The condition known as – Schizophrenia – describes “a mental disorder often characterized by abnormal social behavior and failure to recognize what is real”. Then again, the condition known as – Dissociative identity disorder – describes a condition where a person has “at least two distinct and relatively enduring identities or dissociated personality states that alternately control a person’s behavior”. If these states can be applied to institutions, then the OECD needs urgent medical attention. The OECD released a working paper yesterday (December 9, 2014) – Trends in Income Inequality and its Impact on Economic Growth – by Federico Cingano. It provides evidence that destroys the basic tenets of neo-liberal economics and supports a wider social and economic involvement of government in the provision of public services and infrastructure, particularly to low income groups. The fiscal implication is that deficits need to be higher.



I wonder whether the OECD has bothered to check the message in the paper against its other ideologically-motivated public stances relating to the need for fiscal surpluses, deregulation, structural reform, etc.

As an organisation, the total ‘product’ doesn’t add up.

If you don’t want to read the whole Working Paper, then there is a convenient – Four-Page Summary – which avoids the technicalities but delivers the message.

You can also access the underlying – Tables and Data – for the report.

The main conclusions and implications are:

1. “In most OECD countries, the gap between rich and poor is at its highest level since 30 years. Today, the richest 10 per cent of the population in the OECD area earn 9.5 times the income of the poorest 10 per cent; in the 1980s this ratio stood at 7:1 and has been rising continuously ever since.”

2. “However, the rise in overall income inequality is not (only) about surging top income shares: often, incomes at the bottom grew much slower during the prosperous years and fell during downturns, putting relative (and in some countries, absolute) income poverty on the radar of policy concerns.”

3. The “analysis suggests that income inequality has a negative and statistically significant impact on subsequent growth … what matters most is the gap between low income households and the rest of the population”.

4. The reason that inequality harms growth relates to educational attainment – “increased income disparities depress skills development among individuals with poorer parental education background, both in terms of the quantity of education attained (e.g. years of schooling), and in terms of its quality (i.e. skill proficiency)”.

5. “policies to reduce income inequalities should not only be pursued to improve social outcomes but also to sustain long-term growth”.

6. “Redistribution policies … are a key tool to ensure the benefits of growth are more broadly distributed and the results suggest they need not be expected to undermine growth … it is also important to promote equality of opportunity in access to and quality of education … promoting employment for disadvantaged groups”.

7. The implication is that the major claims relating to ‘trickle-down’ theories, which underpinned the rise of neo-liberalism and the policy shift in favour of privatisations, labour market deregulation, entrenched unemployment, cuts to public funding of health, education and public infrastructure (transport etc) have been shown to be unsupported by the evidence. They are just mindless ideology without an evidence base. The evidence suggests the swing to these policies has undermined economic growth and dented the prospects of millions of people around the world.

When does the economics profession acknowledge this and abandon its blind faith in the so-called ‘free market’, which, of course, is not free as in the textbook at all, but a loaded system where wealth and high income buys increasing advantage at the direct expense of those without and as this working paper demonstrates, at the expense of the socio-economic system overall.

The OECD paper is motivated by two questions:

Is inequality a pre-requisite for growth? Or does a greater dispersion of incomes across individuals rather undermine growth?

It documents the rise in inequality since the 1980s.

Figure 1 (reproduced below) shows the – Gini Coefficients – for a selection of OECD nations in terms of disposable income. If the Gini coefficient is zero it means that everyone in the income distribution has the same income. The ceiling is a value of 1 (perfect inequality or one person has all the income). So rising values indicate increased inequality.

You can see that income inequality increased in most of the nations. Belgium, France and the Netherlands were relatively unchanged while Greece and Turkey experienced reduced inequality.

In the late 1970s and early 1980s, the likes of Margaret Thatcher and Ronald Reagan started talking about so-called – Trickle Down Economics or supply-side economics.

The idea was that if you redistributed national income to the high income groups, their enterprise would generate jobs and income opportunities for everyone. It was no different to the stupidity in Ayn Rand’s Atlas Shrugged.

The underlying view is that the rich are the enterprising souls in our nations and the rest of us rely on their endeavours to eke out an existence.

The opposite is more likely to be the truth. The low income earners have higher marginal propensities to consume (the proportion of each extra dollar spent) than the higher income groups who save more. Giving more income to the poor will increase spending per dollar of extra income generated than giving it to the rich.

But behind trickle-down was a nasty neo-liberal plot to undermine state activity and rewind the gains made by the workers under the welfare states and unionism over the course of the C20th.

Why does inequality undermine growth?

The paper considers several reasons, which I will leave to you to read. In summary:

1. Rising inequality undermines social stability and could reduce the incentive to invest.

2. Poorer groups under invest in so-called human capital accumulation (skills development, education etc) which reduces the productivity and growth potential of a nation.

3. If high inequality undermines aggregate spending, then certain technological innovations which rely on “a minimum critical amount of domestic demand” will be thwarted.

The evidence is firmly in favour of the conjecture that inequality is bad for growth, thus rejecting the major postulates of neo-liberalism which have dominated policy design over the last 30 odd years.

