The always-thoughtful John E. Roemer gave a talk on "The Ideological and Political Roots of American Inequality" at a conference last February. The talk is available as a working paper here; a revised version of the talk appears as an article with the same name in the September-October issue of Challenge magazine, which is available on-line if your library has a subscription. I quote here from the working paper version.
A First Argument for Inequality: Individuals Deserve to Benefit from Their Endowments
The first argument that Roemer considers for inequality is "an ethical one, that individuals deserve to benefit from what nature and nurture endows them with ... The first argument is presented in its most compelling form by thephilosopher Robert Nozick, who in his 1974 book, Anarchy, State and Utopia, advanced the idea that a person has a right to own himself and his powers, and to benefit by virtue of any good luck that may befall him, such as the luck of being born into a rich family, or in a rich nation. ... Nozick is the first the admit that actual capitalist economies are not characterized by historical sequences of legitimate, voluntary exchanges: there is much coercion, corruption, and theft in the history of all societies. But Nozick’s point is that one can imagine a capitalism with a clean history, in which vastly unequal endowments of wealth are built up entirely from exchanges between highly talented, well educated people and simple, unskilled ones, and this unequal result is ethically acceptable if one accepts the premise that one has a right to benefit by virtue of one’s endowments – biological, familial, and social – or so he claims."
Responses from Rawls and Dworkin to this first argument
"The philosophical response to Robert Nozick’s libertarianism came primarily from two political philosophers, John Rawls and Ronald Dworkin. ... Rawls attempted to construct an argument that, if rational, self-interested beings were shielded from the knowledge of the luck they would sustain in the birth lottery, which assigns genes and families, they would opt for a highly equal distribution of wealth – indeed, for that distribution which maximizes the wealth that the poorest class of people would have. . ... The error in Rawls’s argument that those in an original position, behind a veil of ignorance, would choose a highly equal distribution of income, came from his assumption that the decision makers postulated to occupy this position were completely self-interested. Self-interested individuals may be willing to take some risk in the birth lottery – they may be willing to accept some possibility of an unlucky draw in return for the possibility of a lucky draw. ... This does not mean that a strongly equalizing tax system is ethically wrong: but to justify it with the kind of argument Rawls wished to
construct requires that individuals care at least to some degree about others. Rawls’s attempt to derive equality of results from premises of rationality and self-interest fails. ... There was another aspect of Rawls’s theory that was unattractive to some: there was no evident place in it for the role of personal responsibility and accountable choice. ... Ronald Dworkin, in 1981, published a pair of articles which addressed this problem in a radical, new way. He advocated what he dubbed ‘resource equality’ ... In Dworkin’s view, people should be held responsible for their preferences, but not for their resources – where resources include many of the goods that Rawls called morally arbitrary, such as genetic endowments and the social and familial circumstances of one’s childhood. ... Thus, a degree of equality was recommended that was less than Rawlsian, but far more than exists in most advanced democracies today."
A Second Argument for Inequality: Incentives
The second argument that Roemer considers about inequality is "the instrumental one: that only by allowing highly talented persons to keep a large fraction of the wealth that they help in creating will that creativity flourish, which redounds to the benefit of all, through what is informally called the trickle-down process. In a word, material incentives are necessary to engender the creativity in that small fraction of humanity who have the potential for it, and state interventions, primarily through income taxation, which reduce those material rewards, will kill the goose that lays the golden eggs."
A Response: Contrasting The Market Role in Coordination and Incentives
"Economists have long realized that markets perform two functions: they coordinate economic activity, and they provide incentives for the development of skills and innovations. It is not easy to give a definition which distinguishes precisely between these two functions, but there is no question that a conceptual distinction exists. ... In the last thirty or forty years, the economic theorist’s view of the market has changed, from being an institution which performs primarily a coordination function to one that is primarily harnessing incentives. Indeed, the old definition of micro-economics was the study of how to allocate scarce resources to competing needs. This is entirely a coordination view. ...
It may surprise you to hear that the phrase ‘principal-agent problem’ was only introduced into economics in 1973, in an article by Steven Ross. In the principal-agent problem, coordination is not the primary issue – rather, a principal must design a contract to extract optimal performance from an agent whose behavior he cannot perfectly observe. This is par excellence an incentive problem. ...
"The punch line I am proposing is this: to the extent that the market is primarily a device for coordination, taxation can redistribute income without massive efficiency costs. But if the market is primarily a device for harnessing incentives, the efficiency costs of redistribution may be high. ..Although economic theory has shifted on this question during the last generation, it is far from obvious that the shift is empirically justified – by which I mean, we do not know that the market’s role in incentive provision is as important as current economic theory contends. ..."
