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Economics & Finance

What’s Behind the Rising Inequality of Everything?

Benjamin Kessler, INSEAD Knowledge Managing Editor, and Morten Olsen, Assistant Professor of Economics, University of Copenhagen |

However you parse the data, capitalism increasingly appears to disproportionately benefit the very top performers.

Jeff Bezos, the CEO of the company millions depended on for deliveries during coronavirus lockdown, is reportedly set to become the world’s first trillionaire. As forecast by business platform Comparisun, his unique status isn’t due to the current crisis. It is based on a continuation of growth trends in Bezos’s net worth over the past five years, which show increases of about 34 percent annually. In other words, it is the latest addition to the eye-popping study in contrasts that the world economy has become.

The growing concentration of wealth at the top has led prominent American politicians on the left, such as US Senator Bernie Sanders, to proclaim that billionaires, by rights, should not exist. How, then, would they account for Bezos’s almost unimaginable prospective wealth?

The global “superstar economy”

Some have chosen to blame crony capitalism. In this analysis, the most fortunate few have co-opted the political system – which was designed to rein them in – with their dollars and influence. Favour-paying on the part of compromised politicians would certainly help explain the penchant for deregulation that has prevailed on both sides of the aisle in Washington, DC in the last 40 years.

There is a big problem with this theory, however. The general trend towards rising inequality, resulting in more and more goodies jammed into the already bulging pockets of a few “superstars”, is not limited to the United States. It is distinctly seen, though to a lesser extent, in Australia, Canada, China and the United Kingdom among others. Unlike the US, these countries do not have a multi-billion-dollar per year lobbying industry aimed at influencing public policy for the benefit of corporate clients.

Source: Peter Levell

Inequality within nations, though, is just the tip of the iceberg. The rise of a few superstars relative to everyone else is a pattern so firmly etched into the broader economy that it seems to show up virtually any way you parse the data. Just look at how the centre of gravity has shifted dramatically upward in a number of industries. In 1982, for example, 26 percent of total ticket sales for live concerts went to the top one percent of music-industry earners; by 2017, the one-percenters’ share had more than doubled to 60 percent. Within the publishing industry’s top ten global bestsellers of the last 50 years, the Harry Potter series – which ranks #3 altogether, right behind The Holy Bible and Quotations from Chairman Mao Tse-tung – has moved more copies than #4-10 combined.

Income gaps between occupations have also grown globally. The difference in wages between, say, an engineer and a schoolteacher is significantly greater now than it was in 1980. Even within certain professional-class occupations paying well above average, e.g. physicians and college professors, the distance between rungs at the very top of the income ladder has increased. In these sectors, inequality has infiltrated the top one percent, elevating the mega-elite 0.1 percent above the rest.

Source: Gottlieb, Hicks, Hémous, Olsen (2018)

Differences between firms

For salaried employees, enormous pay discrepancies within companies contribute to the overall superstar effect. The galloping increase in CEO salaries since the 1990s, for example, has left ordinary employees in the dust. Far more consequential, however, has been the growth in overall pay gaps between rather than within firms, according to one paper analysing the US labour market from 1978 to 2013.

The authors describe a kind of firm-employee assortactive matching not unlike the current trend towards within-class marriage. In an era of lower job security, the best people will flock to thriving companies capable of paying higher wages, pushing successful firms’ performance even higher. Over time, this brain drain becomes a rising tide that lifts all boats for employees of superstar companies, from the frontline to senior management.

A similar clustering effect has occurred in the developed world’s major cities. London, New York, Copenhagen, etc. have become magnets for talented strivers from their respective nations (as well as expats from abroad), contributing to an economic decline in non-urban areas that can become a veritable death spiral as the tax base shrinks.

Source: Eckert et al (2020)

Underlying economic changes

With all these dimensions of inequality telling the same basic story, we can speculate that the main drivers must be fundamental to the contemporary economy. Crony capitalism and other types of regulatory capture surely exacerbate inequality. But if all forms of soft and hard corruption were to disappear overnight, the upward distribution of resources would continue, albeit at a lower level. In other words, the underlying system, not its subversion, is at the root of the phenomenon.

