If you want to be rich, you'd better be born in, or emigrate to a rich country: Economist Branko Milanovic

A leading global economist explains the current state of global inequality

Published: Mar 19, 2018

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Q. Describe the difference between wealth inequality and income inequality.

It’s actually useful to think of three types of inequalities: Wealth inequality, income inequality and consumption inequality.

Wealth inequality can be simply defined as ‘differences in the total amount of marketable assets that people possess’.  Your wealth is calculated as the total amount of money that you would receive if you sold all your assets—your house, car, financial assets, etc.  It does not include ‘accrued assets’, such as pension rights, because they cannot be sold. On the other hand, when we talk about income inequality, we generally mean differences in disposable income—that is, after-tax income.  

The key difference between income and consumption measures is that lots people can have zero income over a particular period, but your consumption can never be at zero—or you would not survive. If you have zero income, there are other ways to finance your consumption: Government programs provide assistance to the poor, so consumption inequality is muted relative to income inequality. Also, the rich can lend to the poor through the financial system, keeping the spending of the poor (i.e. their consumption rate) relatively high, at least in the short term. In this sense, the number of poor, according to consumption measures, is often lower than according to income measures.

At the other end of the spectrum are people with extraordinarily high incomes who are able to save a lot of their income, which increases their wealth.  The implication is that inequality of consumption is always less than inequality of income, and inequality of income is always less than inequality of wealth.


Lots of people focus on income inequality as the key issue today—but it’s important to remember that income represents something very specific: The amount of money that a particular household had coming in during a given year. If you are trying to measure financial well-being, it is much more useful to look at household wealth, which, as indicated, is even more unequally distributed than income.


Q. Inequality of all types is rising in many nations, while global inequality declines. Please describe the situation.

The reason inequality is going down globally is that very large, populous and relatively-poor countries like India and China are growing quickly. What is different between national inequality and global inequality is that for global inequality, you have an element to consider that is sometimes forgotten: The relative growth rates between poor and rich countries. For example, when China and India grow faster (in per capita terms) than the U.S. and Europe, global inequality will tend to go down, even if inequalities within countries themselves increase. Of course, increases in within-nation inequalities exert an offsetting effect—pushing global inequality up—and then the question becomes, which of the two effects (income convergence or rising within-nation inequalities) will be stronger? In the past 25 years, the former was stronger.

Q. Who has gained the most from globalization?

That is simple to prove empirically: During the period of high globalization (1988-2008), people in the lower and upper middle classes in Asia gained the most.  This is not surprising, because we know that Asian countries—in particular China, but more recently India, Indonesia, Thailand and Vietnam—have grown significantly, and they continued to grow even during the global recession.  

The second group that has gained significantly from globalization is the top one per cent, both in rich countries and in other nations. However, their gains—and therefore their wealth—was reduced somewhat by the financial crisis.


Q. Are the gains of Asia’s middle class directly related to the losses of the lower middle class in the rich world?


If you’re asking, Can we show that the gains of one group were related to or even caused the losses of another group?,  that is a very difficult proposition to prove, even in specific instances like ‘China vs. the U.S.’ or ‘Asia vs. Europe and the U.S.’ As a result, there have been very few studies of this. However, there have been a number of studies looking at the role of Chinese-import penetration  on U.S. wages, and my reading of that literature is that there is significant corroboration that Chinese imports have had a long-term negative effect on wages in sectors that compete with these imports. Many people have either lost their jobs or their long-term wages have been reduced, and in this sense, there is some causality between the two.  

Even if causality exists, it doesn’t mean that we should reject globalization, because there have been many more gains from it than losses. The situation simply calls for policies that take into account who the ‘losers’ will be. The fact is, globalization is not a ‘win/win’ for everybody: Some groups will lose, while many more will gain.

Q. Research has shown that women’s increased participation in the labour force reduced inequality by some 19 per cent. Why would this be the case?

That came out of an OECD study that looked at 25 rich countries. What generally happens is, when you have greater female participation in a labour force, women are mostly at the lower end of the wage scale—and this is stoked by the 20 per cent wage gap that exists between men and women.  Essentially, the mid- and lower-wage segments of earners have a lot more people in them than high-wage segments, and as a result, overall inequality goes down.
 
More importantly, one has to take into account that women’s participation in the workforce increases total household income, and we measure total income distribution at the level of households.  If you have more households with two earners, overall inequality tends to go down—and this is true despite the recently noticed tendency of rich male and female wage earners to marry and/or partner with each other. The bottom line is that greater participation of women in the workforce reduces both wage inequality among wage earners and inequality of disposable income among households.


Q. The ‘Kuznets hypothesis’ [that inequality is low at very low income levels, then rises as an economy develops, and eventually falls again at high income levels] is quite different from Thomas Piketty’s view [that capitalism itself yields rising inequality].  Do you agree with either of them?
Both Piketty and I are big admirers of Kuznets’.  Piketty makes many references to Kuznets in Capital in the 21st Century, but he rejects one important hypothesis: The so-called Kuznets’ inverted U-Curve.

Kuznets argued that at the very early stages of economic development, inequality is low. As a society industrializes, inequality becomes higher, and then, as the society becomes mature, economically and demographically, inequality should go down again.  That hypothesis made a lot of sense until 1980—but since then, we have seen an increase in inequality in the rich world, which seems to disprove Kuznets’ hypothesis.


My argument is that we should instead think about ‘Kuznets waves’. The first wave that Kuznets described happened from the late 19th century until approximately 1980.  Then, the technological revolution occurred in the 1990s, along with globalization, pushing us into a second Kuznets wave.  Remember, Kuznets wrote in the 1960s, so he saw the first wave, but he could not have imagined—for  obvious reasons—that it would be succeeded by other waves.  We now have historical data that he didn’t have in 1960s, showing that similar waves did indeed occur in the past. By the way, some followers of Piketty do not accept my wave argument. They maintain that there are strong forces within capitalism that push inequality up—obviously not forever, but certainly to the levels that it attained in rich countries some one hundred years ago.

