Globalisation and inequality

The new wave

Surprisingly little is known about the causes of inequality. A Serbian-American economist proposes an interesting theory

IT’S a golden age for studying inequality. Thomas Piketty, a French economist, set the benchmark in 2014 when his book, “Capital in the Twenty-First Century”, was published in English and became a bestseller. The book mapped the contours of the crisis with a sweeping theory of economic history. Inequality, which had been on the wane from the 1930s until the 1970s, had risen sharply back toward the high levels of the Industrial Revolution, he argued. Now Branko Milanovic, an economist at the Luxembourg Income Study Centre and the City University of New York, has written a comprehensive follow-up. It reinforces how little is really known about economic forces of long duration.

In some ways “Global Inequality” is a less ambitious book than “Capital”. It is shorter, and written more like an academic working paper than a work of substantial scholarship for a wider readership.

Like Mr Piketty, he begins with piles of data assembled over years of research. He sets the trends of different individual countries in a global context. Over the past 30 years the incomes of workers in the middle of the global income distribution—factory workers in China, say—have soared, as has pay for the richest 1% (see chart). At the same time, incomes of the working class in advanced economies have stagnated. This dynamic helped create a global middle class. It also caused global economic inequality to plateau, and perhaps even decline, for the first time since industrialisation began.

To help interpret these facts, Mr Milanovic provides the readers with a series of neat mental models. He muses, for instance, that at the dawn of industrialisation, inequality within countries (or class-based inequality) was responsible for the largest gaps between rich people and poor. After industrialisation, inequality across countries (or location-based inequality) became more important. But as gaps between countries become ever more narrow, class-based inequality will become more important as most of the differences in incomes between rich people and poor people will once again be due to gaps within countries. He seasons the discussion with interesting comments, such as how incomes and inequality fell over the course of the Roman Empire.

Mr Milanovic’s boldest contribution is about “Kuznets waves”, which he offers as an alternative to two other prevailing theories of inequality. Simon Kuznets, a 20th-century economist, argued that inequality is low at low levels of development, rises during industrialisation and falls as countries reach economic maturity; high inequality is the temporary side-effect of the developmental process. Mr Piketty offered an alternative explanation: that high levels of inequality are the natural state of modern economies. Only unusual events, like the two world wars and the Depression of the 1930s, disrupt that normal equilibrium.

Mr Milanovic suggests that both are mistaken. Across history, he reckons, inequality has tended to flow in cycles: Kuznets waves. In the pre-industrial period, these waves were governed by Malthusian dynamics: inequality would rise as countries enjoyed a spell of good fortune and high incomes, then fall as war or famine dragged average income back to subsistence level. With industrialisation, the forces creating Kuznets waves changed: to technology, openness and policy (TOP, as he shortens it). In the 19th century technological advance, globalisation and policy shifts all worked together in mutually reinforcing ways to produce dramatic economic change. Workers were reallocated from farms to factories, average incomes and inequality soared and the world became unprecedentedly interconnected. Then a combination of forces, some malign (war and political upheaval) and some benign (increased education) squeezed inequality to the lows of the 1970s.

Since then, the rich world has been riding a new Kuznets wave, propelled by another era of economic change. Technological progress and trade work together to squeeze workers, he says; cheap technology made in foreign economies undermines the bargaining power of rich-world workers directly, and makes it easier for firms to replace people with machines. Workers’ declining economic power is compounded by lost political power as the very rich use their fortunes to influence candidates and elections.

This diagnosis carries with it a predictive element. Mr Milanovic expects rich-world inequality to keep rising, in America especially, before eventually declining. Importantly, he argues that the downswing in inequality that occurs on the backside of a Kuznets wave is an inevitable result of the preceding rise. Where Mr Piketty sees the inequality-compressing historical events of the early 20th century as an accident, Mr Milanovic believes them to be the direct result of soaring inequality. The search for foreign investment opportunities engendered imperialism and set the stage for war. There are parallels, if imperfect ones, to the modern economy; rich economies seem to be stagnating as the very rich struggle to find places to earn good returns on their piles of wealth.

Mr Milanovic’s analysis leads him to consider some dark possibilities as he looks ahead. America looks to be falling into the grips of an undemocratic plutocracy, he says, which is dependent on an expanding security state. In Europe right-wing nativism is on the rise. The good news is that emerging economies will probably continue on their path toward rich-world incomes—though that, he allows, is not guaranteed, and could be threatened by political crisis in China or in other markets.

The book’s conclusion is a little unsatisfying. A theory in which rising inequality eventually triggers countervailing social dislocations feels intuitively right, but it also leaves many important questions unanswered. When is war, rather than revolution, the probable outcome of inequality? Are governments at the mercy of the cycle, or can they act pre-emptively to flatten out the waves and avoid crises of high inequality? Mr Milanovic’s contributions are ultimately similar to those made by Mr Piketty. The data he provides offer a clearer picture of great economic puzzles, and his bold theorising chips away at tired economic orthodoxies. But the grand theory does as much to reveal the scale of contemporary ignorance as to illuminate the mechanics of the global economy.

Apr 2nd 2016 | From the print edition
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http://www.economist.com/news/books-and-arts/21695853-surprisingly-little-known-about-causes-inequality-serbian-american-economist