Inequality could be lower than you think

But there is plenty to do to make economies fairer

Even in a world of polarisation, fake news and social media, some beliefs remain universal, and central to today’s politics. None is more influential than the idea that inequality has risen in the rich world. People read about it in newspapers, hear about it from their politicians and feel it in their daily lives.

This belief motivates populists, who say selfish metropolitan elites have pulled the ladder of opportunity away from ordinary people. It has given succour to the left, who propose ever more radical ways to redistribute wealth. And it has caused alarm among business people, many of whom now claim to pursue a higher social purpose, lest they be seen to subscribe to a model of capitalism that everyone knows has failed.

In many ways the failure is real. Opportunities are restricted. The cost of university education in America has spiralled beyond the reach of many families. Across the rich world, as rents and house prices have soared, it has become harder to afford to live in the successful cities which contain the most jobs. Meanwhile, the rusting away of old industries has concentrated poverty in particular cities and towns, creating highly visible pockets of deprivation. By some measures inequalities in health and life expectancy are getting worse.

Yet precisely because the idea of soaring inequality has become an almost universally held belief, it receives too little scrutiny. That is a mistake, because the four empirical pillars upon which the temple rests—which are not about housing or geography, but income and wealth—are not as firm as you might think. As our briefing this week explains, these four pillars are being shaken by new research
Consider, first, the claim that the top 1% of earners have become detached from everyone else in recent decades, which took hold after the “Occupy Wall Street” movement in 2011. This was always hard to prove outside America. In Britain the share of income of the top 1% is no higher than in the mid-1990s, after adjusting for taxes and government transfers.

And even in America, official data suggest that the same measure rose until 2000 and since then has been volatile around a flat trend. It is easily forgotten that America has put in place several policies in recent decades that have cut inequality, such as the expansion of Medicaid, government-funded health insurance for the poor, in 2014.

Now some economists have re-crunched the numbers and concluded that the income share of the top 1% in America may have been little changed since as long ago as 1960. They argue that earlier researchers mishandled the tax-return data that yield estimates of inequality. Previous results may also have failed to account for falling marriage rates among the poor, which divide income around more households—but not more people.

And a bigger chunk of corporate profits may flow to middle-class people than previously realised, because they own shares through pension funds. In 1960 retirement accounts owned just 4% of American shares; by 2015 the figure was 50%.

The second wobbly pillar is the related claim that household incomes and wages have stagnated in the long term. Estimates of inflation-adjusted median-income growth in America in 1979-2014 range from a fall of 8% to an increase of 51%, and partisans tend to cherry-pick a figure that tells a convenient story. The huge variation reflects differences in how you treat inflation, government transfers and the definition of a household, but the lowest figures are hard to believe.

If you argue that income has shrunk you also have to claim that four decades’ worth of innovation in goods and services, from mobile phones and video streaming to cholesterol-lowering statins, have not improved middle-earners’ lives. That is simply not credible.

Third is the notion that capital has triumphed over labour as ruthless businesses, owned by the rich, have exploited their workers, moved jobs offshore and automated factories. The claim that inequality is being driven by the rich accumulating capital was a central thesis of Thomas Piketty’s book, “Capital in the Twenty-First Century”, which in 2014 made him the first rock-star economist since Milton Friedman improbably filled auditoriums in the 1980s.
Not all Mr Piketty’s theories caught on among economists, but it is widely assumed that a falling share of the rich world’s gdp has been going to workers and a rising share to investors. After a decade of soaring stock prices, this has some resonance with the public.

Recent research, however, suggests that the decline in labour’s fortunes is explained in most rich countries by exorbitant returns to homeowners, not tycoons. Strip out housing and the earnings of the self-employed (which are hard to divide between capital and labour income), and in most countries labour shares have not fallen.

America since 2000 is an exception. But that reflects a failure of regulation, not a fundamental flaw in capitalism. American antitrust regulators and courts have been unforgivably lax, allowing some industries to become too concentrated. This has enabled some firms to gouge their customers and book abnormally high profits.

The last pillar is that inequalities of wealth—the assets people own, minus their liabilities—have been soaring. Again, this has always been harder to prove in Europe than America. In Denmark, one of the few places with detailed data, the wealth share of the top 1% has not risen for three decades.

