Clinton and Trump on Fiscal Policy (part 2)

August 17, 2016

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The last post discussed differences between the candidates in their approach to taxing and spending. Both have ambitious spending plans, but Hillary Clinton proposes to raise the revenue to finance hers by increasing taxes on the wealthy. Donald Trump proposes to increase spending and cut taxes at the same time, with the largest reductions for the wealthy.

Estate taxes

The candidates also sharply disagree over estate taxes. As a result of previous tax cuts, estate taxes only apply to individual estates valued at over $5.45 million, or $10.9 million for married couples. Only one estate out of every 500, or 0.2% of estates, are large enough to have to pay any estate taxes at all.

Amounts that exceed these thresholds are taxed at 40%. However,the wealthy are also able to use various legal devices to limit the size of their taxable estates, so that most pay less than half of that.

Consistent with her aim to get the rich to pay “their fair share,” Clinton proposes to raise the estate tax rate to 45% and to apply the tax to more estates. The new, lower thresholds would be $3.5 million for individuals and $7 million for couples.

Trump would abolish the estate tax altogether, creating another big tax break that would benefit only the richest 1/5 of the 1%. For those as rich as himself (or at least, as he claims to be), the tax savings could run into the billions.  Personally, I think that any candidate who claims to care about struggling working families could find a better use for that tax revenue.

I will cheerfully state my own bias here. I think that taxes on large estates are a good idea in a democracy. They help equalize opportunity, rather than letting the children of the rich be born with a gilt-edge guarantee of future prosperity. They also help avoid the formation of  hereditary aristocracies or plutocracies, which tilt power toward the wealthy and away from average citizens. How strange that an alleged populist cannot appreciate that!

Business taxes

In the area of corporate taxes, the Clinton plan is again more moderate than the Trump plan. She proposes some small changes to the tax code in order to discourage businesses from moving abroad. For example, she would crack down on “tax inversions,” where companies avoid US taxes by merging with a foreign company and moving their corporate headquarters to that country.

Donald Trump would reduce the incentive of companies to leave the United States by lowering the corporate tax rate, which at 35% is one of the highest in the world. Many corporations take advantage of the many deductions and loopholes in our tax code, some pretty reasonable and others pretty tricky. In general, Trump proposes to do what many tax critics recommend, lower the rate but close many of the loopholes.

However, the Trump plan is radical in some respects. He proposes a new corporate rate of 15%, which is below even the House Republican recommendation of 20%. He would also apply that rate to all sorts of businesses, including partnerships, limited liability companies and sole proprietorships. As it stands now, those entities “pass through” income to individuals, who pay taxes on it at “ordinary income” rates as high as 39.6% (or 33% after Trump’s other cuts). According to the Center on Budget and Policy Priorities, two-thirds of this pass-through income goes to the top 1% of taxpayers, who are obviously in the top bracket. Taxing those entities at only 15% would be another windfall for the wealthy.

In addition, it would create a new tax loophole for wealthy individuals. Many highly paid employees could lower their taxes to 15% simply by reclassifying themselves as independent contractors and selling their services to their former employers.

The choice

In her tax and spend proposals, Hillary Clinton comes off as the fiscal moderate but social progressive, wanting to finance her new spending plans with modest tax increases on the wealthy. Her tax plan is expected to bring in $1.1 trillion in additional revenue over ten years. Donald Trump comes off as the fiscal risk-taker and plutocrat, willing to increase the deficit in order to give out more tax breaks, primarily for the wealthy. His original plan would have reduced revenue by as much as $9.5 trillion over ten years, although he would hope to offset that by stimulating a higher rate of economic growth. (That’s what tax cutters always hope for but rarely achieve.) The current plan discussed here is just beginning to be analyzed, but I would be surprised if the cost in revenue would come out less than four or five trillion.

