The Martin Effect would be at play.
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| Illustration 13 (click on illustration to zoom in) |
Owing to the Marshall Effect, Milan would have more clients than he could cater to, and he would be faced with the following imbroglio: should I leave money on the table or should I find ways of catering to the excess demand? Luckily, because of technology, he could produce video tutorials that pet owners would use to train their own pets (he did this). And, he could also do shows on channels like National Geographic to cater to the demand of the mass market (he also did this).
This technologically-enabled saturation of all available channels for servicing (the full spectrum of needs of) high-end segments and the mass-market is called the Rosen Effect. The Rosen Effect would gradually depress the income of the second-best dog trainer (and other dog trainers) with the passage of time, while Milan's income grows exponentially.
Usually, this dynamic tends to be simultaneously at play in multiple markets and industries (which would increase societal inequality).
I am not convinced that inequality that stems from the Marshall Effect could be eradicated: it could only be curtailed by employing a more progressive tax code.
7.2) The Martin Effect
In certain situations, a small group of key employees could have hard-to-replace skills that are critical to the survival of a company. Owing to this, their bargaining power would increase and surpass the bargaining power of other members of the organization. And, they would take the lion's share of an organization's income.
Such individuals would include:
- Specialists with skills in technical niche areas like quantum computing, genetic engineering and organic chemistry.
- Highly sought-after members of the management team.
A more progressive tax code could combat this form of inequality.
7.3 The Matthew Effect
"For unto every one that hath shall be given, and he shall have abundance: but from him that hath not shall be taken even that which he hath."
The Matthew Effect was popularized by Robert Merton. It basically asserts that the "rich get richer and the poor get poorer". A small initial disparity in income can snowball over time to become a large income disparity.—Matthew 25:29, King James Version.
The best example that illustrates The Matthew Effect (that I could conjure-up) is that of Kim Kardashian (see Illustration 14)
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| Illustration 14 (click on illustration to zoom in) |
As Illustration 14 shows, Kim Kardashian's success largely stems from her antecedence; i.e. she is the daughter of a super-star lawyer, the late Robert Kardashian. Her father's wealth and connections catapulted her into a world of fame. She made some mistakes in that world, and those mistakes gave birth to the Kim Kardashian brand, which underpins the following income generating ventures (see the highlighted nodes in Illustration 14):
- Perfumes.
- Work-out tapes.
- Sponsored tweets.
- Music.
- Product endorsements.
- Paid appearances.
Her income is multiples of the combined incomes of a small army of men and women from her cohort (who grew-up in less wealthy environments).
The Matthew Effect would, over time, increase the disparity between Kim Kardashian's income and the incomes of members of her cohort.
How can this type of income inequality be addressed? Answer: a more progressive tax code.
8) Assortive Mating
Not too long ago, the primary vector of wealth transfer from the rich to the poor was marriage. A wealthy person would marry a person from a less wealthy background, and support members of the family of the person from the less wealthy background. Net-net, this would, over time, equalize income levels in a society.
Nowadays, marriages of wealthy smart people are increasingly following the homophily principle, i.e. smart wealthy people are exclusively marrying other smart wealthy people. These kinds of unions are typically associated with the chain of causation in Illustration 15:
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| Illustration 15 (click on illustration to zoom in) |
Note: In Illustration 15, getting "high paying jobs" could mean entrepreneurship.
Over time, this chain of causation would concentrate wealth, and it would create a self-reinforcing cycle in which every generation of smart wealthy people increasingly becomes smarter and wealthier than the generation that preceded it (i.e. it's a force of natural selection of sorts).
Conversely, poor people, who lack a college education, have a low likelihood of getting married, and their children typically grow-up in one-income families; where there are insufficient resources to invest in their development. Therefore, it is reasonable to assert that children who grow-up in poor families would be poorer, as adults, than their parents. Why? Because jobs are being outsourced (and offshored) to cheaper destinations, technologies are supplanting people in the workforce, the middle class is hollowing out and social security / welfare programmes are generally underfunded by governments.
Hence, it is reasonable to expect a widening gap between the incomes of the haves and the have-nots.
How can this be addressed? The answer to this question is: I honestly do not know.
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Inequality is a complex problem indeed.
