Columns 2022
Column January 2022
What the rich in the Western world think about income inequality
A recent paper provides an insight in how high earners perceive inequality and what their attitudes are regarding income redistribution.
Not much is known about the rich, let alone the very rich, in America and Europe. Sure, we know how much they earn, how they live and how some display their wealth, sometimes in an embarrassing manner. Yet I find it intriguing to learn more about their own perceptions and what opinions they have about a more egalitarian income distribution.
During a recent meeting of economic researchers in my home country Holland, I ran into a researcher who, together with two colleagues, had done a study on precisely these issues.[1] He was kind enough to share the paper with me. Now, what does it tell us?
Two samples formed the basis for the paper. One sample presented the opinions of 1,000 high income earners who graduated from INSEAD, a prestigious French business school. The results were compared with another sample, put together in the United States by Turk Prime, a crowdsourcing data platform.
To date, studies on high earners showed that most high earners underestimate the extent of inequality in the income distribution. In addition, they believe that they are poorer than they really are. This was confirmed by the paper I received. To put it in simple terms; the richer you are, the more you underestimate your rank in the income hierarchy. But this is not the whole story, as the correlation reverses among the very top of income earners: the super-rich have a correct idea of their top rank. Moreover - and this I find good news - they are more open to redistributive policies. In short, they do not mind to share some of their wealth with others.
This is important as the paper concludes that understanding what might influence preferences for redistribution among the rich has the potential to contribute to policies aimed at reducing income inequality. The paper reported that in comparisons with peers (i.e. reference groups) high income earners signalled a desire to a drop of 18% in the income share allocated to the richest 1%. Should this desire be implemented, it would result in an improvement of the income distribution from a fairly ‘inequal’ country, such as Canada, to a much more egalitarian country like Sweden.
Meanwhile, we see that some super-rich people, such as Bill and Melinda Gates, Warren Buffett and MacKenzie Scott (divorcee of Jeff Bezos) donate large chunks of their wealth to ‘good causes’. They are engaged in philanthropy on a truly grand scale.
Redistributive preparedness sounds attractive from the point of view of a more equal income distribution philosophy. However, the situation is a bit more nuanced. The rich’s ‘ideal’ income distribution in their country is considerably more progressive than it in actual fact is. But, and now comes the paradox: their taxation preferences are more in line with what people in general prefer, and are not consistent with their more ‘egalitarian’ distributional preference. Translated in technical terms: they do not want to have the marginal tax rates adjusted to achieve more equitable outcomes.
How do the super-rich at the top of the income distribution perceive to what extent effort or luck contributed to their wealth? Thinking about one’s own rank within members of their reference group, led high earners to conclude that, in general, financial success is more driven by luck than by effort. This is because the working rich are actively engaged in and exposed to a ‘winner-takes-all’ society, where top positions are scarce and where luck becomes the major determinant of financial success.
Now, what does economic theory say about income distribution? Particularly during or after economic downturns, economists come up with analyses and opinions about this issue. Take, for example, John Maynard Keynes. During the Great Depression, he presented an entirely new analysis of the economy; not from the point of view of the market but from the vantage point of the economy as a whole. Keynes was not after the collapse of the capitalistic system; no, he wanted to save it from its downfall. But he also wanted to rid it of its perverse aspects. In his own words: ‘the euthanasia of the cumulative oppressive power of the capitalist to exploit the scarcity value of capital.’
Regarding this cumulative oppressive power, Thomas Piketty comes to mind when in 2014, just after the end of the Great Recession, he published his ground-breaking book Capitalism in the Twenty-first Century. He argued that wealth, as distinct from income, had, and still has, a cumulative effect across the centuries, larger than the average growth of economies. As a result, the gap between the wealthy and the rest is widening. Apart from a better access to education for all, a global progressive wealth tax could counter this development, argued Piketty.
The question of what is a just or fair distribution of income, is basically a moral/philosophical one. John Rawls’ 1971 classic On Justice dealt with the issue. He concluded that an increase in inequality was only justified if this would improve the material position of the poor. Netherlands’ greatest economist, the late Jan Tinbergen attempted to establish objective criteria for a just and fair income distribution. He had to give up the attempt as there are no objective criteria; they depend on one’s moral convictions. Perhaps this explains why Tinbergen rejected Rawls theory as he felt it was insufficiently quantifiable.
