Inequality, Housing and Economic Growth – In Perspective

Gareth MorganEconomics, Tax and Welfare12 Comments

Earlier this week the New Zealand Initiative (NZI) released their thoughts on inequality and specifically the role housing affordability has played in exacerbating the numbers. It’s good to see a business-funded think tank acknowledging that inequality matters – despite the fact that of late some measures (that exclude the affordability of accommodation) suggest it’s not getting any worse.

And on that the NZI authors pose the question of why – if it’s not getting worse – is newspaper coverage increasing? That’s not hard to answer and I will below. In short the answer is it doesn’t matter whether inequality is rising or not; the long-term persistence of some types of inequality weighs down economic growth.

A second point NZI makes is that inequality isn’t the same as poverty. This is totally correct and discussion should not conflate the two lest our thinking leads to simplistic and flawed policy responses. I’ll deal with that as well as I cover various drivers of inequality .

There are two main drivers of inequality and they have quite different implications:

  1. Inequality arising as the consequence of merit-based economic success, and
  2. Inequality that comes from leveraging market power; profiteering without providing anything of benefit to others. This can include anything from regulatory protection to exercising monopoly power right up to outright corruption.

The first is the type that traditionally economists have lauded as an acceptable part of a market economy (as it provides an incentive for effort), the second obviously is a bad thing. So in effect we cannot – without having first determined what type of inequality we’re dealing with – conclude that the inequality we observe is a good or bad thing. And remember there is also life-cycle inequality (on wealth at least older people have had more time to accumulate assets) and education-based inequality. If the population is ageing then one would expect wealth-based inequality to rise, if the education base is improving one might expect income-based inequality to fall – although I’ve been to plenty of economies where education delivers diddley squat to recipients, e.g.; Egypt.

What we can say is that inequality arising from market power should be addressed by ensuring all participants have equality of opportunity. Note as an aside, that the trend is for educational opportunities to become more skewed as a result of increasing inequality – ie; a self-reinforcing feedback exists.

“… recent experience from China to America suggests that high and growing levels of income inequality can translate into growing inequality of opportunity for the next generation and hence declining social mobility. That link seems strongest in countries with low levels of public services and decentralised funding of education. Bigger gaps in opportunity, in turn, mean fewer people with skills and hence slower growth in the future.” [i]

“Inefficient” inequality begets further inequality when the children of the lower social classes don’t receive the same opportunities as others and so can’t escape the social position they are born into. This in turn impedes economic growth, because they don’t fulfil their potential. “The Great Gatsby Curve” concocted by Canadian economist Miles Corak, shows the relationship between intergenerational social mobility and income distribution. The more inequality, the greater the degree to which it is passed on, the lower the earnings mobility across generations.[ii]

graph1

The conclusion that inequality has arisen because of merit, which underscores the acceptance of inequality as a necessary element of competitive economies (to which both Keynes and Friedman subscribed), does rely on the assumption that government ensures that all citizens are provided the basic services to be able to participate. There’s the rub. As Amartya Sen concluded, too often that doesn’t happen. His capability approach argues it is important to remove barriers to people fulfilling their (reasonable) aspirations.[iii]

For Sen, ‘poverty’ is more than the narrowly defined income deficiency, it is deprivation in the capability to live a good life – far more meaningful than the narrowly-defined metric around income. In his book Development as Freedom he cites development as ensuring three freedoms – political, opportunity (including access to credit), and protection from abject poverty. Poverty in his definition, includes lack of at least one of these freedoms.[iv]

And as the OECD has also concluded,

Intergenerational earnings mobility is low in countries with high inequality ….The resulting inequality of opportunity will inevitably impact economic performance as a whole, even if the relationship is not straightforward.”[v]

So as well as State-funded access to education (including pre-school education and re-training) and healthcare, cash payments to the poor or the instigation of a Unconditional Basic Income (UBI) should be seen as tools for citizens to enable fulfilment of their (reasonable) aspirations. Vitally, the public sector’s role in underwriting income needs to be unconditional – because each individual’s aspirations are different and no government agency, no matter how well resourced, can possibly determine those aspirations better than the individual.

Finally it’s important to acknowledge that the evidence so far suggests that it’s when inequality rises due to poorer households failing to get income rises in proportion to those of the population generally (the median), that one can identify the need for correction. Importantly there is no evidence that increases in income of the highest earning groups that increase the gap over the general population, cause any harm.vi

So inequality can be growth-inhibiting, how much depends on the source of that inequality – whether it’s deserved or imposed, whether it becomes entrenched intergenerationally so power (market and political) is concentrated, and whether it arises because the growth in lower incomes is persistently lower than the growth in the middle incomes.

