What’s the real inequality?

Gareth MorganTax and Welfare

 Judging by the questions we have received, inequality seems to be one of the hot topics of this election.

There are probably a number of reasons for this. The 2010 book Spirit Level summarised the latest incarnation of this debate, arguing that more unequal countries do worse on a range of measures including health (especially mental health), education and crime. Then in 2013 French economist Thomas Piketty added fuel to this fire by arguing that capitalism “naturally” leads to greater and greater inequality. Most recently we have had our own Nigel Latta on the television musing on this topic in Aotearoa. 

What do we mean by inequality?

At its simplest, inequality is the gap between the haves and have-nots. People talk about inequality in a number of different ways, and it is easy to get confused:

Inequality of income – some people have a bigger pay cheque than others. This is what most people mean when they talk about inequality. It refers to income people receive, and it is usually measured with the same data used to collect tax.

Inequality of wealth – some people own more stuff than others even though their taxable income might not be that much higher. This can reflect the impact of any of the following; inherited wealth, the reality that ‘money makes money’ so capital can compound in the hands of an astute investor, the tax loopholes available to income from capital that are not available from wages income. 

Inequality of opportunity – some people have a better start in life than others. This may be related to poverty (whether measured in income or wealth), but it may arise because some people suffer from poor access to health and education services needed to enable a full participation in society and the economy. It is less to do with the gap between the rich and poor per se. 

What kind of inequality are we worried about?

The problem with talking about inequality of income and wealth is that it implies equality is the aim. Clearly in a capitalist society this isn’t the case – no one has a problem with people being rewarded for working hard and getting ahead. That is the obvious problem with the byline for the Spirit Level: “Why More Equal Societies Almost Always Do Better”. Actually, no, that couldn’t be more wrong, the most equal societies failed. Communism wrote its own epitaph in the Soviet Union and China by surrendering to capitalism and lifting living standards accordingly.

So, assuming society is bound to have some inequality in wealth or income, how much should worry us? At what point do the pluses outweigh the minuses? We don’t really know. These questions plague the inequality conversation, including defining the ‘poverty line’, which is usually set as an arbitrary proportion of average income.

Surely we want to make sure that the poor have enough to participate. That is the approach taken by the Nobel Prize-winning economist Amartya Sen. Granted, what is needed to participate in society will change over time as new technology becomes available, but it seems to make sense to focus on giving everyone the basics they need to get ahead. That is why here at the Morgan Foundation our view is that it’s inequality of opportunity that is the real issue, rather than inequality of income or wealth. 

That means we should be focused on making opportunities available to all members of our society, rather than fretting about the gap between the rich and poor. 


What about the Spirit Level? 

Despite all the work by authors of the Spirit Level, there is no strong case that inequality causes some of the problems they claim. Just because two things are correlated (have similar trends) doesn’t mean one causes the other. There is evidence that the most unequal societies also have the poorest people. That means that all the factors attributed to the gap between the rich and poor in the Spirit Level could just as easily be caused by the fact that the poor are far poorer in the economies that don’t perform as well. 

In fact this cause seems more likely than the Spirit Level narrative. Why would the gap between the rich and poor drive negative outcomes? Would the activity of the well-off does impede progress for the poor? Or is the thesis in the Spirit Level little more than the conventional socialist rhetoric of jealousy and status anxiety? 

It seems more credible that it’s a lack of access to the fundamental bottom-line health and education services, or similar human-rights entitlements that is trapping the poor. In the developing world at least, the general view is that lack of political enfranchisement and basic human rights plays a huge role in entrenching grinding poverty. The “locking-out” of significant portions of the population is the real issue, preventing people getting ahead. Lack of equality of opportunity may be driving the trends in poverty (and hence inequality). 

What has driven the rise in inequality?

In the developed world there has been growing inequality of income since the mid-1980’s as capital market deregulation, regulatory reform and the information technology revolution have seen online communication emerge, production processes automate, and world trade explode. This has led to stagnation and reduction of real wage incomes for many in the developed economies as their jobs have been exported or automated. On the other hand the profitability of businesses that have surfed this trifecta of online, automation and globalisation has risen enormously – and with it the incomes of their senior executives whose remuneration is linked to profits.

So who’s to blame for this rising inequality within developed economies – those who invented the IT, those who have done well from these global trends, governments that have not redistributed the gains via taxation, the victims for not re-skilling themselves, those who agreed to enfranchise millions of people in the developing world (and in the process disenfranchise many in the developed world) via deregulation? Certainly economic theory would suggest – and the evidence confirms – that there has been a net economic gain. The issue of course is that those displaced by the changes are in the main, in the developed world and hence highly visible by Western media.

What is happening with inequality in New Zealand?

Despite all the discussion from Nigel Latta on the subject, inequality of income in New Zealand has not grown since the decade of Rogernomics/ Ruthenasia in the late 80’s and early 90’s. Well it hasn’t grown at least once the impacts of tax and welfare (like Working for Families) is taken into account. So that suggests that in our country at least there is a policy to cap the polarization of income distribution.

As for inequality of wealth, we can’t say. Due to the lack of any reliable wealth data in our country, we have no data on the distribution of wealth. This is a pretty massive gap in any analysis of inequality, particularly since we know that the wealthy can arrange their finances to minimise the amount of income tax they pay – through trusts, businesses and most significantly by investing in property and exploiting the loopholes that favour income from capital. 

Nor do we have a measure of inequality of opportunity. When it comes to the things we really want to measure, official statistics often let us down. We’ve talked a lot in the past about how GDP is a poor measure of overall progress – well that applies at the individual level also. Is increased income really a good sign of improved well-being and vice versa? It can be hard to know because well-being means different things to different people. Nevertheless it is what a person is concerned about improving and only part of that story relates to income or wealth for that matter. What if extra income is coming at the expense of leisure time? Someone might choose to work less in order to grow their own food, spend time looking after their children or a loved one. Perish the thought – they might be happier to have a lower income if it means they can swim in their local river. All these factors matter to an individual’s well-being. 

In our book The Big Kahuna it’s inequality of opportunity that really matters, and to assess that we clearly have to look at measures beyond income and wealth. Equality of access to quality healthcare and quality education and training is a major issue here, as both these things are essential for any citizen to get ahead, any child to grow up and be just as able to fulfill their potential as the next. We know from our work on the book Health Cheque that there is not equality of access in the health system. There, the squeaky wheel gets the oil, and the educated middle and upper class is far better at getting what they want from the health system than the poor and ethnic minorities. In researching for our upcoming book on the future of the Treaty of Waitangi, we discovered that there is an ethnic bias in both social and economic disadvantage – that when we correct for age and income, we still find that Maori and Pasifika for example suffer disadvantage. For a so-called advanced society like New Zealand that is shameful.

In conclusion then, our view is that there’s a lot of noise about inequality with the most common errors being people thinking it actually causes disadvantage. Only when one is talking about inequality of opportunity is it logical to see causation of suffering being the denial of human rights or access to health and educational services. Inequality of wealth and income are more the results of that denial than the cause of disadvantage. 

What’s the real inequality? was last modified: December 15th, 2015 by Gareth Morgan
About the Author

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.