This blog post is the 2nd in a 5 part series on income inequality. Click below to navigate between the parts of the series:
Part 2: A Brief Primer on the History of Income Inequality
Most people alive today grew up during a historically unprecedented period of global income equality that began around 1914 and persisted through the 1980s. Even after income inequality began to rise again during the early 1980s, cultural norms around inequality take time to adjust, and it has only been since the great recession of 2008 that the topic has become so high profile and politically polarizing.
At least for the past 500 years, income inequality has been persistently higher than during the mid-20th century. Measurement of income inequality is difficult and spotty the farther back in the past economists try to measure, but recent estimates derived from historical documents suggest that Gini coefficients in the .4-.6 range have been fairly common. The US today has a Gini of .41 and in the late 1940s, it was around .3.
This graph comes from Branco Milanovic’s Global Inequality PDF supplement.
This graph comes from Branco Milanovic’s Global Inequality PDF supplement.
As Picketty and Scheidel discuss in their books, these graphs illustrate that in the absence of violent shocks to economic systems, income inequality tends to rise from low to high levels and then remain there. This is what the second graph above illustrates: between the reforms and revolts of various elements of Chilean society, income inequality rose substantially, briefly plateaued, was interrupted by violence, then repeated the cycle.
The reason for this upward trend in absence of violent shocks is the relationship between the return on capital and growth rate of an economy. When the rate of return to capital (denoted r) exceeds the growth rate of an economy (denoted g), then the ownership of capital (and by extension incomes) will tend to become increasingly unequal. Here’s why: in an economy in which growth is very high, wages will grow faster than, and be more lucrative than, owning capital. Since capital has always been concentrated in the hands of the few, rapidly growing returns to labor tend to reduce inequality by making the working class wealthier.
An Example of R > G
For the vast majority of recorded human history, the rate of return on capital r has been greater than the growth in economic output g. What isn’t immediately obvious is how r > g in these societies actually resulted in the growth of income inequality. So let’s work through a quick example.
Imagine a country in which output growth is 0% - every generation of people creates exactly as much economic output as every previous generation. To keep this simple (and historically accurate), imagine further that this society has only one kind of capital asset: land. Due to randomness, a small number of people start out with slightly more land than others and they are able to rent their surplus land to other people. Historically, rents on capital return 4-5% of their value per year on average.
Barring any external shocks, the first generation in this country would have a very low Gini coefficient because everyone has approximately the same amount of capital. But by the end of the first generation, the people who started out with slightly more land will have rented their spare land to those who are less fortunate and earned 4-5% higher yearly incomes. Because there isn’t any other capital asset to buy in this fictional realm, the wealthier landowners will spend their surplus income to increase their land holdings. This process continues, with added income from capital being reinvested and compounding until the society looks like western Europe in the 17th and 18th centuries. During this period of time, Gini coefficients ranged as high as .7-.8, implying that an extremely small portion of the population (.1% or even .01% of the population) owned as much as 60-90% of all wealth (see the chart at the end of part 1 for a centile breakdown of what wealth ownership in that society looks like).
An Example of R < G
Now let’s rewind the scenario and assume a different starting condition: the same country with the same slightly unequal distribution of land, but the economy’s output growth is quite high - say 6% a year. This is roughly equivalent to China’s growth rate for the past decade. Historically, despite the attempts of wealthy capital owners to take as much of an economy’s growth as possible, a substantial number of laborers benefit directly from the compounding growth in productivity and a large portion of the newly created wealth accrues to the previously disadvantaged. So in this country, a newly productive farmer could see their real purchasing power increase by 6% a year while the capital owner would still only be able to rent their land at the historical average of 4-5%. Assuming that capital owners and laborers save about the same amount of their incomes, laborers in this second country would become wealthier than capital owners. This effect will naturally keep the income and wealth distributions more equal.
We see this in the historical record: in the absence of violent shocks, high growth rates are capable of making large societies substantially more economically equal in a very short amount of time.
We don’t need to look farther than the last century to prove the case. Most nations that participated in WW2 (with the notable exception of Russia) experienced a rapid growth in economic output from 1945 through the mid 1970s. During this time, Gini coefficients in many nations hovered between .3-.4 and the middle class grew rapidly.
What Affects Output Growth?
So, exactly what causes economic growth to accelerate? To many people, it appears that the primary driver of output growth is a category of improvements that economists call productivity gains. These are new machines, technical capacities, processes, and ideas that permit a single person to produce more goods and services per unit time than was previously possible. The most often repeated examples of these improvements in the 20th century are inventions like the assembly line, the internal combustion engine, and nitrogen fertilizers.
While it’s true discoveries like these have been instrumental in boosting growth, the biggest single contributor to economic output growth throughout history — accounting for approximately 50% of growth by most measures — is simply population growth. History strongly suggests that the more humans there are, the more productive we have become at producing the things we want.
The next biggest contributors to output growth appear to be what most modern readers would consider to be mundane: the dramatic decline of infant mortality from interventions like better hygiene, clean water, antibacterial drugs, and more readily available medical care.