"I have argued that these high incomes are inefficient, because of risk-taking externalities that they induce, that they are unnecessary for incentive provision, and that they create a class with disproportionate political power. Finally, there is the very important negative externality of the creation of a social ethos which worships wealth. ... In sum, the positive social value of the institution of extremely high salaries that the leaders of the corporate world, and in particular, of the financial sector, receive, is a big lie. It may well be a competitive outcome, but it is a market failure which could be corrected by regulation or legislation."
A Third Argument for Inequality: Policy Futility
"A third argument for inequality, which is currently most prevalent in the United States, is one of futility: even if the degree of inequality that comes with laissez-faire is not socially necessary in the sense that the incentive argument claims, attempts by the state to reduce it will come to naught, because the government is grossly incompetent, inefficient, or corrupt. ... This is, I think, a particularly American view, so it is probably not appropriate to spend much time on it here."
How Does Inequality Affect Economic Growth?
Historically, many economists believed that a healthy degree of economic inequality was good for economic growth. Branko Milanovic explains in "More or Less":
In "Why Aren't All Countries Rich?", Jessie Romero of the Richmond Federal Reserve discusses some patterns in this literature. As this figure shows, the Latin America and the Sub-Saharan Africa regions have consistently had the greatest degree of inequality.
Thus, given the relatively slow growth rates in these regions in the 1980s and 1990s, and the comparatively fast growth rates in more-equal Asia, economic research at that time had often claimed a connection between greater inequality and slower growth. However, in 1996, Klaus Deininger and Lyn Squire ("A New Data Set Measuring Income Inequality", World Bank Economic Review, 10(3): 565-91, 1996) pointed out that this kind of comparison across countries didn't control sufficiently for other factors that could vary across regions and countries, like variations in political and social institutions or in initial level of development. In their analysis, with these kinds of factors taken into account, the degree of economic inequality didn't seem to influence subsequent growth.
More recently, Andrew G. Berg and Jonathan D. Ostry have been taking a look at the relationship between inequality and the length of periods of economic growth, and their readable summary of their results is here. They write (citations and references to charts have been cut):
In their work, interestingly enough, income inequality and trade openness are major factors in determining how long periods of growth will last, while political institutions and foreign direct investment are of intermediate importance, and external debt and exchange rate competitiveness are of little importance.
"The view that income inequality harms growth—or that improved equality can help sustain growth—has become more widely held in recent years. ... Historically, the reverse position—that inequality is good for growth—held sway among economists. The main reason for this shift is the increasing importance of human capital in development. When physical capital mattered most, savings and investments were key. Then it was important to have a large contingent of rich people who could save a greater proportion of their income than the poor and invest it in physical capital. But now that human capital is scarcer than machines, widespread education has become the secret to growth. And broadly accessible education is difficult to achieve unless a society has a relatively even income distribution. Moreover, widespread education not only demands relatively even income distribution but, in a virtuous circle, reproduces it as it reduces income gaps between skilled and unskilled labor. So economists today are more critical of inequality than they were in the past."The economic literature on the possible causal relationship between inequality and growth seems to have gone from arguing for such a connection in the 1980s and early 1990s, to arguing that the connection wasn't so important in the mid-1990s, and now back to arguing that it may be important.
In "Why Aren't All Countries Rich?", Jessie Romero of the Richmond Federal Reserve discusses some patterns in this literature. As this figure shows, the Latin America and the Sub-Saharan Africa regions have consistently had the greatest degree of inequality.
Thus, given the relatively slow growth rates in these regions in the 1980s and 1990s, and the comparatively fast growth rates in more-equal Asia, economic research at that time had often claimed a connection between greater inequality and slower growth. However, in 1996, Klaus Deininger and Lyn Squire ("A New Data Set Measuring Income Inequality", World Bank Economic Review, 10(3): 565-91, 1996) pointed out that this kind of comparison across countries didn't control sufficiently for other factors that could vary across regions and countries, like variations in political and social institutions or in initial level of development. In their analysis, with these kinds of factors taken into account, the degree of economic inequality didn't seem to influence subsequent growth.
More recently, Andrew G. Berg and Jonathan D. Ostry have been taking a look at the relationship between inequality and the length of periods of economic growth, and their readable summary of their results is here. They write (citations and references to charts have been cut):
"Most thinking about long-run growth assumes implicitly that development is something akin to climbing a hill, that it entails more or less steady increases in real income, punctuated by business cycle fluctuations. ... The experiences in developing and emerging economies, however, are far more varied. In some cases, the experience is like climbing a hill. But in others, the experience is more like a roller coaster. Looking at such cases, Pritchett and other authors have concluded that an understanding of growth must involve looking more closely at the turning points—ignoring the ups and downs of growth over the horizon of the business cycle, and concentrating on why some countries are able to keep growing for long periods whereas others see growth break down after just a few years, followed by stagnation or decay. A systematic look at this experience suggests that igniting growth is much less difficult than sustaining it. Even the poorest of countries have managed to get growth going for several years, only to see it peter out. Where growth laggards differ from their more successful peers is in the degree to which they have been able to sustain growth for long periods of time."
