Opinion: Why inequality matters…

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ANDREW LEIGH, the Federal Member for Fraser, spoke tonight to the Sydney Institute about “Why Inequality Matters, and What We Should Do About It”. Here is his speech:

“Imagine a ladder, in which each rung represents a million dollars of wealth. Imagine the Australian population spread out along this ladder, with their distance from the ground reflecting their household wealth.

“On this ladder, half of all households are closer to the ground than they are to the first rung.

“The typical Australian household is halfway to the first rung.

“Someone in the top 10 percent is at least 1½ rungs up.

“A household in the top 1 percent is at least 5 rungs up.

“Gina Reinhardt is 5½ kilometres off the ground.

“‘The rich are different from you and me’, wrote an awestruck F. Scott Fitzgerald.

“‘Yes’, wrote the laconic Hemingway. ‘they have more money.’

“But why should we care about the gap between rich and poor? Shouldn’t we focus on raising the bottom, rather than how much wealthier the top are than the rest? Aren’t discussions of inequality merely – shudder – ‘the politics of envy’?

“Certainly, there are eminent economists who have taken this position. The University of Chicago’s Robert Lucas has argued that ‘of all the tendencies that are harmful to sound economics, the most seductive, and in my opinion, the most poisonous, is to focus on questions of distribution’. Harvard’s Martin Feldstein says ‘there is nothing wrong with an increase in well-being of the wealthy or with an increase in inequality that results [solely] from a rise in high incomes’.

“Contrary to Lucas and Feldstein, I want to persuade you that inequality matters, that the gap between rich and poor really is an important public policy issue, even apart from the question of poverty. Inequality has costs and benefits, and policymakers need to think hard about the right level of inequality.

“This is an issue that Wayne Swan has put squarely on the national agenda, and I commend his article in The Monthly to you.

“To begin, let me take a moment to review what we know about inequality in Australia. There are many measures of inequality, but I’m going to focus on top income inequality, because it allows me to look at a much longer period, and because it’s very clear that when we’re talking about top incomes, the topic is inequality rather than poverty.”

In Which Some Boats are Lifted More than Others

“About a decade ago, I teamed up with a British economist, Sir Tony Atkinson, on a project to use taxation statistics to learn more about inequality. The idea was to follow work by Simon Kuznets in the 1950s and Thomas Piketty in the 1990s, using breakdowns of taxation figures to look at the top of the distribution. By combining taxation statistics for the top end with national accounts and population statistics for the entire population, we’re able to answer questions like ‘what was the income share of the richest 1 percent of Australian adults?’.

“While regular surveys are only conducted every few years, taxation data are available annually. So we were able to estimate a measure of ‘top income inequality’ going back to the 1910s for Victoria, and the 1920s for Australia.

“The thing that strikes you first is that for all the legends of egalitarian bushmen, early-twentieth century Australia was a strikingly unequal place. I’ll come to the data in a minute, but let me remind you first of the character of the place. The Australian Club in Sydney and the Melbourne Club were elite institutions. True, an Australian gentleman need not have been a man of leisure – both clubs included merchants and squatters from the outset – but great deference was paid to the elite.

“Large fortunes were made in the early-twentieth century, and many of the super-rich lived extravagantly.[7] Retail merchant Samuel Hordern raced yachts and bred racehorses. Goldmining magnate Walter Hall was also a racehorse owner, and collected Old Master paintings. Other super-rich of the era include newspaper proprietor David Syme, pastoralist Samuel McCaughey, union-busting manufacturer Hugh McKay, and retailer Sidney Myer.”

Then things began to change

“In the 1910s and 1920s, the richest 1 percent of Australians had 12 percent of national income – 12 times their proportionate share. By the mid-1950s, this was down to 8 percent. By 1980, it was down to 5 percent.

“You can see the same pattern if you look further up the distribution, at the richest 0.1 percent – the 1/1000th of Australians with the highest incomes. Back in the 1910s and 1920s, the top 0.1 percent had about 4 percent of household income – 40 times their proportionate share. By the 1950s, this had fallen to 2 percent, and by 1980, it was down to 1 percent. Under the Prime Ministership of Malcolm Fraser, the share of income held by the richest 1/1000th of Australians was only a quarter of what it had been under Billy Hughes.

