In recent years, income inequality has gained more coverage in developed countries. It is particularly the case in the U.S. where Ifind myself at the moment, and if you have not already seen it, the viral video from 2009 below, might show you why it was one of the main discussion points among the Bernie Sanders supporters in the presidential primaries.
The research used in the video is economist Dan Ariely’s. If you are like most people, after looking at the video, you probably feel that something is off, something is unfair and this amount of income inequality cannot be good for a society. And you would be right. In the rest of this article I will try to explain in which way you are correct.
In this study, Dan Ariely asked U.S. participants which allocation of wealth each quintile of the population (from the richest 20% of the population to the poorest 20%) should have. To correct for participant bias due to their own real position in society, they were asked to allocate the wealth in a society where they would be randomly assigned to one of the five categories. Surprisingly, there seems to be general consensus that wealth should be roughly distributed in the following manner:
From the video you already know that this is far from being the case in the United States but all across OECD countries, income inequality has risen in the last few decades.
WHY HAS INCOME INEQUALITY INCREASED OF LATE?
As the OECD recognises in its own very complete report on the topic:
“The empirical evidence as to the key drivers of inequality remains largely inconclusive and is made more so by a lack of precise definitions and concepts used in different studies.”
The truth is that there are many interconnected causes to the overall rise in income inequality in developed countries over the last 30 years. Not wanting to focus too heavily on these factors in this article so has to discuss more the less contentious impacts of income inequality, I will only cite the main reasons and invite you to read these two OECD and IMF reports for a more comprehensive understanding of the issue and their many subtleties.
Technological advances have been found to have contributed the most to rising income inequality in OECD countries, accounting for nearly a third of the widening gap between the 90th and the 10th percentile earners over the last 25 years
Neither rising trade integration nor financial openness had a significant impact on either wage inequality or employment trends within the OECD countries. The wage-inequality effect of trade appears neutral even when only the effects of increased import penetration from emerging economies are considered – a finding that runs counter to the expectation that trade flows should drive down wages of workers in manufacturing and/or services in OECD countries
One potential explanation [for increase in income inequality] is the concentration of foreign assets and liabilities in relatively higher skill- and technology-intensive sectors, which pushes up the demand for and wages of higher skilled workers. Financial deregulation and globalization have also been cited as factors underlying the increase in financial wealth, relative skill intensity, and wages in the finance industry, one of the fastest growing sectors in advanced economies.
Inequality can increase as those with higher incomes and assets have a disproportionately larger share of access to finance, serving to further increase the skill premium, and potentially the return to capital.
IMF work finds that a reduction in the minimum wage relative to the median wage is associated with higher inequality in advanced economies, while a decline in unionization rate is strongly associated with the rise of top income shares
Changes in hours worked favour higher-wage earners. Adding part-time workers to the full-time gross earnings distribution increases the Gini coefficient of inequality by more than five percentage points on average and by another two points when self-employed workers are also included. Changes in working-time arrangements affected high- and low-wageworkers differently: More working hours were lost among low income individuals than high ones (mainly due to automation).
WHY IS INCOME INEQUALITY AN ISSUE IN DEVELOPED COUNTRIES?
Although some degree of inequality in society is good, creating incentives to work hard and take risks, studies show that above a Gini index of around 0.3, the inhabitants of a given society are worse off across a whole range of social issues.
Before detailing what these issues are, I would like to dispel a common misconception. Some people argue that fighting income inequality stops growth. Actually, in rich and poor countries alike, research shows inequality is strongly correlated with shorter spells of economic expansion and less growth over time and with more frequent and more severe boom-and-bust cycles that make economies more volatile and vulnerable to crisis. Income inequality is thought by many to have been one of the main factors in the 2008 financial crisis.
