Category: Economics for Business: Ch 18

The Economist is probably not the kind of newspaper that you will read more than once per issue – certainly not two years after its publication date. That is because, by definition, financial news articles are ephemeral: they have greater value, the more recent they are – especially in the modern financial world, where change can be strikingly fast. To my surprise, however, I found myself reading again an article on inequality that I had first read two years ago – and it is (of course) still relevant today.

The title of the article was ‘You may be higher in the global wealth pyramid than you think’ and it discusses exactly that: how much wealth does it take for someone to be considered ‘rich’? The answer to this question is of course, ‘it depends’. And it does depend on which group you compare yourself against. Although this may feel obvious, some of the statistics that are presented in this article may surprise you.

According to the article

If you had $2200 to your name (adding together your bank deposits, financial investments and property holdings, and subtracting your debts) you might not think yourself terribly fortunate. But you would be wealthier than half the world’s population, according to this year’s Global Wealth Report by the Crédit Suisse Research Institute. If you had $71 560 or more, you would be in the top tenth. If you were lucky enough to own over $744 400 you could count yourself a member of the global 1% that voters everywhere are rebelling against.

For many (including yours truly) these numbers may come as a surprise when you first see them. $2200 in today’s exchange rate is about £1640. And this is wealth, not income – including all earthly possessions (net of debt). £1640 of wealth is enough to put you ahead of half of the planet’s population. Have a $774 400 (£556 174 – about the average price of a two-bedroom flat in London) and – congratulations! You are part of the global richest 1% everyone is complaining about…

Such comparisons are certainly thought provoking. They show how unevenly wealth is distributed across countries. They also show that countries which are more open to trade are more likely to have benefited the most from it. Take a closer look at the statistics and you will realise that you are more likely to be rich (compared to the global average) if you live in one of these countries.

Of course, wealth inequality does not happen only across countries – it happens also within countries. You can own a two-bedroom flat in London (and be, therefore, part of the 1% global elite), but having to live on a very modest budget because your income (which is a flow variable, as opposed to wealth, which is a stock variable) has not grown fast enough in relation to other parts of the national population.

Would you be better off if there were less trade? Certainly not – you would probably be even poorer, as trade theories (and most of the empirical evidence I am aware of) assert. Why do we then talk so much about trade wars and trade restrictions recently? Why do we elect politicians who advocate such restrictions? It is probably easier to answer these questions using political than economic theory (although game theory may have some interesting insights to offer – have you heard of the ‘Chicken game‘?). But as I am neither political scientists nor a game theorist, I will just continue to wonder about it.

Articles and information

Questions

  1. Were you surprised by the statistics mentioned in this report? Explain why.
  2. Do you think that income inequality is a natural consequence of economic growth? Are there pro-growth policies that can be used to tackle it?
  3. Identify three ways in which widening income inequality can hurt economies (and societies).

I recently found myself talking about my favourite TV shows from my childhood. Smurfs aside, the most popular one for me (and I suppose for many other people from my generation) had to be Knight Rider. It was a story about a crime fighter (David Hasselhoff) and his a heavily modified, artificially intelligent Pontiac Firebird. ‘Kitt’ was a car that could drive itself, engage in thoughtful and articulate conversations, carry out missions and (of course) come up with solutions to complex problems! A car that was very far from what was technologically possible in the 80s – and this was part of its charm.

Today this technology is becoming reality. Google, Tesla and most major automakers are testing self-driving cars with many advanced features like Kitt’s – if not better. They may not fire rockets, but they can drive themselves; they can search the internet; they can answer questions in a language of your choice; and they can be potentially integrated with a number of other technologies (such as car sharing apps) to revolutionise the way we own and use our cars. It will take years until we are able to purchase and use a self-driving car – but it appears very likely that this technology is going to become roadworthy within our lifetime.

