Inequality in Europe: Branko Milanovic explains
By Alexander Hurst & Ties Gijzel for AWE
The following interview has been lightly edited for clarity.
AWE: There's a mythology about the United States as a "land of opportunity," but the US actually has much higher inequality and lower social mobility than most European countries. How do you explain the existence of greater intergenerational income mobility in the EU versus the US?
BM: Good question. As you implied, historically there has been this narrative of the American Dream and careers open to everybody and upward mobility. I think a lot of that was fed by Europeans who went to the US and came from poorer societies and then would experience upward mobility. But this story always neglected African Americans, who were about 13% of the population then and are about the same percentage now.
People like Raj Chetty and a number of other authors who study intergenerational income mobility have found that countries with high inequality also have low mobility across generations. And that’s why we find the Nordic countries to generally perform much better than the US.
AWE: Can you explain the link between inequality and low income mobility?
BM: This is somewhat speculative, but I think the link comes from the fact that high inequality enables you to maintain your position in society across generations. What is crucial is if you have very low inheritance taxation and an ability to get all the accoutrements of connection for your kids, and a private schooling system which is extremely expensive like in the US. Then you basically limit mobility of the lower classes, or nowadays even of the middle classes, towards the top.
The reason why the Scandinavian countries have done better is that historically they have had a more progressive taxation system, and a more universal higher education system than the US.
AWE: There are a lot of people who want to link inequality and populism - obviously there are other explanatory narratives around identity - but given that there is greater mobility in much of Europe and less inequality, why is there a similar rise in anti-globalist populism on both sides of the Atlantic?
BM: I think what’s driving populism in Europe is that inequality has increased here as well. Inequality has increased in all OECD countries. Not just the UK, but for example Sweden had a very dramatic increase in inequality. The Netherlands had an increase in inequality at the level of disposable income. It was small, but there was practically no OECD country that did not have an increase.
Secondly, maybe Europe is more sensitive to such an increase in inequality because historically after WWII it was a more equal society. And finally a big issue is migration, which is a more powerful political problem in Europe than in the US.
AWE: Why did inequality still rise across the EU despite progressive taxation and the welfare state?
BM: Market inequality went up in all the countries. In Germany it even went up more than in the US. Of course Europe has a more progressive overall system of taxation and transfers than the US, the system as a whole did not become more progressive. If you really wanted to totally eliminate all the increase in inequality, you would have had to become even more redistributive than before, but EU countries did not do that.
AWE: And why didn't they?
BM: I haven't done a study so I don't know for sure, but I think what Europe experienced was similar to what the US experienced--it was constrained by globalization. By decreasing taxes on capital or inheritance, by the ability of people to move, by the mobility of capital, or by political sort of skepticism about the use of public money, so it did not behave fundamentally differently than the US.
AWE: To zoom out a little, because we are talking about inequality within countries, what do you think about the role of the EU, both intra-EU and between the EU and other countries.
BM: That's interesting. When you take the EU as a whole, it has similar inequality to the US. Certainly the top 1% in Europe has a lower share of wealth than in the US, but the GINI coefficients are similar and that's because Eastern and Southern European countries are poorer than northern European countries. The EU itself has a GINI coefficient of .40 [the US is 0.48 — editor’s note], because when you put all these countries together they have different incomes. Romania and Bulgaria have an income that is 1/4 of the Netherlands.
So on a certain level it's politically tougher to deal with than in the US because it requires transfers between countries, even if ultimately that involves a relatively small amount of money. The EU budget is around 1% of GDP, and it leads to all these issues and fights, but these are small amounts for the EU as a whole.
AWE: We’ve identified globalization as a major reason for the increase in inequality and discontent in the developed world, but on the flip side, hasn't expanded trade been enormously beneficial in lifting people out of poverty in the developing world?
BM: Absolutely and you see that in surveys--support for globalization in Asia is 80-90%, and in France, the lowest of all countries, it’s around 30%. I don't think you would have had the decline of poverty and thereby the reduction in global inequality without globalization and the opening of China and other countries.
