26 January 2017

Theresa and Jeremy may be wrong on income inequality – but for how long?

Will the “Gini” go back in its bottle?

by Frank O’Nomics

They are all at it.  First, Theresa May told us of the “need to address economic inequalities that have emerged in recent years”. Then we had Jeremy Corbyn (briefly) argue for a wage cap to “tackle Britain’s high level of income disparity”, which was then watered down to a pay ratio between the highest and lowest paid in a company (backed by an official kite-mark).  Finally, we even had the World Economic Forum, ahead of its meeting in Davos, cite income inequality as one of the key risks facing the world.  The WEF has a strong point, if you focus on the bottom billion, but for the developed world, and for the UK in particular, income inequality has been falling steadily for some time.  In fact, according to recently released ONS data, the difference in real disposable income between the bottom 20% of households and the top 20% is the lowest for over thirty years.  It seems that our senior politicians have been focusing on the top 1%, or even 0.1%, high profile individuals who have seen some fabulous increases in income over the last few years, rather than the population as a whole.  Does this mean that we should stop worrying?  Sadly, not. The data still mask some major concerns for the poorer elements in our society and, even in the broader sense, the extent of the narrowing in income inequality could easily go into reverse over the next couple of years.

Economists and sociologists have for many years used the Gini coefficient, developed by Corrado Gini in 1912, to measure wealth distribution across a nation’s residents.  If we were in a utopia where every household had the same disposable income, then the coefficient would be at zero.  Conversely, if all of a nation’s wealth were concentrated in the hands of one household, the coefficient would be 1.  For the UK, this measure, when looking at household disposable income (after taking off taxes and adding in tax credit and benefits), is 14% lower than its peak in 1993.  The improvements since the financial crisis of 2007/08 have been particularly striking.  Those households in the bottom 20% are 13% better off in real terms over the last 8 years, while middle-income earners have only seen progress of 5% and the wealthiest 20% are still 3% worse off than they were on 2007/08.

Why has this happened?  A lot of the improvement can be put down to the fall in unemployment over the period, but although the recent dip below 5% represents a fall from well over 8% since 2011, this is only marginally below that seen before the financial crisis.  In fact the improvement seems to be  more down to measures taken by the government, particularly the raising of tax allowances and introduction of tax credits, as well as efforts to address the lag in pensioner’s incomes by the introduction of the “triple lock”.  Pensioners overall have seen a 13% increase in real incomes since 2007/08.  The other major factor has been the very low level of inflation that we have seen over the period.  Wage growth may have been below 2% per annum for much of the last 10 years, but this has produced a steady improvement in real disposable income given the benign pressure on the CPI.

Despite these latest ONS numbers looking very encouraging, and certainly contrary to the impression purveyed by senior politicians, there is still much to be concerned about.  Firstly, there are still far too many families in the UK living in persistent poverty, which is defined a living with low income this year and two out of the last three years.  The latest ONS data puts this at around 6.5% of the population, or 3.9 million people.  We also do not look so impressive when compared with other countries.  The most recent data comparing income distribution in 30 OECD countries had the UK as the seventh most unequal; worse than France, Germany and Italy (Sweden was the most equal).  Further, the data looks far less impressive when looked at across age groups. Those measures to help pensioners were overdue, but when one strips them out, non-retired households actually have an income that is still below pre-crisis levels.  There are also still wide differences in income levels across the country, and between rural and urban populations.  Finally, it should be pointed out that, while there has been a narrowing of income inequality in the UK, there is still a very wide disparity in wealth, with the older generation in particular being helped by the impact of quantitative easing on asset prices, especially housing.

The bigger danger in becoming complacent about a falling Gini coefficient is that it seems unlikely to continue. The benefit of a very low inflation rate seems to be disappearing very quickly, helped by the post-Brexit fall in sterling.  The impact of price rises could be compounded by an increase in interest rates, and economic growth, while healthy, does not seem to be at a level that will allow a compensating increase in wages.  Some of the other supportive factors will also fade, given that benefits for non-pensioners look set to be frozen until 2020.  As a result, the Institute of Fiscal Studies and the Resolution Foundation have suggested that 2016 will be the last year for some time that the level of income inequality in the UK will fall.

Has the argument gone full circle?  It seems that Mr. Corbyn and Mrs. May, while they might be wrong on current evidence, are right to raise the issue as a matter for pre-emptive action.  As to what that action should be, it seems unlikely that a wage cap will work.  Not only will this inhibit UK business from hiring talent, it will encourage the development of finding new ways to pay, by increasing benefits-in-kind or housing allowances.  From Mr. Corbyn’s point of view he should be wary of further alienating the electorate by making it impossible for British soccer teams to recruit the stars they need to compete on the European stage.  The narrowing of income inequality we have seen has occurred more as a result of  helping the poorer 20% of UK households than of taxing the richest.  If we can find more ways to do this then we may be able to revisit Harold Macmillan’s 1957 claim “you’ve never had it so good”.

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