By contrast, few deny that the richest Americans have sprinted ahead. But even here, wealth is fiendishly difficult to estimate.

Not so rich pickings

The campaign of Elizabeth Warren, a Democratic presidential contender, reckons that the share of wealth owned by the richest 0.1% of Americans rose from 7% in 1978 to 22% in 2012.

But a plausible recent estimate suggests that the rise is only half as big as this. (For connoisseurs, the difference rests on the factor by which you scale up investors’ wealth from the capital income they report to the taxman.)

This imprecision is a problem for politicians, including Ms Warren and Bernie Sanders, who want wealth taxes, since they may raise less revenue than they expect.

The fact that dubious claims are made about inequality does not reduce the urgency of tackling economic injustice. But it does call for ensuring that the assumptions on which policies are based are accurate.

Those, like Britain’s Labour Party, who favour the radical redistribution of income and wealth ought to be sure that inequality is as high as they think it is—especially when their policies bring knock-on costs such as deterring risk-taking and investment. By one estimate, Ms Warren’s wealth tax would leave America’s economy 2% smaller after a decade.

Until these debates are resolved, it would be better for policymakers to stick to more solid ground. The rich world’s housing markets are starving young workers of cash and opportunity; more building is needed in the places that offer attractive jobs. America’s economy needs a revolution in antitrust enforcement to reinvigorate competition.

And regardless of trends in inequality, too many high-income workers, including doctors, lawyers and bankers, are protected from competition by needless regulation and licensing, and senseless restrictions on high-skilled immigration, both of which should be loosened.

Such an agenda would require governments to take on nimbys and corporate lobbies. But it would reduce inequality and boost growth. And its benefits do not depend on a set of beliefs about income and wealth that could yet turn out to be wrong.

Bipolar Economics

Randomized controlled trials are the flavor of the month in development economics, with their keenest advocates having just been awarded the Nobel Prize. But can this experimental approach really be counted on to produce better economic policies?

Andrés Velasco

velasco99_Sarinya Pinngam  EyeEm_Getty Images_businessmen

LONDON – How can we know if an economic policy is achieving its stated objective? Well, we can create two similar groups, randomly allocate the “treatment” to only one of them and measure the results. By comparing the groups, we will obtain a reliable estimate of how effective the policy is.

This technique, known as randomized controlled trials, or RCTs, had long been used in medicine and social policy. By applying it to development economics, Esther Duflo, Abhijit Banerjee, and Michael Kremer revolutionized how many economists work – and won the Nobel Prize last month.

The achievement was both intellectual and organizational: a global community of randomistas has emerged, committed to using RCTs to change the world. New evidence would cause developing-country governments to discard bad policies and adopt good ones.

Philosopher Nancy Cartwright, Nobel laureates Angus Deaton and James Heckman, and Oxford’s Lant Pritchett have long argued that the evidence RCTs yield is not the gold standard of reliability proponents claim it is. But even if the evidence is strong, will voters and governments find it persuasive? Will policy improve enough to make a difference to people’s lives?

If there was ever a moment when reliable evidence fails to move politicians, this is it. “The experts are terrible!” Donald Trump declared in 2016. “Britain has had enough of experts!” Tory minister Michael Gove retorted when confronted with evidence that Brexit would be bad for the British economy. One can imagine Russia’s Vladimir Putin, Brazil’s Jair Bolsonaro, Turkey’s Recep Tayyip Erdoğan, and the Philippines’ Rodrigo Duterte nodding in agreement.

The experimental approach is mostly atheoretical, which some view as an advantage: let the data speak. But the randomistas do have an implicit model of policymaking, and it is simple: if you build it, they will come. Politicians, if confronted with strong evidence, will do the right thing. Yet other economic research, often produced by other Nobel laureates, helps understand why this is not a satisfactory model.

Start with decision-making. Psychologist Daniel Kahneman and economist Richard Thaler received the Nobel for their pioneering work in behavioral economics, a branch of research showing that the fully rational homo economicus populating economists’ models never was: human beings are prone to overconfidence, biases, and reliance on fallible rules of thumb when making choices.

