Lecture 12: Inequality and the 1% in Europe and the USA

Introduction

The increase in income inequality since 1970 has not been the same everywhere. Why?

Political and institutional factors play a key role in shaping cross-national variation between countries. Explaining this difference is a core part of the study of comparative political economy.

To illustrate this, let’s examine the evolution of top incomes in France and the USA.

Starting with France, Figures 8.1 and 8.2 depicts the share of the upper decile (and centile) in national income (the trend in France is broadly similar for most continental European countries).

The reduction of inequality in France

Four observations stand out from this data:

  1. Income inequality has greatly diminished in France since the Belle Époque. The share of the top decile in national income declined from 45-50% on the eve of WW1 to 30-35% today. This does not mean France is an equal society but it shows that the society of the 19th century was deeply inegalitarian.
  2. The compression of income inequality was entirely due to diminished top incomes from capital. If we only look at wage inequality we’ll see that this has remained stable over time. The least well paid have always received around 25-30 percent of total wages. This has not changed that much over time.
  3. In particular, the share of the top centile (the 1%) in national income has greatly declined over the 20th century. If top incomes from capital (the 19th century rentier class) had not diminished, income inequality would not have declined the 20th century. Hence, it’s the fall in capital income that explains the fall in inequality.
  4. There is no natural equilibrium in the shape of the income distribution. It is shaped by politics and institutions.

The reduction in inequality in France during the 20th century can be explained by what Piketty calls “the fall of the rentier” and the collapse of very high incomes from capital. No generalized structural process of wage inequality compression has occurred.

Piketty suggests that war rather than democratic rationality erased the past and allowed European countries to begin anew.

The different worlds of the top decile

Figures 8.3 and 8.4 depicts the composition of incomes for the top decile in France in 1932 and 2005.

We can see that a significant change has occurred. Today, one has to climb much higher up the social hierarchy before before income from capital outweighs income from labour.

Income from capital only assumes decisive importance in the top one thousandth or 0.1%. The top decile has changed from one occupied by land owners to those employed as ‘super managers’.

In the top 9 percent in France you will mainly find individuals who earn 2-3 times the average monthly wage ($2,000). In other words, this group earns, on average between $4-6,000 a month.

These are mainly private sector managers, doctors, lawyers, senior officials and university professors.

  • Remember it is pre-tax!

To make it into the top half of the 9 percent requires attaining an income 4-5 times the average monthly wage ($8-10,000 a month).  This includes a lot of senior business-finance managers and corporate lawyers.

To make it into the top 1 percent it is necessary to earn an income that is 7-10 times larger than the average monthly wage ($15-20,000 a month). But to make it into the top one thousandth, only those who substantial amounts of financial capital assets are only like to reach this level of income.

Labour market changes

Sometimes the quantitative must become qualitative to understand the social world we live.

Previously the lowest  wage earners were farm laborers and domestic servants. Today the lowest-paid jobs are in the service sector: retail, catering, hotels, security and cleaners.

The labour market has been fundamentally transformed but the structure of wage inequality has barely changed at all. The bottom 50 percent still take the same share of national income.

The 1 Percent

The top decile always composes two different worlds: the 9% in which income from labour dominates and the 1% in which income from capital becomes progressively more important.

This is not to say that someone in the 9% earns nothing from capital.

A manager on an income of $5,000 per month might rent out an apartment at $1,000 per month, and/or hold shares in his/her firm. This is a monthly income of $6,000. 80% of his/her income will come from labour and 20% from capital.

Most capital-income that supplements labour-income among the 99 percent comes from real estate. In the top 1% it is primarily business and financial: dividends and interest from mobile capital. In the top one thousandth it is almost entirely a return financial dividends.

Large fortunes primarily consist of financial assets (stocks and shares in partnerships).

Tax evasion

It is important to note that figures 8.3 and 8.4 are pre-tax returns and therefore the estimates are based solely on income from capital that is reported in national tax returns accounts.

Actual capital income is, therefore, probably completed under-estimated, owing to large scale tax evasion (it is much easier to hide investment income than it is is to hide wage income).

This can be achieved by using foreign bank accounts in countries that do not cooperate with the country in which the taxpayer resides and using quasi-legal tax-exemption strategies on whole categories of capital income.

It is extremely difficult to measure capital income. Very large capital income fortunes are almost always inherited.

