Review: Is inequality a crisis or just capitalism?

June 22, 2012

By Richard Beales
The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

Is rising U.S. income inequality a disaster, or just capitalism? In “The Great Divergence”, Timothy Noah analyses the 30-odd year trend, and concludes it’s a crisis. Yet earning differences are inevitable in any kind of market system. It’s arguably not so much inequality per se as the real decline in middle-class incomes that justifies serious concern.

The trend has made U.S. income distribution, as measured by the widely used Gini coefficient, among the most unequal in the Organisation for Economic Co-operation and Development. With a coefficient of 0.38 (after taxes and transfers) in the mid-2000s as cited by Noah, only Portugal, Turkey and Mexico were more unequal. “Economically speaking, the richest nation on earth is starting to resemble a banana republic”, Noah writes.

Such rhetoric reflects the author’s left-of-center political stance, as does his use of a phrase coined by economist Paul Krugman for the title of his book. Ideology doesn’t prevent him from a nuanced evaluation of a wide array of ideas and economic research about the causes of U.S. inequality. He doesn’t, for example, dismiss immigration as a factor. On the other hand, he makes an intriguing case that the Great Divergence owes something to the decline of organized labor, arguing that strong unions may have helped keep inequality stable or even narrowing in the midst of rising overall prosperity.

Noah isn’t entirely persuasive that income inequality, even growing inequality, is necessarily bad in itself. But he does shed light on how the American middle class has been hollowed out by economic changes, and how ordinary families have often seen little, no or negative changes in their inflation-adjusted paychecks – even as the rich have got much richer. In other words, the rising tide is lifting some boats far more than others. In the United States of late, some lesser craft are sinking.

A triennial Federal Reserve survey, released earlier this month, reinforces the point. Between 2007 and 2010, thanks to the financial crisis and presumably its effect on investment income, the rich – and everyone else except the poorest 20 percent of families – saw their median real incomes go down. Perhaps more significantly, the overall median U.S. family income in 2010 was also down more than 6 percent in real terms since the 2001 survey, against a decline of only just over 1 percent for the top decile of families.

Moreover, the median net worth of American families was down a sharp 27 percent, after inflation, over those nine years, while the median wealth within the top 10 percent of incomes was up 17 percent. The rich do get richer, even through tough times.

Noah discusses the impact of government policy on inequality and also shows how America isn’t the socially and economically mobile haven many of its citizens imagine. That’s important, because some observers claim, essentially, that inequality doesn’t matter in the United States, where everyone can improve their lot by working hard. It’s not that easy.

“The Great Divergence” is fuzzy in places. It pays too much attention to the huge wealth concentration in banks and boardrooms. The phenomenon exists – look no further than the planned purchase, revealed this week, of Hawaii’s sixth-largest island Lanai by Oracle billionaire Larry Ellison for a rumored $500 million or more – but it is more anecdote than the heart of the problem.

And in contrast to his analysis, Noah’s prescriptions seem a tad ideological. The rich should probably pay more tax. It’s hard to see why they shouldn’t pay at least the same rates as the relatively poor, preferably without the mind-numbing range of deductions and tweaks allowed by the current U.S. tax code. But proposing a 70 percent top marginal rate of income tax, even though that has existed in the past, seems unrealistic and not merely provocative, as the author may have intended.

Electing Democratic presidents, another proposal, rests on a record that shows they have generally overseen income gains across the board rather than just for the rich. But it would have been less cute to try to identify the relevant policies rather than the politics.

There are other suggestions in a relatively short concluding section. But Noah doesn’t claim to know all the answers. What he does do in the bulk of the book is raise important questions while providing a very readable and broad-ranging history of American income distribution over roughly the course of the 20th century. And even more than rising inequality, it’s the notion that the middle class is falling behind in absolute as well as relative terms – and in both income and wealth – that makes “The Great Divergence” worthwhile and well timed.

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