When the choices human beings must make are collective, the problems grow exponentially. The observation that what is collectively rational need not be individually appealing is the bread and butter of modern public economics. If a single group benefits from a particular item of public spending (say, a local clinic) which can be financed by borrowing – so that other taxpayers, current and future, will help pay for it – then no amount of sermonizing on the empirically demonstrated benefits of fiscal prudence will keep neighbors from demanding the clinic be built.

As Chile’s finance minister for four years, I participated in countless debates over public spending. I cannot recall that an evidence-heavy academic paper ever helped my side carry the day.

And then there is the thorny issue of distribution. There are some policy changes from which some people gain and no one loses (economists call them Pareto improvements). In such cases, persuasive empirical evidence, skillfully deployed, can change people’s minds. But most policy choices cause someone to lose something. Potential losers then organize to fight the change while potential winners remain uninformed, uninterested, or both. Policy paralysis follows. The results from an RCT are unlikely to change that.

Moreover, human beings care about what others with whom they identify say about them. And, as Rachel Kranton and Nobel laureate George Akerlof have argued, we are willing to incur economic costs for the sake of affirming our identities. A recent immigrant may choose not to learn the dominant language of his new home country in order to fit into a neighborhood populated by other recent migrants. Or voters who identify with a populist leader may continue to support him even if his misguided policies are bankrupting the country. Politics is often identity politics, insensitive to the weight of evidence.

Last is the question of scope and ambition. RCTs are best suited to narrowly defined policy issues. If you want people to sleep under anti-malaria bed nets, should you sell those nets or give them away? Do conditional cash transfers to poor mothers cause them to enroll their kids in school? And my personal favorite: do gender election quotas improve the political representation of women in India? (The answer is a clear yes.)

No amount of research talent can design an RCT to test whether more globalization is desirable, how big government ought to be, or what triggers economic growth. As a result, randomistas can say little about the big issues that inflame passions and around which grand narratives are built.

And it is such narratives, Robert J. Shiller (yet another Nobel laureate) has shown, that organize our thinking about the economy. If not woven into a broad narrative of change, empirical evidence can have limited political impact at best.

Duflo and Banerjee are well aware of all this. In their thoughtful new book, Good Economics for Hard Times, they write: “As we lose our ability to listen to each other, democracy becomes less meaningful and closer to a census of the various tribes, who each vote based more on tribal loyalties than on a judicious balancing of priorities.” What remains unclear is how this observation fits into their theory of social change.

“The only recourse we have against bad ideas,” they conclude, “is to be vigilant, resist the seduction of ‘the obvious,’ be skeptical of proposed miracles, question the evidence, be patient with complexity and honest about what we know and what we can know.” This is both eloquent and right, but it sounds more like an expression of hope than a call to action.

The point is not to dispute the importance of more evidence on “what works” in education, poverty, or health. But economics teaches that we should allocate the marginal dollar where it yields the biggest social return.

And, given the veritable deluge of RCTs in recent years, perhaps academics and donors should devote more time and resources to the big questions that cannot be studied by experimental methods – and to learning more about demand for new empirical evidence and the barriers to policymakers’ use of it.

The same is true of curricula: many academic programs risk teaching students every last econometric wrinkle while imparting little wisdom about how to put that knowledge to work in the real world. As the dean of a public policy school, this causes me to lose a fair bit of sleep.

With no change of course, the supply of quantitative policy evaluations will continue to rise just as demand for it from policymakers seems to be dropping.

Any first-year economics student will tell you the relative price of economists’ services is likely to fall. That is bad news for economists – and for the world.

Andrés Velasco, a former presidential candidate and finance minister of Chile, is Dean of the School of Public Policy at the London School of Economics and Political Science. He is the author of numerous books and papers on international economics and development, and has served on the faculty at Harvard, Columbia, and New York Universities.

Unsettling precedents for today’s world

Events evoke not the 1930s but the period before the first world war

Martin Wolf

Trump Kaiser
© James Ferguson

History does not repeat itself, but it often rhymes. This remark is often incorrectly attributed to Mark Twain. But it is a good one.

History is the most powerful guide to the present, because it speaks to what is permanent in our humanity, especially the forces that drive us towards conflict. Since the biggest current geopolitical event, by far, is the burgeoning friction between the US and China, it is illuminating to look back to similar events in the past. In a thought-provoking book, Destined for War, Harvard’s Graham Allison started with the account of the Peloponnesian war by Thucydides, the great Athenian historian of the 5th century BC.

