'Introducing Kuznets Waves: How income Inequality Waxes and Wanes over the Very Long Run '

Branko Milanovic at VoxEU:

Introducing Kuznets waves: How income inequality waxes and wanes over the very long run: In 1955 when Simon Kuznets wrote about the movement of inequality in rich countries (and a couple of poor ones), the US and the UK were in the midst of the most significant decrease of income inequality ever registered in history, coupled with fast growth. It thus seemed eminently reasonable to look at the factors behind the decrease of inequality, and Kuznets famously found them in expanded education, lower inter-sectoral productivity differences (thus the rent component of wages would be equalized), lower return to capital, and political pressure for greater social transfers. He then looked at (or rather imagined) the evolution of inequality during the previous century and thought that, driven by the transfer of labor from agriculture to manufacturing, inequality rose and reached its peak in the rich world sometime around the turn of the 20th century. Thus, he created the famous Kuznets curve.

The Kuznets curve was the main tool used by inequality economists when thinking about the relationship between development or growth and inequality over the past half century. But the Kuznets curve gradually fell out of favor because its prediction of low inequality in very rich societies could not be squared with the sustained increase in income inequality that started in the late 1970s in practically all developed nations (see the long-run graphs for the US and the UK). Many people thus rejected it.

The upswing in current inequality as a second Kuznets curve

In a new book (Milanovic 2016), I argue however that we should see the current upswing in inequality as the second Kuznets curve in the modern times, being driven, like the first, mostly by a technological revolution and the transfer of labor from more homogeneous manufacturing into skill-heterogeneous services (and thus producing a decline in the ability of workers to organize), but also (again like the first) by globalization, which has both led to the famous hollowing out of the middle classes in the west and to a pressure to reduce high tax rates on mobile capital and high-skilled labor. The elements listed here are not new. But putting them together (especially viewing technological progress and globalization as practically indissoluble, even if conceptually different) and viewing this as part of regular Kuznets waves is new. It has obvious implications for the future, not the least that this bout of inequality growth will peak like the previous one and eventually go down. ...

Skipping forward:

Inequality may not be overturned soon

Which leads us to the present. How long will the current upswing of the Kuznets wave continue in the rich world, and when and how will it stop? I am skeptical that it will be overturned soon, at least not in the US where I see four powerful forces that keep on pushing inequality up. I will just list them here (they are, of course, discussed in the book):

• Rising share of capital income which is in all rich countries extremely concentrated among the rich (with a Gini in excess of 90);
• Growing association of high incomes from both capital and labor in the hands of the same people (Atkinson and Lakner 2014);
• Homogamy (the educated and the rich marrying each other); and
• Growing importance of money in politics which allows the rich to write rules favorable to them and thus to maintain the inequality momentum (Gilens 2012).

The peak of inequality in the second Kuznets wave should be lower than in the first (when in the UK, it was equal to the inequality level of today’s South Africa) because the rich societies have in the meantime acquired a number of ‘inequality stabilizers’, from unemployment benefits to state pensions.

The pro-inequality trends will be very hard to overturn during the next generation, but eventually they may be – through a combination of political change, pro-unskilled labor technological innovations (which will become more profitable as skilled labor’s price increases), dissipation of rents acquired during the current bout of technological efflorescence, and possibly greater attempts to equalize ownership of assets (through forms of ‘people’s capitalism’ and workers’ shareholding).   

Now, these are of course the benign factors that, I think, will ultimately set inequality in rich countries on its downward path. But history teaches us too that there are malign factors, notably wars, in turn caused by domestic maldistribution of income and power of the elites (as was the case in the World War I), that can also do the job of income leveling. But they do it at the cost of millions of human lives. One can hope that we have learned something from history and would avoid this destructive path to equality in poverty and death.