“The collapse of the super-rich is vividly portrayed in William Rubinstein’s book The All-Time Australian 200 Rich List. Published in 2004, the list covers the all-time richest 200 Australians, from Samuel Terry to Kerry Packer. The cut-off for inclusion in the book is that you had to have wealth of 0.17 percent of GDP, equivalent to $2.7 billion today.

“Because Rubinstein’s book covers 200 people and about two centuries, you’d expect an entrant every year or so. But the striking thing is that for four decades, from 1940 to 1980, there wasn’t a single Australian wealthy enough to make the all-time rich list. For example, Rubinstein points out that in the 1940s and 1950s, there were probably only a handful of people worth more than £1 million, and no-one worth more than £8 million (the cutoff necessary to make the all-time rich list in 1955).

“The closed economy of the 1950s and 1960s imposed costs on society as a whole, but nonetheless this was an era marked by full employment (for men), rapid increases in ownership of cars and houses, and significant reductions in poverty. Yet Rubinstein writes that ‘so markedly different were trends among the very rich compared with those for society as a whole that the post-war period seemed to constitute, as it were, an age of affluence for everyone except the very affluent’.

“Corporate Australia was shifting from a period of asset-owning proprietors to professional managers, but managerial salaries remained modest.

“The social norms of this era were different. Rubinstein says: ‘most of the wealthy now eschewed conspicuous consumption and ostentatious display of riches and privilege as politically unwise and economically costly’. Craig McGregor, writing in the 1960s, said that the wealthy ‘feel under some pressure to be accepted by ordinary working Australians rather than the other way round’.

“The fall in inequality in the post-war years isn’t unique to Australia. Atkinson and I have also used taxation data to look at New Zealand, where we see almost precisely the same pattern.

“Others have looked at the English-speaking nations of Britain and the United States, and the (mostly) English-speaking nation of Canada. Across the Anglosphere, the pattern is very similar: inequality fell steadily from the 1920s until the 1970s. Among the factors that made all these countries more equal were rising education, high top tax rates, fairly closed economies, and strong unions.

“Then, starting around 1980, Australian inequality began to rise. Let’s start with the top 1 percent: individuals with a pre-tax income these days of over $200,000. Over the past three decades, Atkinson and I find that the income share of the richest 1 percent has doubled. For the top 0.1 percent – which now means individuals with a pre-tax income of $700,000 or more – their income share has tripled since 1980. The ratio of CEO pay to the pay of an average worker has quadrupled. Relative to average workers, other elite salaries rose too, including the pay of High Court judges, senior public servants, and federal politicians.

“These patterns are common across the English-speaking world, though Australia started from a lower base. From 1980 to the late-2000s, the top 1 percent share rose from about 5 to 10 percent in Australia, but from 10 to 20 percent in the US. So on this measure, Australia is twice as unequal as it was in 1980 – but the US is twice as unequal again.

“So after being largely absent from Australian life for four decades, we saw the return of the magnate. The 1980s saw the rise of people like Rupert Murdoch, Kerry Packer and Alan Bond. In the 1990s: Frank Lowy, Richard Pratt, Harry Triguboff. And in the 2000s, individuals such as Andrew Forrest, Clive Palmer, Ivan Glasenberg, Gina Reinhardt and others. In the most recent year, the cut-off to enter the Australian rich list jumped from $180 million to $215 million. Ten people on the latest BRW Rich List would qualify for the all-time Australian rich list.

“Since 1980, Australia has seen 13 percent of household income gains go to the top 1 percent. The rise in top income inequality is reflected in sales of luxury goods. Prices for waterfront properties and great Australian artworks have soared over recent decades, reflecting their scarcity. Over the past two decades, a bottle of 1971 Grange – one of the great vintages – has increased in price at three times the rate of average earnings. The noughties saw a 70 percent increase in annual Porche sales, and a five-fold increase in Maserati sales.

“Even cocaine – what Robin Williams once described as ‘God’s way of telling you, you are making too much money’– is being consumed in greater quantities. The number of registered helicopters has doubled. Worldwide, builders of private jets are struggling to keep up with demand. High net worth individuals have also donated more to political parties than ever before, with Graeme Wood giving $1.6 million to the Greens in 2010, and Clive Palmer donating $1 million to the Coalition in 2009-10: seeking nothing return but preselection for a federal seat. (I admit, I was alarmed when I heard Mr Palmer was planning to buy his way into parliament. But I’ve spoken to the new head of the CIA, Bob Brown, and he tells me there’s nothing to worry about.)

