How inequality became a global problem

Rarely does a nearly 700-page economics treatise top the best-seller lists while its author is debunked by one publication and lauded as a mock teen idol on the cover of another. But French economist Thomas Piketty was fortunate to publish Capital in the Twenty-First Century in English just as fears of rising wealth and income inequality in the West are reaching a fever pitch.

Dr Piketty’s thesis in a nutshell: as economic growth slows (as he believes it will), the rate of return on capital will grow faster—and the rich will get richer. His book focuses on the 1%, but, more broadly, it is true that income inequality has grown within nations since the 1980s even as inequality has declined between them. In the OECD, the Gini co-efficient—a standard measure of income inequality ranging from 0 (totally equal) to 1 (totally unequal)—rose from 0.29 to 0.316, a nearly 10% increase. While Mexico and Turkey have reined in inequality during the past three decades, the US, UK and even Scandinavian nations steadily grew more unequal. Although only partly reflecting a country’s overall inequality, a particularly striking figure in this regard is that the top 1% share of total national pre-tax income in the US doubled in those years, reaching 20%.

One reason Dr Piketty’s book has become such a lightning rod is that inequality is typically seen as a problem endemic to developing nations, not developed ones. Globally speaking, inequality between nations is believed to have peaked in 1980—a time when OECD nations grew twice as fast as developing ones. Today, developing nations are growing faster and their overall income inequality appears to have fallen since 1980s. The tables have been turned—or have they?

Capital’s pivotal chart depicts a U-shaped plot of wealth inequality through the 19th and 20th centuries. The great dynastic fortunes of Honoré de Balzac’s France and Jane Austen’s England were destroyed by two world wars, while post-war social safety nets kept inequality in the West low for nearly 30 years. Although critics have poked holes in some of Dr Piketty’s data, the general consensus is that he is correct.

But Dr Piketty takes this argument a step further, using tax records from the world top incomes database (which he co-developed) to make the case that six developing nations—including China and India—also display the U-shaped pattern of growing wealth accruing to the top 1%. This is in contrast with a new paper by Martin Ravallion, former director of the World Bank’s Development Research Group, which finds—using household survey data—that while inequality has increased between developing nations since 2000, it has actually fallen within them—a pattern opposite that of the OECD.

The difference may be attributable to the measure being used. Still, one difference in the inequality debate between now and the 1970s, Dr Ravallion notes, is the rejection of the one-time belief that inequality in developing nations was somehow necessary for high growth. Whether living in a developed or a developing nation, inequality has direct implications for an individual’s outcome or even lifespan—researchers at the Brookings Institution found a four-year difference in life expectancy between those in the top cohort of income and those at the bottom. The question is what to do about it.

Dr Piketty has proposed a progressive, globally enforced wealth tax that many commentators have dismissed as utopian. But the OECD’s own report, which used Dr Piketty’s data, notes that the average top tax rates in member nations declined from 66% in 1981 to 41% in 2008—clearly, higher taxation might have a legitimate place.

Ironically, in his review of Capital, former US Treasury secretary Larry Summers offers the same prescriptions for developed economies that World Bank experts have given to developing ones for decades: spend significant sums on infrastructure; invest in human capital; and reduce barriers to private investment in critical sectors such as energy. This echoes the OECD’s conclusion that skills development is critical for elevating labourers in the bottom quintiles of income distribution—which goes double for emerging markets as their economic growth rates begin to converge with the West’s.

If the best time to halt rising inequality was 30 years ago, the second best time is now. As Dr Ravallion notes, higher inequality in developing countries stunts their ability to reduce poverty over time. Dr Piketty’s warnings are being heard.

This post first appeared on GE LookAhead. Publication does not imply endorsement of views by the World Economic Forum.

To keep up with Agenda subscribe to our weekly newsletter.