The last word about income and wealth distribution has not been said. It remains an ongoing concern for politicians, economists, and philosophers, as wide differences between rich and poor may not just be felt as unjust, they may also trigger social and political unrest. After all, Confucius already observed that inequality was worse than scarcity.
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[1] Perceived Inequality, Reference Groups and Preferences for Redistribution Among High Earners (November 2021). Authors: Clement Bellet, Dylan Glover and Mark Stabile.
Peter de Haan January 2022
Column February 2022
Inflation
What could have been expected for quite some time is now unfolding in the Western world: inflation. Where does it come from and what is being done about it? These are the questions which this column attempts to answer.
The other day I was reading a book in which Milton Friedman’s monetarist theory was explained. After a thorough analysis of American monetary policies over more than 100 years, Friedman, and his co-author Anna Schwartz, found that inflation occurred when there was too much money in the economy chasing too few goods. So, said Friedman, cut down the money supply and inflation will gradually disappear. At first sight, this makes sense. There are other insights in economics which also make sense; such the laws of supply and demand. When people ask me what economics is all about, I tell them, jokingly, that economics basically is a mix of common sense and unexpected developments. This, of course, is a definition too simple to be true, as economics is a bit more complicated than that.
Nonetheless, there is a grain of truth in Friedman’s monetarist theory, as inflation indeed occurs in a situation when there is too much money in the economy. For example, this happened in the 1970s in America and Europe: inflation was running out of control while unemployment sharply increased combined with sluggish economic growth. This toxic mix is called stagflation. Friedman had gained much influence in US government circles, including the Fed, the American system of central banks. Paul Volcker was the Fed Chairman at the time. Inflation was running at 11.3 percent. Unemployment figures also rose. Friedman pressurised Volcker to limit the money supply. Instead, Volcker increased the federal funds rate and doubled Fed’s discount rate on loans of reserves of commercial banks. This was a brave decision, since these interest increases had dramatic negative effects on American investments, employment and on the value of the dollar. And it did not work! So, Volcker’s next step was, as Friedman had suggested, limiting the growth of the money supply. However, it was easier to reduce inflation by monetarist means in theory than in practice: inflation kept on rising. And so did unemployment. Subsequently, consumer credit controls were applied. And only gradually, inflation started to drop and employment increased again.
The conclusion was that monetarist policies alone did not work. Friedman was furious. But Volcker ignored Friedman’s tantrum; he had never believed that monetarism was the sole magic bullet. He told Friedman that in addressing inflation other factors were also at play than just the money supply. Consumers’ expectations about future inflation was one such factor, and so was the value of a country’s exchange rate, said Volcker.
Since Friedman launched his ideas in the 1960s, and Volcker’s doubts about them, new insights give us now a better understanding of the causes of inflation. There are three: (i) the effects of supply shocks, (ii) the extent to which an economy is operating above or below capacity, and (iii) as already mentioned by Volcker, people’s expectations of inflation. I add a fourth cause: the inflationary effects of Quantitative Easing (QE), i.e., the huge sums involved in central banks’ bond buy-up programs.
The situation in the Western world now is different from the one during the 1970s. The economies are growing satisfactorily. True, inflation is steeply increasing, but unemployment percentages are low; there are, here and there, even labour shortages (potentially triggering a wage-price spiral). So, let us look into these possible causes and ask which ones are at play.
Well, factor number one, supply shocks, is clearly playing a part. There are supply shortages ranging from computer chips to paper, caused by covid-19 lockdowns. The fact that OPEC limited oil production, triggering a doubling of the price of a barrel of oil, added to inflationary pressures and negatively affected the production of goods. Supply shocks also happened in the 1970s, but once they abated, inflation dropped. Central bankers and the International Monetary Fund (IMF) expect that this will happen again if the present supply bottlenecks are overcome. Then, the economy’s capacity issue. Covid-19 triggered pent-up demand. This is now overshooting economies’ capacities and adds to inflationary pressures. This brings me to the third factor: expectations, there is no doubt in my mind that American and European income earners are worried about rising inflation.