Artificial intelligence (AI) is already becoming part of our life. You can buy a robotic vacuum cleaner online for less than a £1000. You can get gadgets like Amazon’s Alexa, that can help you automate your supermarket shopping, for instance. If you are Saudi, you can boast that you are compatriots with a humanoid: Saudi Arabia was the first country to grant citizenship to Sophia, an impressive humanoid and apparently a notorious conversationalist who does not miss an opportunity to address a large audience – and it has done so numerous times already in technology fairs, national congresses – even the UN Assembly! Sophia is the first robot to be honoured with a UN title!

What will be the impact of such technologies on labour markets? If cars can drive themselves, what is going to happen to the taxi drivers? Or the domestic housekeepers – who may find themselves increasingly displaced by cleaning robots. Or warehouse workers who may find themselves displaced by delivery bots (did you know that Alibaba, the Chinese equivalent of eBay, owns a warehouse where most of the work is carried out by robots?). There is no doubt that labour markets are bound to change. But should we (the human labour force) be worried about it? Acemoglu et al (2017) think that we should:

Using a model in which robots compete against human labor in the production of different tasks, we show that robots may reduce employment and wages […] According to our estimates, one more robot per thousand workers reduces the employment to population ratio by about 0.18–0.34 percentage points and wages by 0.25–0.5 per cent.[1]

Automation is likely to affect unskilled workers more than skilled ones, as unskilled jobs are the easiest ones to automate. This could have widespread social implications, as it might widen the divide between the poor (who are more likely to have unskilled jobs) and the affluent (who are more likely to own AI technologies). As mentioned in a recent Boston Consulting Group report (see below):

The future of work is likely to involve large structural changes to the labour market and potentially a net loss of jobs, mostly in routine occupations. An estimated 15 million UK jobs could be at risk of automation, with 63 per cent of all jobs impacted to a medium or large extent.

On the other hand, the adoption of automation is likely to result in higher efficiency, huge productivity gains and less waste. Automation will enable us to use the resources that we have in the most efficient way – and this is bound to result in wealth creation. It will also push human workers away from manual, routine jobs – and it will force them to acquire skills and engage in creative thinking. One thing is for certain: labour markets are changing and they are changing fast!

Videos

Articles

Report

Questions

  1. What do you think is going to be the effect of automation on labour market participation in the future? Why?
  2. Using the Solow growth model, explain how automation is likely to affect economic growth and capital returns.
  3. In the context of the answer you gave to question 2, explain how human capital accumulation may affect the ability of workers to benefit from automation.

[1] Daron Acemoglu and Pascual Restrepo, Robots and Jobs: Evidence from US Labor Markets, NBER Working Paper No. 23285 (March 2017)

Each January, world political and business leaders gather at the ski resort of Davos in Switzerland for the World Economic Forum. They discuss a range of economic and political issues with the hope of guiding policy.

This year, leaders meet at a time when the global political context has and is changing rapidly. This year the focus is on ‘Creating a Shared Future in a Fractured World’. As the Forum’s website states:

The global context has changed dramatically: geostrategic fissures have re-emerged on multiple fronts with wide-ranging political, economic and social consequences. Realpolitik is no longer just a relic of the Cold War. Economic prosperity and social cohesion are not one and the same. The global commons cannot protect or heal itself.

One of the main ‘fissures’ which threatens social cohesion is the widening gap between the very rich and the rest of the world. Indeed, inequality and poverty is one of the main agenda items at the Davos meeting and the Forum website includes an article titled, ‘We have built an unequal world. Here’s how we can change it’ (see second link in the Articles below). The article shows how the top 1% captured 27% of GDP growth between 1980 and 2016.

The first Guardian article below identifies seven different policy options to tackle the problem of inequality of income and wealth and asks you to say, using a drop-down menu, which one you think is most important. Perhaps it’s something you would like to do.

