The inequality wildcard

The Unbound Economy

DAVOS – As the dramatic events in North Africa continue to unfold,many observers outside the Arab world smugly tell themselves that it is all about corruption and political repression. But high unemployment, glaring inequality, and soaring prices for basic commodities are also a huge factor. So observers should not just be asking how far similar events will spread across the region; they should be asking themselves what kind of changes might be coming at home in the face of similar, if not quite so extreme, economic pressures.

Within countries, inequality of income, wealth, and opportunity is arguably greater than at any time in the last century. Across Europe, Asia, and the Americas, corporations are bulging with cash as their relentless drive for efficiency continues to yield huge profits. Yet workers’ share of the pie is falling, thanks to high unemployment, shortened working hours, and stagnant wages.

Paradoxically, cross-country measures of income and wealth inequality are actually falling, thanks to continuing robust growth in emerging markets. But most people care far more about how well they are doing relative to their neighbors than to citizens of distant lands.

The rich are mostly doing well. Global stock markets are back. Many countries are seeing vigorous growth in prices for housing, commercial real estate, or both. Resurgent prices for commodities are creating huge revenues for owners of mines and oil fields, even as price spikes for basic staples are sparking food riots, if not wholesale revolutions, in the developing world. The Internet and the financial sector continue to spawn new multi-millionaires and even billionaires at a staggering pace.

Yet high and protracted unemployment plagues many less-skilled workers. For example, in financially distressed Spain, unemployment now exceeds 20%. It cannot help that the government is simultaneously being forced to absorb new austerity measures to deal with the country’s precarious debt burden.

Indeed, given record-high public-debt levels in many countries, few governments have  substantial scope to address inequality through further income redistribution. Countries such as Brazil already have such high levels of transfer payments from rich to poor that further moves would undermine fiscal stability and anti-inflation credibility.

Countries such as China and Russia, with similarly high inequality, have more scope for increasing redistribution. But leaders in both countries have been reluctant to move boldly for fear of destabilizing growth. Germany must worry not only about its own vulnerable citizens, but also about how to find the resources to bail out its southern neighbors in Europe.

The causes of growing inequality within countries are well understood, and it is not necessary to belabor them here. We live in an era in which globalization expands the market for ultra-talented individuals but competes away the income of ordinary employees.

Competition among countries for skilled individuals and profitable industries, in turn, constrains governments’ abilities to maintain high tax rates on the wealthy. Social mobility is further impeded as the rich shower their children with private education and  after-school help, while the poorest in many countries cannot afford even to let their children stay in school.

Writing in the nineteenth century, Karl Marx famously observed inequality trends in his day and concluded that capitalism could not indefinitely sustain itself politically. Eventually, workers would rise up and overthrow the system.

Outside Cuba, North Korea, and a few left-wing universities around the world, no one takes Marx seriously anymore. Contrary to his predictions, capitalism spawned ever-higher standards of living for more than a century, while attempts to implement radically different systems have fallen spectacularly short.

Yet, with inequality reaching levels similar to 100 years ago, the status quo has to be vulnerable. Instability can express itself anywhere. It was just over four decades ago that urban riots and mass demonstrations rocked the developed world, ultimately catalyzing far-reaching social and political reforms.

Yes, the problems facing Egypt and Tunisia today are far more profound than in many other countries. Corruption and failure to embrace meaningful political reform have become acute shortcomings. Yet it would be very wrong to suppose that gaping inequality is stable as long as it arises through innovation and growth.

How, exactly, will change unfold, and what form will a new social compact ultimately assume? It is difficult to speculate, though in most countries, the process will be peaceful and democratic.

What is clear is that inequality is not just a long-term issue. Concerns about the impact of income inequality are already constraining fiscal and monetary policy in developed and developing countries alike as they attempt to extricate themselves from the hyper-stimulative policies adopted during the financial crisis.

More importantly, it is very likely that countries’ abilities to navigate the rising social tensions generated by gaping inequality could separate the winners and losers in the next round of globalization. Inequality is the big wildcard in the next decade of global growth, and not just in North Africa.

Kenneth Rogoff is Professor of Economics and Public Policy at Harvard University, and was formerly chief economist at the IMF.  –Kenneth Rogoff