Technology has contributed substantially to output growth, but the impact has been falling since the early 2000s. Starting in the 1870s, technology had a sudden and profound impact on the growth rates of industrializing countries. Everything from railroads to airplanes, to canned goods and electricity rapidly made human life more productive. In Gordon’s book, he makes a very strong case that despite the changes invoked by information technology starting in the 1980s, for most people, life today is materially similar to life in the 1940s. Despite the internet, computers, and smart phones, output growth across most of the world is now much lower than it was during the period 1870-1940. In fact, since the early 2000s, the effect of technology-driven productivity gains have vanished from most economist’s calculations, suggesting that new digital inventions have failed to boost growth in any meaningful way at a macroeconomic level.
Again, If you’re interested in a deep dive on any of the topics in this subsection, pick up Gordon’s The Rise and Fall of American Growth, which expands this summary into 784 pages.
Peaceful, Low-Growth Societies Are More Unequal
The examples above illustrate a crucial point: societies where output growth is low trend toward highly unequal distributions of income and capital ownership. This is interesting because it clarifies something that most people sort of pick up from life experience without any study: when growth is low, the past eats the present. For most traditional societies, there was no way to earn enough from labor to amass anything close to the level of wealth provided by inheriting an old fortune. A random event 200 years ago (your great-grandfather found gold in the mountains, for instance) compounds into staggering inequality that becomes self-perpetuating.
The world in the 21st century appears to be trending towards lower growth rates due in large part to falling fertility, aging populations, declining productivity growth in technology, rising public debt, and increasingly expensive education and healthcare. This suggests that paradoxically, the future will look a lot more like the distant past than did the 20th century’s anomalous equality. And at least in terms of income inequality, we’re already there. As shown in the chart at the beginning of this section, American wealth and income distributions today more closely resemble the end of the gilded age than the 1950s, and current political and economic forces appear poised to reinforce rather than disrupt that trend.
A Note on International vs Domestic Inequality
Throughout the last several hundred years, wealth and income inequality has been defined at the national level: there were poor countries and wealthy countries. Poor countries had low Gini coefficients, but similarly low rates of consumption and per capita income. Rich countries had high Gini coefficients with extraordinarily wealthy people controlling large amounts of national wealth. Importantly, however, poor people in rich nations tended to be far more wealthy than average people in poor nations. Citizenship was an enormously powerful predictor of economic outcomes at the individual level. Those born in rich nations had a high probability of living lives of relative ease, while those born in poor nations had the opposite luck. An easy example of a poor and rich country in the 18th century would be China and Britain respectively.
This divide held true until the middle of the 20th century when most of the previously poor nations began emulating rich western nations. This led to unprecedented yearly growth in countries like China and India as their economies started to catch up to the wealthiest western nations (note this chart is in log scale):
Chart comes from Branco Milanvoic’s Global Inequality pdf supplement. Note the log scale of the Y-axis.
At the beginning of the 20th century, it was factually correct to think of people as rich or poor based upon their nationality. British citizens enjoyed higher standards of living and were substantially wealthier than people living in Zaire, Columbia, or Thailand. Starting in the 1950s, the world became more complicated. Wealthy nations saw their relative economic supremacy rapidly erode as nations like China emulated western innovations and billions of impoverished people climbed their way into the middle class as a result of rapid economic growth (r < g).
This led to a sustained period of fear in the US, Britain, and other wealthy western nations about being overtaken by prosperous nations like Japan (1980s) and China (2000s) whose economies were growing quickly. It’s never possible to know with certainty why nations change political direction, but one interesting argument for the rise of the neoconservative movement in the US was that it was a reaction to an increasing sense that the US had lost its edge relative to other nations. In this light, liberal politicians had been given adequate opportunity to try their hand at keeping American economic exceptionalism alive and well, but they failed. As a result, a slew of pro-business legislation was tried instead. Most of that legislation had the effect of enabling the wealthiest to become wealthier faster. Trickle down economics, tax cuts for the wealthy, intentional and unintentional holes in the tax code for inheritances, capital income, and inter-generational gifts have all figured prominently since the 1980s in the US. And it wasn’t just an American phenomenon: across the Atlantic, Thatcher enacted similar policies. Both nations have shown a pronounced acceleration in income and wealth inequality since that time.
By the early 2000s, the world had changed from one in which standards of living were defined by national origin (Americans were rich, Chinese were poor) to one in which a person’s standard of living was defined by their place on the income distribution within their own country. Today, wealthy Chinese citizens enjoy a much higher standard of living than most middle class Americans and many poor Americans have a standard of living worse than even a middle class citizen in India.
I believe there is a strong argument to be made that this trend is the driving force behind growing political populism, anti-globalism, and anti-capitalism.
Conclusion
Make the jump to Part 3 in which we get into the exciting world of violent leveling with Scheidel’s 4 horsemen: mass mobilization warfare, revolution, state collapse and plague. Although they represent a grim way to alleviate income and wealth inequality, I’ll provide an argument that they are also the most effective.