Specifically, the combination of globalisation and technological innovation seems to act as an engine for the superstar economy. Professional football supplies a clear example. Digital technology considerably lowered the costs of broadcasting matches internationally, expanding the global fan base for the best clubs (Real Madrid, Barcelona, Manchester United). As a result, local leagues must now compete with the world’s greatest players for the attention of home audiences, which was theirs automatically in the pre-digital era. Stealing the spotlight from smaller competitors not only grants superstar clubs an even bigger platform and more money, but it also enhances their attractiveness to elite footballers in search of a home, further burnishing their relative status through assortactive matching.

Similarly, mid-sized manufacturers that would once have had an assured customer base for their finely made, high-end products are losing ground to globalised behemoths. For example, Danish electronics company Bang & Olufsen has struggled to defend its turf against Samsung and others capable of flooding the world market with cheaper yet perfectly serviceable gadgets. The globalised economy, with its enormous returns to scale, rewards the conquest of new markets and erodes the special advantages that protect smaller entrants from overseas competition.

Automation is a part of this story too. A 2019 article co-authored by David Hémous shows how firms’ own incentives – as opposed to external developments such as the sudden availability of new materials or labour skills – explain some of the more curious features accompanying income inequality, including the “productivity paradox” and fluctuations in the relative wages of skilled and unskilled workers. In short, innovation raises demand for low-skilled workers and in turn wages, which incentivises employers to adopt automation as a cost-cutting measure. This obviously promotes income inequality, since white-collar jobs have been far less subject to automation. However, as automation becomes more widespread, its economic impact is diluted. The pay disparity between skilled and unskilled workers to which it contributed begins to grow at a slower rate.

Public policy for the superstar economy

These dynamics create a complex picture for policymakers. A tax on the use of automation equipment, the paper finds, would modestly increase low-skilled wages by encouraging more sparing use of worker-replacing machines. A tax on automation-related R&D would have the same levelling effect initially. As the overall innovation pipeline narrowed over time, however, lower-tier wages would suffer. Recall that economic growth owing to innovation was what hoisted wages to the point that automation became a lucrative option in the first place.

More broadly, governments should recognise that the superstar economy is, to an extent, baked into the capitalist system by now. In a sense, the beneficiaries themselves are not to blame. They are merely capitalising on opportunity, engaging in profit-seeking behaviour as we expect well-run companies to do. Grand gestures such as breaking up superstars into smaller units won’t necessarily level the playing field – although there is no reason for regulators not to look closely at M&A deals wherein monopolies-in-the-making eliminate what little competition they have. Whether, for example, Facebook should have been allowed to buy Instagram is a question well worth asking.

Some are predicting that Covid-19 will change the game profoundly. It is true that the pandemic has disrupted cross-border supply chains, escalated tensions between the two main superpowers and halted international travel for the time being. It remains to be seen, however, whether the globalisation genie can be put back in the bottle. The spoils to be enjoyed by the superstars are too rich and alluring. One can hardly imagine Apple, Samsung et al. opting to pack it in and sell only within their native countries.

As it was before the pandemic, the global economy is a delicate mechanism of tenuously poised weights and counterweights. Wading blindly into that morass could lead to disaster. Perhaps the best response to income inequality is the most simple and direct one: a Scandinavian-inspired redistributive welfare state that does not begrudge the superstars their status, but ensures that some of the proceeds feed back into society at large.

This piece was inspired by Morten Olsen’s recent Tech Talk at INSEAD’s Middle East campus.

Morten Olsen is an Assistant Professor of Economics at the University of Copenhagen.

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Comments
Infostack,

What economists refer to as scale effects are really network effects. The latter concept is nascient, under 50 years old, and only over the past 20-30 years better, but not fully, understood. Network effects can be applied to everything around us, human-made and natural. The biggest difference between human-made and natural networks is sustainability and generativity in the long-run. We have clear evidence from history that human-made networks always fail. The fact is that we observe pareto and standard distributions (outcomes) everywhere in nature, but those human-made distributions throughout history--socio-political and economic networks--become distorted and ultimately collapse due to an imbalance of risk. We are witnessing that today with the pandemic; as capitalism perfects the extreme network effects. It is indeed time to rethink humanity's approach to these networks; something I refer to as equilibrism. But it is not just a redistribution of wealth captured at the core of the network and redistributed to the edge, rather a rethinking of the way risk and return are balanced by incentives that account for marginal differences along curves that resemble those found in nature.

