Divide the pie, watch it grow!
“Confronting Inequality” helps us understand one of the most significant economic issues of our time
Cover of “Confronting Inequality: How Societies Can Choose Inclusive Growth” by Jonathan D. Ostry, Prakash Loungani, and Andrew Berg.
Ostry, J., Loungani, P., & Berg, A. (2019). Confronting Inequality: How Societies Can Choose Inclusive Growth. Columbia University Press. 173 pages.
Overview
Dividing the economic pie can improve the economy. Contrary to popular wisdom and free-market, anti-government fundamentalists, extreme economic inequality is bad for people, politics, and the whole economy. Johnathan Ostry, Prakash Loungani, and Andrew Berg make these three persuasive arguments in “Confronting Inequality: How Societies Can Choose Inclusive Growth.” First, inequality worsens economic growth and makes it less durable. Second, the benefits of most economic policies are not shared. Third, redistribution is not bad for growth (p. 3). The authors’ primary focus is on economic inequality’s economic impacts rather than those afflicting politics and society.
Ostry, Loungani, and Berg argue that structural adjustment programs that liberalize and integrate markets do not increase efficiency when measured by average incomes. Instead, the structural adjustments increase disparity, reducing economic growth in the long run. To be clear, the authors do not flash a green light to frivolous government spending. They believe that large debts require payment and that economic redistribution policies should not be excessive or else they might de-incentivize work; such was the case witnessed in the Soviet Union (p. 9). Market fundamentalists will surely take umbrage at such seemingly simple yet perfectly reasonable arguments.
Regardless of one’s political leanings, the authors provide a persuasive case for why we should address inequality to ensure our economies fare better. In a world where economic inequality is concomitant with growth and innovation, the mathematically grounded conclusions outlined in this concise book will undoubtedly remain relevant for many years to come.
A persuasive case
The authors ensure to properly flesh out the arguments and definitions of inequality early in the book, making the content easy to digest for everyone. They include the Gini coefficient, which “measures the average differences in income between any two randomly chosen people in the population.” A coefficient of 100 means one person owns all the income. They also use the share of income measure. Think of it as slicing the population into deciles and observing how the percentage of income differs between the bottom and top earners. There is also the share of income to labour, which is essentially salaries (p. 15). These metrics are often widely used and standardized, making the authors’ conclusions easy to compare and comprehend for various economic analyses.
Most importantly, the authors leave no stone unturned, addressing counter-arguments wherever appropriate. Austerity is essentially fiscal consolidation whereby a country can either increase its tax revenues or decrease its expenditures to rebalance budgets. Free-market fundamentalists tout austerity as a miracle prescription for all economic issues. But the authors argue otherwise. Their findings suggest that the Gini coefficient increases after fiscal consolidation plans in both the short (one year after) and medium-term (eight years) (p. 72-74). Specifically, the increased inequality is not equal because labourers suffer the worse, where their slice of the pie reduces due to higher unemployment and, consequently, suppressed wages (p. 74). “The notion that fiscal consolidations can be expansionary (i.e. raise output and employment),…has been seriously debunked. Instead, the short-run costs must be balanced against the potential longer-term benefits that consolidation can confer” (p. 78), write the authors.
Pouring gasoline on the fire, long-term unemployment can quickly become a structural problem as workers lose knowledge and skills from being separated from the labour force (p. 77). Readers can appreciate how the authors are unafraid to acknowledge the flawed approach of sacrificing the poor and vulnerable in the name of economic “liberty” and “prosperity.”
It is worth adding that, though they do not reference him, the authors’ core arguments and evidence are more mathematically grounded critiques against Thomas Sowell’s The Quest for Cosmic Justice (1999). Sowell’s book relies primarily on semantics and classical economic ideology to address economic inequality and ‘re’-distribution politics. The authors explain that their evidence shows how “higher inequality lowers growth” (p. 101) and that there is a “weak (and slightly negative) relationship between redistribution and the duration of growth” (p. 101). Furthermore, when modest, “redistribution…has virtually no effect on output” (p. 102). Anyone mostly concerned with the ideological aspects of economic inequality must contend with the reality that causing an ‘injustice’ to a society’s wealthy elite, say, via taxes, may be justifiable. Higher, more equitable taxes can help fund social welfare policies, such as education and healthcare, likely benefiting society overall.
