Global income inequality is indeed falling - but we should still be wary

The encouraging trend will not continue if developing countries' growth stalls and inequality within countries is not kept in check.

Ben Chu
Sunday 24 January 2016 16:58
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Is global inequality getting worse? Or better? Davos, where I spent most of the past week covering the World Economic Forum, is not a particularly great place to consider such matters.

Despite the presence of many of the most prosperous individuals in the world on the Swiss mountain top, this is an instance where an elevated view doesn’t present a clearer picture.

To answer the question requires a focus on definitions and data – more suited to an academic seminar than a meeting of the world’s “elite” where drafts of hot air are actually more common than bright shafts of insight. But Davos, because of its symbolism, usually inspires an inequality debate.

Oxfam started the week with a report that put them firmly in the “worse” camp. “The world has become a much more unequal place and the trend is accelerating” said the Oxfam boss Winnie Byanyima, pointing to research by the charity which suggested the wealth of the top 62 richest people on the planet is now equal to that of the bottom 50 per cent combined.

This prompted a barrage of rebuttals from commentators, arguing the facts were exactly opposite to those laid out by the charity and claiming that global inequality has, in reality, been falling rapidly in recent decades.

So who is correct? To begin to answer that question it’s necessary to clear up some definitions. What do we mean by “inequality”? Are we talking about inequality between average living standards in different nation states? Or do we mean inequality between all the individuals on the planet? The answer to those questions will lead to different pictures. Between the states of the world (unweighted for population) there is, sadly, still not much evidence of convergence.

Further, are we talking about inequality of consumption, or income, or wealth? Or maybe we mean inequalities in health, life expectancy and infant mortality? Again, the answers to those questions are critical. A focus on health shows that for most people on the planet, things have been getting better in recent decades as life expectancy has generally increased – although whether they are improving as fast as we ought to expect is a reasonable question.

Oxfam’s research is all about the wealth, or net worth, of individuals across the planet. The charity’s researchers use credible estimates from the business magazine Forbes to tot up the net worth of the richest 1 per cent of tycoons, oligarchs, heirs, heiress and entrepreneurs, in the world. They then make an estimate of the wealth of the least asset rich inhabitants on the planet and compare the two to arrive at their striking figure of relative wealth shares.

One of the problems with this approach is, as many have pointed out, that student or mortgage debt can very easily push the net worth of someone in a rich country into negative territory. But that doesn’t mean they are necessarily in a weak economic position. An indebted trainee lawyer in America is not, in any real sense, worse off than a farmer in Africa with zero debt. Another problem is Oxfam’s implication that the wealth of the bottom is being appropriated by those at the top. That is a story that is really only partially true and obscures important mechanisms for the advance, or retardation, of living standards in poor countries.

Some argue that the appropriate gauge of global inequality is not wealth but the income of all the people on the planet. Perhaps. But the first thing to recognise about such calculations is that they are inherently sketchy. Working out the average level of income in an economy is relatively straightforward. The state’s GDP, or national income, is divided by the size of the population to generate a mean average income per head. That’s how we can say that Americans are, on average, richer than Britons and Britons are, on average, richer than Sri Lankans, for example.

But to work out the distribution of income within an economy, to estimate the spread of national income between the rich and poor of that country, requires household surveys. Not all countries – particularly in the poorest countries - carry these surveys out regularly or with equal levels of competence.

Nevertheless, the best global income estimates suggest international inequality, adjusted for the purchasing power of different currencies, has fallen in recent decades. The pre-eminent researcher in this field, Branko Milanovic, has calculated that the period between 1988 to 2008 witnessed the first decline in inequality between world citizens since the Industrial Revolution.

This mainly reflects the rapid development of China and India, two poor countries with very large populations. The largest surge across the global income distribution between 1988 and 2008 was seen among those around the middle of the global income distribution. This largely reflects the mass movement of the rural poor in China to cities where they got higher incomes working in manufacturing plants and on building sites. There was also a surge among the incomes of those at the very top as the rich in rich countries did very well in the era of globalization. But the net result was a slight reduction of global inequality.

Yet there’s an important caveat from Milanovic. He estimates that the decline will only be sustained if countries’ mean average incomes continue to converge and if high inequalities within countries are kept in check. This is where the two views of inequality – the Oxfam wealth metric and the Milanovic income metric – should be viewed side by side.

Economic theory used to predict that as countries took off economically their internal income inequality would first expand, as a minority of entrepreneurs got rich using the new industrial techniques available, and then contract, as the rest inevitably caught up. But recent evidence of rising income inequality within some middle-income developing countries, including China, have raised questions about that basic model.

This is a warning sign. When rising national income and economic productivity in a still developing country does not result in a fall in income equality that’s a decent indicator income is being expropriated by a politically-connected minority, rather than genuinely earned. And exploding wealth levels at the top, unrelated to genuine invention or entrepreneurship, can also be a good proxy indicator for such expropriation.

Extraction by exploitative developing world elites is one of the most serious threats to the trend of greater global income equality, not only because of its direct impact on the aggregate figures, but because vested interests tend to obstruct the economic reforms that poor countries need to keep growing.

Many of those developing world elites, as it happens, were in Davos last week, sweeping though the conference centre with their bloated retinues. Perhaps the World Economic Forum wasn’t such a bad place to think about such issues after all.

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