In recent months Pope Francis, president Barack Obama, and the head of the International Monetary Fund, Christine Lagarde, have all nominated inequality as one of the key challenges of our time.

That is an impressive triumvirate, and I think it shows that this is a debate which needs to become more prominent in Australia.

For despite Australia’s strong economic performance over the last two decades, more than two million people still live below the poverty line – including 575,000 children. Yet, at the other end of the scale, the top 1% of income earners in Australia receive around 9% of all income and own 11% of all wealth.

We know that equality is a hot-button issue when a 700-page treatise by a French economist on income and wealth distribution became an international bestseller. Thomas Piketty’s new book, Capital in the Twenty-First Century, assembles vast quantities of empirical evidence on inequality, postulates a single economic relationship which explains inequality, and makes some radical policy proposals.

For those looking for a more concise analysis, I recommend my Labor colleague Andrew Leigh’s book, Battlers and Billionaires: The Story of Inequality in Australia. Leigh’s research shows the main drivers of rising inequality are globalisation and technology, declining union representation and changes in taxation policy.

Globalisation and technology have contributed to exponential growth in pay for CEOs and other top income earners. At the other end of the labour market, declining union membership has put pressure on wages of vulnerable employees who lack bargaining power. And cuts in top income marginal tax rates have contributed to greater inequality in take-home pay – although this has been offset by a progressive welfare system which targets benefits at those on low and middle incomes.

It is true that in a market economy, there will always be a degree of inequality. No one on the progressive side of politics insists that everyone must be on an identical income, or that there should not be incentives and rewards for risk-taking, innovation and hard work. But we also recognise that extreme disparities of income and wealth are not justified in a fair society – and that excessive levels of inequality have damaging economic impacts.

Economists are rethinking the notion that there is a one-way trade-off between equality and prosperity. They are increasingly recognising that excessive inequality – call it “inefficient inequality” – can lead to slower economic growth.

Australia's treasurer Joe Hockey speaks at a press conference ahead of delivering his budget speech to parliament. Photograph: Madeleine Coorey/AFP/Getty Photograph: MADELEINE COOREY/AFP/Getty Images

Squeezing the spending power of those on low and middle incomes will mean lower demand, which is bad for growth. Unequal access to education shuts people out of the labour market and stops them from reaching their potential, which is bad for economic efficiency.

Extreme disparities between rich and poor can undermine social cohesion and erode cooperation and trust, with negative consequences for productivity.

Recent research has shown that countries with more equality experience faster, longer and more durable economic growth. Here is how Christine Lagarde summed up the new economics of inequality:

Put simply, a severely skewed income distribution harms the pace and sustainability of growth over the longer term. It leads to an economy of exclusion, and a wasteland of discarded potential.

Labor has never accepted the notion that there is an either-or choice between equality and growth. Pursuit of growth and fairness is central to our values.

Growth is one of the most powerful tools for tackling poverty and inequality because it creates new jobs and more opportunities. Higher productivity is also central to tackling inequality, because it is the ultimate source of higher incomes in an economy. And investing in education, skills and healthcare improves both growth and social mobility.

The Rudd and Gillard governments tacked inequality through tax cuts and improvements in government benefits. Our 2009 increase to the age pension reduced the share of people living in poverty by an estimated one-fifth.

Labor trebled the tax-free threshold from $6,000 to $18,200, delivering significant tax cuts for those on low pay like women, young workers and part-timers. And we introduced measures to boost living standards for those on low and middle incomes like increases to Family Tax Benefits, the SchoolKids Bonus and the Income Support Bonus.

Labor’s initiatives for redistribution to achieve a fairer society are now all under attack by the Abbott government. Its first budget represents a vicious attack on low and middle income earners in Australia.



'The budget confirms one of the central points of Piketty’s Capital in the 21st Century'. Photograph: Sarah Lee Photograph: Sarah Lee/Guardian

The budget confirms one of the central points of Piketty’s Capital in the 21st Century – that trends in equality and inequality cannot be understood independently of politics.

For Piketty, rising inequality is driven by differences in financial capital rather than human capital. Ownership of capital – assets like shares, property, brands and patents – is unequally distributed in economies around the world, and most people get their incomes from wages, which tend to move in line with economic growth. So when income earned from capital rises at a faster pace than the economy’s growth rate, inequality will rise.

Piketty’s analysis boils down to a single relationship: r > g. In other words, inequality rises when r, the rate of return on capital, is greater than g, the economy’s growth rate. Piketty puts forward policy proposals which focus on reducing r – measures like a global wealth tax and very high marginal tax rates on top incomes.

For Labor, I believe, the focus should instead be on increasing g – the economy’s growth rate – rather than reducing returns on savings and investment.

This is what Labor did during the global financial crisis. As a result, Australia is one of only two countries where the incomes of the bottom 10% grew faster than the top 10% from 2007 to 2010.

Labor should not only increase growth, we should also increase people’s opportunities to gain the benefits of growth. The traditional social democratic approach to fairness has focussed on redistribution through the tax and benefits system. But social democratic parties also need to focus on what has been called “predistribution” – helping people to earn better incomes from the market economy in the first place, before the tax and benefits system kicks in.

As my parliamentary colleague Jim Chalmers has put it, Labor needs not only to redistribute wealth, but also to redistribute opportunity by giving people the tools they need to participate in the market economy.

In the economics jargon, these tools are known as human capital. They include a quality education, mastery of workplace skills, an understanding of technology and the ability to adapt to change and learn new skills.

A fundamental challenge for those of us who care about fairness is to equip people to participate in the economy, so they can access the benefits of growth and globalisation. This will require investment, reinvestment and renewal of human capital, just as the economy requires constant retooling and upgrading of physical capital.

Labor seeks to reduce inequality by increasing growth, increasing productivity, increasing opportunity, and increasing economic participation and social inclusion. Equality of opportunity must remain an Australian value. In this principle, we bring together the tradition of the fair go and our aspirations for the future.

That is why this government and this budget must be contested. At the heart of both is a harsher and meaner nation.

• This is an edited extract of Penny Wong's speech to the Australian Fabian Society