How the wealthy keep themselves on top By Tim Harford, 2013, Financial Times

Posted: June 15, 2015 in Musings
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By Tim Harford

The more unequal a society, the greater the incentive for the rich to pull up the ladder behind them

When the world’s richest countries were booming, few people worried overmuch that the top 1 per cent were enjoying an ever-growing share of that prosperity. In the wake of a depression in the US, a fiscal chasm in the UK and an existential crisis in the eurozone – and the shaming of the world’s bankers – worrying about inequality is no longer the preserve of the far left.
There should be no doubt about the facts: the income share of the top 1 per cent has roughly doubled in the US since the early 1970s, and is now about 20 per cent. Much the same trend can be seen in Australia, Canada and the UK – although in each case the income share of the top 1 per cent is smaller. In France, Germany and Japan there seems to be no such trend. (The source is the World Top Incomes Database, summarised in the opening paper of a superb symposium in this summer’s Journal of Economic Perspectives.)

But should we care?

There are two reasons we might: process and outcome. We might worry that the gains of the rich are ill-gotten: the result of the old-boy network, or fraud, or exploiting the largesse of the taxpayer. Or we might worry that the results are noxious: misery and envy, or ill-health, or dysfunctional democracy, or slow growth as the rich sit on their cash, or excessive debt and thus financial instability.
Following the crisis, it might be unfashionable to suggest that the rich actually earned their money. But knee-jerk banker-bashers should take a look at research by Steven Kaplan and Joshua Rauh, again in the JEP symposium. They simply compare the fate of the top earners across different lines of business. Worried that chief executives are filling their boots thanks to the weak governance of publicly listed companies? So am I, but partners in law firms are also doing very nicely, as are the bosses of privately owned companies, as are the managers of hedge funds, as are top sports stars. Governance arrangements in each case are different.
Perhaps, then, some broad social norm has shifted, allowing higher pay across the board? If so, we would expect publicly scrutinised salaries to be catching up with those who have more privacy – for instance, managers of privately held corporations. The reverse is the case.
The uncomfortable truth is that market forces – that is, the result of freely agreed contracts – are probably behind much of the rise in inequality. Globalisation and technological change favour the highly skilled. In the middle of the income distribution, a strong pair of arms, a willingness to work hard and a bit of common sense used to provide a comfortable income. No longer. Meanwhile at the very top, winner-take-all markets are emerging, where the best or luckiest entrepreneurs, fund managers, authors or athletes hoover up most of the gains. The idea that the fat cats simply stole everyone else’s cream is emotionally powerful; it is not entirely convincing.
In a well-functioning market, people only earn high incomes if they create enough economic value to justify those incomes. But even if we could be convinced that this was true, we do not have to let the matter drop.
This is partly because the sums involved are immense. Between 1993 and 2011, in the US, average incomes grew a modest 13.1 per cent in total. But the average income of the poorest 99 per cent – that is everyone up to families making about $370,000 a year – grew just 5.8 per cent. That gap is a measure of just how much the top 1 per cent are making. The stakes are high.
I set out two reasons why we might care about inequality: an unfair process or a harmful outcome. But what really should concern us is that the two reasons are not actually distinct after all. The harmful outcome and the unfair process feed each other. The more unequal a society becomes, the greater the incentive for the rich to pull up the ladder behind them.
At the very top of the scale, plutocrats can shape the conversation by buying up newspapers and television channels or funding political campaigns. The merely prosperous scramble desperately to get their children into the right neighbourhood, nursery, school, university and internship – we know how big the gap has grown between winners and also-rans.
Miles Corak, another contributor to the JEP debate, is an expert on intergenerational income mobility, the question of whether rich parents have rich children. The painful truth is that in the most unequal developed nations – the UK and the US – the intergenerational transmission of income is stronger. In more equal societies such as Denmark, the tendency of privilege to breed privilege is much lower.
This is what sticks in the throat about the rise in inequality: the knowledge that the more unequal our societies become, the more we all become prisoners of that inequality. The well-off feel that they must strain to prevent their children from slipping down the income ladder. The poor see the best schools, colleges, even art clubs and ballet classes, disappearing behind a wall of fees or unaffordable housing.
The idea of a free, market-based society is that everyone can reach his or her potential. Somewhere, we lost our way.
‘The Undercover Economist Strikes Back’ by Tim Harford is published this month in the UK and in January in the US


logicus Aug 16, 2013
The uncomfortable truth is that you have become an apologist for the wealthy.