Last year the Fed adopted a 2% average inflation target over the whole economic cycle. This average implies that inflation may temporarily be above the 2% norm, as long as it returns to this 2% in due time. This approach was later followed by the European Central Bank (ECB).
At the end of January last, Fed Chairman Jerome Powell hinted at an Fed interest rate raise this coming March to quell inflation; it is now 7 percent in the US. Markets expect interest rates to increase three more times this year. It was with the greatest possible care that Powell brought this intention up, since any increase in the interest rate will have negative repercussions: investments may drop, share prices may take a nose dive, and consumers may prefer to save rather than spend. In addition, the Fed had already announced that it would end their QE bond buy-up program, to limit the growth of the money supply. This is one side of the QE coin. The other side is the Fed selling the bonds again, known as Quantitative Tightening (QT) to limit the total money supply in circulation. The Fed said that QT would only start after a raise in the interest rate. The immediate result of Powell’s hints, was a 9 percent drop in the S&P 500 index of stocks. After all, higher interest rates make investing in shares less attractive.
What about the ECB; what are their plans to counter inflation, which is running at more than 5 percent in the Euro-zone? The Fed was very cautious in announcing an interest raise. The ECB is even more cautious. Why is this? At the end of 2021, ECB’s President, Christine Lagarde announced that ECB’s interest rate of zero percent would not be raised this year. What the ECB will do is very slowly decreasing their bond buy-up program, so as to keep interest rates of government bonds low.
The ECB is looking at the basic inflation; i.e., excluding volatile developments in energy- and food prices. This basic inflation figure is lower than in the US and the United Kingdom. And the ECB expects that energy prices will come down in the course of this year. Lagarde cautiously suggested that ECB’s interest rate will only increase in 2023.
But there is another reason why the ECB is not raising the interest rate now: the differences between the economies of Euro-zone countries. Should the ECB raise the interest rate, this will be very bad news for Southern ECB member-countries, such as Greece, Spain, and Italy, whose debt-to-GDP ratios have ballooned. Now, ending buying up bonds would shoot interest rates up, which will be very costly for these heavily indebted southern Euro-zone members. Such a decision, may also affect financial markets, especially in Italy, whose public debt is equal to 155 percent of GDP.
In sum, the Fed has to find a fine balance between raising rates enough to quell inflation but not so much that they tip economies into recession. The dilemmas for the ECB are even more complicated and potentially more dangerous than for the Fed. The ECB is to control two risks at the same time; one of inflation running out of control, and the other the prospect of defaults of heavily indebted member-countries.
Peter de Haan February 2022
Column March 2022
The State is back in business
After a fairly long time in which the market had the upper hand, the pendulum is swinging backwards into the state’s favour.
Why is that? This columns deals with the question.
The other day, I was reading a biography of Friedrich Hayek (1899-1992), the famous Austrian economist who was a passionate supporter of the market. He argued that the market and the prices established there were best equipped to allocate an economy’s scarce resources. Any government encroachment would lead to misallocation of these resources, resulting in inefficiencies, waste and loss of international competitiveness. In short, Hayek was a liberal economist, favouring the market over government intervention. There was another economist, even more radical in his beliefs than Hayek. This economist was no other than Milton Friedman (1912-2006) who once said: The business of business is business. What Friedman implied with this bon mot is that business left to itself is not just good for business but also good for society. So, urged Friedman, leave business alone. And he added: the smaller government intervention the better!
Since the 1980s, the neoliberal system of free trade and globalisation brought the world a lot of good, pulling hundreds of millions of poor people out of dire poverty thanks to emerging economies’ economic growth. Producers saw their markets enlarge and consumers benefitted from lower prices of many goods. However, this was not the whole story. The darker side of the coin was that industrial jobs were lost in high-income countries, as emerging economies produced manufacturing goods cheaper. And the environment deteriorated; pollution and climate change are now recognised as serious problems. Wages did not grow much, while the rich got wealthier – inequality grew. Last but not least, neoliberalism contributed to the 2008 global financial crisis. Governments had to step in to prevent a worldwide financial and economic meltdown.