In their work, interestingly enough, income inequality and trade openness are major factors in determining how long periods of growth will last, while political institutions and foreign direct investment are of intermediate importance, and external debt and exchange rate competitiveness are of little importance.
Herbert Hoover, Deficit-Spender: Correcting John Judis in The New Republic
In the October 6 cover story for The New Republic, titled "Doom!", John B. Judis admonishes readers to beware the economic lessons of the 1930s--and then proceeds to make a number of incorrect statements about what happened in the 1930s.
In the third paragraph, Judis pats himself on the back for asking Mitt Romney a tough question. Judis asked: "I want to ask you something about history.You know, when Herbert Hoover had to face a financial crisis and then unemployment, his strategy was to balance the budget and cut spending, and that made things worse. When Roosevelt came in, unemployment was twenty-five and went to fourteen percent by 1937. With deficits. Aren't you repeating the Hoover mistake?"
Before listing the various mistakes here, the actual spending, debt, and deficit numbers starting in 1930, both in nominal terms and as a share of GDP, are readily available in the Historical Tables volume that is published each year with the president's proposed federal budget. All numbers I quote here are from the "Historical Tables" volume in the 2012 budget. From that source, you can easily confirm the following facts:
1) Hoover's budget strategy over his term of office was not to balance the budget. The budget ran a small deficit of -.6% of GDP in 1931, followed by a much larger deficits of 4.0% of GDP in 1932 and 4.5% of GDP in fiscal year 1933 (which, as Judis points out at a different point in his discussion, started in June 1932 and was thus mostly completed before Roosevelt took office in 1933).
2) Hoover did not cut spending. In nominal terms, federal spending went from $3.3 billion (!) in 1930 to $4.6 billion in 1933. Given price deflation during that time, the real increase in government spending would have been larger. With the economy declining in size, federal outlays more than doubled from 3.4% of GDP in 1930 to 8.0% of GDP in fiscal year 1933.
3) Because of this pattern, it would be hard to find an economic historian to argue that fiscal tightness was a significant factor in worsening the Great Depression from 1929 to 1932. The economic literature has for half a century focused on how overly tight monetary policy deepened the Depression, and has noted at length how the dysfunction of monetary policy at that time worked through banks and the financial system and through the exchange rate to hinder the economy. It would also be hard to find an economic historian to argue that the primary reason for the drop in unemployment rates from 1933 to 1937 was a surge of expansionary fiscal policy.
4) During the 1932 presidential campaign, Franklin Roosevelt promised to wipe out the Hoover budget deficits and instead to run a balanced budget. In his first few months after taking office, FDR tried to put this policy into effect--before soon abandoning it. For a source, here is a description from the quick history at the Franklin D. Roosevelt American Heritage Center Museum: "Roosevelt promised in his 1932 campaign that he would end the deficits that had plagued the Hoover administration and restore a balanced budget. This he never did, and eventually he would come to consider deficit spending a useful and necessary response to recession. In 1933, however, he remained committed to fiscal orthodoxy, and on 10 March he asked Congress to pass legislation cutting government salaries and veterans' benefits. Both Houses passed the Economy Act within days, despite protests from some progressives who argued correctly that the measure would add to the deflationary pressures on the economy... The New Deal soon departed from these conservative beginnings."
It gets worse. Judis writes (a bit smugly) how Romney evaded his question, and then writes: "But he [Romney] seemed to be suggesting that the premise of my question was flawed because deficits are much larger today and will probably continue unabated. And they are larger--but that is because our GDP and government are also larger."
But deficits as a share of GDP are much larger now than than they were in the Great Depression. The two biggest deficits in the 1930s were 5.5% of GDP in 1936 and 5.9% of GDP in 1934. The budget deficit was 10.0% of GDP in 2009, 8.9% of GDP in 2010, and (estimated) 10.9% of GDP in 2011.
Judis believes that additional fiscal stimulus is warranted. I supported both the Bush fiscal stimulus package in 2008 and the Obama stimulus package in 2009, although I had some disagreements with their design and targetting. While I do think it's tremendously important to get the U.S. deficits under control in the middle term, I wouldn't try to slash the deficit in the short run with unemployment still up around 9%.
But the notion that the Great Depression was an example of highly active fiscal stimulus and the Great Recession was not is upside-down. Recent years have seen a far larger fiscal stimulus in response to a lower unemployment rate than in the 1930s. During the Great Depression, Franklin Roosevelt faced unemployment rates of 25% and continued the Hoover policy of budget deficits, running deficits no larger than 5.9% of GDP and more usually in the range of 3-4% of GDP through the 1930s. During the Great Recession, the U.S. economy experienced unemployment of nearly 10%, and has responded with fiscal stimulus on the order of 10% of GDP.