AWE: Can we reduce inequality and raise real wage levels in a low growth environment, or do we absolutely need higher growth?
BM: That’s a controversial question. I am old fashioned in that I don't think we can do it without growth. What would be considered an acceptable standard of living in the Netherlands is probably in the 90th or 92nd income percentile in the world.
So if you want to take the whole global GDP and say ok, we don't want to grow anymore, you cannot sufficiently redistribute from the top 5 or 7 percent to bring all these other people out of poverty, much less bring them to the same level of income that even the poorest people in the West have, because that's about the 70th percentile.
In fact, to bring everybody to that level, which is not considered acceptable by most people in the US or Western Europe, you would need world GDP to be 3.5x what it is now.
So the trade-off is simple: either we continue to grow and bring 60% of the world population to much higher incomes, which would require triple, quadruple or quintuple the total current economic pie, or all western Europeans and North Americans would have to give 80% of their income to the people below. And obviously that's a non starter.
AWE: So growth is essential to tackling inequality, but at the same time inequality has been shown to slow down growth. Do you think we should start by tackling inequality as a strategy to reach higher levels of growth?
BM: Yes — the IMF recently found that high levels of inequality negatively impact growth. But what we really mean is the growth rate at the mean, because if we say “GDP went up 6%” it doesn't mean that everybody went up 6%. It might be 1% growth for those on the bottom and 15% for those on the top.
So we should aim for reducing inequality in rich countries, which would then increase growth and particularly growth for the middle class.
We've seen that austerity policies in Europe haven't worked. The Italian economist Alberto Alessino at Harvard invented the notion of expansionary austerity, but it just didn't work like that. For example Italy is at the same income level today as it was in 1999, or 2001. Basically they have not grown in a generation. It’s the same for the UK and Greece.
AWE: What is the most effective public policy intervention for reducing inequality?
BM: Historically it was education. Today’s developed countries reduced the wage premium between the highly educated and others, and the highly educated became much more numerous. But there were other policies too, like unemployment benefits, the minimum wage, trade unions...
AWE: And so what should we focus on today?
BM: I don’t think we can just focus on the same policies as in the past, mainly because the middle class isn’t willing to be taxed at the same rates it accepted 40 years ago.
Then, trade unions have declined in all countries, and that’s not accidental. The type of work that people do is different, and we don't spend our whole career in a big plant where everyone is together, so it's more difficult to organize people and their objectives don't always coincide.
When it comes to education, in highly educated societies (14 years or more of schooling) increasing education won't give you the same result because there is a plateau. The essential impact we had in the past was moving from 5-7 years of education to 14.
So I think we should focus differently: on equalizing endowments (meaning endowments in human capital) making access to education more equal, and reducing the concentration of financial capital. We need pro-middle class policies that give higher returns to small investors, and to reduce the loopholes and special treatment that large investors get.
AWE: Could we do that through a universal basic income?
BM: Let me give you three ways.
One, we could shift tax policies to benefit the middle class, like guaranteeing investments up to 5000 dollars. Small investors are often afraid to invest because you could lose all the money that you have, so there could be a government guaranteed scheme that would provide a floor below which you would not fall.
Second, we could expand the use of employee stock ownership plans, and increase the number of workers who are shareholders.
Third is transfer— using inheritance taxes to transfer money to everyone who has reached age 18. Or perhaps using that money not to give a transfer, but to give advantageous loans to everyone at the rate at which the government borrows, which is almost zero.
AWE: Could you envision making the public at large shareholders through sovereign wealth funds?
BM: Yes, absolutely. If the public were shareholders then everyone would get income from capital. Income from capital increases inequality, but that's because historically it has been concentrated in the hands of the rich. In any developed country around 10% of people own between 70-90% of financial assets, so if that type of income goes up, then of course it translates into higher inequality. But if you had a national sovereign fund that would pay everybody, then obviously the source can go up and it would reduce inequality.