Across the great divide: Wealth inequality in New Zealand

Wealth inequality has gone from a fringe concern to one of the defining issues of our time. It’s even become something that New Zealand businesses may need to take seriously.

“What Thomas Piketty has done is start shooting up the positions that the neoliberals used to hold as a matter of accepted practice, positions where their heavy artillery has been squatting for decades.” It is with this dramatic metaphor that New Zealand economist Geoff Bertram describes the effect that Piketty’s blockbuster Capital in the Twenty-First Century has had on his profession – and intellectual circles more generally – around the world. Until recently, the neoliberal argument – that inequality is simply the result of people being rewarded for their hard work and effort – has held sway. This has led to one of two conclusions: either inequality would continue increasing, as was right and just; or, if government action could be reduced to the absolute bare minimum and the right incentives created, everyone would be freed up and encouraged to work hard and use their talents productively, leading to reduced inequality.

Piketty’s argument, in contrast, is that extremely high levels of inequality, as were seen in the Victorian era, are the natural ‘steady state’ for capitalism. And that steady state is not the result of people’s hard work or effort but is driven by largely predetermined economic forces – in particular, the way that invested wealth grows faster than wages and salaries do.

His prediction, of a massive concentration of wealth at the top ushering in a century of huge income gaps, has put inequality front and centre of world debate – if it wasn’t there already. The IMF, the OECD and the World Bank have all warned in recent years that income inequality is both an economic and social problem. This year’s World Economic Forum, where the great and good of global business gathered, cited widening income gaps as the single greatest threat to economic growth. And just last month, ratings agency Standard and Poor’s downgraded its view of the American economy largely because of its sky-high inequality levels. Piketty isn’t solely responsible for these concerns, but he has given them the biggest boost imaginable.

Income inequality has long been a rallying cause on the left and in social policy circles, especially since 2009’s The spirit level, which linked wider income gaps with a huge range of health and social problems across developed countries. But what we are seeing now is an increasing acceptance in business and economic circles that inequality is a problem for everyone – and that people in those circles, too, may need to reach out across the increased divide between the haves and the have-nots. If they don’t, the argument runs, they risk dealing with a society that is increasingly fractured, dysfunctional and unable to pull together to tackle the biggest problems.

So is the issue being discussed in the New Zealand context? “Absolutely,” says Shamubeel Eaqub, who, as principal economist with the New Zealand Institute for Economic Research, speaks frequently to policy makers and business audiences around the country. “Certainly in the policy context of fairness and equity, those issues, inequality and poverty, are discussed with far more gravity and frequency than in the past.”

He cites two reasons for this increased discussion: the recession, with all the effects it has had on those at the bottom of the spectrum, and the “surging” global interest in the subject. “Those two things have created the perfect storm in terms of raising it in policy circles.” To that one might add New Zealand’s recent world-beating rise in income gaps. From the mid-1980s to the mid-2000s, inequality rose faster here than anywhere else in the developed world, albeit from a very low base. People in the poorest 10% of the country now have less to spend, once housing costs are deducted, than they did in the 1980s; meanwhile, incomes at the very top have doubled.

This poses a problem for businesses on several fronts, economists say. For a start, it offends an ingrained sense of fairness. At the level of the individual business, Britain’s High Pay Commission found convincing evidence in a 2011 report that big income gaps within a company were extremely demotivating for ordinary staff. Those staff compared their rewards with those received by senior management, and where the gap was significant, the comparisons resulted in feelings of injustice.

“Injustice in turn erodes engagement [and motivation]”, the commission noted. Staff at the wrong end of a big pay gap were less supportive of senior management’s goals, whereas workers who felt treated fairly were more likely to identify strongly with their company and “internalise” managers’ goals. For modern companies, where the quality of what is produced, the service provided and ultimately the success of the business is often determined by the motivation of employees, the effects of this disengagement can be hugely damaging. International evidence suggests businesses with highly engaged workforces have growth rates more than double those with less engaged staff. Based on this kind of evidence, the commission noted, “Within-firm pay inequality is associated with lower firm performance.”

Big income gaps can also reduce consumer demand. The US economist Joseph Stiglitz argues that unequal economies channel money away from low and middle-income households, who typically spend anything extra they receive, and direct it instead to the rich, who tend to save a significant portion of their income. As the American venture capitalist and billionaire Nick Hanauer points out, despite his own great wealth, he still only buys one pair of jeans a year. The same income, spread amongst thousands of ordinary households, would do far more to stimulate the economy. Income inequality has also been cited as one of the prime drivers of the global financial crisis (GFC). IMF researchers Andrew Berg and Jonathan Ostry argue that the root cause of the GFC was that low- and middle income households couldn’t afford basic things like buying a house because the American economy was diverting so much of national income to the richest few. Those low- and middle-income households ended up borrowing the money they needed – from those very people at the top, who had unusually large amounts of money looking for a home. The GFC was simply the inevitable unwinding of that arrangement.