However, I will focus on the three eras of conflict of the past 120 years. From them much is to be learnt.

The most recent conflict was the cold war (1948-1989) between a liberal democratic west, led by the US, and the communist Soviet Union, a transformed version of the pre-first world war Russian empire. This was a great power conflict between the chief victors of the second world war. But it was also an ideological conflict over the nature of modernity.

The west ultimately won. It did so because the scale of western economies and the speed of western technological advances vastly outmatched those of the Soviet Union. The subjects of the Soviet empire also became disenchanted with their corrupt and despotic rulers and the Soviet leadership itself concluded its system had failed. Despite moments of danger, notably the Cuban missile crisis of 1962, the cold war also ended peacefully.

Going further back, we reach the interwar years. This was an interregnum in which the attempt to restore the pre-first world war order failed, the US withdrew from Europe and a huge financial and economic crisis, emanating originally from the US, ravaged the world economy.

It was a time of civil strife, populism, nationalism, communism, fascism and national socialism.

The 1930s are an abiding lesson in the possibility of democratic collapse once elites fail. They are also a lesson of what happens when great countries fall into the hands of power-hungry lunatics.

2 charts showing that the period before the first world war saw the rise of the US and Germany. Share of global GDP (%) and  the share of global manufacturing output (%)

Going further back still, we reach the decisive period 1870-1914. As Paul Kennedy noted in his classic book, The Rise and the Fall of the Great Powers, in 1880, the UK generated 23 per cent of global manufacturing output. By 1913, this had fallen to 14 per cent.

Over the same period, Germany’s share rose from 9 per cent to 15 per cent. This shift in the European balance led to a catastrophic Thucydidean war between the UK, an anxious status quo power, especially once the Germans started building a modern fleet, and Germany, a resentful rising one.

Meanwhile, US industrial output went from 15 to 32 per cent of the world’s, while China fell into irrelevance. Thereupon, US action (in the 20th century’s big conflicts) and inaction (in the interwar years) determined the outcomes.

Today’s era is a mixture of all three of these.

It is marked by a conflict of political systems and ideology between two superpowers, as in the cold war, by a post-financial crisis decline of confidence in democratic politics and market economics as well as by the rise of populism, nationalism and authoritarianism, as in the 1930s, and, most significantly, by a dramatic shift in relative economic power, with the rise of China, as with the US before 1914.

For the first time since then, the US faces a power with an economic potential exceeding its own.

The pre-1914 period ended in a catastrophic war, as did the interwar period, albeit with a relatively successful post-1945 aftermath.

The cold war ended in peaceful triumph.

Now, the world confronts challenges that easily match those of the earlier periods. So what lessons are we to learn from these eras?

2 charts showing that the last 40 years have been notable for the rise of China. Share of GDP (%) and share of global manufacturing output (%)

Perhaps the most obvious one is that quality of leadership matters. President Xi Jinping’s capacities and intentions are clear enough: he is devoted to party dominance over a resurgent China. But the political system of the western world and especially the US and UK, the two powers that dragged the world through the 1930s, is failing.

US President Donald Trump’s erratic leadership recalls that of Germany under Kaiser Wilhelm. Without better leadership, the west and so the wider world are in deep trouble.

Another lesson is the overriding importance of avoiding war. Prof Allison describes well how mutual suspicion fuelled the journey to war in 1914. It is even more crucial for the US and China to avoid head-on conflict now. That was the great success of the cold war. But nuclear deterrence may not be enough.

Yet perhaps the most important conclusion is that avoiding yet another catastrophe is insufficient. We cannot afford the old games of great power rivalry, however inevitable they must seem. Our fates are too deeply intertwined for that. A positive-sum vision of relations between the west, China and the rest has to become dominant if we are to manage the economic, security and environmental challenges we face.

Humanity has to do far better than it has done before. Today, that must seem a fantasy, given the quality of western leadership, authoritarianism in China and rising tide of mutual suspicion. But we must try. We have to manage this difficult new era strategically. On our ability to do that all our futures now depend.

