The coronavirus pandemic has shown once again the importance of inequality. It may seem that the virus does not distinguish between the rich and the poor, the educated and the illiterate, people from prosperous and disadvantaged background. However, as always, inequality matters. If you have a big house, it is easier for you to get through the lockdown. If you are educated, you are quite likely to switch to remote work. If you have savings, it is easier for you to survive a losing a couple of months worth of your income, let alone pay for food delivery instead of going to a store.
A number of studies have already shown that during the epidemic it is better to be rich and educated to stay healthy. In developed countries (even in the United States), authorities are taking unprecedented measures to ensure equal access to healthcare during the crisis. For example, a study by economists from Columbia University shows that New York City has managed to administer an equal number of coronavirus tests to both rich and poor. However, poor people are more likely to test positive – as they have to go out for work or shopping, thus in poor neighborhoods, the risk of contracting the disease is much higher.
Unequal outcomes and unequal opportunities
Inequality has always been an important subject of economic research, but it started attracting particular attention after the 2008-09 crisis. It was at this point when it became clear that not everybody benefitted equally from globalization and economic growth of the 1990s and 2000s.
It turned out that the ones who gained the most from globalization and technological progress were the “global top 1%” (the high-skilled knowledge workers in advanced economies) as well as the so-called 'global middle class’ that mainly consists of Chinese and Indian workers. At the same time, the ‘lower’ middle classes in developed countries suffered from wage stagnation and job losses due to automation and competition with imports from developing countries. It catalyzed the Occupy Wall Street protest movement, sharply increased the popularity of Thomas Piketty’s book Capital in the Twenty-First Century, and brought about a significant rise in populism in the US and Europe.
Why are Western societies concerned about growing inequality? The answer to this question is not as obvious as it might seem. Income inequality in itself does not necessarily lead to injustice or inefficiency. For example, the command economies had much lower levels of income inequality, but they were neither fair nor efficient. If everyone is paid equally, what is the point of working harder? And it is certainly not fair that those who work hard earn as much as those who do nothing?
This is why economists distinguish between inequality of outcomes (for example, income inequality) and inequality of opportunity. If initial opportunities are equal, it is in no way unfair or inefficient that harder-working and more talented individuals earn more. A number of experiments have shown that people disapprove of unfair inequality while having a positive or neutral attitude towards fair inequality.
Unfair inequality is first and foremost unequal opportunities. How can it be measured? The first way is to quantify intergenerational mobility by calculating the correlation between parents’ and children’s. The most accurate estimations have been carried out in developed countries with longitudinal income tax data, such as those of the US or Sweden. However, in recent years, the World Bank has also developed the Global Database on Intergenerational Mobility (GDIM), which helps estimate intergenerational mobility in cohorts born between 1940 and 1989 in 148 countries.
The other approach, “IOp”, is to decompose inequality of outcomes (e.g. income inequality) into inequality that is driven by exogenous factors (such as parental background, gender, race, ethnicity, place of birth, etc.) and into the remaining inequality due to effort and luck. Following this approach, researchers analyze income distribution in a country and measure the contribution of factors outside of an individual’s control to income inequality; this part of inequality captures inequality of opportunity. For instance, see such estimates for all post-communist countries in the EBRD Transition Report 2016-2017.
Implications of unfair inequality
Inequality of opportunity is both unfair and inefficient. It is inefficient because a person born “in the wrong place and at the wrong time” cannot realize their potential, thus reducing productivity of the whole economy. It is unfair because it, in fact, suggests the existence of privileges of birth, which are considered unacceptable in modern society. As a result, a society with higher inequality of opportunity is more likely to be politically unstable, which also has a negative impact on economic growth.
Can we say that inequality has a negative influence on economic growth? In the 1990s, a number of cross-country studies showed that it is difficult to identify reliable correlations between inequality and growth: the results depend on the sample, time period, specification of econometric models, etc. However, in their recent paper, IMF economists Shekhar Aiyar and Christian Ebeke make progress by taking advantage of the recently collected data on inequality of opportunity (the very GDIM dataset discussed above). They show that in a sample of countries with low inequality of opportunity (the countries with ‘fair’ inequality) there is no correlation between income inequality and economic growth. At the same time, the countries with high inequality of opportunity have a strong negative correlation between income inequality and growth. In these countries, the higher the inequality, the slower the economic growth – as, in these countries, inequality is unfair and inefficient.
Aiyar and Ebeke demonstrate that in countries with equal opportunities, even high initial income inequality does not have negative effects on economic growth. They highlight the need for institutions that break the link between income (and wealth) inequality and unequal opportunities. These institutions ensure that the rich and poor are equal before the law and have equal access to politics and media. Without these institutions, income inequality becomes inequality of opportunity.
Even if members of the older generation earn their wealth through fair competition, they are tempted to change the rules of the game to ensure the prosperity of their children. This brings about the ‘Great Gatsby Curve’ proposed by American economist Alan Krueger in 2012, showing that countries with high-income inequality (Latin American countries, the US, and China) also have low intergenerational mobility. The countries that have managed to avoid high inequality of opportunity are mainly the Nordic and some Anglo-Saxon countries (excluding the US). What do they have in common? Democratic institutions, independent media, intolerance of corruption, and reasonably equal access to high-quality education and healthcare.
