The Economist
Inequality and the world economy
True Progressivism
A new form of radical centrist politics is needed to tackle inequality
without hurting economic growth
Oct 13th 2012
BY THE end of the 19th century, the first age of globalisation and a spate
of new inventions had transformed the world economy. But the “Gilded Age”
was also a famously unequal one, with America’s robber barons and Europe’s
“Downton Abbey” classes amassing huge wealth: the concept of “conspicuous
consumption” dates back to 1899. The rising gap between rich and poor (and
the fear of socialist revolution) spawned a wave of reforms, from Theodore
Roosevelt’s trust-busting to Lloyd George’s People’s Budget. Governments
promoted competition, introduced progressive taxation and wove the first
threads of a social safety net. The aim of this new “Progressive era”, as it
was known in America, was to make society fairer without reducing its
entrepreneurial vim.
Modern politics needs to undergo a similar reinvention—to come up with ways
of mitigating inequality without hurting economic growth. That dilemma is
already at the centre of political debate, but it mostly produces heat, not
light. Thus, on America’s campaign trail, the left attacks Mitt Romney as
a robber baron and the right derides Barack Obama as a class warrior. In
some European countries politicians have simply given in to the mob: witness
François Hollande’s proposed 75% income-tax rate. In much of the emerging
world leaders would rather sweep the issue of inequality under the carpet:
witness China’s nervous embarrassment about the excesses of Ferrari-driving
princelings, or India’s refusal to tackle corruption.
At the core, there is a failure of ideas. The right is still not convinced
that inequality matters. The left’s default position is to raise income-tax
rates for the wealthy and to increase spending still further—unwise when
sluggish economies need to attract entrepreneurs and when governments,
already far bigger than Roosevelt or Lloyd George could have imagined, are
overburdened with promises of future largesse. A far more dramatic rethink is
needed: call it True Progressivism.
To have or to have not
Does inequality really need to be tackled? The twin forces of globalisation
and technical innovation have actually narrowed inequality globally, as
poorer countries catch up with richer ones. But within many countries income
gaps have widened. More than two-thirds of the world’s people live in
countries where income disparities have risen since 1980, often to a startling
degree. In America the share of national income going to the top 0.01% (some
16,000 families) has risen from just over 1% in 1980 to almost 5% now—an
even bigger slice than the top 0.01% got in the Gilded Age.
It is also true that some measure of inequality is good for an economy. It
sharpens incentives to work hard and take risks; it rewards the talented
innovators who drive economic progress. Free-traders have always accepted
that the more global a market, the greater the rewards will be for the
winners. But as our _special report_ (http://www.economist.com/node/21564414)
this week argues, inequality has reached a stage where it can be inefficient
and bad for growth.
That is most obvious in the emerging world. In China credit is siphoned to
state-owned enterprises and well-connected insiders; the elite also gain
from a string of monopolies. In Russia the oligarchs’ wealth has even less to
do with entrepreneurialism. In India, too often, the same is true.
In the rich world the cronyism is better-hidden. One reason why Wall Street
accounts for a disproportionate share of the wealthy is the implicit
subsidy given to too-big-to-fail banks. From doctors to lawyers, many
high-paying professions are full of unnecessary restrictive practices. And
then there
is the most unfair transfer of all—misdirected welfare spending. Social
spending is often less about helping the poor than giving goodies to the
relatively wealthy. In America the housing subsidy to the richest fifth
(through mortgage-interest relief) is four times the amount spent on public
housing for the poorest fifth.
Even the sort of inequality produced by meritocracy can hurt growth. If
income gaps get wide enough, they can lead to less equality of opportunity,
especially in education. Social mobility in America, contrary to conventional
wisdom, is lower than in most European countries. The gap in test scores
between rich and poor American children is roughly 30-40% wider than it was
25 years ago. And by some measures class mobility is even stickier in China
than in America.
Some of those at the top of the pile will remain sceptical that inequality
is a problem in itself. But even they have an interest in mitigating it,
for if it continues to rise, momentum for change will build and may lead to a
political outcome that serves nobody’s interests. Communism may be past
reviving, but there are plenty of other bad ideas out there.
Hence the need for a True Progressive agenda. Here is our suggestion, which
steals ideas from both left and right to tackle inequality in three ways
that do not harm growth.
Compete, target and reform
The priority should be a Rooseveltian attack on monopolies and vested
interests, be they state-owned enterprises in China or big banks on Wall
Street.
The emerging world, in particular, needs to introduce greater transparency
in government contracts and effective anti-trust law. It is no coincidence
that the world’s richest man, Carlos Slim, made his money in Mexican
telecoms, an industry where competitive pressures were low and prices were
sky-high. In the rich world there is also plenty of opening up to do. Only a
fraction of the European Union’s economy is a genuine single market. School
reform and introducing choice is crucial: no Wall Street financier has done
as much damage to American social mobility as the teachers’ unions have.
Getting rid of distortions, such as labour laws in Europe or the remnants of
China’s hukou system of household registration, would also make a huge
difference.
Next, target government spending on the poor and the young. In the emerging
world too much cash goes to universal fuel subsidies that
disproportionately favour the wealthy (in Asia) and unaffordable pensions that
favour the
relatively affluent (in Latin America). But the biggest target for reform is
the welfare states of the rich world. Given their ageing societies,
governments cannot hope to spend less on the elderly, but they can reduce the
pace of increase—for instance, by raising retirement ages more dramatically
and means-testing the goodies on offer. Some of the cash could go into
education. The first Progressive era led to the introduction of publicly
financed
secondary schools; this time round the target should be pre-school
education, as well as more retraining for the jobless.
Last, reform taxes: not to punish the rich but to raise money more
efficiently and progressively. In poorer economies, where tax avoidance is
rife,
the focus should be on lower rates and better enforcement. In rich ones the
main gains should come from eliminating deductions that particularly benefit
the wealthy (such as America’s mortgage-interest deduction); narrowing the
gap between tax rates on wages and capital income; and relying more on
efficient taxes that are paid disproportionately by the rich, such as some
property taxes.
Different parts of this agenda are already being embraced in different
countries. Latin America has invested in schools and pioneered conditional cash
transfers for the very poor; it is the only region where inequality in
most countries has been falling. India and Indonesia are considering scaling
back fuel subsidies. More generally, as they build their welfare states,
Asian countries are determined to avoid the West’s extravagance. In the rich
world Scandinavia is the most inventive region. Sweden has overhauled its
admittedly huge welfare state and has a universal school-voucher system.
Britain too is reforming schools and simplifying welfare. In America Mr Romney
says he wants to means-test Medicare and cut tax deductions, though he is
short on details. Meanwhile, Mr Obama, a Democrat, has invoked Theodore
Roosevelt, and Ed Miliband, leader of Britain’s Labour Party, is now trying to
wrap himself in Benjamin Disraeli’s “One Nation” Tory cloak.
Such cross-dressing is a sign of change, but politicians have a long way to
go. The right’s instinct is too often to make government smaller, rather
than better. The supposedly egalitarian left’s failure is more fundamental.
Across the rich world, welfare states are running out of money, growth is
slowing and inequality is rising—and yet the left’s only answer is higher
tax rates on wealth-creators. Messrs Obama, Miliband and Hollande need to
come up with something that promises both fairness and progress. Otherwise,
everyone will pay.
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