As I have said before, the Republican Party has the perennial problem of how to win electoral majorities while pursuing an economic agenda whose top priority is tax relief for rich people. The solution is often some form of cultural conservatism with broad appeal, such as Christian conservatism. Declining enthusiasm for the Religious Right has created an opportunity for a more troubling form of conservatism, more nativist and nationalist, to arise. In Donald Trump we have an odd marriage of nationalist populism and anti-tax plutocracy, the first appealing more to the less educated, and the second more to the rich. But not enough of the educated middle class are buying into this mix to make it the new ideological foundation for the party. Meanwhile, the Democrats are gradually becoming more progressive again, and they should be a formidable political force. For one thing, they are winning the battle for the hearts and minds of the younger generation, at least in this election.


Clinton and Trump on Fiscal Policy

August 16, 2016

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I am hoping that some potential voters are still interested in hearing about policy differences between the presidential candidates. As the election campaign stands now, it seems to be mostly a debate over the candidates’ character. Does Donald Trump have the right temperament to be president? Is Hillary Clinton trustworthy? Their actual policy proposals are often overshadowed by the latest mini-scandal, what Trump said about so-and-so, or what was found in an email on Clinton’s server. I watched the CBS evening news the day that Clinton presented her economic plan, and they made no mention of it. They did, of course, do a story on Trump’s description of the President as the “founder of ISIS,” which he later said he meant sarcastically, sort of.

Meanwhile, the country faces a number of difficult policy decisions, which will remain important regardless of who wins, but on which the candidates have taken very different positions.  Decisions about fiscal policy–how to tax, how to spend–are among the most important. They affect what the federal government is able to do, and what impact it has on the economy.

Spending

Both candidates promise to accomplish things that require new spending, although they often describe their goals without trying to put a price tag on them. One goal they have tried to price out is repairing and improving the nation’s infrastructure. Hillary Clinton has proposed to spend $275 billion over five years, and Donald Trump has promised to out-build her (that’s what he’s good at) with his own $500 billion plan.

Each candidate has other initiatives that will also need funding. Clinton wants to increase federal aid to education so that students from families with incomes below $85,000 can attend state colleges tuition free. (That threshold would rise to $125,000 over the next four years.) Trump wants to put more money into strengthening the military.

The candidates differ dramatically on how they would pay for their new spending. Clinton is the more fiscally conservative here, proposing to pay for new spending with higher taxes targeted specifically at the wealthy. Trump, on the other hand, wants to cut taxes, so at least in the short run the government would face a double whammy of more spending but less revenue. (He hopes that the government would recover at least some of that revenue when his tax cut stimulates the economy; more on that later.) Trump proposes to offset some spending with reductions in “waste, fraud and corruption,” a familiar goal to be sure, but I couldn’t find any proposals for specific budget cuts on his website. He has also said that he is willing to run a larger deficit and take on more debt. He has boasted about his ability to manage debt, but we know from his business history that his methods include declaring bankruptcy and repaying debt at less than full value. At one point Trump even suggested that the United States could also shortchange its bondholders, something that the country has never done. (That could very well end up costing the country more, since it would shatter confidence in our bonds and force the Treasury to pay higher interest rates.)

So on the face of it, Clinton seems to be the fiscal conservative, and Trump the fiscal risk-taker, which makes some Republicans very nervous. However, his “borrow and spend” approach isn’t that much of a departure from what Republican administrations actually do, as opposed to what conservative orthodoxy says they should do. While Republicans sound like the ultimate deficit hawks when they are opposing Democratic spending plans, their record on reducing deficits and balancing the budget is actually very poor. Both Ronald Reagan and George W. Bush ran up large deficits by doing a lot of what Trump wants to do, increase military spending while cutting taxes.

Ever since the 1980s, Republicans have supported their tax proposals with an argument from “supply-side” economics. Tax cuts aimed at corporations and the wealthy provide more capital that businesses can use to expand, create jobs, and boost incomes. That in turn increases tax revenues, so the tax cuts don’t really increase government debt in the long run. Not very many economists subscribe to this view today, at least with regard to cuts in personal income taxes. We have had relatively low taxes on the wealthy for 35 years, and we have experienced sluggish growth and a soaring national debt. In contrast, during the great period of economic growth in the mid-twentieth century, tax rates were higher, but growth rates were also higher and deficits were smaller.

