Is inequality of income distribution determined by social values?

There has been a spirited discussion in recent years about the effects of inequality of income distribution on the social fabric and the quality of life. As noted in an earlier post, it seems likely that inequality has some adverse effects on life satisfaction which are independent of the income levels of the individuals concerned. Stronger claims have been made by Richard Wilkinson and Kate Pickett in their book, ‘The Spirit Level: Why More Equal Societies Almost Always Do Better’. These authors suggest that in association with lower social trust, a wide range of health and social problems are worse in societies in which inequality is higher. The evidence has been hotly contested - references to opposing contributions listed on a Wikipedia site.

It seems more likely that the correlation that has been observed between low income inequality and high social trust is the result of high social trust leading to a reduction in inequality, rather than a reduction in inequality leading to higher social trust. The big welfare states have been undeniably successful in reducing inequality of income redistribution. Andreas Bergh and Christian Bjornskov have provided evidence that historical levels of social trust may predict the current size of welfare states. High trust levels could be expected to help sustain big welfare states by limiting problems caused by free riding on welfare, by reducing the costs of regulation and monitoring, and by reducing tax evasion and revenue collection problems.

In this post I want to discuss evidence linking trust levels with the importance that people in different countries place on progress toward a more humane society and government action to reduce income inequality.

   

The first step is to consider whether there is a link between social trust and high priority for progress towards a more humane society. The World Values Survey asks respondents to choose which goal is most important: a stable economy; progress toward a less impersonal and more humane society; ideas count more than money; and the fight against crime. Individuals who say that most people can be trusted are more likely to select a humane society and less likely to select the fight against crime as the most important objective. The percentages from the 2005-08 survey choosing progress toward a less impersonal and more humane society are plotted in Figure 1 below against levels of social trust for 53 countries.

Figure 1 suggests that in societies in which there are high levels of social trust, a higher proportion of the population tend to attach most importance to the humane society objective. The main exceptions are for low income countries (China, Vietnam and Indonesia) in which priorities could be expected to be different. France is also exceptional in having a relatively high attachment to the humane society objective despite relatively low levels of trust. This case is particularly interesting in terms of the direction of causation. There are some obvious historical reasons why French people could be expected to attach importance to the humane society objective (egality, fraternity etc.) despite relatively low social trust, but there does not seem to be any obvious reason why French people should have relatively low levels of trust if causation ran in the opposite direction.

The next step is to look at the link between the humane society objective and income inequality. Figure 2 shows the level of income inequality after taxes and transfers (as measure by the gini coefficient) plotted against the proportion of the population attaching most importance to the humane society objective for 21 OECD countries.

Figure 3 shows the link between the humane society objective and government involvement in income redistribution for the 21 OECD countries. The extent of income redistribution is measured as the ratio of the gini coefficient after taxes and transfers to the gini coefficient before taxes and transfers. The value of the variable would be 1.0 if there are no taxes and transfers which reduce income distribution. The ratio is shown in reverse order on the vertical axis. Countries with the greatest income redistribution appear at the top of the chart.

Figure 4 shows the link between the humane society objective and a measure of egalitarian sentiment from the World Values Survey. This measure is derived from responses to a question asking for a value from 1 to 10 to be assigned depending on whether views are closer to the proposition ‘Incomes should be made more equal’ (1) or ‘We need larger income differences as incentives’ (10). The percentages with ratings from 1 to 4 were used as a measure of egalitarian sentiment.

Figure 2 shows that disposable income (i.e. income distribution after tax and transfers) tends to be more equal in countries where a relatively high proportion of the population view the humane society objective as particularly important. Chile is an obvious exception.

Figure 3 shows that the extent of government income redistribution tends to be greatest in countries where support for the humane society objective is greatest. The extent of redistribution is lower than would be predicted on this basis in Chile, Mexico, Turkey and Korea, but these are all countries with relatively low average incomes by OECD standards.

Figure 4 shows that, as might be expected, egalitarian sentiment tends to be greatest in countries in countries in which there is greatest support for the humane society objective. However, comparing Figure 3 and Figure 4, it is apparent that high levels of redistribution are not always associated with strong egalitarian sentiment. For example, egalitarian sentiment seems to be particularly strong in Chile and Switzerland which have redistribution levels somewhat lower than might be predicted on the basis of support for the humane society objective. In the case of Sweden, redistribution is greater than might be predicted and egalitarian sentiment is lower than might be predicted.

The overall picture that emerges is consistent with the view that inequality of income distribution tends to reflect social values. People in high trust societies tend to have greatest support for moving toward a more humane society and greatest income redistribution, leading to relatively low income inequality. Although egalitarian sentiment tends to be greatest in countries where there is greatest support for moving towards a more humane society, it is stronger in some countries in which there has been little income distribution than in countries that have extensive redistribution. The experience of a big welfare state may dampen egalitarian sentiment.