Moreover, as epidemiologists Richard Wilkinson and Kate Pickett show in The Spirit Level: Why More Equal Societies Almost Always Do Better (or if you prefer video, in this TED Talk) strong income inequality affects nearly every aspect of society negatively, including but not limited to: Life expectancy, math and literacy, Infant mortality, homicides, imprisonment, teenage births, trust, obesity and mental illness (including drug dependency). The impact of income inequality is far from negligible, since problems in all these fields are in general from twice to 10 times more common in unequal OECD countries than their more equal counterparts.
Maybe more surprising is the fact that these issues affect not only the poorest individuals of an unequal society but the rich as well. The biggest differences happen at the bottom of society for sure but even for the rich, it is better to be rich in a more equal country.
Furthermore, in a world faced with truly global issues, research shows that more equal societies have stronger community life and that their people are more willing to act for the common good – they recycle more, spend more on foreign aid, score higher on the Global Peace Index, and business leaders in more equal countries rate international environmental agreements more highly.
Finally, income inequality erodes democracy. In a 2014 paper, economists Martin Gilens and Benjamin Page state “that economic elites and organized groups representing business interests have substantial independent impacts on U.S. government policy, while average citizens and mass-based interest groups have little or no independent influence.” Though most often in the United States, the middle and upper classes agree on policy issues, when their opinions differ, the rich and business groups are more influential, though they represent a smaller part of the population. This in turn fuels the feeling of injustice that is at the heart of the whole matter.
HOW DOES INCOME INEQUALITY AFFECT US INDIVIDUALLY?
As the British poet John Donne famously noted “No man is an island”. Income inequality gives us what Wilkinson and Pickett refer to as “social evaluation anxiety”. It is the fear of negative social judgement, it threatens our self-esteem and social status and it affects all members of a given society, rich or poor, because it is an atmosphere that permeates all parts of society. Several studies show that tasks that raise our stress level the most are those that have social evaluative threats.
In short we feel more stressed, less happy, more defensive and less trusting with high income inequality. This in turns affects negatively all the societal aspects cited previously.
I will soon write an article about individual and social wellbeing where I will delve more deeply into these issues.
SO WHY ARE WE SLOW TO CHANGE?
The first reason is that we strongly underestimate inequality in society. In his research, Dan Ariely also asked participants what they thought the allocation of wealth in society was. Below are the results for the United States, from top to bottom: what the actual wealth repartition is, what people think the wealth repartition is and what people think it should be (same graph as previously shown). The first reason for not addressing this issue more is that we are unaware of it.
Secondly, though particularly true in America, people underestimate the impact income inequality has on social mobility. As Wilkinson famously quipped “If Americans want to live the American dream they need to go to Denmark”. Sociologists Stephen McNamee and Robert Miller Jr. point out in their book, “The Meritocracy Myth,” that Americans widely believe that success is due to individual talent and effort. However, unfortunately your position within society at birth is a much stronger influencer on where you will end up on the wealth scale than those qualities. In general, people think that moving up socially is significantly more likely than it is in reality. This optimism - interestingly more common among poorer and politically conservative participants than richer and liberal ones – limits large scale support for measures aimed at reducing income inequality.
WHAT MEASURES COULD BE PUT IN PLACE?
The situations concerning this issue being quite different in each OECD country, there are no universal measures to put into place and in any case, no silver bullet to address this complex systemic problem. However, to offer an illustration of the range of policies countries are considering, I have placed below the plan put forward by the New Economics Foundation for Great Britain in their 2014 report on addressing income inequality in the UK.
The progressive British think tank identified the following five high-level goals accompanied with a set of policy area priorities for each:
- Universal provision of high-quality childcare that is affordable for all. High-quality childcare can transform life opportunities for children and will help to address unequal starting points. Making it equally available and affordable to all families would give parents more choices about balancing their families’ needs and their working lives.
Policy priorities: Public funding supporting the supply of childcare in order to cap family childcare expenditure at 15% of income; increased standards of training and qualifications to ensure childcare is always high quality; and better working conditions for childcare workers, including a Living Wage, stable contract hours and career and pay progression opportunities.