Colin,

I love social inequality. It is what makes the world go round and round. Inequalities define nature, and are unavoidable. Why pursue eliminating them, when we should use them to our advantage? Notice how inequalities are what drive sports? Some players are taller, others are faster, some stronger. We don’t eliminate these inequalities, we compete against them in order to thrive.

Ath,

This was a well made article that I feel understands deeply the problem with the current systems. Yet comes from a capitalist realist perspective where instead of removing and replacing a deeply corrupt and ultimately utterly unfair economic system such as Capitalism with say forms of Anarchism or Communism or otherwise.

Merely shrugs and says regulation will work.

Welfare states are better then normal capitalists state, but they still prey and rely on things being worse in the third world to maintain their standard. I do not think welfare states are sufficient to save the world from climate change, inequality and the numerous other problem's facing the world.

So while informative, I feel your article provides no real solution.

M Olsen,

Thank you for your comment and your reflections. I see two problems

First, although, in principle you might be right, we are not at the cusp of a revolution. Neither anarchism nor communism will be implemented at any scales in the years to come. Minor reforms of redistribution, however, are certainly possible and are implemented all the time. If you are only focused on a revolution you will never do the work that can actually matter. Don't let the perfect be the enemy of the good!

Second, if the twentieth century taught us anything is that grand ideas can fail miserably in practice. I'd much rather live in today's capitalist Norway than yesteryear's destitute communist China.

Identifying and diagnosing the problem is the first step to a treatment.

Alex,

The root cause of income inequality isn't capitalism. If it were, it would only exist in countries using capitalism. China has billionaires, it also has 900 million surviving on subsistence farming. No, the root cause of unequal incomes is the unequal distribution of talent. The 65 year old vice president of Engineering makes more than the 23 year old recent college grad Engineer. Salaries are directly proportional to the magnitude of the decisions one makes...
Now, the problem has been that the income GROWTH of the top 1% has been greater than the other 99. This didn't used to be the case. Those two line were the same until they diverged (in the US) in the early 70s. What causes that?? The US went off the gold standard. Starting then, the US government currency and debt was no longer fixed, and the money supply could be expanded by the federal bank purchase of gov bonds (printing money). This increase in money supply ends up at the top.
Example, the covid "stimulus" was almost $3T. That's about 10,000 per capita. I don't remember getting my $50,000 share for my family of 5. That money has flown into bond and stock markets, pushing the Dow to all time highs. Brazos makes under 100k salary, but his Amazon stock has increased by Billions this year.
All the fake money and 0% interest rates have made housing unaffordable for young people. If you want to call the gov printing fake money "crony capitalism", I'd agree with that.
In engineering, we don't apply a solution until we understand root cause. Otherwise, it's just whack-a-mole... Capitalism and taxes aren't the root cause, so more government and higher taxes isn't the cure. Controlling government created "fake money" is

motocyclerider,

America isn't true captialism. The government really has complete control. To many times the government props up failing financial institutions and other failing business. If the markets were 100% free it would beore of a level feild. The other issue is the decline of America manufacturing. This has killed the middle class. Nafta and open boarders. Less bailouts, free markets, and massive tariffes on foreign made products would right the ship.

Wombster,

We should not be focussed on inequality, we should be focussed on the plight of the least-fortunate. Differences fuel specialisation, trade and prosperity. Network effects amplify the beneficial differences and allow them to spike, but that is not an inherently negative outcome. Humanity, as a group of biological organisms, is designed to compete with other species and within our species. Efforts to remove that competition (such as extreme redistributive policies) simply deflect the competition to the illegitimate economy and encourage corruption. Diverting some of the surplus created by that competition to ensuring equality of opportunity will deliver more good for society than removing the ability to prosper. It is no coincidence that the most equal and prosperous societies are also those where corruption is least prevalent, and the reverse is also true. But we should not confuse cause and effect: the reason these societies are the most equal and the most prosperous is because they are the least corrupt, and therefore distribute the opportunities to prosper most equally and transparently.

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