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Redistribution or Inclusion?

Many people fear that profound and deepening income inequality is a global phenomenon with similar causes everywhere. But there are two sources of inequality – disparate productivity levels among firms and unequal distribution within them – and conflating them prevents clear thinking on either one.

RIYADH – The issue of rising income inequality loomed large at this year’s World Economic Forum in Davos. As is well known, the United States’ economy has grown significantly over the past three decades, but the median family’s income has not. The top 1% (indeed, the top .01%) have captured most of the gains, something that societies are unlikely to tolerate for long.

Many fear that this is a global phenomenon with similar causes everywhere, a key claim in Thomas Piketty’s celebrated book Capital in Twenty-First Century. But this proposition may be dangerously misleading.

It is crucial to distinguish inequality in productivity among firms from unequal distribution of income within firms. The traditional battle between labor and capital has been about the latter, with workers and owners fighting over their share of the pie. But there is surprisingly deep inequality in firms’ productivity, which means that the size of the pie varies radically. This is especially true in developing countries, where it is common to find differences in productivity of a factor of ten at the provincial or state level and many times higher at the municipal level.

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