Monday, November 24, 2014

The Heirs of Inequality

ROME – It has long been known that spurts of rapid economic growth can increase inequality: China and India are the latest examples. But might slow growth and rising inequality – the two most salient characteristics of developed economies nowadays – also be connected?

That is the intriguing hypothesis of a recent study by the French economist Thomas Piketty of the Paris School of Economics. Piketty has done some of the most important work on inequality in recent years.

Taking advantage of the French bureaucracy’s precision, Piketty was able to reconstruct the French national accounts over nearly two centuries. The economy from 1820 until World War I – a kind of second ancien regime – had two striking features: slow growth – about 1% a year – and an outsize share of inherited wealth, which accounted for roughly 20-25% of GDP.

The link between low growth and the importance of inheritance, Piketty argues, was not coincidental: with inherited wealth yielding 2-3% a year and new investment only 1%, social mobility was extremely limited and stratification was encouraged.

That began to change with WWI, when growth picked up – a trend that accelerated sharply after World War II. With annual economic growth running as high as 5% during the post-1945 boom, inherited wealth shrank to only 5% of French GDP, ushering in a period of relative mobility and equality. Ominously, however, during the past two decades of slow growth, the share of inherited wealth has rebounded to about 12% of France’s economy.

This pattern should be a cause for concern, because annual GDP growth in the eurozone during the past decade has averaged about 1%. Similarly, average annual growth in the United States has slowed from around 4% between 1870 and 1973 to roughly 2% since then.

Joseph Stiglitz, the Nobel Prize-winning economist, also believes that low growth and inequality are interconnected, but he believes that the causal arrow moves in the opposite direction. As he put it in a recent interview, “I think it’s inequality that’s causing low growth.” In his new book The Price of Inequality, he writes that, “Politics have shaped the market, and shaped it in ways that advantage the top at the expense of the rest.” Rent-seeking, the ability of entrenched elites to allocate resources to themselves and smother opportunity for others, invariably leads to a less competitive market and lower growth.

There is some support for this argument in Piketty’s work: the French economy takes off after WWI and again after WWII, both periods in which the French political system opened up and enacted progressive reforms.

But, according to Ilyana Kuziemko, an economist at Princeton University, there is also evidence that low growth does indeed increase inequality. Public-opinion data and experimental research indicate that people (or at least Americans) become less favorable to income redistribution during economic hard times. Gallup polls, for example, show support in the US for reducing inequality falling from 68% to 57% during the current recession, despite all of the public rhetoric – and evidence – that the top 1% of income earners have captured almost all of the gains from economic growth in recent years.

Curiously, hard times may actually trigger among the economy’s losers a psychological mechanism known as “last-place aversion.” Experimental economists have found that subjects asked to play distribution games become much less generous toward those below them when they are in second-to-last place. They would rather distribute money to those above them on the totem pole than help those at the bottom to surpass them.

This finding dovetails with the work of Harvard University’s Benjamin Friedman, who argues in The Moral Consequences of Growth that “economic growth more often than not fosters greater opportunity, tolerance of diversity, social mobility, commitment to fairness, and dedication to democracy.” Similarly, lack of growth tends to breed xenophobia, intolerance, and a negative attitude toward the poor – the US and Europe in recent decades serve as cases in point for Friedman. “People in the 30th percentile are desperate not to fall into the 20th or tenth percentile,” he concludes.

Thus, a slow-growth/high-inequality economy may become a self-perpetuating cycle. But both Stiglitz and Piketty do not think that it must be so. “First of all, the Scandinavian countries, which have the greatest equality, are also among the fastest-growing advanced economies, and take the example of Japan, which has experienced deflation for about 20 years but successfully maintained a decent level of equality and standard of living,” Stiglitz argues.

Piketty believes that the key may lie in making a psychological adjustment to a period of slower growth: “We may need to accept the fact that the post-WWII years of 4% and 5% annual growth were the exception, and that 1% annual growth – after allowing for population growth – is much more the norm.”

Indeed, Piketty argues that our “obsession with growth” merely “serves as an excuse for not doing anything about health, about education, or about redistribution.” And it is an obsession rooted very much in the present. “We forget that for centuries growth was essentially zero,” he writes. “One percent real growth means doubling the size of your economy every 30 or 35 years.”

Piketty sees that as grounds “to be a little optimistic.” But, as he suggests, the share of inherited wealth may turn out to be a strong indicator of whether that rate of growth will be enough to ensure greater social mobility and reduce economic inequality.

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    1. CommentedLeo Arouet

      Una buena hipótesis. Lo más común es que el crecimiento económico genere mayor desigualdad.

    2. CommentedAvraam Dectis

      It might also be worthwhile to deemphasize the focus on GDP and instead give much higher attention to changes in personal incomes and living standards.

      The current state of the USA is a good example of why this is important. GDP has recovered to what it was before the great recession, but median income is now down by 7%.

      What does it matter if the economy is growing if most people are seeing declining incomes?

      Thank you.

      Avraam J. Dectis

        CommentedAvraam Dectis

        Also, accepting high growth rates as exceptions that cannot be duplicated is pathetic defeatism.

    3. CommentedZsolt Hermann

      This paragraph might be the key for the article and to the solution of the crisis:
      "...Indeed, Piketty argues that our “obsession with growth” merely “serves as an excuse for not doing anything about health, about education, or about redistribution.” And it is an obsession rooted very much in the present. “We forget that for centuries growth was essentially zero,” he writes. “One percent real growth means doubling the size of your economy every 30 or 35 years.”..."
      Our obsession with quantitative growth is both unnatural and it is unsustainable in a closed, finite system.
      We have reached saturation by now, that is why we are in a system failure not in a crisis. The previous exploitative, competitive growth system depleted both the human resources, and the natural resources. Whether slow growth is the cause of inequality or inequality is the cause of slow growth is theoretical, the problem is the stubborn obsession with quantitative growth itself.
      This whole paradigm is based on totally unnecessary, artificially inseminated desires for products we do not need for normal human life.
      This unnatural and artificial system is breaking down now, bringing with itself huge waves of unemployment as all the industries, companies producing above necessity goods will go out of business.
      Either way humanity will return to a necessity and resource based economy as we do not have a choice, we are part of this vast natural system around us we are not above it, if we want to develop further, our development has to become quantitative, adapting to the conditions around us, using what we already have in a mutually responsible and considerate way in our modern global, interdependent human network.
      This planet can sustain much more people than we have today provided we learn how to use it in a natural way.

    4. CommentedA. T.

      Wealth is an outcome of past competition but it is also an opportunity for future competition. Thus, unless periodically accounted for, the inequality of outcome (a good thing) of one period becomes inequality of opportunity (a bad thing) for the next. Unbalance opportunity, and of course growth will slow – those at the top will put their efforts into maintaining the status quo (rather than into growth or disruption) since they are already at the top. And if they are at the top by a large enough margin, their efforts to halt progress will be successful.

      The only way to maintain growth is to counteract long-term accumulations.