And the elephant in the room, which Judis doesn't discuss, is the accumulation of debt. After all of the deficits of the 1930s, the total ratio of federal debt held by the public still totaled only 44.2% of GDP in 1940. Throughout the 1930s, the federal government had a lot of capacity to borrow--and could then still ramp borrowing much higher to finance the fighting of World War II. But in 2011, total federal debt held by the public is an estimated 72% of GDP. Looking ahead over the next decade, the federal government has a lot less capacity to borrow.
ADDED: For a follow-up on the post on October 4, see my post on More Herbert Hoover: Father of the New Deal.
In the third paragraph, Judis pats himself on the back for asking Mitt Romney a tough question. Judis asked: "I want to ask you something about history.You know, when Herbert Hoover had to face a financial crisis and then unemployment, his strategy was to balance the budget and cut spending, and that made things worse. When Roosevelt came in, unemployment was twenty-five and went to fourteen percent by 1937. With deficits. Aren't you repeating the Hoover mistake?"
Before listing the various mistakes here, the actual spending, debt, and deficit numbers starting in 1930, both in nominal terms and as a share of GDP, are readily available in the Historical Tables volume that is published each year with the president's proposed federal budget. All numbers I quote here are from the "Historical Tables" volume in the 2012 budget. From that source, you can easily confirm the following facts:
1) Hoover's budget strategy over his term of office was not to balance the budget. The budget ran a small deficit of -.6% of GDP in 1931, followed by a much larger deficits of 4.0% of GDP in 1932 and 4.5% of GDP in fiscal year 1933 (which, as Judis points out at a different point in his discussion, started in June 1932 and was thus mostly completed before Roosevelt took office in 1933).
2) Hoover did not cut spending. In nominal terms, federal spending went from $3.3 billion (!) in 1930 to $4.6 billion in 1933. Given price deflation during that time, the real increase in government spending would have been larger. With the economy declining in size, federal outlays more than doubled from 3.4% of GDP in 1930 to 8.0% of GDP in fiscal year 1933.
3) Because of this pattern, it would be hard to find an economic historian to argue that fiscal tightness was a significant factor in worsening the Great Depression from 1929 to 1932. The economic literature has for half a century focused on how overly tight monetary policy deepened the Depression, and has noted at length how the dysfunction of monetary policy at that time worked through banks and the financial system and through the exchange rate to hinder the economy. It would also be hard to find an economic historian to argue that the primary reason for the drop in unemployment rates from 1933 to 1937 was a surge of expansionary fiscal policy.
4) During the 1932 presidential campaign, Franklin Roosevelt promised to wipe out the Hoover budget deficits and instead to run a balanced budget. In his first few months after taking office, FDR tried to put this policy into effect--before soon abandoning it. For a source, here is a description from the quick history at the Franklin D. Roosevelt American Heritage Center Museum: "Roosevelt promised in his 1932 campaign that he would end the deficits that had plagued the Hoover administration and restore a balanced budget. This he never did, and eventually he would come to consider deficit spending a useful and necessary response to recession. In 1933, however, he remained committed to fiscal orthodoxy, and on 10 March he asked Congress to pass legislation cutting government salaries and veterans' benefits. Both Houses passed the Economy Act within days, despite protests from some progressives who argued correctly that the measure would add to the deflationary pressures on the economy... The New Deal soon departed from these conservative beginnings."
It gets worse. Judis writes (a bit smugly) how Romney evaded his question, and then writes: "But he [Romney] seemed to be suggesting that the premise of my question was flawed because deficits are much larger today and will probably continue unabated. And they are larger--but that is because our GDP and government are also larger."
But deficits as a share of GDP are much larger now than than they were in the Great Depression. The two biggest deficits in the 1930s were 5.5% of GDP in 1936 and 5.9% of GDP in 1934. The budget deficit was 10.0% of GDP in 2009, 8.9% of GDP in 2010, and (estimated) 10.9% of GDP in 2011.
Judis believes that additional fiscal stimulus is warranted. I supported both the Bush fiscal stimulus package in 2008 and the Obama stimulus package in 2009, although I had some disagreements with their design and targetting. While I do think it's tremendously important to get the U.S. deficits under control in the middle term, I wouldn't try to slash the deficit in the short run with unemployment still up around 9%.
But the notion that the Great Depression was an example of highly active fiscal stimulus and the Great Recession was not is upside-down. Recent years have seen a far larger fiscal stimulus in response to a lower unemployment rate than in the 1930s. During the Great Depression, Franklin Roosevelt faced unemployment rates of 25% and continued the Hoover policy of budget deficits, running deficits no larger than 5.9% of GDP and more usually in the range of 3-4% of GDP through the 1930s. During the Great Recession, the U.S. economy experienced unemployment of nearly 10%, and has responded with fiscal stimulus on the order of 10% of GDP.