France since 1980

The long-term stability in wage inequality should not mask short-term fluctuations.

For example, after May 1968′ Charles De Gaulle’s government increased the minimum wage by 20%. It was then indexed to the average wage such that the purchasing power of the low paid increased by more than 130 percent between 1968′ and 1983′.

Figure 9.1 shows the evolution of the minimum wage in France and the USA.

This political effect this had on the labour market led to a significant compression of wage inequalities.

The turn toward fiscal austerity and wage competitiveness from the 1980’s, particularly under Mitterand, meant that this compression was reversed. Wages were frozen and profits increased.

From the late 1990’s when the purchasing power of the bottom 50 percent stagnated it increased for the top decile, primarily because of a new phenomena: super salaries at the very top (where purchasing power increased by 50 percent).

Inequality in the USA

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Figures 8.5 and 8.6 represent the share of the top decile (and centile) in national income in the USA.

The most striking fact is that the USA has become much more inegalitarian than France (and Europe). It is quantitatively as extreme as Old Europe in the first decade of the 20th century.

Inequality was at it’s lowest from 1950-1980 in the USA where the top decile took 30-35 percent of national income (the same as most of Europe today).

This is what Paul Krugman describes as “the America we love”, the period of the TV series Mad Men.

The explosion since 1980

Since 1980 income inequality has exploded. The shape of the curve is impressively steep (from 35 percent to 52 percent today). If it continues it will go beyond 60 percent in 2030.

Remember, this most likely under-estimates the returns to capital income because of tax evasion strategies.

The financial crisis did not impact on the structural increase in inequality at all.

Figure 8.6 shows that the bulk of the increase in inequality came from the 1% whose share in national income rose from 9 percent in the 1970’s to a staggering 20 percent today.

The top 1 percent include those making $352,00 a year. The 4 percent earn between $150-350k, and the 5 percent between $108-150k. The top 0.1 percent earn $1.5 million a year (US academic economists are usually in the top 4 percent). Hence, the largest fortunes are in the top 0.01 percent.

Cause of the financial crisis?

Given that US income inequality peaked at extremely high levels in both 1929 and 2007 it seems reasonable to ask whether it was a causal factor behind the financial crisis of 2008?

This is a tough question to answer. But it is not unreasonable to assume that it contributed to financial instability. Inequality meant a virtual stagnation of the purchasing power of low to middle income earners. The implication is hat low income earners had to substitute their declining wages with rising credit-card debt.

This debt was repackaged and recycled into complex and increasingly uncertain financial markets.

Larger share of the pie

From 1977-2007 (the eve of the crisis) the richest 10 percent appropriated three quarters of all economic growth.

The top 1 percent absorbed a staggering 60 percent of the total increase of US national income during this period.

For the bottom 90 percent the rate of income growth was less than 0.5 percent per annum. Is it possible to imagine a democratic society accepting such divergences between social groups for long period of time?

To get a sense of how this compares to Europe, see Figure 9.8.

The rise of the super-manager

What caused this rapid rise in inequality in the USA?

It was largely a result of rising wage inequalities and the rise of top salaries for super managers in large US firms (something we will discuss more next week). This accounts for two thirds of the increase. One third is associated with capital income.

Is this skills-based remuneration (and therefore based on merit) or favorable tax treatment for the rich (i.e. based politics)?

Figure 8.9 and 8.10 depicts the precise composition of top income in the upper centile.

In 1929 income from capital was the primary source of income for the top 1%. In 2007 one had to climb into the top 0.1% for this to be true. Qualitatively, who are all these people?

60 to 70 percent of the top 0.1 percent ($1.5m per annum) consisted of top managers. Athletes, actors, and celebrities make up less than 5 percent. It is more about super managers, and corporate executives, than it is about super stars.

Who are these super managers in the 0.1 percent? 20 percent work for banks and financial institutions whilst approximately 80 percent work in the non-financial sector.

Conclusion 

The debate that tends to dominate from a macroeconomic point of view (regardless of whether you think rising inequality is justified or not) is the stagnation of wages for the majority, rather than the exponential increase at the top.

Top incomes might be able to purchase luxury items but market economies require mass consumption. There are only two ways this can happen: wage growth or private debt (credit cards).

Next week we will examine the role of politics and institutions in explaining the cross-national variation in different worlds of capitalism in Europe and the USA.

The slides can be found here: lecture-12

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