Sitting Still Will Be Hard for the Fed

The Federal Reserve is expected to stand pat next year after a tumultuous 2019, but it may not be able to do so

By Justin Lahart

The Federal Reserve is expected to leave rates steady after its two-day policy meeting this week. Photo: leah millis/Reuters

Federal Reserve officials would like to spend the next year not doing much of anything. They probably won’t get their wish.

The Fed starts a two-day policy meeting on Tuesday and at its conclusion the central bank will almost certainly leave rates on hold. An active year, during which it reversed course on its planned rate increases and then conducted three “insurance” rate cuts on worries that trade tensions and global weakness would put the economy at risk of recession, is ending on a muted tone.

With recession fears dialed back, investors’ focus will turn to the Fed’s projections for 2020.

These will likely show that most officials expect their target range for overnight rates will remain at the current 1.5% to 1.75%. That would be happy news for the Fed in an election year where it would prefer not to be seen as helping or hindering any candidate—a concern that is likely heightened given President Trump’s frequent criticism.

But while a projection for no change in rates may be the most balanced forecast, given the combination of potential headwinds and tailwinds the economy faces, it may not count as the most likely outcome. It is all too easy to imagine scenarios in which the Fed ends up having to cut rates and it is possible to imagine ones where it ends up raising them.

Trade worries, for example, for now are muted on the expectation that the U.S. and China will soon strike a “phase-one” deal. But given how often trade tensions have eased only to flare up again over the past two years—particularly last spring, when a U.S./China deal seemed imminent, only to fall apart—it is hard to have much confidence.

The presidential election also poses a risk, especially if the Democrats nominate a candidate who spooks employers and investors into believing corporate tax and regulatory costs are about to head substantially higher.

Conversely, if the economy faces few obstacles and grows steadily, pushing the unemployment rate down past its current 50-year low of 3.5%, the Fed may be hard pressed not to take back at least some of this year’s insurance cuts—particularly if inflation readings or wage growth pick up.

The only reliable prediction one could have made about the Fed in recent years has been that it wound up doing something unexpected.

Bolivia’s Crisis of Legitimacy

By: Allison Fedirka     

After the recent wave of unrest in South America that included Ecuador, Chile, Colombia and Bolivia, some are beginning to wonder what will happen next.

Each country will respond to the turmoil in different ways, but they all have one thing in common: They need to maintain or restore the legitimacy of the government and build public confidence in whatever solution the government comes up with to meet the demands of protesters.

Without this, the unrest is likely to continue and will fade out only as protesters grow fatigued or through a crackdown by security forces.

But the legitimacy of the government is a larger problem for some countries than others.

Bolivia will face the biggest challenge because the power vacuum created by the unrest there has undermined the legitimacy of the current and future governments, leaving the population divided.

Establishing Legitimacy

The question of a government’s legitimacy is a particularly sensitive topic for young democracies in South America.

In the not-too-distant past, several countries in the region were ruled by dictatorships, authoritarian leaders and military regimes.

People in these countries over the age of 50 – some of whom hold positions of power in the government and military – can still recall what life was like under these repressive regimes.

Democracy is a relatively new phenomenon in South America, especially when compared to places like the United States or Western Europe.

And while government legitimacy is important in all countries, South American nations are more mindful than most that a government’s claim to authority can’t be taken for granted.      

Elected officials are constantly aware that a social movement can thwart their ability to pass laws or stay in power.

Legitimacy becomes a critical question particularly during transitions of power, especially when the transition does not occur through a scheduled, democratic election.      
Political parties and civil society organizations see transparency and free and fair elections as necessary before elected leaders can be given the mandate to govern.

Therefore, many struggle to see as legitimate any government or official who rose to power without going through the electoral process.

Such value is placed in the democratic process that any government or leader who does not win the approval of the people through an election is seen as a threat to democracy itself.

Take Paraguay and Brazil as examples.

In both countries, recent presidents were removed from office through impeachment: Fernando Lugo in Paraguay and Dilma Rousseff in Brazil.

Both Lugo and Rousseff, along with their supporters, referred to their impeachments as coups and criticized the congressional proceedings under which their removal from office was executed.

By questioning the legitimacy of the impeachment proceedings themselves, they were also questioning the legitimacy of the next leaders who would take over as president.