Personal income taxes

As I said, Hillary Clinton proposes to increase taxes on the wealthy. She would put a 4% tax surcharge on incomes over $5 million, in effect raising the top tax bracket rate from 39.6% to 43.6%. She would also like to make anyone with an income over $1 million pay at least 30%. Although millionaires are in the 39.6% bracket now with regard to “ordinary income,” they can pay as little as 20% on income from capital gains. That’s why Warren Buffet can point out that he pays taxes at a lower rate than his secretary. (He is supporting Clinton’s plan, by the way, even though it will raise his own taxes.) The proposal for a 30% minimum rate for millionaires was previously proposed by President Obama, and has come to be known as the “Buffet rule.”

Clinton is not proposing any major tax changes for the non-millionaire majority. Donald Trump, on the other hand, is proposing “lower taxes for everyone, making raising a family more affordable for working families.” His first proposal cut taxes so much that most analysts dismissed it as fiscally irresponsible. More recently, he has apparently adopted the plan put forth by House Republicans, at least with regard to tax rates. The details are not entirely clear because they are not yet available on the Trump website.

We do know that the Trump plan proposes to simplify the rate structure by replacing the current seven tax brackets with only three: 12%, 25% and 33%. To keep the presentation brief, I will focus on households headed by married couples filing joint returns, but the general conclusions would be true for single filers as well. Here is how the plans would affect households with various taxable incomes (after deductions and exemptions):

  • $25,000: Currently this household is in the 15% bracket, but their effective tax rate is only 11.3%, since the first $18,550 is taxed at only 10%. Their tax is now $2,822. After Trump’s simplification, all their income is taxed at 12%, so their tax rises slightly to $3,000.
  • $30,917: I’ve picked this odd number because it is the break-even point where Trump’s plan makes no difference. The household is currently in the 15% bracket, but their effective rate is 12% already, and it remains 12% in Trump’s plan. Their tax is $3,710 either way.
  • $50,000: This household is also in the 15% bracket under the current system, with an effective rate of 13.1% and a tax of $6,572. After Trump’s simplification, they are taxed entirely at 12%, for a tax of $6,000 and a savings of $572.
  • $100,000: This household is currently in the 25% bracket, but with an effective rate of 16.5%. Under Trump’s plan, they are still in the 25% bracket, but their effective rate drops to 15.2% because the first $75,300 of their income is taxed at his 12% rate. Their tax goes down from $16,542 to $15,211, a savings of $1,331.
  • $1 million: Currently they are in the top 39.6% bracket, with an effective rate of 34.2%. Trump’s top bracket is only 33%, so their effective rate comes down to 30.2%. Their taxes fall from $341,666 to $301,695, a savings of $39,970.

And so it goes. The greater the taxable income, the larger the tax reduction, not only in dollars but in rate. Like all Republican tax proposals, this one gives the greatest tax relief to the wealthy who pay the most taxes, with the aim of making the rate structure flatter and less progressive.

In addition, the Trump plan does not address the “Buffet rule,” and so it continues allowing millionaires to pay a lower rate if their income is primarily from capital gains.

The Trump plan is marketed as “lower taxes for everyone, making raising a family more affordable for working families.” But the family with a $50,000 taxable income saves $572, while the family with the million-dollar income saves $39,970. Why should the government give up badly needed tax revenue to help families that are already doing fine?

A word of caution: a complete analysis of a tax plan would have to consider more than just the tax brackets and rates. For example, the House Republican plan (and maybe the Trump plan?) also proposes to increase the standard deduction from $12,600 to $24,000, while eliminating the personal exemption. Some households, especially those without children, would see their taxable income fall. Others, especially families with two or more children, could lose more from the loss of exemptions than they gain from the increased standard deduction. I don’t think that changes my basic conclusion, but it is not simple. The candidates need to post their plans with as much specificity as possible, so that outside experts can evaluate them.