How concerned should we be about trends in income distribution?

At the end of my last post I suggested that the evidence on changing income redistribution – in the OECDs recent publication ‘Divided We Stand’ - poses some serious questions to those of us who are inclined to argue that governments can create widespread opportunities by just getting out of the way. I stick by that, but I don’t see much that is of particular concern in trends in income distribution in OECD countries since the mid-1980s.

In his discussion of Wayne Swan’s recent ravings about income distribution, Henry Ergas agreed with Swan that it is possible to avoid a rising gap between income growth of those at the top of the income distribution and those at the bottom. He noted, however, that ‘the four countries that from the mid-1980s on, most conspicuously did so’ were ‘Portugal, Ireland, Greece and Spain, usually known as the PIGS. In those countries, the bottom 10 percent’s incomes increased by about 1.7 percent more a year than those of the 10 percent at the top’.

I had missed this point when I first looked at the ‘Overview’ of ‘Divided We Stand’. When I looked at the relevant table, it seemed like a good idea to graph the data. The result is shown below.

The PIGS certainly stand out for their success in achieving relatively high rates of growth for those in the bottom 10% of the income distribution. As expected, the growth in average incomes of those at the bottom of the income distribution in the United States was substantially lower than for those at the top – but the same is also true of Sweden. This presumably reflects substantial economic reforms undertaken in Sweden since the mid-1980s.

The growth in incomes for those in the lowest 10% of the income distribution in Australia looks fairly good by comparison with most other countries, and the income growth that occurred is hopefully more likely to be sustained that for the PIGS.

The overall picture shown in the graph suggests a fairly loose relationship between the growth in incomes at the top and bottom of the income distribution. Is the relationship any closer between growth in incomes at the top and in the middle of the distribution?

The second graph suggests that there has been a fairly close relationship between growth in incomes at the top of the income distribution and those in the middle. Given all the talk about rising income inequality in the United States, I was surprised to see that the US does not stand out in terms of incomes at the top rising much more rapidly than those in the middle. What is all the fuss about? Are the researchers who view rising inequality in the US as something exceptional looking at more recent trends? Or are they jumping at shadows?

Postscript:

After some further reading, I am inclined to answer my questions as follows:

1.         Most of the fuss has been about increases in incomes of the top 1% in the US. The increase in share of the top 1% was relatively large by comparison with most other OECD countries. See Figure 12 of the ‘Overview’ of ‘Divided We Stand’.

2.        Growth in incomes of the top 1% has been highly volatile in the US. See Figure 2, of the Congressional Budget Office report: ‘Trendsin the Distribution of household Income Between 1979 and 2007’.

3.      The issue is whether the increase in the incomes of the top 1% is at the expense of the rest of the population. Various explanations have been given for the rapid increase in incomes at the very top of the distribution, but I don’t think a convincing case has been made that there has been systemic market failure. With the benefit of hindsight some remuneration experiments could be counted as failures, but it would be unreasonable to expect all market experiments to succeed. Failure of particular remuneration experiments doesn’t mean that the 99% would benefit from regulation of the remuneration of the 1%, or from higher taxation of the income of the 1%.  

Is Australia's 'fair go' ethos under threat?

In his recent essay about the rising influence of ‘vested interests’ in Australia, Wayne Swan, the treasurer, notes that we Australians ‘always prided ourselves on being a nation that’s more equal than most – a place where if you work hard, you can create a better life for yourself and your family’ (‘The Monthly’ March 2012). He argues that this ‘fair go’ ethic is ‘under threat’ from ‘the rising power of vested interests’. He was not referring to the union movement, which has exercised extraordinary influence under the Gillard government. He was referring to wealthy people who have campaigned in recent years against a new resource rent tax and carbon taxes.

 Swan claims:

‘A handful of vested interests that have pocketed a disproportionate share of the nation’s economic success now feel they have a right to shape Australia’s future to satisfy their own self interest’.

An editorial in the Australian Financial Review (AFR, 3-4 March) contrasted the tone of Wayne Swan’s essay with that of an essay by Bob Carr, former premier of New South Wales, which was published in the AFR on the preceding day. The AFR noted:

‘Mr Carr’s thoughtful musings on the crisis of democratic socialism and the need for Labor to embrace the reform era of the Hawke-Keating era stand in stark contrast to Mr Swan’s belligerent swipe against private enterprise’.

Carr’s comments about the reforms of the Hawke-Keating era are worth quoting:

‘The best bet for Australian Labor might be to embrace and not shy away from the bold economic reform of the Hawke-Keating era. British Labor will sound absolutely inauthentic if it repudiates Blairism. In a similar spirit, Australian Labor cannot walk away from its legacy and is entitled to define itself as the party of economic liberalism, open markets and rising living standards’.