I consider the current increase in inequality over the last 25 or 30 years to reflect essentially the second technological revolution, structural transformation of the economy away from manufacturing jobs and into services, and globalization. There are strong similarities to the first upswing of the Kuznets Wave, because you can argue (as Kuznets did) that it was the product of the Industrial Revolution and structural change away from agriculture and into manufacturing.

Q. In the 20th century, inequality was reduced by forces including increased taxation and social transfers, hyperinflation, unionization, education and wars. Will these same things be required to reduce inequality in the 21st century?


I divide the forces that reduce inequality into malign and benign forces, and the principal malign force in the modern era is war. It has reduced inequality not only through the destruction of physical assets but also through the increases in taxation that were necessary to finance war efforts. And sadly, in today’s environment, we cannot rule it out.

The key benign forces that reduced inequality in rich countries between the end of World War II and the 1980s were mass education, trade unions, socialist political parties, high taxes and social transfers, and technological progress (where it helped low-skilled labour more than high-skilled labour).

I don’t think that many of these forces will remain operative in the near future. Trade unions have been pretty much decimated, not only by anti-labour legislation but also by the movement away from massive factories that brought large numbers of workers together in one place to service sectors with much smaller sizes of units. Mass education will not play a big role either. It was a force for equalization when the rich countries moved from an average of six or seven years of education to today’s average of 13; but we are not going to see a massive move from 13 to 20 years of education. That is why the quality of education, rather than a focus on mass education, is crucial today.

Finally, I do not think that higher taxes and transfers are accepted any longer by the majority of the electorate, and that may be due to a much more skeptical view that today’s citizens have of government’s ability to use money effectively.

Q. What is currently the most powerful benign force to reduce inequality?
In my view, we should be focusing on the equalization of endowments. This means first, better access to high-quality education for all, so that the returns to education become more equal, and second, what I call ‘de-concentration’ of capital ownership. That means tax incentives to promote wider ownership of capital and includes greater participation in Employee Stock Ownership Plans.

If wage gaps between workers decrease and distribution of income from capital becomes more equal, then you can achieve relatively equal outcomes even without a greater government role in the redistribution of current income. If this is not done, the danger is that with the heavily-skewed distribution of property that exists today in the rich economies, any increase in the capital share of national income translates directly into greater inequality in personal incomes. Then you either let inequality get worse or you need to increase redistribution of current income—for which, as I mentioned,  there is little political appetite anymore. You will be thus left without instruments to offset underlying increase in inequality.

There are other tools that would help.  For one, the taxation of wealth, including the taxation of inheritance—which, strangely enough, has actually gone down recently.  However, I really believe that we should pay more attention to equalizing the assets that people own. Redistribution will remain as an extremely important mechanism, but I doubt that it can be significantly increased.

Q. Talk a bit about the difference between ‘location-based inequality’ and ‘class-based inequality’.

It turns out that 50 to 60 per cent of income differences between individuals in the world today are due simply to the mean income differences between the countries they live in. In other words, if you want to be rich, you had better be born in a rich country—or emigrate there. The very poorest people in the U.S. have an income level that is equal to that of the lower middle class in China and the upper middle class in India.

Put simply, at least half and possibly more of your income is determined by where you live, which for 96 per cent of people in the world is where they were born. Then, about 20 per cent is due to the income level of your parents. So, your citizenship plus your parental background explain around 70-80 per cent of your income. Obviously, if I had data for gender, race, ethnicity and other things that are similarly ‘given’ to an individual at birth, that percentage would go up. But the lion’s share of it is due to citizenship, and as a result, this is what I call ‘the citizenship premium’ or ‘citizenship rent’.

Q. Does inequality threaten the sustainability of democratic capitalism?

Yes and no. I would not say that it threatens the stability of capitalism as such, and that’s not because everybody is happy with the capitalist system as it exists; it is simply because there are no alternatives.  When you look at it objectively, compared to 20 or 50 years ago, where for example, slavery still existed in some countries, and feudal relations were prevalent in places like Afghanistan and  in the early  20th century in Iran and (what is now) Pakistan—that is all practically gone. Things have become much more commercialized. We also had the huge challenge of socialism, with the nationalization of property, central planning and so on; and that is also gone.  So we really have, for the first time in history, a total domination of one mode of production, capitalism, and it doesn’t have any competitors.  

The issue is really about democratic capitalism, and that is a very different proposition. We have had many regimes that were capitalist, but not democratic: Spain, Greece, Chile, South Korea, Brazil and historically, Germany, Austria, Russia and many others. The kind of disenchantment with democratic political processes that we are seeing today is something that might lead to the strengthening of authoritarian tendencies or to ‘illiberal democracy’ as it is called.  I’m not sure that this is something we will be able to avoid.  So, there is no doubt that capitalism will remain; but democracy is more questionable.


Q. You have said the case of China essentially asks us to question all of our prior beliefs; how so?
Because it is a country that is nominally ruled by the Communist Party, but despite its authoritarian system, it is the most economically-successful country, of the past 40 years. We cannot disregard that fact.

Branko Milanovic is the author of Global Inequality: A New Approach for the Age of Globalization (Belknap Harvard, 2016). He is on the faculty of the Stone Center on Socio-Economic Inequality and a Visiting Presidential Professor at the Graduate Center, City University of New York, and was formerly the Lead Economist in the World Bank’s Research Department. 

[This article has been reprinted, with permission, from Rotman Management, the magazine of the University of Toronto's Rotman School of Management]

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