In New Zealand inequality rose dramatically as a result of early 1990’s reforms, reforms which directly whacked lower income people. That inequality persists and is worsening if you look at wealth inequality (property). It suggests New Zealand has work to do if we want economic growth to fulfil its potential. Acknowledging that “trickle down” has not delivered and ensuring there are opportunities for all, should be at the centre of policy now.

“… policies to reduce income inequalities should not only be pursued to improve social outcomes but also to sustain long-term growth. Redistribution policies via taxes and transfers 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. But it is also important to promote equality of opportunity in access to and quality of education. This implies a focus on families with children and youths – as this is when decisions about human capital accumulation are made — promoting employment for disadvantaged groups through active labour market policies, childcare supports and in-work benefits”.vi

 

[i] The Economist, 13 Oct 2012, http://www.economist.com/node/21564421

[ii] Miles Corak (2013), “Inequality from Generation to Generation: The United States in Comparison,” in Robert Rycroft (editor), The Economics of Inequality, Poverty, and Discrimination in the 21st Century, ABC-CLIO.

[iii] Sen, Amartya (1985). Commodities and capabilities. Amsterdam New York New York, N.Y., U.S.A: North-Holland Sole distributors for the U.S.A. and Canada, Elsevier Science Pub. Co.

[iv] Sen, Amartya 1999 “Development as Freedom” Oxford

[v] OECD, 2011 “Divided We Stand: Why Inequality Keeps Rising”, OECD Publishing

vi Cingano, Federico “Trends in Income Inequality and its Impact on Economic Growth” OECD 2014

 

Inequality, Housing and Economic Growth – In Perspective was last modified: October 21st, 2016 by Gareth Morgan
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Gareth Morgan

Gareth Morgan

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Gareth Morgan is a New Zealand economist and commentator on public policy who in previous lives has been in business as an economic consultant, funds manager, and professional company director. He is also a motorcycle adventurer and philanthropist. Gareth and his wife Joanne have a charitable foundation, the Morgan Foundation, which has three main stands of philanthropic endeavour – public interest research, conservation and social investment.

  • Ranald Ducat

    Think I got the graph – best to be lower left? Are there older charts to show trends?

  • Matt

    You might just avert all this discussion by replacing the ideology that growth is paramount with the ideology that inequality is a greater evil. It’s ideology either way. QED.

    • Matt

      Further, is there a decent argument anywhere that 1. truly free markets can exist in practical reality; 2. if they can exist, they lead necessarily to better overall economic growth and prosperity. Economic history clearly shows that protectionism has led to better economic growth (for the projected economies).

    • ‘Growth ideology’ – utilitarianism possibly, if there was any consideration of how resources were divided in that growing economy. The problem is ‘there isn’t’ agreement. Inequality is not the other alternative. There is free market perspectives as well, whether old fashion ‘classical economics’ with minarchist ‘nominal’ state, or no state with anarchocapitalism. The issue is ‘which ideology.

  • Duncan Cairncross

    The best treatment of this was the book – The Spirit Level
    https://en.wikipedia.org/wiki/The_Spirit_Level:_Why_More_Equal_Societies_Almost_Always_Do_Better

    And they DID find that when the upper levels go further up it DOES adversely effect society

    • David Washer

      I agree, a most interesting study of this topic. The writers gave a series of 3 lectures in Auckland University a year or so ago and by the third lecture you had to be in early to get a seat in the main auditorium, or watch a video screening in a neighbouring auditorium. Well worth a read.

      • Gondwana Islandnz

        And in their third and final lecture they had a graph plotting OECD nations inequality against survey results of which populations believed that the government had a role in fixing the social problems. New Zealand was at the far end! We are No.1. in the world for adopting the attitude that the government’s role is minimal. An extraordinary finding that deserves a book or Ph.D thesis or research effort to verify and deepen our understanding of this phenomena and what it means for fixing our negative social and ecological trends.

  • mark

    It started with the death of unions, the complete restructuring of the state sector and becoming one of the most open countries in the world. This led to a block of our society that could afford to live and realise the dream to purchase a house now a group I think that leads an impoverished life.

    But government policy has led to hope completely disappearing for this block as in the last decade house prices have skyrocketed way past the affordability level.
    Immigration and temporary workers who flood in by the hundreds of thousands keep wages low and in many cases work for less than our minimum wage. This wage on its own we know is not enough to survive on anyway.

    We need government policy that will grow jobs and wages in the lower skilled areas. Stop immigrants coming that are taking unskilled jobs from Kiwis. Get the hundreds of thousands of unemployed and underemployed back in work and pay them a living wage. If you brought 5000 lawyers from ‘poor’ countries and let them start practising law in Wellington for $15 per hour youd have a revolution.

    If businesses are not paying people a living wage then other businesses and tax payers are subsidising their lives. Through working for families or accommodation allowance or number of other subsidies that come with being poor.