One suspects that the real objectives of the Republican plan are probably something else besides providing tax relief to the working class. Many Republicans sincerely believe that more tax cuts for the wealthy will promote economic growth, although doing that from the top down is a dubious proposition. Democrats are more likely to believe that government spending on useful job-creating projects is a more direct path to growth. The difference is even starker, since some Republicans have advocated tax cuts specifically to deprive the federal government of revenue in order to keep government small and weak, “small enough to drown in a bathtub,” as anti-tax crusader Grover Norquist has put it. As far as I know, Donald Trump has not made that argument. He really can’t, since he is promoting increases in both military and domestic spending. But it may be an objective of House Republicans, who could be very influential in a Trump administration. They do want to reduce domestic spending, although they have to be careful about how they present that to the public. Better to speak of “entitlement reform” than “cutting social security benefits”; better to speak of “reducing dependency on government” than “taking away food stamps from hungry children.” Surveys have found that Americans like the idea of limited government in the abstract, but rarely rally around when specific programs are on the cutting board.

A presidential campaign should be an opportunity to have an honest, fact-based debate over fiscal policy, among other things. Right now, that’s just not the kind of thing that get’s voters’ attention.

In the next post, I’ll discuss differences between the candidates on estate taxes and corporate taxes.

Continued


Global Inequality (part 3)

August 8, 2016

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This final post on Branko Milanovic’s Global Inequality will focus on the future prospects he sees for reducing economic inequality in the world. He discusses three kinds of inequality: inequality among countries, inequality within poorer countries, and inequality within richer countries, especially the United States.

Inequality among countries

Milanovic expects the median incomes of countries to continue to converge as the economies of poorer countries continue to grow faster than those of richer countries. However, he expects this convergence to be limited in several ways. Currently “it is only Asian countries that have been catching up with the rich world.” Progress has been much slower in other parts of the world, especially Africa. And although growth in China accounts for a lot of the global convergence in incomes, this may not always be the case. In a few years, China may be so far above average that further development there may increase global inequality rather than reduce it. Then continued convergence will depend on what other countries do.

Although the narrowing gap between rich and poor countries is encouraging, it is occurring so slowly that “one cannot expect global inequality to be reduced by more than one-fifteenth of its current level” over the next twenty years.

Inequality within poorer countries

Milanovic suggests that countries like China are passing through a phase of the first Kuznets wave that more developed countries experienced at least a century ago. They are experiencing a familiar pattern in which industrialization initially increases opportunities for the few, and only later for the many, as discussed in the previous post. Although the data are somewhat sketchy, Milanovic sees signs that economic inequality has peaked in China and is beginning to subside. Mass education and a reduced supply of cheap, unskilled labor would be among the reasons for the transition.

On the other hand, many poor countries are still in an even earlier phase of the transition, in which inequality is increasing because the benefits of economic development have yet to be experienced by large portions of their populations.

Inequality within richer countries

I found Milanovic’s views on this topic a bit confusing. On the one hand, he maintains that information technology and globalization have initiated a new Kuznets wave of economic change, in which inequality is rising again but will ultimately fall. To make that case, he needs reasons for the fall as well as the rise. Otherwise, he cannot distinguish his theory from more pessimistic assessments like Piketty’s Capital in the Twenty-first Century, which sees rising inequality as a fundamental feature of capitalism. However, when Milanovic tries to identify mechanisms by which inequality might fall, he expresses little confidence that they will work any time soon.