- Narrow the difference between top-to-bottom earnings and rebuild the link between economic prosperity and wages. Over time, the proportion of UK economic prosperity shared out as wages has shrunk in favour of shareholder profits. Within this smaller wage share median wages have fallen while pay at the top has sky-rocketed. Concerted action to restore wages and shrink the income gap would create a healthier economy and address in-work poverty.
Policy priorities: Ensure workers have a collective voice in workplace decision-making by law; establish a Department of Labour tasked with restoring wages in the economy and improving working conditions; establish a stronger wage-floor to eliminate in-work poverty; and enforce pay ratio reporting to address wage differentials.
- Access to valued careers for all with opportunities for progression and skills development. Non-graduates are being increasingly funnelled into low-paid, dead-end jobs with little or no prospects of future progression. Addressing the lack of investment in training and development for staff and managers would broaden opportunities for purposeful and rewarding work.
Policy priorities: Promote pooled training investment by sector; invest in incentive structures to improve high-quality management skills at different levels; use state support to ensure apprenticeship schemes lead to progression at work across more industries; and establish better education, training and employment links at the local level.
- Creation of good jobs for all that benefit workers, the economy and society. Everyone should have the right to a well-paid, secure and meaningful job. But the current jobs market is hugely unbalanced, both in terms of geography and job quality. We need to invest in good, environmentally sustainable jobs around the country.
Policy priorities: Co-ordinate and co-produce a national industrial strategy; establish a state investment bank with regional focus; funding for better jobs and training to guarantee full employment; and reform business to ensure workers have a collective voice.
- A fairer, more progressive tax system. When you take account of direct and indirect taxes, those on low incomes in the UK are being hit too hard, while billions of pounds each year are being lost through tax avoidance and evasion at the top. Progressive tax reforms would help to address inequality at root as well as redistributing economic power.
Policy priorities: Strengthen legislation and resources to abolish tax avoidance and evasion; implement and co-ordinate more progressive income and wealth taxes; establish a Land-Value Tax; and shift the tax burden onto environmentally unfriendly activities through green taxes.
Before ending this article, I would like to leave you with a final thought. Wilkinson and Pickett’s research interestingly show that though within a given society income inequality can have wide-ranging negative impacts, there is no such correlation between countries themselves. As we saw this is because social evaluation anxiety only exists within ones community and as of today, that community is usually found no higher than at a national level. However, historically, our community has always grown, from a few families in a cave, to a village, a valley, a city-state, a region, a state and today a union of states such as the European Union or the United States. Though not linearly over time, our social consciousness has gradually grown to encompass larger and larger groups. At some point in history, we can imagine that we will feel part of a global community of humans. If that is the case the mechanics explained here above will undoubtedly operate at a planetary level. Maybe after controlling income equality within OECD nations, our policies should start to tackle global income equality. Maybe we could even get a head start.
 The results are consistent in all studies regardless of political affiliation, sex, wealth, nationality, or that you are a Liberal or a conservative.
 Phillipon and Reshef 2012; Furceri and Loungani 2013
 Kennedy, B., Kawachi, I., Glass, R. and Prothrow- Stith, D. (1998). Income distribution, socio-economic status and self-rated health in the United States: Multi-level analysis. British Medical Journal, 317, pp. 917–21
 Berg A, Ostry JD. Inequality and Unsustainable Growth: Two Sides of the Same Coin?: International Monetary Fund, 2013.
Stiglitz JE. The price of inequality: How today's divided society endangers our future: WW Norton & Company, 2012.
 Wilkinson RG, Pickett K. The Spirit Level: Why Equality is Better for Everyone. London: Penguin, 2010
 Wilkinson RG, Pickett KE, De Vogli R. Equality, sustainability, and quality of life. BMJ 2010;341:c5816.
 Generate the most cortisol in the brain