The Consequences of Extreme Inequality

In 1912, Italian statistician Corrado Gini introduced a concept (which came to take his name) called the Gini Coefficient. The coefficient, which is a measure of statistical dispersion, is used primarily to measure the level of economic inequality, such as income, wealth, and consumption inequality.

This coefficient is calculated by subtracting from cumulative income in a perfectly equal distribution, cumulative income in the actual distribution. If you graph these lines, you get something like the chart below, where the blue line represents an equal distribution, and the red line represents the actual distribution. This graph is called the Lorenz Curve.

Graphic source: C. Holbrook

For this particular graph, the Gini Coefficient of the red line is 0.5, with 0 meaning perfect equality, and 1 meaning perfect inequality. That’s roughly the Gini Coefficient for the United States today (though more lopsided in actuality), before accounting for the effects of taxes and transfers. That’s to say, in the absence of redistributive taxing and spending.

The United States has had, of course, different levels of inequality at different points in time. This chart from adapted by Berruyer shows us the U.S. Gini over the last century:

As we can see, income inequality peaked during the Great Depression around 1932, and bottomed during the Vietnam War around 1969. This period of course coincides with the the Second World War and widespread union membership. From 1936 to 1971 the top marginal rate of income tax was no less than 70 percent (and averaged 82 percent), union membership hovered around 30 to 35 percent, and inflation averaged below 3 percent.

The decade of the 1950’s saw a mean top marginal rate of income tax at 87 percent but real compound annual stock market growth in the double digits, not to be met until the 1990’s. Further, from the era of 1936 to 1971, real GDP per capita grew at an annualized compound annual growth rate of 3 percent, meaning a doubling every twenty-five years. Real GDP per hour worked grew from $24.12 in 1948 to $41.20 in 1971, a 71 percent increase in 23 years. By comparison, it took from 1986 to 2019 to achieve the same level of growth, a compound annual growth rate of just 1.5 percent.

I’m not going to argue here that suppressed inequality or steep progressive taxes necessarily increased long-term growth, but it clearly didn’t inhibit or stunt it.

Graphic sources: C. Holbrook. Data for graphs from FRED and Robert Shiller.

For those fiscal conservatives out there, reducing income inequality could lead to reduced government spending through decreased welfare costs. If lower income people have greater incomes (i.e. they are more self-sufficient), they either will no longer qualify for assistance or will be eligible for a lower level of assistance.

Say for example, we had frozen the Gini Coefficient in 1970, what might our distribution of income look like today? In 1970, the market income Gini was around 0.40 for the United States, which compares to today’s value of around 0.53.

Graphic source: C. Holbrook. Data for graphs from WID.

This earnings curve is a little clearer when we show just the bottom 80 percent:

That’s what the distribution would look like. Instead of a median individual income at $42,652, we’d have it at $66,780, which is almost today’s median household income. Even those in the 98th and 97th percentiles would see a greater income, a hike of 6 and 2 percent respectively. If you made a 95th percentile income today (about $200,000), with the 1970 distribution you’d be making closer to $220,000.

And it’s not like the top 1 percent would really see a loss in standard of living considering they save half of their income anyways. The top 1 percent threshold would only fall by 4 percent from $520,000 to $500,000. Sure, they’d see a slowdown in the accumulation of fictitious capital. No decline in economic growth mind you, just a decline in the appreciation of financial assets never spent, held as equity in companies that only issue as much in new shares as they buy back at later dates.

As J. M. Robertson and later the Right Honorable Lord Keynes wrote some 128 and 84 years ago respectively, economy-wide savings are economy-wide reductions in spending, which is met by reduced output. Companies can’t sell without buyers, and companies without buyers can only shake losses or grow earnings by reducing their cost of goods and other operating expenses. That is to say, reducing output, employment, and nonficticious investment.

It may very well be the case that the level of earnings inequality has such a detrimental effect as to actually reduce the absolute earnings of firms and their predominately affluent shareholders. And such a possibility in and of itself should place a taxing weight on the souls of the millions of people who cannot even secure for themselves a basic level of economic security. Home ownership, health insurance, regular employment.

Picture yourself for a moment one of those people. Imagine how then you’d feel to learn that some exceptionally small propertied class and their lackeys (intentioned or not) in Washington had been so blinded by immediate self-interest as to implement policies that not only probably reduced their own eventual absolute earnings but gutted the potential for human progress among hundreds of millions Americans here and passed and their millions of yet-born progeny.

And should we be all that concerned if the most absolutely wealthy citizens were to in fact lose some share of their earnings? God forbid the CEO of corporation were to average only $5,000 an hour in compensation as opposed to their present $10,000. Is encroaching feudalism really a path we’re satisfied with?

I think given a clear understanding of the broader consequences of stable (and reduced) inequality, even those lucky affluent few would disagree. They, by consequence of their property and hierarchical power entitle themselves to almost all new income at the expense of great progress and opportunity for the bottom three-quarters of the population. I’d like to believe that no healthy person can feel anything but guilt at such a cost of their own greed.

Despite a more than doubling of GDP per capita over these last fifty years, real median earnings have grown by less than two-fifths. The minimum wage as a share of per capita labor productivity has fallen by more than half. We have an entire generation of Americans who in some sense are earning less than or equal to what their parents or grandparents did.

Had we managed to hold the level of inequality constant, a sudden decline from that point to where we are now would be considered one of the greatest economic disasters ever, though not quite as bad as the Great Depression when common people worked overtime to feed and clothe their children— though today millions work overtime to house and educate their children.

In conclusion, maybe Congress and the petité bourgeois shouldn’t be so squeamish about some mildly laborist policies. Is union membership really irreconcilable with economic growth? Will a fifteen dollar wage for the menial worker really stretch the corporate income statement to the breaking point? Perhaps we should be less speculative and more observant. We have the data to dispel these myths.

And maybe once regular people obtain the satisfaction brought by noticeably increased living standards, the nation as a whole will feel once again that it’s worthwhile to lend a helping hand to those less fortunate.

Main photo license and source. No changes made.

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