Income Inequality Is Good For The Poor

Income Inequality Is Good For The Poor

A comparison of global data shows that developed countries with more income inequality have higher standards of living for the poor and middle class.
Scott Winship
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Arguments against income inequality come in two flavors. The first asserts that inequality is simply unfair or distasteful. Some people do not want to live in a world in which the top 1 percent of earners pulls in more than 20 percent of income, particularly when its take in Scandinavian countries is far below the American share and when today’s American share is far more than the same share 35 years ago.

More commonly, those upset about income inequality appeal to the supposed consequences of inequality. Observers routinely argue that the growth of inequality has robbed the poor and middle class of their rightful share of the economic pie and even that inequality has shrunk the pie itself. They compare the United States unfavorably with various developing countries, as if our comparable inequality levels mean that America is no more appealing than some of the poorest nations in the world. For instance, Georgia Levenson Keohane, a fellow at the left-leaning Roosevelt Institute, says Americans “are living, some argue, in a North American banana republic: our income inequality is worse than that of Guyana, Nicaragua, and Venezuela. When it comes to shared prosperity, we keep company with Iran and Yemen.”

Of course, the American middle class is much more affluent than its counterparts in these countries—more than three times richer than in Venezuela or Iran, and more than ten times richer than in the others. Our poorest households are similarly better off compared with the poor in these nations. In fact, despite the claims that more inequality leads to lower living standards below the top, the patterns across the developed nations of the world suggest that if anything, higher inequality is accompanied by richer middle class and poor populations.

What the Data Says about Income Inequality

I recently analyzed data on national living standards from three different sources encompassing 160 countries. I compared the living standards enjoyed by the poor and by the middle class to inequality measures from two sources. These comparisons consistently showed that once the developed nations of Europe, Asia, and the English-speaking world are distinguished from the developing world, there is a tendency for countries with more inequality to have higher living standards below the top.

These findings make sense if you are open to the idea that greater inequality might actually increase the size of the economic pie rather than shrinking it.

The one exception was that countries that have more income concentration in the top 1 percent of households tend to have poorer low-income populations. None of these point-in-time comparisons, however, constitute very strong evidence that inequality raises or hurts living standards. Any number of economic, political, cultural, or demographic factors could be operating undetected, making it look like inequality affects living standards even though something else is behind both.

Stronger evidence comes from looking at how changes in inequality relate to changes in living standards. Data from sociologist Lane Kenworthy indicate that the tendency is for countries with larger increases in income concentration within the top 1 percent to have stronger income gains not only within the middle class but among the poor.

These findings make sense if you are open to the idea that greater inequality might actually increase the size of the economic pie rather than shrinking it. That is, if economic growth is strong enough—enlarging the pie by a sufficient amount—then even though the slices going to the poor and the middle class are comparatively skinnier, they still end up with more pie. The mistake that decriers of inequality make is to assume that the economic pie is fixed, so that a bigger slice for the top must necessarily result in less pie for everyone else. In fact, the evidence from economic research over the past 15 years is that in developed countries, more inequality tends to go hand in hand with stronger economic growth.

The United States Doesn’t Have More Income Inequality

My analyses focus on inequality before governments redistribute income through progressive taxes and cash transfers. Another reason that inequality does not tend to lead to lower living standards in the developed world is that below the top 1 percent, inequality before taxes and transfers does not vary much across rich countries. By the most used measure, inequality within the bottom 99 percent is barely higher in the United States than in Denmark.

By the most used measure, inequality within the bottom 99 percent is barely higher in the United States than in Denmark.

This is surprising, given how much governments can influence income inequality even before they tax and spend. Some governments have labor policies that strongly favor unions, or they set relatively high minimum wages. Government regulation can promote or retard entrepreneurship and make it more or less costly to hire workers. Some countries mandate generous vacations and paid leave. Various policies can affect marriage and fertility. Yet, setting aside how much income the top 1 percent earn, all of this “pre-distribution” appears to matter little for inequality.

The United States—and to a lesser extent other English-speaking countries—differs from continental Europe in that we redistribute much less than they do. As I show in the paper, continental Europe is unique among the nations of the world in the amount of income it redistributes.

Clearly, there are cultural factors at work. A 1999 survey asked respondents from 27 countries whether they agreed that “it is the responsibility of government to reduce differences in income.” In continental Europe, the percentage agreeing ranged from 57 to 90 and was generally 70 or higher. In the English-speaking nations, the percentage agreeing never exceeded 68 and was generally 50 or lower. In the United States, just 35 percent agreed—lower than in any other country. Cultural factors are also likely to explain why the United States has higher income concentration than other countries even before taxes and transfers.

All of this matters greatly for policy debates. Increasingly, two main issues underlie all other economic disputes: (1) whether the United States should become more like Europe in its welfare state and economic institutions or whether it should remain uniquely receptive to free-market capitalism and (2) whether high and rising inequality has hurt the poor and middle class, in which case the argument that we should embrace Europe’s policies becomes more attractive. The evidence suggests that inequality, if anything, leads to higher living standards for everyone. Our values and our economic performance are not in conflict.

Scott Winship is the Walter B. Wriston Fellow at the Manhattan Institute.

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