When it comes to income inequality, it's all relative

Fri, Oct 12, 2012, 01:00

ISSUES OF fairness receive more attention in public discourse in Ireland than in most other countries. That equity is high on the agenda reflects a strong cohesiveness in this society and is itself a factor in the maintenance of that cohesion in the face of quite extreme economic circumstances.

An unusual feature of the equality debate here is its state-centric nature. A Martian arriving out of the blue might easily get the impression that government – what it does and does not do – determines income inequality. Politics matters, but economic and social factors are more important.

The main determinant of relative income inequality is the level of economic development. The rich world – Europe, followed by North America – is most equal globally, with the poorest continent, Africa, having the most unequal distribution of income.

Agrarian societies that grow beyond the size of tribes have never been anything but very unequal. Ownership of the key resource – land – tends to be highly concentrated and opportunities for advancement are few: a farm labourer in such a society has very little opportunity to change economic status, regardless of initiative or intelligence. But social fluidity increases when the development process gets under way. That process begets meritocracy, as illustrated by the marginalisation of landed aristocratic classes in the developed world.

The extent to which societies come to prize meritocratic values also plays a role in outcomes. Northern Europe has always been more meritocratic than Mediterranean Europe. Nordic societies are the most income-equal in the world because a deep belief in fairness led to the creation of a large redistributionist state, not the other way around.

A very large number of economic and social factors interact with political decisions – most notably in the form of tax and welfare systems – to affect income equality levels. Ireland’s experience illustrates the complex, multivariable nature of the dynamics driving income distribution.

Income inequality declined in the late 1990s (see chart). Explosive job creation resulting in the virtual disappearance of unemployment was the most important factor in compressing incomes at the time. If job creation pulled those at the bottom up, the return of lots of educated emigrants is likely have dampened wage growth at the upper end, further narrowing the gap.

The State played a role too. The introduction of the minimum wage at the turn of the century gave a boost to those on lower incomes, but big tax cuts are likely to have widened relative income inequality as they benefited higher earners the most. This period was curious in that booms usually cause less equality of income – entrepreneurs’ profits rise more rapidly than wages in good times. It may be that because this period of boom was driven by foreign-owned companies that this effect was limited.

From a low point in 2001, income inequality began to rise again. In the period that followed, indigenous entrepreneurs drove a boom in the property sector. The fortunes made pushed incomes up at the top end.

The immigration wave in the first decade of this century is likely to have had the opposite effect on equality as that of the 1990s. Most new arrivals this century have been foreign, and foreigners arriving in new countries are more likely to work in lower skill industries. This probably dampened wage growth in these sectors.

Offsetting these effects were an increasing number of lower income earners being exempted from tax and rapid increases in most welfare payments – the growth in the social transfers bills exceeded even the growth of the public sector pay bill.

The bursting of the bubble led to another change in the direction of the trend. Incomes became more equal, as normally happens in slumps. The numbers of higher-earning self-employed shrank by even more than salaried employees, big bonuses evaporated, the equities-owning class saw its income fall as bank shares ceased paying dividends, savers lost interest income as rates were slashed and many of the billionaire developer class lost their shirts.

But then in 2010, the most recent year for which figures are available, the single biggest annual change in income equality took place. This has caused some puzzlement in scholarly circles. The decline in employment was much smaller than 2008-09 and tax increases in 2010 made the income tax system even more progressive. The decline in net income for those lucky enough to retain well-paid jobs was almost certainly greater than falls in incomes of those depending on welfare.

Next month the 2011 figures come out. They will show whether what happened in 2010 was a statistical aberration.

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