    For me the failure of trickle down economics and outsourcing work to the world is that business has killed their customers. Pre the inequality gap the employed whether unskilled or not could participate in society and were consumers. Now they dont earn enough to live without subsidies and this does not bode well for businesses. This is why we are seeing no growth in the ‘West’ as businesses by using cheap labour in poor countries have killed off their consumers who cant afford their goods.

    The way forward has to be to grow wages from the bottom up. Australia has a third higher capita GDP as it has a third higher wages. Their consumers are their employees. In NZ businesses have been able to keep wages low with government policy but they have to sell their goods offshore to people who can afford them.

    Were becoming less like Australia and more like Fiji everyday.

    Let it be policy to pay people a living wage so we can grow our economy and let people feel like theyre part of society again. Then we might be able to stop building more prisons!

  • jh

    In his book Development as Freedom he cites development as
    ensuring three freedoms – political, opportunity (including access to
    credit), and protection from abject poverty. Poverty in his definition,
    includes lack of at least one of these freedoms.[iv]

    ………

    I think economists could use help from evolutionary psychologists.

    http://www.psy.cmu.edu/~rakison/Problems%20with%20SSSM%202011.pdf

    Why did 10/13 white children captured by Native Americans prefer the life in the woods to civilisation?

    But also I keep hearing that economic growth can keep on and I’m wondering if our present crop of thinkers are rooted in the past. Ian Hamilton of Tailrisk economics posited this:

    “The distinctive feature of the New Zealand economy is that land is an important input into the productive process. This is obvious with the agricultural,fishing and forestry sectors but it also applies to international tourism. In a simple model of the New Zealand economy where the supply of land is fixed, and New Zealand’s isolation means it is not a ‘natural’ location for the production of a broad range of internationally traded goods and services, then an increase in the labour supply through large scale immigration will reduce the
    marginal product of labour. As a result:

    Real wages will fall

    Owners of land will benefit

    There will be an outflow of ‘native’ labour in search of higher wages in Australia

    The economy will be bigger, but average incomes will fall

    Resources will flow into low value service production.

    This conventional model of the impact of an increase in labour supply is obviously a simplification of a complex reality, but we think that the fixed factor effect is important enough to be considered in any discussion or analysis of the impact of immigration in New Zealand. The official analysis, however, almost entirely omits it. There is a tendency to follow the international literature, where omitting the impact of fixed factors of production is a simplification that doesn’t matter very much, without thinking at all about how New Zealand could be different.

    The model seems to be consistent with some of the observed facts:

    Real per capita export growth has slowed significantly as labour supply has increased

    Labour productivity growth has been very slow

    Census data shows Auckland median income growth was the second lowest of any
    region over 2001-2006, and the lowest over 2006 to 2013. Auckland is the ‘poster child’ of superdiversity. If there was anything in the ‘diversity dividend’ argument Auckland should have been leaping ahead in the income stakes.

    http://www.tailrisk.co.nz/documents/TheSuperdiversityMyth.pdf
    Any comments Gareth Morgan?

  • jh

    Finally it’s important to acknowledge that the evidence so far suggests
    that it’s when inequality rises due to poorer households failing to get
    income rises in proportion to those of the population generally (the
    median), that one can identify the need for correction. Importantly
    there is no evidence that increases in income of the highest earning
    groups that increase the gap over the general population, cause any
    harm.vi

    ………..

    Remember too that poorer families work in the service sector and have all the hastles of parking, traffic, long hours for low pay, noise and an environment that Greorge Mombiot calls an “assault to the senses” while others waft into their private parking place in gentleman’s hours and go to conferences sponsored by banks (who benefit from it all).

    http://www.massey.ac.nz/massey/about-massey/news/article.cfm?mnarticle_uuid=1E27606A-CA5C-9A61-06BA-1D96F4285A37

  • jh

    A not so popular view is provided by an ecologist who looks at humans as though they were living things in an ecosystem. The economy is conceived as being within that ecosystem.
    https://en.wikipedia.org/wiki/Fates_of_Nations
    You read that and you’ll go up a level Gareth Morgan?

  • Matt

    NZ has continuously allowed itself to be the victim of the “cruel joke” of free market ideology. This was true during the period of the colonial special relationship with Mother England – when we were essentially an economic province of the UK. And it has been even more true since. We have never really given protectionism a proper go and allowed the development of our own diverse industrial economy. We continue to play the role we have picked for ourselves: the weak economy that exists according to the whim of the powerful international economies and multinational corporations. TPP, TISA continue the spiral.

    Economic inequality is one inevitable consequences of this globalisation and harmonisation with imported neoliberal economic and social organisation. We need to be much more skeptical, independent and dissenting of external power structures such as the OECD, WTO, World Bank, the Anglo-American Economies, China, large multinational corporations. We need internal change to match and government that shows leadership. The path to achieving those goals is obviously difficult and unpopular, the benefits longer term.