These arguments find varying degrees of acceptance among economists. But a more basic reason to be worried about income gaps – one that is very broadly accepted – is inequality’s effect on social cohesion. “Having big gaps between haves and have-nots ... is a problem,” Eaqub says. “It frays social cohesion, trust and sense of community. Lose that empathy within the community and things don’t work so well.”

Auckland University economist Tim Hazledine made this point in his 1998 book Taking New Zealand seriously. The less people trust each other, he argued, the more effort has to be devoted to policing interactions, bringing in lawyers, managing things rather than doing – all of which is highly inefficient. (Inequality can also be a huge barrier to adaptation: US academic Dani Rodrik has provided strong evidence that unequal societies, lacking this trust and sense of shared interest, are less likely to carry out the adjustments needed to respond to major economic shocks.) For all these reasons, Eaqub says, there is now discussion of inequality in business circles, even if that debate is “still in its infancy”. In a recent presentation on the economy that he gave to a group of chartered accountants, “Someone stood up and said, ‘Why didn’t you mention poverty?’”.

That wording is telling, however, because poverty is only half the equation. Inequality, properly speaking, is not just about the gap between those at the lowest end and the middle: it is also about the gap at the other end, the one created by the rich pulling further and further away from the middle. It involves, in the words of New Zealand political economist Robert Wade, asking ourselves whether the sharp increase in income concentration at the top “should have prompted a large body of social science research and public debate about the question: ‘When are the rich too rich?’”

In contrast to the debate around poverty, this is not a discussion that most people in New Zealand’s business and economic circles want to have. Warehouse CEO Mark Powell may have said earlier this year that he is “embarrassed” by how much he earns, but he followed that up by saying of his salary: “It is what is.”

And that’s how it should be, says Business New Zealand head Phil O’Reilly. He sat on the Expert Advisory Group on Solutions to Child Poverty in 2012, and says he is kept awake at night worrying about “the people circling around the bottom”. But he cautions against linking those concerns to a drive to curb high salaries. “Those at the top pay quite a lot of tax. If you start doing too much of that [curbing top incomes], those people will leave.” Social cohesion matters, O’Reilly says – but that applies to the wealthy, too. “You need to make sure that everyone buys into the social contract. I don’t see many wealthy New Zealanders bitching about how much tax they pay. So you don’t want to get into a debate where those who might pay the bulk of the tax simply leave.”

Eaqub agrees, saying that if he had to prioritise one or the other, poverty “ranks much higher” than inequality in the broader sense. “If I had a limited amount of resources to implement policy that would survive the tumult of politics, I would go for poverty alleviation rather than inequality measures [such as higher taxes], which are more likely to be changed by a change in government.”

Both Eaqub and O’Reilly advocate a stronger focus on education, especially for those at the bottom, in order to boost social mobility. Their focus is on equality of opportunity, not equality of outcome. The problem here, however, is that international evidence suggests very strongly that creating more equal opportunities is extremely difficult without first reducing income gaps. The Canadian labour economist Miles Corak has a graph, known informally as The Great Gatsby Curve (page 34), which shows just how closely the two issues are linked. In egalitarian Denmark, only one fifth of your income as an adult can be predicted from what your parents earned. In the highly unequal US, your parents’ income predicts half of what you will earn. (In this graph, New Zealand is about where we would expect to be, slightly worse than average with an inherited income factor of around one third, in line with our slightly worse than average inequality ranking.)

It’s not hard to see why the two things are linked, Corak argues. In very unequal societies, children grow up with very different advantages, including the housing they live in, the food that parents can afford to give them, and the kind of schooling they receive. Those advantages or disadvantages are then amplified and reinforced in adulthood, and passed onto the next generation. In very equal countries, in contrast, most parents have sufficient income to give their children a decent start, and high-quality public services help further reduce the gap. These countries, it might be noted, close up the inequality gap at both ends, boosting incomes for poorer families and paying for that by levying much higher taxes on the rich.

There are other reasons to be sceptical about any approach that ignores what is going on at the richer end, says Auckland University economist Susan St John. Writing earlier this year, she argued that the forces that make some people poor are the same ones that make other people rich. “Deregulation of the labour market, ostensibly to give workers a chance to get a job, produces the low wages that allow higher profits to flow to the shareholders. The poorly paid need cash support such as Working for Families to sustain demand and so to sustain profits while allowing wages to be low … Likewise, the tax-funded Accommodation Supplement is appropriated in higher rents by landlords. GST on everything is part of the flat tax mantra and allows flatter lower tax rates for top incomes.” In this “trickle up” world, St John says, wealthier people can’t avoid thinking about their own role in widening inequality.

