The Business of Inequality

<>Nelson Spirited Conversations; 24 July, 2013. (Revised)


Keywords: Distributional Economics; Political Economy & History;


On a recent television program New Zealander Robert Wade, Professor of Development Studies at the London School of Economics, suggested that New Zealand might be ruled by 1 percent of the population, say 35,000 adults. The Deputy Prime Minister, Bill English, rejected the claim, adding to Wade ‘Dont you dare say that again’.


Wade was referring to an argument that a small minority of rich people in America and Britain – ‘the 1 percent’ – have influence on government decision-making out of proportion to their numbers, for a purpose which is quite different from what the rest of the community desires. This literature argues that the 1 percent are not only rich but come mainly from the finance sector, which the government supports it to the detriment of the rest of the economy. New Zealand has no financial sector comparable with the American and British ones, so one cannot simply transfer their experience. Even so, Wade was right to raise the question – to dare to raise the question – whether there was a group who had disproportionate influence on the governing of New Zealand.


I am going to take up this challenge by looking at a particular example of a political decision. Working through it one can, I think, make some progress about how New Zealand is governed today and where those who govern want to go. There are many possible examples; tonight I am going to focus on the decision to give the Sky City Casino a number of concessions in order that it will build an international convention centre in Auckland.


The background to the project arises because New Zealand has no facility to host big international conventions. Many cities have convention centres, but they do not have the large conference hall, the breakout rooms and the associated catering and hotel facilities to attract very large ones. The result, it is argued, is that New Zealand is missing out on a growing international industry, which instead goes to Melbourne and Sydney in this part of the world.


However, when the calculations were done, it was concluded that such an Auckland centre would not be commercially viable, that is, generate sufficient profit for the private sector to invest in it. Other businesses would benefit, and it is possible that they may make sufficient profit to justify the project on a national basis. There is much dispute whether this will happen, with allegations that some of the evaluations are biased.


Because the convention centre is not commercially viable, there is no private consortium willing to risk its funds in the investment. Instead the potential beneficiaries – they are mainly the hotels and the providers of other auxiliary services and the building contractors – expect the government to stump up with the investment funds, thereby exposing the government to the risk of the downside despite not getting a return on its investment, even if the private sector interests do.


Additionally a major worry is that any international convention centre may not be adequately utilised – that it may be a great white elephant. So there is a downside risk; we could be left with an investment which gives insufficient return.


You will recognise the parallels with the Think Big investment strategy. The government is being asked to invest its funds to the benefit of the private sector. In the case of the Major Projects it was the government – the tax payer – which was left carrying the cost when the projects failed commercially.


We learned from the Think Big experience, and over the years the government has introduced a number of measures which, while they do not rule out engaging in another investment disaster, they do make it transparent when the government offers a large subsidy to a sectional interest.


Faced with this, and the overall fiscal constraint, the government invited proposals for the convention centre from the private sector. All of them required some government support. Apparently there was no careful evaluation of the merits of each proposal, but the Prime Minister, as Minister of Tourism, chose the proposal from the Sky City Casino, apparently on a hunch.


(As an aside: the PM has been accused of cronyism in his choice. I do not know whether he is particularly close to Sky City. New Zealand is such a small society that any PM would almost certainly know the principals of all the proposals. What I am struck by is the casualness of the decision making. That he did not get a proper evaluation suggests that he is insensitive to the possibility of claims of cronyism, a conclusion reinforced by his forgetting meetings with Ian Fletcher before he was appointed to head the GCSB. It is well to remember that these sort of informal relations and decisions are considered a curse in the public sector but are a norm in business.)


Sky City said it would go ahead with an international convention centre if it were given a number of concessions which would increase the profitability of the casino activities. In the end the government agreed to:

a 27-year extension of Sky City’s licence;

230 extra pokie machines;

12 automated multi-player gambling tables;

the introduction of cashless pokie machines and ones that can take $100 notes.


While such concessions are extremely valuable to the casino but there is no suggestion that they would increase its international clientele; the financial gains will be from greater use by New Zealanders. Therefore some other New Zealand enterprises – smaller ones – will suffer.


The existence of restrictions on gambling arises because some gambling – especially involving pokies – is socially damaging and requires controls. Accepting this, an economist would argue that the restrictions were of value and the enterprise which obtained a licence should pay the Crown for the privilege. The effect of the proposed deal is that the Crown receives the payment and uses it to subsidise the convention centre.