Despite the book’s clear and concise presentation of ideas and facts, some parts may be unclear to readers who do not possess an in-depth understanding of mathematical and statistical methodologies used in economics. Admittedly, due to my chronically limited knowledge and skills in this area, it is impossible for me to critically review or comment on the authors’ methodologies when reading the technical notes – I was a political science and public administration major, so I do not possess any valuable skills. It is also worth noting that “Confronting Inequality” is from Columbia University Press, an academic institution, so the intended target audience may well be people far more educated than benighted folks such as myself. The equations outlined in the Technical Appendix remain valuable for anyone who can understand them. Nevertheless, the authors present their ideas clearly for those without the necessary econometric training and knowledge. Do not let the complexity intimidate or discourage you from reading this book.
Readers may remain skeptical about the authors’ suggestion to tax capital to finance a basic income plan to increase the “overall output per person” (p. 94). The purpose of a basic income is to improve individual output and mitigate the issue of depressed workers’ wages, which compromises their ability to pay for health care and education to upskill and achieve financial stability. At first, this makes sense. Most countries rely too heavily on taxing workers’ wages, ultimately reducing an individual’s financial capacity to save and invest appropriately. But would a tax on capital be effective? It’s unclear because the authors do not specify what types of capital ought to be taxed, whether it be property, corporate shares/stock, wealth, machinery (such as robots), or inheritance, to list just a few examples.
Moreover, basic income is a complicated policy to design and implement, despite its advocates’ rosy, risk-free visions. To the authors’ credit, discussing a basic income policy at length would go beyond the book’s scope. Nevertheless, there are often many questions to be answered. For example: who to tax, who will receive the income (based on specified wealth or income thresholds); how will legislatures and the public avoid and contend with a backlash from the wealthy; how will governments prevent or discourage capital owners from offshoring tasks and jobs to cheaper jurisdictions; or what will be the frequency and sum of the payments to recipients based on factors like cost of living, medical conditions, and the number of dependents for which a recipient must care? It is, in a word, complicated.
If not prudent, governments could unintentionally dole out too much liquid cash and reduce the incentive work, a point acknowledged by the authors when social welfare is too generous (p. 9). The result is minor inflationary pressures and an increased potential of financial fraud – there will always be fraudsters who fabricate their income, wealth, and tax information to obtain the financial assistance they do not need. And, of course, governments would have to review existing social welfare programs and projects assisting the needy; should these welfare institutions be replaced or scaled-down now that basic income provides them with the freedom to care for themselves (supposedly)?
In some cases, it is unfeasible to give citizens money and expect them to make the correct decisions. Some individuals cannot effectively make decisions because of cognitive or physical conditions. Depending on the severity of their health conditions, many will still require caretakers or professional, public services to assist with daily life, especially for areas that are not profitable enough for a private entity to fill. It sounds paternalistic, but exceptions are necessary for these unique circumstances. Equal treatment towards everyone, regardless of their health conditions, could be negligent.
Why “Confronting Inequality” is relevant to our times and for the future
The most salient point from this book is that dividing the economic pie can improve the economy. It’s a valuable insight to all voters, policy analysts, and legislators.
Secondly, the countries with the least economic inequality experience longer growth spells than countries with higher inequality, such as those in Sub-Saharan Africa. The authors define growth spells as “long period[s] of healthy growth marked by an upbreak and down break” (p. 7 and 150). They say that “upbreaks” are periods when growth takes off, marking the beginning of a growth spell. “Downbreaks” are periods when growth slacks, marking the end of a growth spell (p. 27).
Thirdly, Ostry, Loungani, and Berg mention three structural reforms for high-income countries that increase Gross Domestic Product (GDP) the most with the smallest increase in inequality. The reforms include domestic finance reforms, tariff reforms (likely because the poor do not have to shoulder the burden of taxes on imported goods and the cost reduction for licensing to ship things to and from a country), and the rule of law (p. 42-43). However, low-income and middle-income countries require different policy prescriptions (you’ll have to read the book for that).
The authors suggest governments focus on several things. Firstly, governments should provide job counselling and retraining for recently unemployed workers to re-enter the workforce quickly. Secondly, they should implement an earned income tax credit to encourage people to keep working. Thirdly, governments must collaborate with other governments to prevent a race-to-the-bottom in tax rates to ensure the poor can fully participate in financial markets (it would also help reduce the need to tax labour and consumption heavily). And lastly, governments should fund education and healthcare to ensure a high quality of life from the cradle to the grave (p. 109-110).
Who should read “Confronting Inequality”?
Anyone looking for a balanced perspective on economic inequality without the usual antipathy towards the rich and disdain from the poor should leaf through the pages of “Confronting Inequality.” It is a valuable resource for anyone exhausted from reading articles falsely suggesting that growth and distribution are mutually exclusive. The book is short, easy to read, and well-organized. Students of all economic disciplines will find valuable insights in the technical sections. Those inclined towards politics will learn about the vital need for redistributive policies. Buy the book from wherever you like or borrow it from your local library today.