Milanovic identifies five “benign forces” that could theoretically reduce inequality:

  1. Political changes could result in higher and more progressive taxation. However, the global mobility of capital makes it easier for the wealthy to escape taxation. In addition, many citizens of modest means have trouble supporting higher taxes, even when that might be in their own best interest.
  2. The widening wage gap between more and less educated workers could be narrowed by improvements in the quantity and quality of education. However, Milanovic has trouble imagining that average years of education could rise above thirteen. He also thinks that improvements in the quality of education “face natural limits, given by the aptitude and interest of students to excel in whatever they choose to do.” Some would object that if better education were more widely available, more students would rise to the occasion.
  3. As the technological revolution proceeds, innovations that originally profited the few can be more widely adopted. On the other hand, the ownership of capital has become more concentrated lately, so the control of profitable innovations remains largely in the hands of a few.
  4. As wages rise in poorer countries, workers in richer countries should face less competition from foreign low-wage labor. However, it could be a long time before poor countries outside of China and a few other Asian countries experience much wage growth.
  5. Technological progress could raise the productivity of low-skill workers specifically. But this would go against the historical experience of capitalism, in which technological change normally boosts the income of the more skilled over the less skilled.

I found the last point especially troublesome, since it seems to me to undercut one of the strongest reasons for a Kuznets curve in the first place. Surely the mass-production technologies of the twentieth century helped bring many blue-collar workers into the middle class by boosting their productivity, raising their wages, and making former luxuries like automobiles more affordable. If we are looking for mechanisms for reducing inequality in the new wave of change, shouldn’t we be looking for a new productivity revolution along the lines suggested by Rifkin’s The Zero Marginal Cost Society or Paul Mason’s Postcapitalism? Milanovic  doesn’t anticipate anything that radical, but maybe the falling inequality phase of the alleged Kuznets curve won’t work without some fairly dramatic change. Ironically, Milanovic begins his chapter on future inequality by criticizing previous attempts at prediction for assuming too much continuity from the present to the future.

The United States: A “perfect storm of rising inequality”?

Milanovic is especially pessimistic about reducing inequality in the United States. He provides five reasons he expects the rise in inequality to continue:

  1. The share of national income going to capital rather than labor will remain high, especially since businesses find it economical to replace labor with machinery.
  2. The income from capital will remain highly concentrated.
  3. The people with the highest incomes will also be the ones who can save and invest the most, so the same people will be getting most of the benefits from both labor income and capital income.
  4. These labor-rich and capital-rich individuals will also tend to marry each other, so that wealth and income are even more concentrated for households than they are for individuals.
  5. The rich will use their political power to support policies that protect their economic interests at the expense of those of the middle class and the poor.

Milanovic concludes:

It is hard to see where any forces might come from that could counter rising income inequality in the United States….Forces promoting offsetting policies such as more widespread education, a higher minimum wage, and more generous welfare benefits seem weak compared with the almost elemental forces that favor greater inequality.

By this time, the reader who has followed the argument from the beginning may be wondering what happened to the original idea of the Kuznets curve, with its rise and fall of inequality. Well, “the second Kuznets curve will have to repeat the behavior of the first if inequality is to decline again. But it is doubtful whether this second decline will be accomplished by the same mechanisms as those that reduced inequality in the twentieth century….” What mechanisms Milanovic does suggest are mostly political, especially changes in tax policies and improvements in public education, changes that seem unlikely in the light of his previous remarks. The reliance on political rather than economic mechanisms sounds more like Piketty than Kuznets.

To summarize, Milanovic starts with a Kuznets theory emphasizing economic reasons why inequality first rises and then falls. He does broaden it by suggesting that extreme inequality generates malign forces like violent conflicts that can destroy the wealth of some and create opportunity for others. Yet he ends with a pessimism that economic forces will reduce inequality either benignly or malignly. This leaves it an open question whether what we are living through is a second Kuznets wave at all. If it isn’t, then the first Kuznets curve was a unique historical event from which we cannot generalize, and the book’s theoretical framework falls apart.

In general, I found the book’s data very informative and its interpretations thought provoking. But in the end I found its theoretical position on the central question of falling inequality too ambiguous to be convincing.


