HBR Blog Network

Why Income Inequality Is Here to Stay

by Branko Milanovic | 9:00 AM January 3, 2013

Before the global financial crisis, income inequality was relegated to the underworld of economics. The motives of those who studied it were impugned. According to Martin Feldstein, the former head of Reagan's Council of Economic Advisors, such people must have been motivated by envy. Robert Lucas, a Nobel prize winner, thought that "nothing [is] as poisonous" to sound economics as "to focus on questions of distribution." But amid bailouts, unemployment, and ever-fresh financial scandals among the top 1%, the issue of income inequality has seeped into the mainstream economics and become a legitimate subject of research. Yet most of this new research simply studies the problem; the ideas on how to check rising income inequality in the United States and elsewhere seem to be remarkably few. An observer might get the impression that the long neglect in which the study of inequality has been held resulted in dearth of ideas on how economic policy should deal with it. This is not true. Despite the impression that nothing more substantial can be said on the topic, economists and political philosophers have worked out, within fairly consistent frameworks, the ideas about what the optimal, or a better, distribution of income would be. I shall focus here on two, perhaps the most influential, approaches due respectively to the political philosopher John Rawls (http://en.wikipedia.org/wiki/John_Rawls) and economist John Roemer (http://en.wikipedia.org/wiki/John_Roemer) . Let's start with Rawls. In his Theory of Justice (http://www.amazon.com/Theory-Justice-Original-John-Rawls/dp/0674017722) (published in 1971), Rawls dismissed socalled "meritocracy" as wholly inadequate. In such a society, poor people are not formally barred from any career, but society does almost nothing to correct for the imbalance of the starting positions. In Rawls' view, what is needed is at least "liberal equality" where inheritance of wealth is limited and access to education is effectively equalized for all. This is because neither inherited wealth nor privileged education is something that one has obtained through her own efforts, but rather by the circumstances of her birth. As such, it should not influence one's income. Rawls went even further by favoring equalization of other "underserved" characteristics, such as talent, which is also inherited without any of the subject's contribution. In that view, he rejoined the Dutch economist Jan Tinbergen, the winner of the first Nobel Prize for economics some 40 years ago, who thought that paying for talent is like paying somebody a rent: it is an income that is strictly speaking unnecessary to bring forth production. A distribution which would adjust for all such "undeserved" circumstances (family and wealth into which one is born, and talents he or she inherited) must be, it would seem, very egalitarian. Not necessarily. By allowing income distribution to grow more unequal as long as it was compatible with greater absolute incomes of the poor, Rawls, in a peculiar version of trickle-down economics, left the door open for a potentially high inequality. First, incomes could be unequal if they corresponded to differences in effort "cleaned" of all inherited advantages and disadvantages, and second, if such

inequality was to the benefit of the poor . Both are very stringent requirements, yes, but after making severe corrections for all "underserved" original advantages, Rawls would have been comfortable with a substantial inequality in incomes. John Roemer, in his 1998 book Equality of Opportunity (http://www.amazon.com/Equality-Opportunity-JohnRoemer/dp/0674004221) and more recent writings, tried to further elaborate the idea that incomes should be proportional to effort, and should abstract from all circumstances that favor or disadvantage a person. Thus if there are two classes of people who, because of their different backgrounds, have different levels of productivity (say, the productive As, and the less productive Bs) incomes must not be decided based on this difference in productivity. Rather it is the effort that should be rewarded. Suppose that you belong to a disadvantaged class B, but that your effort puts you at the 80th percentile of all B's distribution of effort. Then you should be paid as much as an A who is at that same percentile point (80th) of all A's distribution of effort even if A, due to the advantage he or she inherited, produces more than you. Roemer's prescription would allow for relatively wide income inequalities within various classes of people (since we can assume that their effort levels will also be distributed very widely), but between-class inequality would be zero. As in Rawls's theory, incomes would depend on effort, "cleaned" of circumstances, but Roemer's overall income distribution could be narrower since there is no explicit provision that inequality may rise so long as absolute incomes of the poor benefit from it. When we therefore pose the question how to check rising inequality, political philosophers and economists do provide us with some answers which, when translated in political terms, range from relatively moderate reforms to very radical. Choosing Rawlsian liberal equality would mean a significant increase in tax rates paid by the rich, higher inheritance taxes, and equalization of real chances of access to the best education. Roemer's approach would further equalize earnings between various groups (defined by parents' education and income, race or gender), while allowing for variability of incomes within the groups. Finally, If we wanted to go even further, and to correct for the "rent" received by the talented, as required by Rawls' "democratic equality," an even more thoroughgoing equalization would occur. There would be perhaps limits on top salaries, or very high marginal tax rates (75%-90%) as well as much stronger emphasis on public provision of education (perhaps, for instance, nationalizing parts of assets held by private institutions such as Harvard and Yale and using them to boost the quality of public education). Thus, there are ideas on how to fight the forces that seem to be driving countries toward an inexorably rising inequality. But even this short sketch suffices to show how seemingly far away are these ideas from the mainstream political desires of the US electorate. For all but the tamest of these proposals, any popular support is lacking. Citizens seem to wish for things that are mutually inconsistent: lower inequality, greater equality of opportunity (so that inherited advantages matter less), and a continuation of current low-tax policies. It is difficult to see how the latter can, particularly in an era of technological revolutions when large fortunes are quickly made, lead to the outcomes much different from those of the last three decades. So, it seems, it is not the ideas that are wanting but willingness to try them.