Bob Carr’s article was written before he knew that he was about to become Australia’s foreign minister. Unfortunately, it is not likely that he will be able to continue to write sensibly about Labor politics while in his new position.

The AFR editorial went on to suggest that Swan ‘is wedded to an outdated ideology’ and to claim that ‘Mr Swan is arguably the most left-wing treasurer since Jim Cairns’. (Jim Cairns was federal treasurer for a brief period in the 1970s.)

I rarely read newspaper editorials, let alone quote them, but that one seemed to me to be exceptionally good. There are, however, a couple of points that I would like to add.

My first point is that it is particularly obnoxious for a government representative to criticize people for trying to defend their wealth against confiscatory taxation. There may be a strong case for governments (state rather than federal) to obtain a larger share of resource rents on behalf of citizens, but it was outrageous for the federal government to seek to do this by changing the rules applying to existing mining projects. When an investment has been made on the basis that governments will take a share of rents according to a particular set of rules it is extreme opportunism (if not theft) to announce a sudden change in the rules which enable the government to take a larger slice of rents. In my view the miners are entitled to argue that such behaviour is contrary to Australia’s ‘fair go’ ethos.

My second point is that the tone Wayne Swan has adopted is counter-productive if his aim is to promote serious consideration of the issues associated with changes in income distribution. Swan refers to the recent OECD publication, ‘Divided We Stand: Why Inequality KeepsRising’. This report suggests that income inequality is likely to rise in countries like Australia in the absence of ongoing government involvement in extensive income redistribution.

The evidence on changing income redistribution poses some serious questions to those of us who are inclined to argue that governments can create widespread opportunities by just getting out of the way. It also poses the serious question for advocates of redistribution of how they propose to build widespread community support for removal of disincentives in the tax-welfare system. In that regard, Wayne Swan’s performance could only be described as abysmal.

Do comparative statements about 'national happiness' imply views about the characteristics of a good society?

Yes! I explain why in the draft of Chapter 5 of the book I am writing. This chapter is now available on the book’s web site.

The question of whether measurement of ‘national happiness’ implies views about the good society is not just an arcane topic of academic interest. International agencies such as the UN and OECD and some governments have shown dissatisfaction with use of GDP as a well-being measure and an increasing interest in measuring national well-being more directly. Some of this interest in well-being measurement is motivated by helping individuals to make better choices, but the hope is often expressed that such measurements will assist governments to make better public policy choices and even to pursue national happiness as an over-riding policy objective.

   

Some researchers have suggested that that average life satisfaction is the strongest candidate as a measure of societal well-being because it is a single number that can be collected directly through surveys without ‘arbitrary weighting’.  (For example, see: Jon Hall et al, ‘Cutting through the Clutter: Searching for an Over-Arching Measure of Well-Being’, Journal of Institutional Comparisons, 8(4)2010.)

After reading the draft of Chapter 5 I hope everyone will agree with me that it is fanciful to view average life satisfaction as a measure of national happiness that does not involve arbitrary weighting. Perhaps it might be helpful if I provide a brief outline of the argument here to help readers decide whether or not to read the draft chapter.

It is possible, of course, to conduct surveys asking people in different countries how satisfied with life they are on a scale of 1 to 10 and then to average the results obtained for each country. The issue is whether it is appropriate to view such averages as measures of ‘national happiness’.

When people refer to such averages as measures of national happiness they are implying that national happiness rises to the same extent if a person’s life satisfaction rating rises from 9 to 10 as if some other person’s rating rises from 1 to 2. Individual researchers can make such claims if they wish, but they cannot claim that they are value free. I don’t think that they could even claim that such a view of ‘national happiness’ reflects values that are widely shared.

The need for value judgements is usually more transparent when composite indicators are used to make assessments of national happiness.

    

Whatever method is used, it seems to me that when researchers make comparative statements about levels of national happiness they are making implicit claims about the extent to which different countries have characteristics that a good society might be expected to have. So, why not consider directly what characteristics ‘good societies’ should have and make comparative assessments on that basis?

I suggest that there would be widespread support for the view that good societies are characterized by peacefulness, extensive opportunities for individual flourishing and a degree of economic security. The indicators used to measure the extent to which different countries have those characteristics show a similar ranking of countries to that provided by the OECD’s ‘Better Life’ index and the UN’s Human Development Index. The main advantage of using the ‘good society’ framework is in focusing explicitly on a consideration of the characteristics of good societies.

In my view, a focus on the characteristics of good societies is particularly appropriate from a public policy perspective because it tends to concentrate attention on matters that are within the domain of public policy. By contrast, when governments adopt ‘national happiness’ as an over-riding objective they are blurring the distinction between public and individual responsibilities.

I would be grateful for any comments on Chapter 5, or on any of the other chapters.