Global Inequality (part 2)

August 4, 2016

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The Kuznets curve

Milanovic’s interpretation of global trends in inequality relies heavily on a modified version of an idea proposed by Simon Kuznets in the 1950s. Kuznets observed a rise and fall pattern in inequality within industrializing countries. In a graph plotting inequality against per-capita national income, the pattern appears as a curve in the shape of an inverted U. This suggests that as industrialization increases national output and average income, the benefits flow first to the few, and only later to the many. Limited prosperity widens the gap between rich and poor, but then more widespread prosperity narrows it.

Consider the United States at its peak of economic inequality around the end of the nineteenth century. Industrialization has created a wealthy class of industrialists and a very small middle class of well educated workers. Meanwhile, massive numbers of workers displaced by the decline of farm jobs have poured into the cities, keeping wages low for those without capital or urban skills. Then consider the country fifty years later. Population growth has slowed along with urbanization, since urban families have fewer children than farm families. (The postwar baby boom will change that temporarily, but that is more of a response than an impediment to widespread prosperity.) Education and skill levels have risen. Assembly-line technology has boosted worker productivity, helping to justify higher wages; and perhaps requiring higher wages because businesses need consumers to buy their mass-produced products. Workers have mobilized both in the workplace and in the political sphere to fight for better wages, better working conditions, and a social safety net. A large middle class, a hallmark of general prosperity, has emerged.

Many economists once accepted the Kuznets curve as a fairly good description of trends in inequality, generalizable to many industrializing nations. However, since the 1980s, the downswing in inequality has come to an end in many rich countries. “The indubitable increase in inequality in the United States, the United Kingdom, and even in some fairly egalitarian countries like Sweden and Germany, is simply incompatible with the Kuznets hypothesis.”

Recent thinking about inequality is less confident that any long-term decline in inequality must or will occur. One popular theory says that the future of inequality depends on the outcome of a “race between education and what is known as skill-biased technological progress (that is, technological change that favors high-skilled workers).” Inequality could decline if less skilled workers can acquire skills quickly enough, but there is no guarantee that will happen. In Capital in the Twenty-First Century, Thomas Piketty is especially pessimistic. He sees rising inequality as the historical norm, because the rate of return on capital tends to exceed the general rate of income growth. The twentieth-century decline in inequality in the US and other developed countries was due to a special set of circumstances that need not be continued or repeated. Only radical political action, such as higher taxes on wealth, can counteract the economic forces favoring inequality.

Multiple Kuznets waves

Milanovic’s main contribution to this discussion is the suggestion that the Kuznets curve associated with industrialization is not the only such curve. Fluctuations in inequality have occurred in repeated waves over the past 500 years. Milanovic regards the most recent rise in inequality as just the upswing phase of a new Kuznets wave, which will eventually have its downswing phase as well. That means that the Kuznets curve remains relevant to our understanding of the present, since it does not just describe a one-time, historically unique feature of industrialization.

Milanovic see Kuznets waves even in preindustrial times, although his description of them makes me wonder whether Kuznets himself would recognize them. “Before the Industrial Revolution, when mean income was stagnant, there was no relationship between mean income level and the level of inequality. Wages and inequality were driven up or down by idiosyncratic events such as epidemics, new discoveries…, invasions, and wars.” For example, a widespread epidemic might raise wages by making labor more scarce, but the gains would be wiped out in Malthusian fashion as population growth resumed.

Notice that this focus on idiosyncratic events removes two key elements of the original theory. For Kuznets, the rise and fall pattern of inequality was tied to mean income level, and the rise came before the fall. Without those elements, about all that remains is the observation that inequality fluctuates in either direction for many different reasons, which no one doubts. Calling the fluctuations “Kuznets waves” creates the impression of having a general theory of waves with some application to today’s economy. But if preindustrial fluctuations are merely idiosyncratic–or as Milanovic says, “Changes in inequality versus mean income are irregular in preindustrial societies but shift into regular cycles in industrial and postindustrial societies”–then we have only the one completed Kuznets cycle of the industrial era on which to base the claim that there are regular cycles at all. We may be at the beginning of a second regular cycle, but how would we know? The possibility that the industrial Kuznets wave is the only Kuznets wave is harder to dismiss. I don’t think that Milanovic ever entirely overcomes this difficulty, as much as I would like him to!