Myweehoney Aug 16, 2013
The main reason to be worried about increasing wealth inequality is that the 99% are the spending and tax base for western economies. The very rich spend much less proportionately of their income and always manage to be taxed at lower rates. How will economies grow if consumer spending, ie the 99%, is continuing to be squeezed. And where will the tax income be harvested to pay for reasonable government services.

NIHILIST Aug 16, 2013
Educate people into understanding that a rich life is independent of financial wealth.

Pepijn Aug 16, 2013
I wonder whether inflation plays a role. The database shows the top 1% income share declining from 1950 to 1982, a period when inflation was steadily rising. As of 1982 the trend reverses and the top 1% share starts growing rapidly. Maybe the ability to preserve capital as inflation declines plays a role (assuming the top 1% make a good share of income out of capital rather then labour alone). On the other hand, for those in debt declining inflation is obviously bad news.

InterestedReader Aug 16, 2013
“In more equal societies such as Denmark, the tendency of privilege to breed privilege is much lower.”

Hold on, you’re confusing inequality of wealth and inequality of income here; Denmark has very low income inequality, but also one of the world’s highest levels of wealth inequality (by Gini coefficient).

Voice of Truth Aug 15, 2013
Easy to do when you have the financial muscle to transfer increasing amounts from the middle and lower classes to the top 1%, while having complete control of the system.

Alan Hutchinson Aug 15, 2013
@the white rabbit : Good point. Tom Palley has argued the same. There was a minimum of greed in or around 1978 (see the database which Tim Harford cites). Since then, middle class affluence has been funded by increasing debt which led to the crash of 2008.

DEBT SLAVE Aug 15, 2013
Blood will flow in the streets eventually…

francobollo Aug 15, 2013
good article

AB99 Aug 15, 2013
Agree with Burtonshaw. Too many smart and potentially productive young people in USA, UK lured away from science, engineering etc. into finance and law. Yes, we need the rule of law to allow markets to function but isn’t there a point beyond which more lawyers actually means more complexity and lower competitiveness?

A_Reader Aug 15, 2013
Dear All,

A comment: the impact of the very few in the Society is obvious. The not so obvious is that the inequality does not come from now. It is a very long process that might have begun some centuries ago, but now with the complete absurd actions of Central Banks and the existence of technology the main points became enormously clear.

Technology made it possible to see what has been happenning for a very long time… maybe it has been a pattern of Human development since the first start.

Concentration of power implies in “too big to fail” structures. Through them we have power in the hands of a very interconnected few that together have the control of absolutely everything… and more specially in the so called “Capitalist and developed” world. And BTW there is nothing of Capitalism in it, it is the old Plutocratic regime that controls the State and its institutions through “institutionalised” criminality (the absurd “legalised” actions taken by a few).

The population is taught since a very early age to behave and accept not only the ways things are but why’s. Films, magazines, the midia besides schools and educational systems are stablished to keep all the “frame(work)” in place. No talk on Civil Disobesience. No talk of independent thought, unless when coming from the well connected few (so called “famous”) institutions that keep the control. From there comes the “networks” and in such a way that going agaisnt them can become professional (and maybe even mental) suicide.

It is simply a pattern that governs the small and the large: it is the same structure. One can certainly make a model of this so called “anthropological dynamics” and the math behind it is quite simple in its description but very sofisticated to make it in an analitical way. It is all about the work of Prof Benoit Mandelbrot that has been propositaly neglected by the so called Scientific Establishment. And the reason is very simple: it is too complex and influencial for the simple minds who have been on the top and for a very long time. The Establishment can make it through lies that benefit themselves (=> “The majority is allways wrong” or “Every majority is stupid”).

The work of Prof Mandelbrot proves the stupidity of the vast majority of the so called “Scientific” work outside there. It also proves their irrelevance. As a matter of fact it also proves the structures behind the dynamics and why they are orgamnised in that way: the greedy behind the Human Condition.

Will there be enormous destruction in the coming years? Are we close to wars that are ultimately caused by reactions to the current (anthropological) organisations / social and anthropological orders?

Nature has Its ways to make Itself heard. The paradigm should be the one of SME’s and not “large powerfull too big to fail” structures controlled by “Yes men” with very close to psycho behavior.

I hope to be wrong … although I have a quite good track record….

Many thanks,

Best regards,

A_Reader, Ph.D.

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