“Three big factors drove this rise in top incomes inequality over the past generation. First, the returns increased markedly for those at the top of their field: what economists call ‘superstars’.

“The IT revolution made it possible for superstar professionals to reach more clients. The biggest companies grew, so top CEOs were servicing a larger organisation. English-speaking labour markets merged, so a large Australian firm looking for a CEO will now conduct a worldwide search, where in the 1970s they would have looked for the best Australian for the job.

“Second, union membership has collapsed, from half the workforce in the early-1980s to one-fifth of the workforce today. Empirically, there’s a strong relationship between the unionisation rate in an industry and the amount of wage equality. Unions tend to work harder to get pay rises for their lowest paid members, or to campaign for a common dollar increase (eg. $10 a week), which reduces inequality.

“And third, top tax rates were cut. In 1970, Australia’s top personal income tax rate was 69 percent. By 1980, it was 60 percent. By 1990, it was 47 percent. Lower taxes increase top wage earnings by providing an incentive to take on additional work, and they increase capital earnings by allowing investors to reinvest a greater share. There were good reasons for cutting top tax rates, and I’m not arguing for them to rise again today. Yet a surge in inequality was a clear by-product of this decision.”

Who Cares?

“But should we care about inequality? Or do we take the view that then Workplace Relations Minister Tony Abbott put in 2003: ‘in the end we have to be a productive and competitive society and greater inequality might be inevitable.’?

“One set of arguments suggests that we should care about inequality for what are called ‘instrumental reasons’. Inequality, some contend, is associated with worse outcomes in areas that society cares about, such as health, crime, savings and growth. This argument is put most strongly in The Spirit Level, by Richard Wilkinson and Kate Pickett. It is an argument that I used to believe. Indeed, I deeply want to be true, but my own research persuades me otherwise.

“The closer you get to these asserted effects, the more fragile are the findings. If there are negative effects of inequality on those social outcomes, they must be extremely small. (There are also small positive effects. For example, my own work shows that inequality boosts growth, though the trickle-down process is slow.)

“I now believe that a better reason to care about the distribution of income is because humans have a palpable discomfort with high levels of inequality. As a father of two boys, I can attest that my sons are constantly benchmarking one against another. In preparing for this talk, I asked my older son whether he’d prefer that he and his brother both got one biscuit, or he got two and his brother got three. He chose one apiece.

“This isn’t confined to children. In a famous economics experiment called the ‘ultimatum game’, the first player decides how she would like $100 divided between her and the other person. The second player chooses whether to accept that division, or give all the money back.

“If all we cared about was being better off, then the second player should accept the division when he gets anything at all. So if the first player proposes to keep $99 and hand over $1, a second player who doesn’t care about inequality should accept. Yet in thousands of settings, it has been shown that people have a cut-off around $25, below which they’d rather get nothing than receive a share that they regard as miserly. It offends our dignity – our sense of justice.

“This sense of egalitarianism reflects what Lester Thurow termed ‘the income distribution as a public good’. Anyone who thinks that economics is about maximising money rather than maximising wellbeing hasn’t gotten past first year. In maximising wellbeing, inequality matters – because a dollar brings more happiness to a poor person than to a rich person.

“There are also practical ways in which an increase in top incomes can reduce wellbeing for others. If people are competing for ‘positional goods’, such as a home in a desirable suburb, a place in a top university, or a sought-after job, then inequality may lead to an ‘expenditure cascade’, as those in the middle have to spend more to stay in the race.

“When top incomes are modest, a young man can happily wear a $200 suit to a job interview. But if top incomes rise, he may feel a need to buy a $1000 suit to compete.

“Another reason to care about inequality is that unequal societies tend to be immobile societies. Australia has always prided ourselves as being a place where – as Craig McGregor once put it – ‘The lack of widespread extremes in social differentiation makes it easy for class-jumpers to “pass”.

“And yet when I studied the relationship between the earnings of fathers and sons, I found that the degree of intergenerational mobility in Australia wasn’t much different from Britain.

“True, it is easier to move from rags to riches (or the reverse) in Australia than it is in the United States. But Australia is less socially mobile than many Scandinavian nations, where being born on the ‘wrong side of the tracks’ is barely a barrier at all.

“A belief in social mobility sits deep in the heart of the Australian national identity. When we talk about what a good society should achieve, it’s one of the things that first comes to the lips of politicians of all stripes. And yet we know that the more unequal a society, the less mobile it is.

