Let’s all eat cake: The terrible inefficiency of inequality

November 3, 2014

     By Duncan Green     

Alex Cobham, of the Center for Global Development (@alexcobham), welcomes Oxfam’s new inequality campaign, argues for making inequality a core part of the post-2015 ac at Tana 2014 - headframework, and comes over all French Revolution on wealth registers and cake (the eating of).

International acceptance of stark economic inequalities reflects a grand political failure. A failure that locks in the wasting of human potential for generations, to say nothing of the immediate damage to poverty reduction and economic growth. The evidence turns on its head all the old platitudes about inequality being a necessary price to pay for greater economic efficiency.

Evidence on inequality’s costs

There is an understandable tendency, in thinking about the damage that inequality does, to focus on the more immediate and mechanistic implications. Income poverty will be worse, for a given mean income, if the distribution is more unequal. And in that situation, future growth will also do less to reduce poverty. So reducing inequality will help us reduce poverty.

A typical response to these claims is to say that while that’s fine in principle, measures to reduce inequality may in practice reduce growth too. In this way, the cake may end up being more evenly sliced, but it will also be smaller. At some point this growth-reducing effect becomes so big that even lower-income people are better off with a less equal slice of a bigger cake.

This argument is not supported by the evidence. In fact, the reverse is true. Inequality has been shown to reduce the level of growth – not least, by researchers at the International Monetary Fund. Redistribution also turns out to be ‘benign’. So reducing inequality will lead to progress against income poverty, both directly and through higher growth. The cake, once more equally sliced, grows bigger.

US inequalityBut even this is only a small part of the story. The extent to which inequality wastes human potential is far greater. Across societies of similar per capita income levels, those that are more unequal tend to fare consistently worse on all sorts of measures of well-being, from physical and mental health, to violent crime and education.

Children who grow up at the wrong end of major inequalities are likely to have lower self-esteem and to enjoy poorer economic and social outcomes over their whole lives. And in general societies which are characterised by higher economic inequality seem more willing also to tolerate greater gender inequalities, and perhaps (think India or Brazil) other group inequalities.

Political obstacles

It surely meets the criterion for a true tragedy, if knowing the destination that higher inequalities lead to, we remain powerless to resist the path. Why tolerate inequalities that condemn both people and societies to these needless losses?

Part of the reason is likely to be locked up in other damage that inequality does. Higher inequality is associated with lower trust among people, and weaker social capital more broadly. These conditions in turn make corruption and bad governance more likely. And these in turn are conditions in which elites are more likely to be able to block egalitarian policy measures, or to manipulate their operationalisation to prevent wider benefits – resulting in higher inequality, and so we go round again…

A political science paper from September finds that in the US, “economic elites and organized groups representing business interests have substantial independent impacts on U.S. government policy, while average citizens and mass-based interest groups have little or no independent influence.”

These political realities and the threat they pose are the reason Oxfam is right to join many other organisations around the world in making the fight against inequality their leading priority – both in the developing world and in high-income countries like the UK.

Without broader mobilisation, change is unlikely – even as the evidence builds of large social costs. The alternative would be to accept as final the inability of “average citizens and mass-based interest groups” to exert influence over policy.

Policy prioritiesinequality = conflict

If we retain the hope that change is possible, then there are a number of policy measures bearing more and less directly on inequality that should be considered. An immediate opportunity lies in the post-2015 development framework which will succeed the Millennium Development Goals, and apply to all countries – not just those below some arbitrary per capita income level.

First, we can easily improve the current proposed target (10.1) for income inequality reduction. As it stands, there would be a commitment to ensure that the bottom 40% of households in each country enjoy higher income growth than the national average. But while laudable, this contrives to ignore the income share of the rich – which is central to any assessment of inequality.

A much more direct measure of inequality is the ratio of income shares of the top 10% to the bottom 40%, the Palma ratio. With the support of leading actors from Oxfam to Joseph Stiglitz, the post-2015 target should be for progressive reductions in national Palma ratios. Ideally, as nef propose, a Palma target would be accompanied by a broader set of inequality indicators.

The second area in which there is space to move the post-2015 proposal towards something much more sharp and pointy is that of illicit financial flows. Again we might think of replacing a general target with some specific, accountable policy measures. Here are some I made earlier, in relation to the tax transparency of multinationals, of corporate and other legal entities, and of individual ownership of assets and income streams.

On the latter, we should also take much more seriously Thomas Piketty’s important proposal for a global wealth register. He writes that this promotes the goal of ‘democratic and financial transparency’:

Everyone would be required to report ownership of capital assets to the world’s financial authorities in order to be recognized as the legal owner, with all the advantages and disadvantages thereof. As noted, this was what the French Revolution accomplished with its compulsory reporting and cadastral surveys. The capital tax would be a sort of cadastral financial survey of the entire world, and nothing like it currently exists.

This feels more like a data revolution to me than anything currently under discussion at the UN. And with sufficient mobilisation, we could surely bypass the guillotine (or pitchfork) stage, and adopt this type of transparency directly.

Dilbert's take on the whole cake thing

Dilbert’s take on the whole cake thing

Our inability to address inequality’s inefficiencies – and the great waste of human potential that results – surely ranks alongside our inability to prevent world-changing climatic damage, as a political failure at global scale.

We contrive to organise the cake so that it is smaller than need be, and divided so unevenly that it will grow more slowly and less consistently in future. But if we wanted to, we could both have it and eat it. Why don’t we let ourselves eat cake?

November 3, 2014
Duncan Green