We dont know how much social damage these extensions to the opportunity for gambling will generate, nor the financial cost to the government in additional corrections staff, court personnel, health clinicians, policemen and social workers, nor on extra social security spending. It may be a little, it may be a lot. Research I was involved in suggested the biggest damage from gambling was psychological – damaging to the gamblers and their families. Clearly there is a tradeoff between the establishment of an international convention centre and other things New Zealanders’ want or dont want.


There are many other examples which could be used to illustrate the general point. Time and again the government has proved it is particularly responsive to the desires of the business community, especially the Auckland one. Examples include those which impact on the environment, the sale of Mighty River Power, the backdown over restrictions on alcohol sales and reducing harm from gambling, favourable tax policy to the rich and the rigorous reductions of government spending and the privatisation of supply.


Now Mr English might agree that this is true, and yet offer a different perspective. He might say that if the decisions do favour the business sector in the first instance, that is because they also favour all – or most – New Zealanders. His argument is that the private sector produces the incomes and jobs which enable New Zealanders to have a higher standard of living.


It is broadly true that businesses pursuing profit will increase GDP and jobs. (I have to add a caveat here that this may not be true in the medium term when the businesses are in the hyper-financial sector.) But is aggregate market output necessarily what we want, since it may include spending and jobs on economic bads like the social damage from gambling and environmental depletion? Are all jobs are equally valuable? Let me give a simple example which shows they may not be.


The Canterbury Earthquakes have done enormous damage, including people dying, lives messed up, and the destruction of heritage, residential, public and commercial buildings. Shortly after the shaking had settled down there was a view that the rebuild was beneficial to the New Zealand economy because it would create economic activities, profits and jobs. Let’s get real before we get enthusiastic. The gainsayers are not saying we need more earthquakes are they? Would it not be better if there had been no earthquakes and the workers were, say, out surfing on the same pay? Isnt the logic that we would benefit from more earthquakes of the Canterbury magnitude? What nonsense!


Or to go back to my casino gambling example, are we really better off from all the additional corrections staff, court personnel, health clinicians, policemen and social workers dealing with the social damage from gambling? Would not it be better if their jobs were unnecessary and they went surfing? It is not always true that increased output from increased profits is a good thing.


At this point I can go down a number of paths. For instance, there is a need for a rigorous economic assessment of what the government is doing about the environment. However, I was asked to talk tonight about inequality which is also the context of Robert Wade’s comments. In brief, his thesis was that inequality has been growing in America and Britain especially with the very extreme end – the 1 percent – receiving an increasing share of income.


So what has been happening to the incomes of our top 1 percent of taxpayers? Currently their share of reported taxable income amounts to about 9 percent of the total; that means the top one percent’s average before-tax income is about nine times that of the average taxpayer. They pay about 14 percent of all income tax and their share of after-tax income is about 7 percent, or seven times the disposable income of the average taxpayer.


There is a caveat here, because there is considerable tax avoidance among those in the higher income brackets. A common means is that if one lives only for a limited number of days each year in New Zealand, then one does not have to pay income tax. This is true for some of our most prominent rich. There is an irony here. Taxation may be the price of citizenship, but while rich tax avoiders not paying the price, they are still treated as eligible for knighthoods.


How does our one percent compare with those in other jurisdictions? In the United States the top one percent get 22 percent of all income if capital gains are included (and 18 percent if capital gains are excluded, as they are in the New Zealand data). So our rich are not nearly as rich as the American rich, nor as those in Britain.


One of the important features of the American and British rich is that they had much lower shares of income in the past. Twenty years ago the share of the rich Americans was 15 percent; it has gone up dramatically since then – by half to 22 percent. Twenty years ago though, the share of the New Zealand top one percent was still about today’s 9 percent of taxable income. Their share has not changed much over the two decades, although of course it is possible that tax avoidance has increased. So it is hard to conclude that New Zealand’s rich have been benefiting relative to the rest of the community in the way which has happened in America and Britain.