“If high inequality entrenches poverty and plutocracy across generations, it will damage something that many of us hold sacred. The BRW Rich List is likely to increasingly become populated by those with inherited wealth rather than the self-made.

“My final concern about high inequality is that it has the potential to corrode the polity. Campaign contributions in themselves are not a cause for concern, but we must worry when donations buy policy outcomes that personally benefit the donor. At its worst, big donors pay for advertisements that aim to persuade voters that an extreme policy is a moderate one.

“We’ve seen some of this in the United States over recent years. As the Republicans have moved noticeably to the right, deep-pocket donors such as the Koch Brothers, Harold Simmons, and Sheldon Adelson now spend millions of dollars apiece on advertisements showing Republican candidates wearing jeans and talking to ordinary voters, while arguing that it is the Democrats who are out of touch with working America.”

What to do about it?

“So, what should we do about rising inequality in Australia?

“In preparing for my talk, I went back and read the talks given in 1999, when The Sydney Institute hosted a debate on inequality between Craig Emerson and Julie Bishop. Both argued that education was key to reducing inequality. Emerson focused particularly on fairer private school funding and targeted early education for early childhood programs.

“Education is still the most promising way of reducing inequality. Harvard economists Claudia Goldin and Larry Katz argue that we can think about inequality as a ‘race’ between education and technology.[34] When education outpaces technology, we get the ‘great compression’ of the postwar decades.

“When technology outpaces education, we get the ‘new Gilded Age’ of the recent era. Improving the quality of Australia’s education system, and (yes Craig), early childhood intervention programs for the most disadvantaged is a vital way to reduce inequality.

“Targeted welfare is also important. It often goes unnoticed today, but one of the great achievements of the Hawke and Keating Governments was to target income support where it is most needed. Applying means tests and assets tests to the pension in the 1980s was politically tough, but absolutely essential to the sustainability of the system.

“Our Labor government has taken politically difficult decisions to impose means-tests on the Baby Bonus, Family Tax Benefit Part B, and the Private Health Insurance rebate. None of these decisions had bipartisan support, but they were important in ensuring that the tax and transfer system doesn’t perpetuate inequality.

“We also need to recognise that – as Ken Henry pointed out in the 2011 Tax Forum – progressive income taxes are the best tool for redistributing income. The debate about progressivity frequently arises when talking about corporate income taxes, tobacco taxes, the GST, or carbon pricing.

“The points are valid ones, but the right way to deal with equity issues is through the system that’s best set up to address the problem: the tax and transfer system.”

Conclusion

“Egalitarianism sits deep in the Australian character.[35] We tend to think that Jack is as good as his master, if not better. Most of us don’t like tipping. If the plumber drops around, we’ll offer him a cuppa. It’s normal to sit in the front seat of a taxi. I’ll say ‘g’day mate’ to a bus driver as I would to a cabinet minister.

“We don’t typically say ‘sir’ in Australia. In fact, I enjoy the irony that the only knight I know is my inequality co-author Sir Tony Atkinson.

“In his study of Japanese prisoners of war, Gavan Daws writes:

“‘I began imagining that if human beings were worked and starved and beaten to the point of death, they would be reduced to barely functioning skeletons, scraps of biology, with… all national culture and character tramped out of them. Not so. … all the way down to starvation rations, 1000 calories a day and less, to 100 pound of bodyweight and less .. the prisoners of the Japanese remained inextinguishably American, Australian, British, Dutch.

“‘The Americans were the great individualists of the camps, the capitalists, the cowboys, the gangsters. The British hung on to their class structure like bulldogs, for grim death. The Australians kept trying to construct little male-bonded welfare states. [Unlike Americans] Australians could not imagine doing men to death by charging interest on something as basic to life as rice.

“That was blood-sucking; it was murder. Within little tribes of Australian enlisted men, rice went back and forth all the time, but this was not trading in commodities futures, it was sharing, it was Australian tribalism.’

“My grandfather turns 90 years old this year. For most of his life, Australia became a more egalitarian place. It has only been in the last few decades that we have seen again a rise in inequality, now creeping up back towards what it was in the Great Gatsby era into which he was born. The risk is that too much inequality will destroy Australia’s egalitarian spirit.

“There are many things about the 1950s and 1960s that we would not want to keep – but one value worth trying to reclaim about that era was the sense of egalitarianism. Too much inequality strains the social fabric, threatening to cleave us one from another. Australia is a stronger nation when we act together than when we pull apart.”

 

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