Global Inequality (part 2)

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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

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