And it is very much those wealthier people who are the focus of Thomas Piketty’s work and what has variously been dubbed the ‘Piketty phenomenon’ and the ‘Piketty panic’. The core of his argument (see ‘The Piketty Companion’ on page 35) is that the world needs to be very, very worried about concentrations of wealth. Many centuries’ worth of economic data, compiled by Piketty and colleagues, show that the rate of return on invested wealth is typically much greater than the growth in wages and salaries. When wealth becomes increasingly concentrated at the top, as it is now, those with wealth are likely to pull further and further away from the rest, until the economy reaches a ‘steady state’ of very high inequality reminiscent of the Victorian era.

Piketty’s arguments have commanded world attention thanks to exceptional data, and because he is a highly respected economist. “There is nothing fringe at all about Piketty’s work,” Bertram says.

Does his argument apply in New Zealand? Not according to O’Reilly. "I just don’t think Piketty runs [here]. I get quite upset about people saying, because I read a book or I saw some statistics about another country, that that must apply to New Zealand.” And it’s certainly true that New Zealand’s wealth data is extremely poor. But we do know that our wealthiest 10% control half of all net assets, as is the case in the countries that Piketty discusses, such as Sweden and Germany. And there is some evidence, from the NBR Rich List and elsewhere, that that concentration is growing.

There may be reason to believe, then, that Piketty’s arguments do apply, and that he has provided one more reason for kiwi companies to think that a widened gap between the rich and the rest is going to harm them. “There’s enough of a burning platform [for action], even if we’re not at the same point as the United States,” Eaqub says. His advice for warding off the threat of spiralling inequality? “Let’s do something earlier, now, in a more gradual fashion.” It might prove to be the most painless option. ×

The Piketty Companion

Thomas Piketty’s Capital in the Twenty-First Century is, Shamubeel Eaqub says wryly, “one of those books that everybody has something to say about, but nobody has read”. And that’s perhaps fair enough: not everyone has the stomach for 700 pages of economic argument, no matter how many Jane Austen references it may contain. So what do you need to know about Piketty if you’re going to have something to say?

The extraordinary success of the book rests on one key insight: capitalist economies do settle at a ‘natural’ distribution of income and wealth – but one with extremely high levels of inequality, like those seen in the class-ridden 19th century (hence all the Austen references). At that time, the top 10% owned a staggering 90% of all wealth (much of it inherited), and took home 45% of all income. In addition, the return that the wealthy made on their investments, around 4-5%, was naturally much greater than the growth in wages and salaries, which was around 1-2%. This difference ensured that those with wealth would, in the natural order of things, hold onto their privileged position in perpetuity. This is what economists call an ‘equilibrium’, a settled state – one determined, Piketty argues, by the relationships between an economy’s natural rates of growth and saving.

This arrangement was shattered by two world wars and the Great Depression, which both destroyed the rich’s assets (whether physical or financial) and put in place a political settlement (with strong trade unions and the like) that constrained the returns they could get on their remaining wealth. Assets became more evenly spread, and wages and salaries grew faster than investments, for the first time in history. This, Piketty argues, was the real explanation for the ‘golden age’ of postwar equality.

Since the 1980s, however, the natural order of things has been reasserting itself. The rate of return on assets has been rising back to its usual level, and wage growth has been slowing down, also to its historical level. This is driving the top 10%’s share of wealth and income rapidly upwards, back towards its 19th-century level, though we aren’t quite there yet. In this perspective, the mid-20th century seems less like a natural progression in history than a one-off exception to the rule, while the future looks discomfortingly Victorian, an ‘equilibrium’ state with a hugely powerful asset-owning class holding most of the wealth and income.

Geoff Bertram, who has a chapter in the forthcoming Bridget Williams Books work ‘The Piketty Phenomenon: New Zealand Perspectives’, points out that all these conclusions are open to challenge, as economic works always are. But, if they survive criticism, their contribution will have been enormous. “Piketty’s theory that the economy finds equilibrium in a state of very high inequality – that’s the Nobel prize-winning bit, that’s the bit where he has done what no one else has done.”

For many people, Piketty among them, the thought that capitalism naturally leads back to very high levels of entrenched inequality is a frightening one. This leads Piketty to suggest a solution: a progressive global wealth tax. Every year, people with wealth of more than, say, €1 million would pay a tax worth, say, 1% of the value of their assets; those with wealth of over €5 million would pay 2%; and so on. This would reduce the ultimate return on invested wealth, redistribute assets, and help stave off Victorian-style levels of wealth accumulation.

In addition, to prevent high income earners from accumulating large amounts of wealth in the first place, the top tax rate in developed countries should be as high as 80%. (Since high salaries are largely the result of increased bargaining power, rather than actual merit, this would be entirely justified, Piketty argues.) These solutions are controversial and, in the case of the global wealth tax, highly unlikely to be implemented, given the difficulties of international cooperation. But, in Piketty’s view, they represent the world’s best hope of avoiding a return to the Victorian era.