This has been using tax data. There is a second standard source to measure income inequality in New Zealand – the Household Survey. It gives a better indicator of the standard of living because it is based on total household incomes, rather than the individual’s personal incomes, because it includes dependants, so comparisons can allow for household composition and size, and because it can be measured after-tax and benefits. The latest results, updated to the March 2012 year have just been released.


Because the data is based upon a sample of up to only 5000 households, the analysis cannot be as fine grained as the tax data which covers all taxpayers, so it is usual to report the results only in deciles. So we have data on the top ten percent but not the top one percent on this basis.


The basic finding is that the top ten percent of households have about a quarter of all household income. – that’s about two and half times the average level of incomes. It goes up and down a bit. In the year to March 2010 it was 26.7 percent while in the year to March 2012 it was 24.3 percent, reflecting fluctuations in the business cycle. (Additionally it is quite difficult to interpret the figures in recent years because of the impact of the Christchurch earthquakes with some households receiving insurance payouts; I proceed with caution.)


Allowing for this noise, the basic conclusion is that the quarter share of the top ten percent has been fairly constant for almost two decades. On this indicator there has been no increase in inequality since 1993, a conclusion similar to that we derived from the top one percent of those who reported taxable income.


Before discussing what happened before 1993, I should point out that there are a number of indicators of inequality, and they may tell different stories. So let us look at two more.


Consider the share of income of the bottom fifth of households. Most estimates suggest that around about a fifth of the population is in poverty, so what is being reported closely corresponds to the poor’s income share.


The income share of this poorest fifth of New Zealand has hovered near 8 percent of total income for the last two decades. That means that on average their income is about 40 percent of the disposable income of New Zealanders and a sixth of the level of the top ten percent. Because of time I am not going to say much about the difficulties the poor have of living on such a low incomes. To summarise all the research, it is bloody difficult, they probably have unnecessary physical and psychological health and it handicaps the life opportunities of their children.


Earlier I said that the share of the poorest fifth hovered near 8 percent over the last two decades. It is a bit more complicated than that. From 1993 to 1999 their income share was 8.1 percent but it drifted down to 7.5 percent in 2004. That is quite a big shift.


But their real incomes did not fall – on the whole – even if their share did. In the period of the Labour Government it rose by about 22.0 percent in real terms – relative to inflation. However overall incomes rose even faster – by 23.6 percent – so the bottom fifth got further behind.


(Compare 2.4 percent annual income growth per annum during Labour’s administration with 0.1 percent a year during the first three years of the current National government. The stagnation is in part a consequence of the shock from the Global Financial Crisis.)


You may be surprised that under a Labour Government the poor did not do very well. There were three reasons. First, benefits were increased in line with prices rather than wages, so they did not share in the rising real wages. Second, beneficiaries were not entitled to the working-for-families tax credit, which benefited those in higher deciles. Third, many beneficiaries were unable to take advantage of the booming labour market to find jobs. (It is, however, possible that beneficiaries were greater recipients of some of the concessions Labour introduced, like reduced rents for state rental housing – any accommodation supplements are included in the calculations – and increased primary health care subsidies.)


So we have now two indicators of inequality over the same period, one – the income of those at the top – says there was negligible change in inequality, the other – the incomes of those at the bottom – says there was a small increase in inequality. Let’s look at a third.


The Gini coefficient looks at the whole distribution – at all households. I wont go into the details of its construction and meaning, but essentially it measures the average difference between the incomes of all the households (scaled by the average income).


One of the advantages of the Gini coefficient it is that it is available for international comparisons. New Zealand is in the most unequal half of the 35 OECD countries. In about 2010 we were 14th in terms of inequality, near Canada, Ireland and Australia – below the United States and Britain and much more unequal than most of the non-Mediterranean European OECD members.


However, small countries are likely to have lower inequality than large ones. I shant go through the details of the arguments, but observe that there is no inequality in a country of one person. When we adjust the Gini coefficient for population size, we find New Zealand is eighth to most unequal. So it would be stretching it to say we were in the middle of the OECD in terms of the income inequality dimension, and we are certainly not among the bottom of those with low inequality.


Looking at New Zealand by itself through time, it turns out that our Gini coefficient has been falling slightly since about 1993, whether you measure it by household incomes, as I have been doing earlier, or just by market incomes, ignoring the impact of income taxation and benefits. By this Gini measure the income distribution is getting slightly less unequal. The shift is perceptible – perhaps it amounts to a five percent reduction in the width of the income distribution.

