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Inequality’s conditional legitimacy

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Figure 1: how Bermuda compares to OECD counrties on a measure of income inequality

In the first of a two-part commentary, economist Robert Stubbs examines inequality in Bermuda.

My recent column exposing our unenviable, internationally extreme degrees of income inequality and poverty in Bermuda, advocating for the adoption of a thoughtfully designed and carefully implemented living wage on the island, elicited varied reaction ranging from sympathetic understanding and agreement, to a more circumspect scepticism, to outright derision and dismissal. Such a range of opinion is only natural when broaching economic solutions of a fundamentally redistributive nature. That much is to be expected.

What was more interesting were the genuine doubts expressed regarding the validity of my argument, and in this regard many of my critics had misgivings in a common area of concern. While many people in Bermuda are willing to concede poverty is an undesirable economic outcome, giving rise to a multitude of harmful social and economic consequences, many are unwilling to accept extreme income inequality is similarly damaging.

So why did I choose to conflate the two? Why speak of the “twin afflictions” of extreme income inequality and poverty? After all, isn’t income inequality an inherent condition of a well-functioning, productive capitalist system?

This is a common view shared often globally, raising pertinent economic questions of considerable importance. In other countries, economists typically respond to such criticism by citing various research establishing the multiple causal pathways by which extreme income inequality acts to curtail the life chances of the disadvantaged, thereby impeding social mobility and entrenching deprivation among the poor. Regrettably, such responses are often of limited effect.

While many may accept extreme inequality’s damaging consequences — such as causing greater residential and social segregation, or producing unequal access to quality education, or denying impoverished parents the ability to make other life-changing investments in their children, or producing less extensive and privileged social networks, not to mention the natural hereditary differences in inherited incomes — many consider effective solutions to these longstanding, widely recognised problems as particularly elusive. And, more often than not, the seemingly unyielding nature of such intractable problems consigns many to feelings of resignation and despair.

I believe a more effective reply to these concerns will more adequately recognise inequality’s inherent political dimensions. In addressing this criticism, I provide a more precise statement of my argument’s claims, framing the problem in terms that establish important relations between the most consequential facts at issue. Such are the benefits of framing the problem as such, it not only formally acknowledges a link between inequality and poverty, it lends considerable insight in the historical circumstances facilitating the development of these unfortunate conditions, both here and in the wider world, and centres attention on the most significant impediments to date obstructing effective global reform.

Without question, income inequality is an intrinsic condition of capitalism. Any economic system designed to incentivise risk taking will necessarily result in the unequal income of investors. Entrepreneurs must be compensated for taking risk, and their incomes will vary depending on the success or failure of their ventures.

But market incomes vary in compensation for numerous other factors as well. Take the professions for instance. Income earned in the professions must bear some relation to the time, effort and expense of obtaining the requisite qualifications. Earning qualification as a surgeon, professor or, even, actuary requires years of relatively arduous study. Individuals obtain such qualifications at an older age, resulting in shortened careers, and, if these professions did not offer higher incomes, their ability to attract sufficient aspiring candidates would be seriously compromised.

So income inequality is not only to be expected, it is indeed necessary for a well-functioning capitalist system. To be sure, a certain degree of income inequality enhances the productivity or efficiency of an economy. But this must be a condition of diminishing returns.

The hypothetical circumstance of one person receiving an entire country’s income exists only as a theoretical conjecture. At some point, greater income inequality becomes self-defeating.

So how much is too much? How might we judge whether a given level of income inequality is economically, socially and, potentially even, politically harmful? What possible criteria might we apply in gauging whether a country’s inequality is excessive?

While precise evaluations of inequality’s optimal level may be the purview of empirical economists, are there any conditions the public could monitor for telltale signs of inequality’s excess? Or, to pose the problem slightly differently, are there any preconditions to inequality’s legitimacy?

I believe there decidedly are, and I suggest we begin with the following most fundamental two. The first precondition to inequality’s legitimacy is that the lowest income individuals of a country are receiving enough income to maintain a socially accepted adequate standard of living. One may quibble over how “socially accepted” is to be determined, but in general it can be considered a consensus of opinion which will vary from country to country.

The second most basic precondition to inequality’s legitimacy is that individuals in the upper half of a country’s income distribution are paying their socially accepted fair share of taxes. (The economic significance of these conditions is that the first addresses both a symptom and cause of harmful levels of inequality, while the second addresses a significant cause).

The full value of framing the problem as such begins to emerge when we move to its implementation, for how might we apply such criteria? What economic data would we use in assessing whether these preconditions are met? If a consensus of opinion is to be formed, what data would the public require in making such an evaluation?

While a host of economic data would be helpful in performing such an assessment, unquestionably the following two would be the best place to start:

1, A historical incidence of poverty presenting both its current level and change over time (Figure 2), and;

2, A tax incidence analysis displaying the full burden of taxation (in direct and indirect taxes) across a country’s entire income distribution (Figure 3).

And therein lies the rub. Governments worldwide publish vast quantities of economic data, much of it in exhaustive detail, and yet it is precisely in the areas of poverty and relative tax burdens governments keep their citizens most uninformed. It is this very information, the data most important to assessing inequality’s legitimacy, governments most guardedly resist disclosing.

In my last column, I wrote of Singapore’s and Bermuda’s resistance to recognising the full extent of their poverty. Indeed, Singapore refuses to adopt a definition of poverty, let alone publish an estimate of its incidence, but these are not the only countries whose governments have taken active measures to conceal unwelcome poverty news. This occurs frequently in countries large and small, in both the offshore and onshore worlds.

Every four years, the German government commissions private researchers to produce an official report regarding poverty and wealth in Germany, crucial sections of which the government routinely amends, weakens or drops altogether prior to its official publication. The latest report was published last year, after a delay of one and a half years, during which substantial portions were removed concerning the corrupting influence of concentrated wealth on Germany’s democratic process.

Even worse, while the report itself showed a deteriorating poverty situation in Germany, particularly among children and the elderly population, in an executive summary provided by the government, the report’s findings were cunningly misconstrued to the public. For instance, although the report found more than half a million German children living in abject poverty, in households unable to provide such basic necessities as adequate food or heating, the government’s executive summary referred to “only few children” living in “conditions of substantial material deprivation”.

In Canada, not only has the federal government long resisted calls to adopt a definition of poverty, effectively framing the determination of an official Canadian poverty line, but the Canadian government historically has shown great difficulty in divulging poverty data required under its international obligations. For almost 40 years following the formation of the Organisation for Economic Co-operation and Development in 1961, the Canadian government refused to provide the OECD with the data it required to periodically update the OECD’s measure of poverty in each member state.

Robert Stubbs is an economist, CFA, holds an International Bond Dealer Diploma and has completed the ACAS actuarial exams. He was formerly head of research for Bank of Bermuda and his professional interests at present lie in enterprise risk management

Figure 2: more people are struggling financially
Figure 3: lower income groups pay out a higher proportion of income in taxes