Articles

Project Davos: what’s the single best way to close the world’s wealth gap? The Guardian, Aidan Mac Guill (19/1/18)
We have built an unequal world. Here’s how we can change it World Economic Forum, Winnie Byanyima (22/1/18)
Oxfam highlights sharp inequality as Davos elite gathers ABC news, Pan Pylas (21/1/18)
Inequality gap widens as 42 people hold same wealth as 3.7bn poorest The Guardian, Larry Elliott (22/1/18)
There’s a huge gender component to income inequality that we’re ignoring Business Insider, Pedro Nicolaci da Costa (22/1/18)
Ahead of Davos, even the 1 percent worry about inequality Washington Post, Heather Long (22/1/18)
“Fractures, Fears and Failures:” World’s Ruling Elites Stare into the Abyss GlobalResearch, Bill Van Auken (18/1/18)
Why the world isn’t getting a pay raise CNN Money, Patrick Gillespie and Ivana Kottasová (1/11/17)

WEF archive
Articles on Inequality World Economic Forum

Questions

  1. Distinguish between income and wealth. In global terms, which is distributed more unequally?
  2. Why has global inequality of both income and wealth grown?
  3. Explain which of the seven policy options identified by the Guardian you would choose/did choose?
  4. Go through each one of the seven policy options and identify what costs would be associated with pursuing it.
  5. Identify any other policy options for tackling the problem.

Where you live in Great Britain can have a profound effect on your earning potential. According to a report published by the Social Mobility Commission, there is a growing geographical divide, with more affluent areas getting relatively richer, while ‘many other parts of the country are being left behind economically and hollowed out socially’.

The Commission uses a Social Mobility Index to rank the 324 local authorities in England. The index is a measure of the social mobility prospects for people from disadvantaged backgrounds. It is ‘made up of 16 key performance indicators spanning each major life stage’.

The index shows that children from disadvantaged backgrounds have lower educational attainment, poorer initial jobs and poorer prospects for advancement in the labour market. Often they are stuck in low paid jobs with little chance of getting on the housing ladder and fewer chances of moving away from the area.

The problem is not simply one of a North-South divide or one of inner cities versus the suburbs. Many inner-city areas have been regenerated, with high incomes and high social and geographical mobility. Other inner-city areas remain deprived.

The worst performing areas are remote rural or coastal areas and former industrial areas, where industries have closed. As the author of the report states in the Guardian article linked below:

These areas have fewer specialist teachers, fewer good schools, fewer good jobs and worse transport links. … Many of these areas have suffered from a lack of regeneration: few high-paying industries are located there, and they often exhibit relatively limited job opportunities and clusters of low pay.

The problem often exists within areas, with some streets exhibiting growing affluence, where the residents have high levels of social mobility, while other streets have poor housing and considerable levels of poverty and deprivation. Average incomes for such areas thus mask this type of growing divide within areas. Indeed, some of the richest areas have worse outcomes for disadvantaged children than generally poorer areas.

There are various regional and local multiplier effects that worsen the situation. Where people from disadvantaged backgrounds are successful, they tend to move away from the deprived areas to more affluent ones, thereby boosting the local economy in such areas and providing no stimulus to the deprived areas. And so the divide grows.

Policies, according to the report, need to focus public investment, and incentives for private investment, in deprived areas. They should not focus simply on whole regions. You can read the specific policy recommendations in the articles below.

Articles

Social mobility is a stark postcode lottery. Too many in Britain are being left behind The Guardian, Alan Milburn (28/11/17)
State of the Nation – Sector Response FE News (28/11/17)
Social mobility: the worst places to grow up poor BBC News, Judith Burns and Adina Campbell (28/11/17)
How Britain’s richest regions offer worst prospects for poor young people Independent, May Bulman (28/11/17)
Small Towns Worst Places In Britain For Social Mobility, New ‘State Of The Nation’ Report Reveals Huffington Post, Paul Waugh (28/11/17)

Report

Social mobility in Great Britain: fifth state of the nation report Social Mobility Commission, News (28/11/17)
Fifth State of the Nation Report Social Mobility Commission, News (28/11/17)

Questions

  1. Explain how local multipliers operate.
  2. What is the relationship between social immobility as identified in the report and the elasticity of supply of labour in specific jobs?
  3. What is the link between geographical, occupational and social mobility?
  4. Explain why, apart from London, English cities are ‘punching below their weight on social mobility outcomes’.
  5. Go through each of the key policy recommendations of the report and consider the feasibility of introducing them.
  6. What policies could be adopted to retain good teachers in schools in deprived areas?
  7. To what extent might an increased provision of training ease the problem of social mobility?
  8. Investigate policies adopted in other European countries to tackle local deprivation. Are there lessons that can be learned by the UK government, devolved governments, local authorities or other agencies?