And the elephant in the room, which Judis doesn't discuss, is the accumulation of debt. After all of the deficits of the 1930s, the total ratio of federal debt held by the public still totaled only 44.2% of GDP in 1940. Throughout the 1930s, the federal government had a lot of capacity to borrow--and could then still ramp borrowing much higher to finance the fighting of World War II. But in 2011, total federal debt held by the public is an estimated 72% of GDP. Looking ahead over the next decade, the federal government has a lot less capacity to borrow.
ADDED: For a follow-up on the post on October 4, see my post on More Herbert Hoover: Father of the New Deal.
Global Equality and the Lucas Horse Race
It is possible that although inequality within many countries is rising, global inequality is actually falling. After all, a number of countries with lower levels of per capita income, like China and India, have been experiencing rapid growth. Perhaps from a global viewpoint, the gap between high and low incomes is diminishing even though within countries, that gap has been rising.
In the Winter 2000 issue of my own Journal of Economic Perspectives, Robert E. Lucas
contributed "Some Macroeconomics for the 21st Century." He offers a horse-racing metaphor that I have found useful in explaining the rise in global inequality over the last couple of centuries--and he predicts that the 21st century will be one of greater global equality. Here's Lucas:
Milanovic writes: "Global inequality seems to have declined from its high plateau of about 70 Gini points in 1990–2005 to about 67–68 points today. This is still much higher than inequality in any single country, and much higher than global inequality was 50 or 100 years ago. But the likely downward kink in 2008—it is probably too early to speak of a slide—is an extremely welcome sign. If sustained (and much will depend on China’s future rate of growth), this would be the first decline in global inequality since the mid-19th century and the Industrial Revolution.
One could thus regard the Industrial Revolution as a “Big Bang” that set some countries on a path to higher income, and left others at very low income levels. But as the two giants—India and China—move far above their past income levels, the mean income of the world increases and global inequality begins to decline."
In the Winter 2000 issue of my own Journal of Economic Perspectives, Robert E. Lucas
contributed "Some Macroeconomics for the 21st Century." He offers a horse-racing metaphor that I have found useful in explaining the rise in global inequality over the last couple of centuries--and he predicts that the 21st century will be one of greater global equality. Here's Lucas:
"We consider real production per capita, in a world of many countries evolving through time. For modelling simplicity, take these countries to have equal populations. Think of all of these economies at some initial date, prior to the onset of the industrial revolution. Just to be specific, I will take this date to be 1800. Prior to this date, I assume, no economy has enjoyed any growth in per capita income—in living standards—and all have the same constant income level. I will take this pre-industrial income level to be $600 in 1985 U.S. dollars, which is about the income level in the poorest countries in the world today and is consistent with what we know about living standards around the world prior to the industrial revolution. We begin, then, with an image of the world economy of 1800 as consisting of a number of very poor, stagnant economies, equal in population and in income.What is the evidence on global inequality? Branko Milanovic offers a useful figure, where inequality is measured by the Gini coefficient. For those not familiar with this term, the quick intuition is that it is a measure of inequality where 0 represents complete equality of income and 100 represents complete inequality (one person has all the resources). Here is a figure showing Gini coefficients for relatively equal Sweden, the less equal U.S. economy, the still-less-equal Brazilian economy, and the world economy.
"Now imagine all of these economies lined up in a row, each behind the kind of mechanical starting gate used at the race track. In the race to industrialize that I am about to describe, though, the gates do not open all at once, the way they do at the track. Instead, at any date t a few of the gates that have not yet opened are selected by some random device. When the bell rings, these gates open and some of the economies that had been stagnant are released and begin to grow. The rest must wait their chances at the next date, t + 1. In any year after 1800, then, the world economy consists of those countries that have not begun to grow, stagnating at the $600 income level, and those countries that began to grow at some date in the past and have been growing every since.
The first is that the first economy to begin to industrialize—think of the United Kingdom, where the industrial revolution began—simply grew at the constant rate a from 1800 on. I chose the value α = .02 which, as one can see from the top curve on the figure, implies a per capita income for the United Kingdom of $33,000 (in 1985 U.S. dollars) by the year 2000. ...
So much for the leading economy. The second assumption ... is that an economy that begins to grow at any date after 1800 grows at a rate equal to a α = .02, the growth rate of the leader, plus a term that is proportional to the percentage income gap between itself and the leader. The later a country starts to grow, the larger is this initial income gap, so a later start implies faster initial growth. But a country growing faster than the leader closes the income gap, which by my assumption reduces its growth rate toward .02. Thus, a late entrant to the industrial revolution will eventually have essentially the same income level as the leader, but will never surpass the leader’s level. ...