Wait a moment! Some measures seem to suggest that in the last two decades income inequality has increased, some that it has remained much the same, others that it has decreased. What has been going on?


We can readily resolve the paradox once we understand there is no rigorous measure of inequality. You may have been told that the Gini coefficient was such a one, but it is about as useful a measure of inequality as GDP is of welfare – helpful but certainly not authoritative. There is no authoritative measure. What the conflicting measures are telling us is that any change in the income distribution over the last two decades has been small – very small – and possibly in either direction.


But if we go back before 1993 – we have data back only a decade to 1982 – the same indicators are consistent in what they say. There was a huge change in inequality, so large as that it does not matter which measure we use. I’ll use the Gini coefficient.


According to the OECD, New Zealand’s Gini coefficient increased from 0.27 in 1985 to 0.32 to 2009. That is roughly equivalent to the income distribution getting about 40 percent wider.


However, over the same period there was a general increase in income inequality equivalent to about a 25 percent increase in the standard deviation. New Zealand had one of the biggest increases in inequality. So much so, that whereas New Zealand was in the bottom half of the OECD countries in 1985, it had joined the top half by 1993.


What this means is that all the big increase in income inequality which has occurred in New Zealand occurred before 1993. We know precisely why it happened. First in the late 1980s, the Rogernomic Labour government slashed top income tax rates; that was a spectacular benefit to the rich. Whereas the top 10 percent had about a 20 percent share of household disposable income in the early 1980s, by the mid-1990s they had a 25 percent share. The tax cuts boosted their income by a quarter. Consequently the rest of the community – the other 90 percent – had a reduction in their income share, and also their incomes since this was a period of economic stagnation.


Second, in the early 1990s, the Ruthanasia National Government savagely cut the income share of beneficiaries by another ten percent. There have been no corresponding changes of such magnitudes since, which is why income inequality has been largely stable since 1993.


So it is true that income inequality has increased in New Zealand, but it happened between 1985 and 1993, two decades ago. Observe that the increased inequality can be readily explained by conscious actions of the governments at that time – by changes in tax and benefit policies (not, as in America and Britain, the result of market forces from the financial sectors). The consequence of this increasing inequality by the actions of our government was that before 1985 we were among the more egalitarian of rich nations; since 1993 we have been among the most unequal.


While there is no evidence there has been a significant increase in income inequality in the last two decades, the critical fact is that by international standards New Zealand has been at the high income inequality end among rich countries for about two decades. Does that matter?


There are three classes of reasons why it might. The first group is that there is accumulating evidence that communities with high economic inequality suffer from various forms of social distress. The best demonstrated correlation – those of you who have read The Spirit Level will have seen it – is that unequal societies are more likely to have poorer health, but there is also evidence of higher social delinquency including criminality. Thus far, the research provides but a correlation and every scientist knows that correlation is not causation – that two events are associated does not prove that one causes the other. There are various hypotheses about the mechanisms which might cause the social distress, but none are yet proven in a scientific court. Even so, in my view, there is enough evidence to suggest that we should be concerned about increasing economic inequality.


It also seems likely that the greater the economic inequality, the lower the intergenerational mobility. There is a view that economic inequality at a point in time doesnt matter, what matters is equality of life chances. The reality is that a child who comes from a deprived background is likely to have poor health throughout the rest of their life, and to have less access to educational and vocational opportunities and more likely to experience social delinquency. That is the central issue about child poverty – it is not just that a quarter and more of our children do not have an adequate standard of living through no fault of their own. Those children are our future adults; if we under-invest in them, we are under-investing in our future.


I have just described a set of arguments which centre on the inefficiency of economic inequality. The second group of arguments is about the equity of economic inequality. That is a political judgement; how fair do we want New Zealand to be? Are we happy that New Zealand is among the most unequal societies in the rich world?


Undoubtedly some inequality is necessary for economic success. But how much? We know that many successful economies function on significantly lower levels of inequality than New Zealand, including France, Germany Japan, the Netherlands and the Scandinavians. It seems unlikely that we need current levels of inequality to improve our economic performance. That, by the way is an efficiency argument; let’s return to equity.


