How are the benefits of economic growth shared across society? Much of the current discussion assumes that income inequality is rising, painting a gloomy picture of the rich getting richer while the rest of the world lags further and further behind. But is it really all bad news?
The reality is complex, but by looking at recent empirical data we can get a comprehensive picture of what is happening to the rich and poor.
Let’s start with the share of total income going to that much-maligned one per cent. Reconstructed from income tax records, this measure gives us the advantage of more than a century of data from which to observe changes.
The blue line in the left hand panel below shows the long-term trend in the US. Prior to the Second World War, up to 18% of the all income received by Americans went to the richest 1%. Following the war, the share of the top 1% dropped substantially, increasing again in the early 1980s until it returned to its pre-war level. This U-shaped long-term trend for top income share is not unique to the US; several other English-speaking countries shown in the left hand panel followed the same pattern. After a decline in the past, inequality is now on the rise.
But it’s not a universal phenomenon. The right hand panel shows that in a number of equally rich European countries, and in Japan, things developed quite differently. Just like in the countries on the left, the income share of the rich reached a low point in the 1970s, but then, rather than bouncing back up to previous levels, it remained flat or increased only modestly, giving us an L-shape on the graph. Income inequality has decreased drastically since the beginning of the 20th century so that today a much smaller share of total incomes is paid to the very rich.
One lesson to take away from this empirical research is that there is reason to believe that we can do something about inequality. If there was a universal trend towards more inequality it would be in line with the notion that inequality is determined by global market forces and technological progress, where it is very hard (or for other reasons undesirable) to change the forces that lead to higher inequality. It is dangerous to believe that there is a unanimous trend to higher inequality, as this encourages the belief that growing inequality is inevitable.
The reality of different trends suggests that it is not global forces that shape the distribution of incomes but the country-specific institutional and political framework. Therefore it is crucial to understand the institutional settings that allowed some countries to achieve economic growth without returning to the old levels of top income inequality. A major step in this direction is the forthcoming book from the inequality researcher Sir Tony Atkinson in which he makes concrete proposals on how to reduce inequality, based on the insights from periods in which inequality decreased.
The data on top income share do not measure the share of income that reaches the pockets of the rich, but rather the gross income before taxes are paid. Yes, the rich do avoid paying taxes, and top marginal income tax rates were higher in the past, but progressive taxation still does a great deal to narrow the gap between rich and poor: in the US, 37% of the total sum of income tax is paid by the top 1%, while less than 3% is paid by the bottom 50%. The redistribution means that the incomes of the poor are higher after taxes (because of transfer payments such as pensions, child benefits, and unemployment benefits) and the incomes of the rich are reduced after taxes (due to generally progressive income tax rates).
This difference between pre-redistribution ‘market incomes’ and eventual disposable income is shown in the next chart. Redistribution through taxes and transfers reduces inequality considerably.
In this chart inequality is measured with the Gini index, an inequality measure that not only looks at the top of the income distribution but captures the whole distribution.
We can see that market income inequality in the UK, the US, and France is fairly similar (Gini between .5 and .52) – but there are big differences in how much these countries reduce inequality by redistribution. Inequality in both market and disposable income are steadily increasing in the US, and compared to similarly rich countries the US redistributes comparatively less.
These data are based on household surveys, a shortcoming of which is that they under-report top incomes. Likewise, the shortcoming of the top income measure is that it is necessarily silent about what is happening within the bottom 99% of the distribution. Taking the ‘top 1%’ chart and the ‘market income vs disposable income’ charts together allows us to understand how inequality has developed. In the UK, the pre-tax share of the top 1% has been rising continuously since the late 1970s, but disposable income for all earners followed a very different trajectory, with inequality increasing rapidly in the 1980s but not changing much since then. If anything, income inequality has actually fallen in the UK over the last 25 years. In summary, the incomes of the poor in the UK are growing as fast as the incomes of the rich, apart from the top 1%, whose incomes are racing away.
Before we turn to the global income distribution I want to shift the focus from Europe and North America down to South America. In all of the South American countries shown in the following chart, income inequality has fallen since the year 2000. It is shown in the chart for the bigger South American countries (and it can be studied for the other countries on OurWorldInData.org here). Rapidly falling inequality in South America that lifts millions out of poverty is a huge success, and demonstrates once again that there is not one simple answer to whether inequality is rising or falling within individual economies.
We’ve looked at the changing income distribution within countries but what about the global picture? The chart below shows income estimates for the world in the year 1820, adjusted, as always, to take account of inflation and price level differences between countries. Two centuries ago no country in the world had a life expectancy over 40 years, and even in relatively rich countries like England and France the poor were so malnourished and weak that they were effectively excluded from the labour force. The share of the world population living in absolute poverty was estimated to be around 90%.
Over the next 150 years some countries achieved economic growth while others remained poor. While Europe and the European offshoots in North America and Oceania grew rapidly, most of Asia, most of Latin America and all of Africa remained poor. The consequence of this was a hugely unequal world. The bimodal (“two-humped”) blue line for 1970 shows the world income distribution of a planet clearly divided into rich and poor countries.
Since the 1970s the world has changed. The circle of countries achieving economic growth includes much of Asia, Latin America, and for the last two decades also includes Africa. The consequence of this is that global poverty is falling faster than ever before – the share of the world population living in poverty has decreased from over 50% in 1981 to 17% in 2011.
Because of rapid growth in formerly poor countries, the world income distribution has changed dramatically. The bimodal distribution of very high inequality across countries in 1970 has changed into a unimodal distribution of lower inequality today. The latest research on this question shows that the Gini index for global inequality has fallen from 72.2 in 1988 to 70.5 in 2008 (the last year for which we have data).
While there is no reason for complacency, it’s a fact that global poverty is falling faster than ever before, with the share of people living in poverty decreasing from more than 50% in 1981 to 17% in 2011. There is still a long way to go to improve living standards for the world’s worst-off, but we can take a clear and heartening message from the data: global income inequality is falling and global poverty is in decline.
If you are interested in long-term trends of living standards around the world follow me on Twitter where I share many data visualisations of long-term trends from my web publication Our World In Data.