Thursday, June 2, 2011

Re-examining inequality

During four decades the prevailing idea about economic inequality was that of an U-inverted curve where disparities in income grow in the early stages of development and then decrease in the more mature stage. This theory, which is known as the 'Kuznets-Williamson' model, led to consider growing inequality as inevitable in the process of economic development. The so-called 'new economic geography' school initiated by the work of P.Krugman has implicitly assumed increasing returns and imperfect competition, which lead to agglomeration effects and polarization of economic activity. Decades ago,  a great French economist,  Fran├žois.Perroux developed  the idea of 'growth poles' which explains that growth is by essence an unbalanced process. Albert Hirschmann* once likened  development  to the break up of traffic jammed in a tunnel. At first, progress in some lanes gives people in the stalled lanes hopeful expectations for the future. But if their lanes remain stalled long after other lanes move, frustration can mount and provoke radical behaviour, like jumping the median strip.

Although economic development makes ultimately societies better off,  the basic assumption was  the existence of a trade off between equity (or equality) and growth (efficiency) due to the fact that assets and skills are distributed unevenly in the population,  economic development will inevitably be uneven. The benefits for few will then trickle down on the poor in the form of fiscal transfers, taxes and public goods (schools, hospitals, public transport, etc...).

In fact,  recent trends on poverty and social exclusion show that they are widespread in most advanced economies ( in Italy, according to a recent report published by the national statistical office, almost a quarter of the total population is at risk of poverty). This seems to contradict the theory based on the U-curve of inequality. In many western countries, inequality has started to rise again over the last two decades, after a period of decrease. Italy is today one of the countries with the highest Gini index (which measures inequality in income distribution). This means that the relationship between growth and inequality is more complex, and is often conflicting.

Italy is again an emblematic example as it is a relatively young nation with a persisting dual structure between the North and the South. Until a few decades ago, the State and households were the main providers of  wealth and 'welfare' in which there were no major tensions between the  increase of  wealth and its distribution among people; in fact more than three quarters of households are owners of their houses, which is now a myth for young people. In the 50s and the 60s, the welfare State has contributed to reduce substantially inequality among individuals thanks to the provision of basic services such as healthcare, education, pensions and human rights for all. Today, these services are much less guaranteed with dramatic consequences on millions of people who lost their jobs, houses or simply cannot buy enough food with their income. Think about the new poor, immigrants, the elderly, young families; those services  should become universal rights just as the right to work !

In a more complex and fragmented society (sometimes called  'post-modern'), with less State and less 'family' (as a safety net), growth leads to more inequality in income. In the past twenty years, the share of  output going to labour (wages) has strongly decreased relative to the share going to rentiers;  more recently, relative poverty has increased, especially among young people (as well as the elderly dependent on their pensions) which in turn contributes to a fall in consumption and output.

Without a substantial increase in equality among people, there cannot be any sustainable recovery of our economies, simply because of the weak demand of goods, but also the lack of enthusiasm and joy of living of the young generations. How can a country grow without them? Coming back to Hirschman's metaphor, imagine that after sometime we are still stopped while others get ahead, then we might be tempted to get to the other lane; traffic will be stalled again, and no one else is making progress, and then frustration and anger will prevail.

Studies on inequality and poverty should be revisited in the light of new advances in economic theory and empirical evidence on the poor. OECD has recently developed a 'Better life index'* which takes into account not only individual and household incomes but also public goods such as healthcare, schools, childcare infrastructure, efficient public transport, etc. In fact, a salary of 1000 euros in Frankfurt is not the same thing as living in Sofia, not only because of the differences in the provision of public goods but also housing and food  prices.
As Amartya Sen puts it, poverty and wealth are not only a matter of income and goods, but of capabilities, in other words,  the ability of people to transform resources in activities, freedom, development.

The index allows citizens to compare lives across 34 countries, based on 11 dimensions -- housing, income, jobs, community, education, environment, governance, health, life satisfaction, safety, work-life balance -- giving their own weight to each of the dimensions. See the Better Life Initiative of the OECD to celebrate its 50 years since its foundation after the Marshall Plan:,3746,en_2649_201185_47912639_1_1_1_1,00.html

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