While we have some choice about how much inequality we are willing to tolerate, we do not have unlimited discretion. If our tax rates are too high, we will drive capital and enterprise away from New Zealand. But I would think there is some room for clever increases in tax rates and benefit payments, which would contribute to a reduction in economic inequality.


And while redistribution through the tax and benefit system remains an important component of any war on excessive inequality – and on poverty – we need to think more about what is called ‘predistribution’ policies which try to prevent inequalities occurring in the first place rather than ameliorating them later through redistribution.


It is perhaps ironic that this National government is far more concerned with predistribution policies than are its critics. Their policies – aiming to get welfare beneficiaries back into the labour force with decent skills – are clumsy and often cruel. Moreover the more economically unequal a society is, the more expensive are effective predistribution policies – as Mr English will find out. His may well be ineffective.


Even so that it is exploring such policies puts the government ahead of its critics. It would be disappointing if the government inching into predistribution meant advocates of reducing inequality were to ignore the strategy, especially – and regrettably – since some of the policies they put forward to ameliorate inequality are very clumsy and relatively ineffective.


Do we want to pursue a lower inequality strategy, or are we happy to remain among the most unequal of the rich? That is a political decision. I imagine Mr English would say that the National government has got it about right, perhaps pointing out that it was reelected on this judgement. But you could hardly say that the electorate was offered an alternative vision. The advocates for less inequality have had little impact on our political parties. What they are exploring is whether there is a public demand for a reduction in inequality.


My guess is that there probably is a demand for a kinder gentler society – a more egalatarian one – than the one we have, one which is socially more like we were before 1985, when we were in the bottom half of OECD inequality. Whether there is a will to make the sacrifices to move back towards there is another matter.


One major issue is that we seem to be socially fragmenting. In the kinder gentler society which people yearn for, just about everybody was a neighbour. Today each of us is a lot less knowledgeable about swathes of New Zealanders, and there is a lot less empathy – compassion – for those who are worse off than we are.


This results in ill-informed accounts in the public debate about beneficiaries. Many commentators have no knowledge of the minimal living standards which beneficiaries experience. I do observe a willingness to impose sanctions on beneficiaries with no reflection that those who will suffer most will be their children – innocent children.


This leads to the third group of arguments for avoiding great inequality. It was presented by Robert Wade in terms of America and Britain where the issue is starker. There, he argues, the power of the rich means they are able to have considerably greater influence over government than those with less income. Because of their greater influence, the American and British government’s responses to the Global Financial Crisis have been pro-rich at the expense of the general populace – all the more ironic because the rich got the world into the crisis by their greedy actions.


Is this as true in New Zealand? We have not got the powerful financial sector that those two economies have, so we cannot simply transfer their experience to ours – unless we have a colonial mentality. But as my opening example on the convention centre decision may suggest – as do many other examples – that business is more influential on policy than the country wants.


Now Bill English would say ‘dont you dare say that again, Easton’. I remind him that I have explained better than has his government why it might be deferential to business – because it often delivers economic output and jobs.


However, I have a sense that New Zealand business is increasingly out of touch with the rest of society other than in its role as consumers. It is a consequence of that social fragmentation I have just been describing. It may well be that big business does not connect with its workers and locals as well as did the small businesses which were the traditional foundations of the New Zealand economy. But it is probably also a symptom of the declining empathy and neighbourliness that I was just describing.


I first became aware of the phenomenon during the Rogernomics era, when the advocates of the policies were so obviously out of touch with typical New Zealanders. When they said they were running ‘crash-through’ policies, they ignored that the victims of the crash were in social groups they did not know.


This is perhaps best illustrated by the consequence of the tax changes which meant that the rich’s incomes continued to grow in real terms while the majority of the community’s real incomes actually declined. Thus the rich have no personal sense of the economic stress which dominated the Rogernomics era; many still think of it as economic success despite the clear evidence of stagnation. Another example of the change is that while there were rich before Rogernomics, they did not show their wealth off and most of their public donations were anonymous. Today the rule is ‘flaunt it’, as conspicuous consumption rules.


This fragmentation leads me to my final conclusion. I wonder if public sentiment is not placing as much importance on economic growth that business wants and can deliver. The public does want jobs but it also wants environmental sustainability, a better quality of output and less inequality. I should not be surprised if it desires a kinder gentler society – and an egalitarian one.