The industrial wave of inequality

Milanovic’s description of rising inequality during the early stages of industrialization follows Kuznets pretty closely. “As Kuznets argued, it is the structural movement, the transfer of labor from the low-income, low-inequality agricultural sector to the higher-income, higher-inequality industrial sector (and concomitantly, from rural to urban areas) that increases income inequality.”

For the later downswing in inequality, Milanovic’s contribution is to consider “benign” factors and more “malign” factors in combination. Benign reasons for more widespread prosperity include those I mentioned earlier, such as greater access to education and skills, technology-based productivity gains, and political mobilization for industrial workers.  For the malign factors, he draws on the work of Piketty, who argues that “the two world wars not only led to higher taxes but also destroyed property and reduced large fortunes.” Unlike Piketty, however, Milanovic sees the malign factors as consequences of economic developments, including inequality itself. The conditions leading to World War I included “very high income and wealth inequality, high savings of the upper classes, insufficient domestic aggregate demand, and the need of capitalists to find profitable uses for surplus savings outside their own country.” The result was nationalist rivalries, imperialism, colonialism, and ultimately war. The moral of the story: “A very high inequality eventually becomes unsustainable, but it does not go down by itself; rather, it generates processes, like wars, social strife, and revolutions, that lower it.”

In summary, Milanovic remains faithful to the main thrust of the Kuznets argument, that rising inequality eventually reaches some sort of limit, but he has a broader view of the mechanisms by which inequality then declines.

A postindustrial wave?

Milanovic believes that the emergence of a global information society is a development comparable in its significance to the Industrial Revolution. Therefore it has its own Kuznets curve of rising, then falling, inequality, but we have seen only the rising phase so far. As in the early phases of industrialization, the economic benefits have been going primarily to the few.  We can expect this to change only if we share Milanovic’s confidence that the general logic of the Kuznets wave applies: Inequality cannot increase without encountering some kind of limit.

Here is Milanovic’s description of the new inequality:

The 1980s ushered in a new (second) technological revolution, characterized by remarkable changes in information technology, globalization, and the rising importance of heterogeneous jobs in the service sector. This revolution, like the Industrial Revolution of the early nineteenth century, widened income disparities. The increase in inequality happened in part because the new technologies strongly rewarded more highly skilled labor; drove up the share of, and the return to, capital; and increasingly opened the economies of rich countries to competition from China and India…. The structure of demand, and thus of jobs, moved toward services, which in turn were staffed by less qualified and worse-paid labor. On the other hand, some service sector jobs, as in finance, were extremely highly paid. This widened wage, and ultimately income, distribution.

While in the earlier era it was the shift from agriculture to manufacturing that created wealth for some and subsistence wages for others, now it is the shift from manufacturing to services.  Not only are many service jobs too low-skill and low-productivity to pay a good wage, but service workers are hard to organize because they are widely dispersed in small work units.

What remains to be seen is whether the latest increase in inequality can be reversed by more egalitarian trends, as in the classic Kuznets curve, or if it will turn out to be irreversible. Milanovic prefers the first alternative, and I want to believe him. But when he tries to identify mechanisms that would restore greater equality today, his arguments get a bit tentative and half-hearted. This will be the subject for the last post.

Continued


Global Inequality

August 3, 2016

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Branko Milanovic. Global Inequality: A New Approach for the Age of Globalization. Cambridge: Harvard University Press, 2016.

Branko Milanovic is a Serbian-American economist specializing in economic development and inequality. His global perspective on inequality goes beyond the familiar idea that gaps in wealth and income always seem to be widening. There is some truth to that, but it is far from the whole truth.

Who is gaining from globalization?