"Ideas can be imitated and resources can and do flow to places where they earn the highest returns. Until perhaps 200 years ago, these forces sufficed to maintain a rough equality of incomes across societies (not, of course, within societies) around the world. The industrial revolution overrode these forces for equality for an amazing two centuries: That is why we call it a “revolution.” But they have reasserted themselves in last half of the 20th century, and I think the restoration of inter-society income equality will be one of the major economic events of the century to come."
Milanovic writes: "Global inequality seems to have declined from its high plateau of about 70 Gini points in 1990–2005 to about 67–68 points today. This is still much higher than inequality in any single country, and much higher than global inequality was 50 or 100 years ago. But the likely downward kink in 2008—it is probably too early to speak of a slide—is an extremely welcome sign. If sustained (and much will depend on China’s future rate of growth), this would be the first decline in global inequality since the mid-19th century and the Industrial Revolution.
One could thus regard the Industrial Revolution as a “Big Bang” that set some countries on a path to higher income, and left others at very low income levels. But as the two giants—India and China—move far above their past income levels, the mean income of the world increases and global inequality begins to decline."
The Kuznets Curve and Inequality over the last 100 Years
The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel first started being given in 1969, the backlog of worthy economists who were deserving of the prize was very large. Thus, it was a considerable compliment when the third Nobel prize given in economics went to Simon Kuznets in 1971. Among other major contributions, Kuznets was one of the primary contributors to thinking through the issues of constructing national income accounts and GDP. But my focus here is on a theory which grew out of his Presidential Address on "Economic Growth and Income," delicvered to the American Economic Association in 1954 and published in the March 1955 issue of the American Economic Review. This lecture led economists to speak of a "Kuznets curve."
Here's a short explanation of the logic behind the Kuznets curve from Branko Milanovic in the September 2011 issue of Finance and Development has several articles with perspectives on inequality. "The Kuznets curve, formulated by Simon Kuznets in the mid-1950s, argues that in preindustrial societies, almost everybody is equally poor so inequality is low. Inequality then rises as people move from low-productivity agriculture to the more productive industrial sector, where average income is higher and wages are less uniform. But as a society matures and becomes richer, the urban-rural gap is reduced and old-age pensions, unemployment benefits, and other social transfers lower inequality. So the Kuznets curve resembles an upside-down `U.'"In 2011, of course, the notion that inequality always declines as an economy grows no longer seems plausible. Later in the same issue, Facundo Alvaredo offers some nice figures of trends in inequality around the world since about 1900, where inequality is measured by the share of total income going to the top 1% of the income distribution. There are four figures, each with a group of countries. "In Western English-speaking countries, inequality declined until about 1980 and then began to grow again. Continental European countries and Japan had a decline until about 1950; since then income distribution has leveled. For Nordic and Southern European countries, the drop in inequality in the
early part of the century was much more pronounced than the rebound in the late part of the period. Developing countries show initial declines in inequality followed by a leveling off in some cases and an increase in inequality in others."
For a series of posts in July on the extent and causes of U.S. income inequality, see:
How high is U.S. income inequality?
Causes of Inequality: Supply and Demand for Skilled Workers
How the U.S. Has Come Back to the Pack in Higher Education
An Inequality Parade
The Global Biomedical Industry
Ross C. DeVol, Armen Bedroussian, and Benjamin Yeo write on "The Global Biomedical Industry: Preserving U.S. Leadership," which is available (with free registration) from the Milken Institute website. In this industry, they include pharmaceuticals, medical devices and equipment, and the accompanying research, testing, and medical labs. Some excerpts (footnotes deleted throughout):
The U.S. hasn't always been a leader in biomedical technologies
The shift to U.S. leadership in pharmaceuticals
The share of new chemical entities for the world as a whole produced by firms with a U.S. headquarters rose from about 31-32% in the 1970s and 1980s to 57% in the most recent decade. The U.S. share of global pharmaceutical R&D spending has risen to roughly half the world total over the last decade.
The U.S. has no guarantee of continuing its technological leadership
The U.S. advantage in regulatory processes and clinical trials is diminishing
The U.S. hasn't always been a leader in biomedical technologies
"Prior to 1980, European firms defined the industry, both in terms of market presence and in their ability to create and produce innovative new products. Historical advantages and an enviable concentration of resources fueled the success of firms in Germany, France, the U.K., and Switzerland. Japan had a presence in the industry as well. But beginning in the 1980s, the United States surged to the forefront of biomedical innovation. This sudden and remarkable shift was no accident: It was the result of strong policy positions taken by the federal government. The absence of price controls, the clarity of regulatory approvals, a thoughtful intellectual property system, and the ability to attract foreign scientific talent to outstanding research universities put the U.S. on top."