Gradually, all this trigged discontent in high-income countries where employment in the manufacturing sector shrank. Politicians from these countries were quick to point the finger at more competitive countries. This development prompted, for example, former US President Trump to start a trade war with China, blaming China for unfair competition. Former American Secretary of the Treasury, Henry Paulson saw the prospect of an economic iron curtain – one that throws up new walls on each side and unmakes the global economy as he had known it.
The Covid-19 pandemic was neither good news for free traders and globalists. Immediately after the pandemic’s outbreak, countries realised with a shock that essential medical products, such as face masks, and medicines, which they used to produce themselves, were now supplied by only a handful producers, in particular from India and China. Governments decided to limit their dependence and started to renew the production of essential and strategically important goods at home. To counter the negative economic impact of the pandemic, governments, who could afford it, pumped huge amounts of money into their economies to prevent another looming financial crises. This helped a great deal; meanwhile, governments strengthened their role in the economy.
Now that the dust is settling after the worst of the covid-19 pandemic has passed, governments around the world consolidate their tighter grip in various ways, ranging from designing industrial strategies, to stepped-up regulation and reigning in the power of large business conglomerates.
Made in China’s 2025, China’s industrial strategy, is being copied by other countries. For example, France designed its own industrial strategy France 2030, which is not just focussing on strategically important industrial activities; the French film industry will receive a boost as well. Britain’s finance minister announced that the government will channel billions of pounds to research and development to promote industrial innovation. President Biden’s Innovation and Competition Act is yet another example of government-led investments. The European Union (EU) is heavily investing in battery production and digital innovations. Supply chains, which used to be globalised, are being localised again, to strengthen independence from foreign supplies, although foreign suppliers would probably have been able to produce these goods cheaper.
The war between Russia and Ukraine will no doubt lead to a strong self-sufficiency drive of EU member-countries in the realm of energy supply and other strategically important investments, such as defence materiel.
Already some time ago, President Xi launched a campaign for greater self-reliance and common prosperity. Vice-premier Liu He underscored President Xi’s campaign by saying that China was moving into a new phase that prioritises social fairness and national security. Nonetheless, China’s latest five-year plan, includes a dual-circulation strategy, consisting of a ‘great international circulation’, to keep China open to the world, and a ‘great domestic circulation’, to bolster its internal market. Needless to say, as a consequence of Covid-19, China’s great domestic circulation has gained in importance.
The move to a larger involvement in the economy has drawbacks. As I mentioned, Henry Paulson talked about an economic iron curtain, when he analysed the consequences of the so-called Sino-Western decoupling. Just one example: Nasdaq’s Golden Dragon China Index, which tracks Chinese firms listed in New York, fell by 43% last year.
Since 2006, regulatory restrictions ranging from trustbusting, to environmental, social and governance regulations, increased in most Western countries. The state wants a greater say in what businesses do. On the one hand they limit monopolistic tendencies and on the other they intend to protect the environment, workers and consumers. However, at the same time they also limit businesses’ manoeuvring space, and their innovative capacity. As Keynes would have said: they kill ‘animal spirits’.
Finally, taxation. Public opinion is not favourably disposed towards multinational and wealthy people, evading taxes. For example, American multinationals book two-thirds of their foreign profits in tax havens, twice as much as in 2000. To give you an idea of the magnitudes involved: in 2106 around $1 trillion of global profits were booked in so-called investment hubs, such as the Cayman islands, Ireland, and Singapore, where the average effective tax rate is only 5%. The OECD, the organisation of high-income countries, negotiated a new tax pact. A total of 136 countries have signed up to a 15% global minimal rate. This deal is planned to get into force in 2023. Affected multinational companies will think twice before launching a protest. As I said, public opinion is not in their favour at the moment.
The question is: will governments be able to find a middle way between more control, regulation and investment in business-oriented activities. Or will it, as Hayek said at the time, frustrate the efficient allocation of scarce resources? Will greater government involvement in the economy necessarily lead to inefficiency, less innovation and cronyism? Not necessarily, given the fact that there are many efficiently state-run companies across the globe. But there are also a lot of highly inefficient, capital guzzling ones. The key question is: will the pendulum swing backwards again in the state’s favour? Time will tell.
Peter de Haan March 2022