The latest edition of the IMF’s Fiscal Monitor, ‘Tackling Inequality’ challenges conventional wisdom that policies to reduce inequality will also reduce economic growth.

While some inequality is inevitable in a market-based economic system, excessive inequality can erode social cohesion, lead to political polarization, and ultimately lower economic growth.

The IMF looks at three possible policy alternatives to reduce inequality without damaging economic growth

The first is a rise in personal income tax rates for top earners. Since top rates have been cut in most countries, with the OECD average falling from 62% to 35% over the past 30 years, the IMF maintains that there is considerable scope of raising top rates, with the optimum being around 44%. Evidence suggests that income tax elasticity is low at most countries’ current top rates, meaning that a rise in top income tax rates would only have a small disincentive effect on earnings.

An increased progressiveness of income tax should be backed by sufficient taxes on capital to prevent income being reclassified as capital. Different types of wealth tax, such as inheritance tax, could also be considered. Countries should also reduce the opportunities for tax evasion.

The second policy alternative is a universal basic income for all people. This could be achieved by various means, such as tax credits, child benefits and other cash benefits, or minimum wages plus benefits for the unemployed or non-employed.

The third is better access to health and education, both for their direct effect on reducing inequality and for improving productivity and hence people’s earning potential.

In all three cases, fiscal policy can help through a combination of taxes, benefits and public expenditure on social infrastructure and human capital.

But a major problem with using increased tax rates is international competition, especially with corporation tax rates. Countries are keen to attract international investment by having corporation tax rates lower than their rivals. But, of course, countries cannot all have a lower rate than each other. The attempt to do so simply leads to a general lowering of corporation tax rates (see chart in The Economist article) – to a race to the bottom. The Nash equilibrium rate of such a game is zero!

Videos

Raising Taxes on the Rich Won’t Necessarily Curb Growth, IMF Says Bloomberg, Ben Holland and Andrew Mayeda (11/10/17)
The Fiscal Monitor, Introduction IMF (October 2017)
Transcript of the Press Conference on the Release of the October 2017 Fiscal Monitor IMF (12/10/17)

Articles

Higher taxes can lower inequality without denting economic growth The Economist, Buttonwood (19/10/17)
Trump says the US has the highest corporate tax rate in the world. He’s wrong. Vox, Zeeshan Aleem (31/8/17)
Reducing inequality need not hurt growth Livemint, Ajit Ranade (18/10/17)
IMF: higher taxes for rich will cut inequality without hitting growth The Guardian, Larry Elliott and Heather Stewart (12/10/17)

IMF Fiscal Monitor

IMF Fiscal Monitor: Tackling Inequality – Landing Page IMF (October 2017)
Opening Remarks of Vitor Gaspar, Director of the Fiscal Affairs Department at a Press Conference Presenting the Fall 2017 Fiscal Monitor: Tackling Inequality IMF (11/10/17)
Fiscal Monitor, Tackling Inequality – Full Text IMF (October 2017)

Questions

  1. Referring to the October 2017 Fiscal Monitor, linked above, what arguments does the IMF use for suggesting that the optimal top rate of income tax is considerably higher than the current OECD average?
  2. What are the arguments for introducing a universal basic income? Should this depend on people’s circumstances, such as the number of their children, assets, such as savings or property, and housing costs?
  3. Find out the details of the UK government’s Universal Credit. Does this classify as a universal basic income?
  4. Why may governments reject the IMF’s policy recommendations to tackle inequality?
  5. In what sense can better access to health and education be seen as a means of reducing inequality? How is inequality being defined in this case?
  6. Find out what the UK Labour Party’s policy is on rates of income tax for top earners. Is this consistent with the IMF’s policy recommendations?
  7. What does the IMF report suggest about the shape of the Laffer curve?
  8. Explain what is meant by tax elasticity and how it relates to the Laffer curve?