The technical aspects of the paper, though of interest to me and no doubt others who are trained to read econometric discussions, are not covered in this blog. You can read them at your leisure if interested. My assessment is that the work is technically sound, although in any studies of this type there is room for debate.

The paper finds that:

The impact of inequality on growth turns out to be sizeable ….

The paper then estimates the counter-factual – what would real GDP growth have been if inequality was unchanged between 1990 and 2010. This is the weakest part of the paper given it uses a Solow growth model to estimate the unknown alternative growth rates. But more sound growth models would not differ much over this horizon anyway.

The following graph is taken from Figure 3 in the Paper and shows the “Estimated consequences of changes in inequality on cumulative per capita GDP growth (1990-2010).

The Paper concludes that:

Rising inequality is estimated to have knocked more than 10 percentage points off growth in Mexico and New Zealand. In the United States, the United Kingdom, Sweden, Finland and Norway, the growth rate would have been more than one fifth higher had income disparities not widened. On the other hand, greater equality helped increase GDP per capita in Spain, France and Ireland prior to the crisis.

We learn that “income inequality is negatively associated with average educational attainment”. More detailed analysis shows that the nations with “widening income disparities” endure lower “outcomes of individuals from low socio-economic backgrounds” although “medium and high background individuals” seem to be unaffected.

Thus “higher inequality lowers the opportunities of education (and social mobility) of disadvantaged individuals in the society, an effect that dominates the potentially positive impacts through incentives.”

The effect is intergenerational. The “estimated probability of graduating from university is highest for individuals who have highly educated parents”. Children from disadvantaged backgrounds are unlikely to complete tertiary education.

The neo-liberals continually chatter about the intergenerational impacts of fiscal deficits and justify cutting public spending on education at all levels, yet public provision of first-class education is one of the best ways of promoting income growth for the nation as a whole.

Cutting public spending on education undermines prosperity for all.

Children from lower income households achieve poorer outcomes in terms of numeracy and other measures.

Further, higher inequality lowers the amount of opportunities available to disadvantaged individuals in the society. Studying the labour market outcomes of different individuals confirms this.

The paper concludes that:

The analysis above suggests that higher inequality may lower the inflows of human capital in an economy, as low background individuals see their educational outcomes worsen. A permanent increase in inequality has therefore the potential to lower the stock of human capital.

The paper recommends a change in policy emphasis in OECD nations to focus on reducing income inequality and providing more employment and education opportunities for low income households.

There should be cash transfers, more access to public services, particularly, health and education.

This is exactly the opposite to the current policy thrust in most nations.

As inequality increases in a nation, the probability of a person from a low income household being employed falls sharply.

The first thing a government should do is introduce a – Job Guarantee – to ensure there are always opportunities for everyone to earn a reasonable income that will be sufficient to allow the individual to participate meaningfully in society.

There is absolutely no excuse for governments tolerating mass unemployment. It is a large driver of the increased inequality in advanced nations. The distribution of unemployment is highly biased towards a disproportionate impact on low income households.

Then there is the issue of redistribution. Many progressives instinctively see the solution as taxing the rich to give to the poor. From a Modern Monetary Theory (MMT) perspective that instinct is misplaced.

First, the ‘tax to give’ concept implies that the government needs to raise revenue to distribute to other more worthy groups. Wrong. The government can give as much tax relief as it likes to the poor without having to raise revenue from the high income groups.

Second, the only reason the government might want to tax anyone is to deprive them of purchasing power. Is it a progressive solution to deprive anyone of the chance to enjoy material pleasures? I doubt it. It sounds more like a religious notion to me based on some puritanical instinct.

Third, it might be that the economy has too much spending and high inequality, which suggests that to allow the lower income groups to spend more the high income groups have to spend less. Then a tax hike on the high income groups makes sense.

But it is not to raise money for the government so that the poor can spend more. It is to create more real resource space (free up real resources previously used by the high income groups) to allow them to be used by others. I am talking in abstract terms here rather than literally handing over the lambos!

So progressive groups have to work through these concepts before jumping to their instinctive conclusions. The OECD Working Paper found that raising the floor helps growth but depriving the rich of income does not.

Conclusion

Another piece of the evidence jigsaw against neo-liberalism. I am sure very few academic economists will have cause to rethink what they teach today. They will wheel out the mainstream textbooks and teach the same rubbish – indoctrinating their students in an approach that kills prosperity and has no basis in reality.

Things have got to change.

I have a meeting today with representatives of a new movement in Australia – the Australian Progressives. They have political pretensions. They are interested in basing their policy formulations (as far as I can tell from a prior meeting in Melbourne last Friday) using the understandings they glean from MMT. In other words, they will aim to educate the public initially about the opportunities a currency issuing government has to advance public welfare by increasing sustainable forms of employment, enhancing public services, etc.

All of which would reduce unemployment and increase real GDP growth. The OECD confirms that last conclusion in their latest Working Paper!

That is enough for today!

(c) Copyright 2014 William Mitchell. All Rights Reserved.