The shift to U.S. leadership in pharmaceuticals
The share of new chemical entities for the world as a whole produced by firms with a U.S. headquarters rose from about 31-32% in the 1970s and 1980s to 57% in the most recent decade. The U.S. share of global pharmaceutical R&D spending has risen to roughly half the world total over the last decade.
The U.S. has no guarantee of continuing its technological leadership
"The dominance enjoyed by the U.S. biomedical industry does not come with a long-term guarantee. The U.S. assumed the mantle of leadership by being the first to commercialize recombinant DNA research—and that achievement was made possible only because it had built an environment and infrastructure that allowed innovation to flourish. But if another nation duplicates or improves upon this formula by building a similar ecosystem and subsequently makes a pivotal scientific breakthrough in nanotechnology, personalized medicine, embryonic stem cell research, or some other cutting-edge field, it could tip the scales in the other direction. That scenario is a real possibility: While the U.S. led with 29.7 percent of nanotech-related patents granted between 1996 and 2008 (as measured by resident country of first-name inventor), China was a close second, with 24.3 percent of these patents. ... Pharmaceutical patents that credit at least one inventor in China or India rose four-fold between 1996 and 2006—China held 8.4 percent and India 5.5 percent of worldwide patents. Other countries in Asia and around the world are also making advances, among them Taiwan, South Korea, Malaysia, Australia, Canada, Brazil, and Chile. ... In stem cell science, other nations with sophisticated biomedical research infrastructure in place—including the U.K., Japan, France, Switzerland, and several others—have instituted more flexible government funding guidelines than the U.S. These nations have been attracting leading embryonic stem-cell researchers from countries with more restrictive policies."
The U.S. advantage in regulatory processes and clinical trials is diminishing
"While the FDA has seen an increase in average review times, the European Medicines Agency (EMA) has been streamlining. After declining to 12.3 months in 2007, the average FDA review time for new drugs increased to 17.8 months in 2008. This number does fluctuate, and while it improved in 2009, anecdotal evidence suggests that the 2010 numbers will reflect a slowdown. Meanwhile, the EMA has reduced its drug approval time to 15.8 months. ... Medical device approvals from the FDA have become even more problematic than drug approvals. The EMA approves some devices in almost half the time it takes for similar approvals by the FDA. ..."
"Innovation is the driver of ultimate market success, and the U.S. originated more than half of the leading 75 global medicines (or new active substances as measured by worldwide sales) in 2009. Clinical trials are a critical step in that process as well as a benchmark that reflects the degree of innovation taking place in a given location. As of early 2011, 50.9 percent of all clinical trials in the world were being held in the U.S. Despite the size of its clinical capacity, the average relative annual growth in the U.S. declined by 6.5 percent between 2002 and 2006. Meanwhile, trial growth, particularly among emerging nations, outpaced the U.S. during that time. In countries
like China and India, average relative annual growth increased by 47 percent and nearly 20 percent, respectively. ...
Clinical trials are a lengthy and expensive step in the U.S., but other countries are finding ways to make trials faster and more cost-effective.As shown below, emerging markets such as China and India can conduct clinical trials for about half the cost of those in the U.S. Russia is even more cost-effective and offers experienced researchers trained in “Good Clinical Practice” standards set by the International Conference on Harmonization. In Russia, 8,000 (or 1 in 86) physicians are involved in clinical trials. ... In addition to cost advantages, these emerging nations also have vast populations that make it faster and easier to enroll the required number of patients in a trial. According to the Association of Clinical Research Organizations, completely enrolling patients in a phase III clinical trial for a cancer treatment would take almost six years in the U.S. However, if companies have access to a global pool of patients, the process could be cut to less than two years. These new international options for clinical trials pose clear benefits to U.S. firms: They can conduct some
portions of their testing overseas, reducing their time and costs while gaining valuable knowledge about how to adjust their compounds as they move through the U.S. approval process. An estimated 40 to 65 percent of clinical trials that investigate FDA-regulated products are conducted outside the U.S., although many of these trials are for comparative purposes.
"But taking a longer view, this trend raises a cautionary flag for U.S. competitiveness. Clinical trials require scientific staff, and as other nations develop this specialty, they are amassing high-value experts, infrastructure, and technical capacity. U.S. firms will increasingly have to fight for their share of a finite pool of global talent and investment dollars, and the U.S. economy may lose high-wage jobs. In 1997, according to the Tufts Center for the Study of Drug Development, about 86 percent of FDA-registered principal investigators were based in the United States, but by 2007, that was down to only about 54 percent."
How Are Global Investors Allocating their Assets?
The second chapter of the IMF's most recent Global Financial Stability Report is about "Long-Term Investors and their Asset Allocation: Where Are They Now?" Here are a few of the main themes, with citations and footnotes eliminated throughout:
What are the big trends?
