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May 28, 2009

Capitalism and Inequality

Opponents of capitalism believe that the system is inherently flawed because it creates enormous inequalities in wealth. Back in March 2004, The Economist published an article that examined that belief ["More or less equal?"]. It wrote:

"Is the familiar claim that capitalism makes global inequality worse actually true?Unfortunately, this apparently straightforward question turns out to be harder to answer than one might suppose. There are three broad areas of difficulty. The first is measuring what people, especially the poorest people in developing countries, consume. The second is valuing consumption in a way that allows useful comparisons to be made across countries and over time. And the third, in effect, is settling on an appropriate basis of comparison. Which matters more, for instance: whether inequality is widening among nations, or whether inequality is widening among all the people of the world, regardless of which country they happen to live in? Judging any claim about global inequality is impossible without a clear understanding of how the researchers concerned have dealt with all three questions."

The article presented a panel of graphs that visually depicted global economic trends. The article concluded:

"Once you take account of the fact that China and India have performed so well since 1980, and especially since 1990, together with the fact that these two countries account for such a big share of all the world's poor, it is difficult to stay as pessimistic about global trends in poverty and inequality as the critics of global capitalism wish to be."

One expects The Economist to be pro-capitalism but the article readily admits that macro-measures don't tell us everything we need to know about poverty. It notes, for example, that the "World Bank attempts to measure 'consumption poverty', as opposed to 'income poverty'." The article also concluded that detractors who blame globalization for the ills of poor countries are ignoring simple logic.

"Can it be plausibly claimed that these countries [in sub-Saharan Africa] are the victims of globalisation? That would be an odd conclusion, given that sub-Saharan Africa's economies are so comparatively isolated from the rest of the world economy—by force of history, circumstance and, to a large extent, the policies of their own and other governments. Sub-Saharan Africa plainly suffers not from globalisation, but from lack of it. The focus of attention should be on how to extend the benefits of international economic linkages to the region."

Readers of this blog know that I agree with the conclusion that developing countries need more connectivity with the global economy not less. In a recent follow-up article with the same title, The Economist reports that inequality gap appears to be shrinking ["More or less equal?" 4 April 2009 print issue]. Five years ago the magazine argued: "Would ... worsening of inequality entitle one to conclude that India and China had taken a wrong turn these past 20 years? Of course not. Look at Africa to understand that there are worse things than inequality." In the latest article, the magazine notes just how unequal things have become in America.

"Between 1947 and 1979 the top 0.1% of American earners were, on average, paid 20 times as much as the bottom 90%, according to the Economic Policy Institute, a think-tank in Washington, DC; by 2006 the ratio had grown to 77. In 1979, 34.2% of all capital gains went to the top 1% of recipients; by 2005 the figure was 65.3%. All this happened during a period when American workers’ median real incomes stagnated (though the notional value of any health insurance would have risen steeply)."

Many people blame stagnant wages on globalization and, the article admits, globalization has played a role -- not just the role that people think.

"Many people would point to globalisation, in particular the opening up of the Indian and Chinese markets that vastly increased the global labour force, putting downward pressure on unskilled wages. But academic studies have not found this to be a big factor in explaining the level of wages for the unskilled in recent years. Globalisation may, however, explain some of the changes at the very top of the scale. The emergence of a global market for talent in areas such as banking, the law and investment may explain why the top 0.1% have been so well rewarded."

The fact that the rich got richer bothers a lot of people and The Economist details some of the arguments that have been used to justify the value of economic inequality.

"In the 1970s it was argued that high taxes had reduced incentives and thus economic growth. Entrepreneurs had to be motivated to build businesses and create jobs. But extensive study by economists has found little correlation, in either direction, between inequality and economic growth rates across countries. One argument advanced in America is that wide income disparities might encourage more people to want to go to college, thus creating a better-educated workforce. But Lawrence Mishel of the Economic Policy Institute points out that several societies that are more egalitarian than America have higher college enrolment rates. There might also be an argument in favour of wealth disparities if social mobility was high and the sons and daughters of office cleaners could fairly easily rise to become chief executives. But America and Britain, which follow the Anglo-Saxon model, have the highest intergenerational correlations between the social status of fathers and sons; the lowest are found in egalitarian Norway and Denmark. Things are even worse for ethnic minorities; a black American born in the bottom quintile of the population (by income) has a 42% chance of staying there as an adult, compared with 17% for a white person. As a result, talent is being neglected. Of American children with the highest test scores in eighth grade, only 29% of those from low-income families ended up going to college, compared with 74% of those from high-income families. Since the better-off can afford to keep their children in higher education and the poor cannot, breaking out of the cycle is hard."

The trickle-down theory touted by some economic conservatives simply hasn't proven correct. It would be hard to argue against the fact that wealthy investors provide the capital for entrepreneurial activities that create jobs and stimulate the economy; but The Economist is making a larger point -- breaking out of the poverty cycle is difficult. Wealth not only affects educational opportunities it affects health.

"The gap between the life expectancy of the top and bottom 10% respectively rose from 2.8 years to 4.5 between 1980 and 2000. That does not meet the definition of a fair society by John Rawls, a 20th-century philosopher, who described it as one in which a new entrant would be happy to be born even though he did not know his social position ahead of time."

The article notes that gap between rich and poor is starting to shrink (mainly because of bad economic times not because the poor are becoming better off). It also makes the odd claim that the poor will be relatively less affected by the recession because they have less to lose.

"Although [the poor] may lose their jobs and default on their loans, they will not be troubled by collapsing asset prices because they do not own assets. Edward Wolff of New York University points out that the proportion of American households owning some stocks (including mutual funds and 401k pension plans) went up from 32% in 1983 to 51% in 2001. But only 32% of the population owned more than $10,000-worth of stock, and many middle-class people are only modestly affected by falling asset prices. The richest 10% of the American population owned 85% of all stocks."

The bottom line is that the gap between rich and poor may be narrowing, but it's not for the right reasons. It would be foolhardy to pursue policies that take from the rich to give to the poor. Such schemes have never worked. What does work are policies that encourage the wealthy to invest in businesses that create good paying jobs and foster a stable, prosperous, and growing middle class. There will always be rich people and poor people, but the fewer poor people there are the better off society becomes. Both developed and developing countries face economic inequality challenges. I'm convinced they can be mitigated through free markets and global connectivity. That is the philosophy behind Enterra Solutions' Development-in-a-Box™ approach. Developing countries need foreign direct investment to promote sustainable growth. That investment comes from successful businesses and individuals (i.e., the well-to-do). In many ways, the debates about economic inequality are red herrings. The debates shouldn't be about wealth but about the moral and economic choices that the wealthy make.

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