Do wages matter?

03rd February 2011 | Posted in Economics

I’ve worked in some places where people have earned obscene amounts of money. In none of them have I seen serious resentment over income differences between the best rewarded and the worst paid. But lots of clever imagespeople are wondering whether this sort of income inequality matters. The UK government has Will Hutton working on a proposal to deal with ‘fair wages’ in the public sector and he’s already proposed a cap on the highest paid in relation to the lowest. I wonder whether it’s a worthwhile task.

There was a lot of political chat last year around a book ‘The Spirit Level’ which tried to prove that income inequality matters. The authors, Kate Picket and Richard Wilkinson, set out to prove that ‘more equal societies almost always do better’. Drawing data on levels of mental illness, teenage pregnancy, violent crime and other social problems and making comparisons between various rich counties they convince themselves that those societies where the gap between rich and poor is smallest are also the most successful. By their measures Japan, where wages are held in relatively tight bands, and Scandinavia, where taxation vigorously re-distributes the cash of the well-off, do well: the UK and US, where the market is allowed to dominate, do badly. There was a period last year when even David Cameron looked like a fan of the book.

Sadly for the authors, their analysis has taken something of a shoeing in the last year or so. Critics say their use of the data is selective: in ignoring suicide and alcohol abuse, they have selected out two problems which are prevalent in more equal places; others argue that by factoring some outliers into their analysis they have skewed the research in favour of their preferred outcome. There are also inevitable questions about causality: have the researchers done enough to isolate income inequality as the sole factor driving the social problems they’ve identified? Probably not, it seems. Although those in favour of the Spirit Level’s arguments are campaigning hard it seems likely that the idea has run out of political puff, particularly since even capping banker’s bonuses looks to be beyond the government’s will.

But perhaps Pickett and Wilkinson are looking for the wrong effect of inequality. Between 1952 and 1986 there was not a single year when the richest 1% of Americans earned more than 10% of national income. In 2007 it reached 18.3%, a figure not seen since 1929 according to the Economist. That such high levels of income inequality were immediately followed by the Great Depression and the current Global Financial Crisis is a fact worthy of examination. No-one doubts that sub-prime lending drove the boom which led to the bust, but one economist, Raghuram Rajan, argues that the lending was the consequence of a political response to wage inequality. Rather than spend more on education and training to redress inequalities – solutions too slow and resource-consuming for most political tastes – liberalizing lending regimes and their regulation was a quick fix to put lifestyles, if not cash, in reach of the lowest paid, albeit one in which the seeds of it’s own destruction were already sown. Like The Spirit Level, ‘though Rajan’s book, ‘Fault Lines’ has received criticism. His dates don’t add up, say some. The sub-prime boom began in 2000, yet the technological changes of the 1980s were the ones which hit the least well paid in the US hardest and their incomes have held course since then. Others argue that the political pressure on the availability of credit was a tiny factor in the American housing boom compared with lax standards, irrational exuberance and the more usual suspects of bubble creation.

So, inequality may not cause social problems or economic crises. In the context of events in Egypt, maybe it causes riots? A scandalous piece of opportunistic nonsense in The Telegraph this week ‘IMF raises spectre of civil wars as global inequalities worsen’ almost argues that it does. Sadly for any rabid readers, the document concerned (marked, incidentally, ‘not to be presented as representing the views of the IMF’) doesn’t mention riots as a potential outcome of income inequality. More reasonable commentators point out that Tunisia and Egypt are societies where incomes are relatively well distributed, that the horribly unequal UK and US are relatively peaceful places and the cause of the current difficulties in North Africa and the Middle East are most likely to be political.

John Stuart Mill, having defined freedom as the ability to pursue your own interests as long as they don’t damage the interests of others, wrote ‘A society which puts equality – in the sense of equality of outcome – ahead of freedom will have neither equality or freedom’. The British Social Attitudes Survey has consistently reported around 75% of the population saying that the gap between rich and poor is too wide. But the same survey shows less than 35% of people think it’s the government’s job to do something about it. European egalitarianism does not play well with the phlegmatic British spirit, it seems, and although we quite like the idea of equality we seem much happier about equality of opportunity than we are about equality of earnings, something that the government seems quite happy to grind into the dust of their lunatic reforms to University funding.

I’m bound to wonder why the government is trying to fix a problem in the absence of any data showing that one exists. Given that Will Huttton’s remit only covers the public sector and the issue over bankers bonuses has already been dodged, it’s hard not to come to the conclusion that this is more to do with the impression of ‘fairness’ than a serious attempt to do anything about it.

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