As these cases show, it’s incredibly difficult to justify the removal of an elected government and to build support for a government that takes over from an ousted leader.

Legitimacy is clearly a necessary component for the success of any government, but it’s also critical to the success of any strategy to deal with social unrest.

Trying to bring order by using excessive force or by introducing reforms that offer no real change and don’t have broad support among the public often don’t work in the long run; these strategies resemble the behavior of dictatorial governments. But doing nothing is not an option.

Ecuador, Chile and Colombia have already started to build support for their strategies.

The governments have called on an array of political players, thought leaders and social groups to participate in a national dialogue geared toward finding solutions.

In Ecuador, President Lenin Moreno has met with indigenous leaders to discuss economic reforms.

Chile has started making arrangements for a referendum on constitutional changes (one of the key demands of the protesters) in the first half of next year.

The government also recently proposed a law that would allow the military to be deployed to protect critical infrastructure without declaring a state of emergency.

In Colombia, the government launched a “national dialogue” over critical social and economic issues and introduced economic reforms to decrease living costs.

In all these cases, getting buy-in from civil society has been critical to establishing the legitimacy of the government approach and avoiding backlash and further disarray.

Bolivia’s Power Vacuum

Bolivia, however, faces a bigger challenge than these other examples when it comes to legitimacy.

The protests in Bolivia resulted in the resignation of President Evo Morales, who held office for 13 years, longer than any other post-independence Bolivian leader.

Bolivia’s history is riddled with political and military strongmen, and Morales’ long tenure in office resembled the hold on power of other “caudillos” in Bolivia’s past.

It enabled him to exert undue influence over certain institutions.

In a decision that was widely criticized, the Supreme Court, for example, ruled that Morales could run for another term in 2019 despite a 2016 referendum in which a majority of Bolivians voted against extending term limits.

In Bolivia’s case, restoring the legitimacy of the government goes beyond finding a new president or passing legislation to meet protesters’ demands; it requires the reconstruction and legitimization of all major government institutions.

That’s because Morales’ ouster has left a power vacuum in Bolivia.

Normally, when a leader is removed from office, the post gets filled by the next in line to the presidency.

But in Bolivia, Morales stepped down from office (at the request of the military) rather than being removed by force.

After his departure, many other high-ranking government officials also resigned, including the vice president, the parliamentary leader and the president of the Senate, gutting the government of all the senior officials who would have been next in line for the presidency according to the country’s constitution.

Senate Vice President Jeanine Anez ultimately took over, even though this post is not included in the line of succession stipulated in the constitution, because the remaining lawmakers (most of whom were members of the opposition party to which Anez belongs) agreed that this was the most logical solution.

Morales’ supporters, however, have attacked Anez’s presidency as illegitimate, though their activities have been limited thanks to the strong police and military presence on the streets.

The power vacuum will make it extremely difficult to legitimize whoever comes to power next in Bolivia.

Anez’s caretaker government has tried to impose a smooth transition.

She has cleared the military of leaders who pushed for Morales’ resignation and worked with other members of the government to arrange elections for early 2020.

Efforts are also underway to sign unity pacts with protesters in the hopes of reducing street violence and the number of security forces needed to keep the peace.

At the same time, however, she has already taken measures to realign Bolivia’s foreign policy toward the U.S. and its regional allies.

Moreover, there are several key questions about the upcoming election that remain unanswered. First, who will be eligible to run for president?

Some Morales supporters still want to see him or his close allies like Vice President Garcia Linera run for office.

Some have also questioned the electoral court authorities who were removed when Anez took power and were replaced with people who were more in line with the opposition.

Voter turnout and public safety will also be a concern given the continued clashes between Morales’ supporters and opponents and the heavy presence of police and military forces.

Elections are necessary to establish the legitimacy of the next Bolivian leader, but whoever comes out on top will still need to work hard to maintain the legitimacy of their administration throughout their tenure.

Legitimacy is a critical question for all South American governments, particularly during times of major unrest.

It is built largely by getting civil society groups on board with government policies and reforms.

But the power vacuum left by Morales’ resignation poses a particularly difficult challenge for Bolivia’s next government.

Lessons learned from Bolivia’s experience may serve as a blueprint for other countries such as Venezuela, Cuba and Nicaragua that could face a similar fate in the future.