Economists are in a much better position to talk about global income now that they have some decent global data. Milanovic’s data come from “more than 600 household surveys covering about 120 countries and more than 90 percent of the world’s population over the period 1988-2011.”

He uses the data to construct a remarkable chart, in which he plots percentiles of income on the horizontal axis and cumulative percentage growth in income on the vertical axis. The chart then shows which percentiles from poorest to richest have benefited the most in this period of globalization. The poorest people on earth, such as most Africans, have seen almost no improvement. However, the people in the middle of the distribution, from the 20th to the 70th percentiles, have experienced over 40% growth in income.

Who are these people? They are not the middle class in rich countries like the United States; they would be above the 70th percentile. They are the emerging middle class in rapidly developing countries. Ninety percent of them live in Asia, especially China, India, Thailand, Vietnam and Indonesia. They are not yet as rich as our middle class, but they are moving rapidly in that direction. In about three decades, the Chinese are expected to be as rich as citizens of the average European Union country.

Above the 70th percentile of global income, the recent gains in income rapidly fall off, reaching zero for people at the 80th percentile! (Remember that means zero gain, not zero income.) Who are they? They are mostly the lower middle classes within the richest countries, people who have been relatively well off historically but are not currently gaining from globalization. Think of the less-educated American blue-collar workers who are now in competition with foreign labor and haven’t seen wage gains in decades.

Above the 90th percentile of global income, income gains rapidly rise again, with a gain of over 60% at the top of the distribution. This group is the global 1%, the richest people on earth. Half of them are in the United States, and the other half are mostly from Europe and Japan. Together they receive 29% of the world’s entire income and control 46% of its wealth. They include the world’s billionaires, 1,426 individuals who together own twice as much as all the people of Africa.

For those of us who would welcome a reduction in economic inequality, globalization brings good news as well as bad news. The good news is some decline in inequality among countries, as the benefits of economic development spread to the developing world, especially Asia. The bad news is twofold. In the world as a whole, some countries remain stuck in poverty. And within the most developed countries, the benefits of globalization are going almost entirely to the upper class, at least so far.

Historical trends in inequality

Now let’s put these recent trends in historical perspective. How much of this is new, and how much of it have we seen before? The answer depends on which aspect of inequality we consider.

Milanovic makes a simple but important logical distinction: “Global inequality, that is, income inequality among the citizens of the world, can be formally considered as the sum of all national inequalities plus the sum of all gaps in mean incomes among countries.” This is just standard statistical logic: Whenever a population is divided into subgroups, the total variation within the population is the sum of the between-group variance and the within-group variance. In this case, the subgroups are countries. Milanovic refers to the between-country differences as “location-based inequality” and the within-country differences as “class-based inequality.”

The two kinds of inequality have developed differently in different historical periods:

  1. In the early 1800s, only about 20% of the total inequality in the world was due to location; far more was due to class differences within countries. But over the course of the century, as the industrial economy took shape, location-based inequality increased because the countries that industrialized first became much richer than the rest of the world. At the same time, the class divide within the industrializing countries got worse.
  2. From about the 1920s to the 1970s, country differences in income reached a peak, accounting for about 70% of all global inequality. However, class differences diminished as the middle class grew within the richer countries. The world seemed divided into largely prosperous Americans and Europeans and mostly poor Africans, Asians and Latin Americans.
  3. In the most recent period so far, globalization has reversed both twentieth-century trends. Country differences have started to decline, because growth has accelerated in Asia while decelerating in Europe and North America. But at the same time, internal inequality has increased in many rich countries, especially the US, UK and Italy. The middle class has been shrinking and the rich have been getting richer.

To put it simply, the recent decline in inequality among countries is new in the industrial era. The recent increase in inequality within wealthy countries is not quite as new, but it’s a return to something last seen in the nineteenth and early twentieth centuries.

Next we will turn to Milanovic’s attempt to make sense out of these developments and anticipate where the two components of global inequality may go next.

Continued


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