"To set the stage, the longer-term developments in global asset allocation show three main trends: (i) a gradual broadening of the distribution of assets across countries, implying a globalization of portfolios with a slowly declining home bias; (ii) a long-term decline in the share of assets held by pension funds and insurance companies in favor of asset management by investment companies; and (iii) the increasing importance of the official sector in global asset allocation through sovereign wealth funds and managers of international reserves."
Does the inflow of capital to emerging markets pose danger if there is a sudden stop or reversal?
"While the trend toward longer-term investment in emerging markets is likely to continue, shocks to
growth prospects or other drivers of private investment could lead to large investment reversals. The
structural trend of investing in emerging market assets accelerated following the crisis, driven mostly by relatively good economic and investment outcomes. Still, the sensitivity analysis in this chapter showed that a negative shock to growth prospects in emerging markets could potentially lead to flows out of emerging market equities and bonds. These flows could reach a scale similar to—or even larger than—the outflows these countries experienced during the financial crisis. ... Policymakers should prepare for the possibility of a pullback from their markets in order to mitigate the risk of potentially disruptive liquidity problems, especially if market depth may not be sufficient to avoid large price swings. Emerging market policymakers ... should prepare contingency plans to maintain liquidity in asset markets during periods of market turmoil, perhaps using sovereign asset managers as providers of liquidity as other investors exit, as some did during the crisis ...
Will countries start taking more risk with foreign exchange reserves?
"As heightened risk awareness and regulatory initiatives push private investors to hold “safer” assets, sovereign asset managers may take on some of the longer-term risks that private investors now avoid. ... However, global foreign exchange reserve holdings (excluding gold) have grown so fast in recent
years that their size for many countries now exceeds that needed for balance of payments and monetary purposes. ... Therefore, an increasing share of reserves could be available for potential investment in less liquid and longer-term risk assets. A new IMF estimate puts core reserves needed for balance of payments purposes in emerging market economies at $3.0–$4.4 trillion, leaving $1.0–$2.3 trillion potentially available to be invested beyond the traditional mandate of reserve managers, in a manner more like that of SWFs."
What about sovereign wealth funds?
"Sovereign wealth funds (SWFs) hold some $4.7 trillion in assets ... while international foreign exchange reserves amount to $10 trillion. Taken together, the value of assets in SWFs and foreign exchange reserves is equal to about one-fourth of the assets under management of private institutional investors. ..."
What are the big trends?
"To set the stage, the longer-term developments in global asset allocation show three main trends: (i) a gradual broadening of the distribution of assets across countries, implying a globalization of portfolios with a slowly declining home bias; (ii) a long-term decline in the share of assets held by pension funds and insurance companies in favor of asset management by investment companies; and (iii) the increasing importance of the official sector in global asset allocation through sovereign wealth funds and managers of international reserves."
Does the inflow of capital to emerging markets pose danger if there is a sudden stop or reversal?
"While the trend toward longer-term investment in emerging markets is likely to continue, shocks to
growth prospects or other drivers of private investment could lead to large investment reversals. The
structural trend of investing in emerging market assets accelerated following the crisis, driven mostly by relatively good economic and investment outcomes. Still, the sensitivity analysis in this chapter showed that a negative shock to growth prospects in emerging markets could potentially lead to flows out of emerging market equities and bonds. These flows could reach a scale similar to—or even larger than—the outflows these countries experienced during the financial crisis. ... Policymakers should prepare for the possibility of a pullback from their markets in order to mitigate the risk of potentially disruptive liquidity problems, especially if market depth may not be sufficient to avoid large price swings. Emerging market policymakers ... should prepare contingency plans to maintain liquidity in asset markets during periods of market turmoil, perhaps using sovereign asset managers as providers of liquidity as other investors exit, as some did during the crisis ...
Will countries start taking more risk with foreign exchange reserves?
"As heightened risk awareness and regulatory initiatives push private investors to hold “safer” assets, sovereign asset managers may take on some of the longer-term risks that private investors now avoid. ... However, global foreign exchange reserve holdings (excluding gold) have grown so fast in recent
years that their size for many countries now exceeds that needed for balance of payments and monetary purposes. ... Therefore, an increasing share of reserves could be available for potential investment in less liquid and longer-term risk assets. A new IMF estimate puts core reserves needed for balance of payments purposes in emerging market economies at $3.0–$4.4 trillion, leaving $1.0–$2.3 trillion potentially available to be invested beyond the traditional mandate of reserve managers, in a manner more like that of SWFs."
What about sovereign wealth funds?
"Sovereign wealth funds (SWFs) hold some $4.7 trillion in assets ... while international foreign exchange reserves amount to $10 trillion. Taken together, the value of assets in SWFs and foreign exchange reserves is equal to about one-fourth of the assets under management of private institutional investors. ..."
