The Inequality Challenge

Editor’s Note: This article will be published in the January 2013 issue of Current History.

High levels of inequality have become a subject of intense debate, particularly in the United States, where inequality has risen sharply over the past 30 years. The rise in inequality in most advanced countries and in many developing countries should be analyzed in the context of other big changes that have affected the global economy over the past three decades. These trends include major technological advances, mostly related to information technology; globalization, which has accelerated growth in many developing nations; and the changing role of the state.

Some degree of inequality is a natural part of a market economy—a reflection of the economic incentives that fuel it. For example, as the Harvard economist Simon Kuznets argued, rising inequality accompanies the initial stages of development, when workers attracted by higher wages in cities move from the countryside. The view that the efficient working of the market economy necessarily requires very high inequality, however, finds little empirical basis. There are well-functioning market economies, such as the Scandinavian countries, where income is quite equally distributed. Moreover, recent empirical work at the International Monetary Fund has shown that, on the contrary, growth appears to be more sustained when inequality is moderate than when it is extreme. Very high inequality, as well as raising troubling moral questions, can result in social divisions that reduce the efficiency of both government and the economic system. We believe that inequality in the United States and in many other countries has reached levels that are excessive on both equity and efficiency grounds. High and rising inequality is especially problematic when growth is slow and the living standards of the typical family are declining. Certainly the temptations of protectionism or retarding technology-induced shifts in employment must be resisted. But at the same time, as the trends that led to higher inequality appear set to persist or even intensify, it is important for policy makers to take corrective measures.

There is no secret to the recipes that governments can use to mitigate inequality; beginning in the 1920s and throughout the immediate post– World War II period, all advanced countries, including the United States, invested heavily in education, adopted more progressive taxation regimes, tightened labor and financial market regulations, and widened and deepened the social safety net. Most recently, governments in Latin America have shown how developing countries can use investments in education and small cash transfers to significantly reduce inequality, alleviate poverty, and improve health and education outcomes, even in an environment of very limited resources. With globalization, increased coordination across countries is needed to ensure that nations retain the capacity to tax corporations, mobile capital, and the highest earners.