I just read Andrew Leigh’s new book that he will launch July 1st in Canberra, July 2nd in Melbourne, and July 3rd in Sydney. I encourage you to attend one of these because it’s a ‘good yarn’.

In this new book, Andrew makes a plea for an egalitarian Australia that values mateship and that frowns on displays of wealth and inequality. He analyses the historical data on inequality, arguing that the low-point of inequality was reached in the 1970 and that Australia is currently becoming more unequal such that we have ‘returned’ to the levels of inequality in the 1930s. This leads Andrew to talk about the proximate causes and consequences of inequality, where he ultimately sides with the majority of Australians who dislike inequality.

You can see in this book Andrew Leigh’s passion for improving Australian society, as well as his great intellectual strengths: an easy anecdote-based writing style, a phenomenal memory for facts and names, and an almost unparalleled energy to ferret out data to illuminate his argument. He has dug up the prices of land and labour since the middle of the 19th century to see how labourers have fared relative to land owners; scoured the inheritance records since 1915 to see the reduction in wealth inequality from 1915 to the 1970s (with a virtual flat line since); combined data on top-income tax and transfers to arrive at long series for post-tax male gini-coefficients; found longitudinal data on the opinions of Australia about inequality; and of course he has dug through mountains of literature on inequality through the ages in Australia. I am always a bit in awe of Andrew’s easy command of facts and anecdotes and it is on full display in this book.

Andrew’s basic contention also seems pretty solid to me, which is that income inequality was high at the end of the 19th century, has gone through almost 60 years of decline since the first World War, and is in recent decades on the up again. Because the welfare system has expanded hugely in the last 50 years, income inequality overstates the actual degree of consumption inequality and hence one should probably see the current situation more as a slight reversal in the high equality achieved in the 70s rather than a true return to the days of the 19th century, but the trend is clear. Andrew essentially sees this rise in inequality as normatively bad in that greater inequality offends his sensibilities and he fears it would eventually lead to a society most of us do not want.

Along the way, Andrew constructs a narrative of inequality in Australia over the last 250 years with many charming factoids to keep the reader smiling, such as that Rugby League split off from rugby union because the working men playing rugby league wanted to be paid for their efforts rather than impoverish their families by indulging in the upper-class hobby of rugby union. The story of how the early governors of Australia failed to uphold equality because they found that giving more land to the more successful and bigger farmers simply meant more food production than handing out land to many inefficient farmers, is similarly enlightening: it shows how inequality truly can be good for a whole country in some circumstances simply because some people are more efficient with resources than others.

Andrew’s eventual policy prescriptions are a combination of the politically expedient and the basic advice to the poor of following the habits of the rich: somewhat Tony-Blair style, Andrew claims Australia is in danger of losing what is good about it, and then advocates the state to look after the weakest, the poor to look after their children in the way the rich do, and for Australia to maintain the pillars of the current labour party (the unions).

Andrew’s analysis of the causes and consequences of inequality is hampered by the desire to cater for two audiences: the academy and the general public. Andrew solves this tension by keeping the story mainly empirical and not to ‘get dirty with theory’ and thus adopt a larger narrative as to how economies work and hence where inequality comes from and how it interacts with other circumstances. This comes at a cost though: it leads Andrew to accept ‘facts’ he finds in recent empirical economic papers that really, on reflection, would kill his whole argument if he stuck to them. In particular, Andrew accepts that inequality does not adversely affect health and that it is good for economic growth, with trickle-down occurring in the long run. If he truly believed that, he should be a warm advocate of more inequality as ultimately being good for everyone’s health and wealth. It is clear from his policy prescriptions that he in fact does not believe either but he just can’t get himself to openly dismiss the (largely American) empirical literature that says these things.

In particular, Andrew accepts the idea that inequality is good for economic growth. He explains in endnotes why: if you look at the countries that have grown the last 50 years you will find that those that grew faster also became more unequal and that shocks to inequality seemed to have mildly positive effects on economic growth. Let us take that empirical stylised fact at face value. Does it then follow that inequality would help Australia’s economic growth? Not at all. Why not? Well, you need to unpack the deeper mechanisms to really understand what is going on.

Let us thus think about the different types of economic growth underlying the economies of different countries and their growth experience the last 50 years. Loosely speaking, one type of growth is of the ‘beggar thy neighbour variety’ where you have countries growing fast because they undercut the taxation of other countries. Switzerland, the Virgin Islands, Luxemburg and others are good examples of these. They saw fast growth combined with rising inequality, helped by laws encouraging greater inequality, i.e. laws that attracted the very rich to park their money in those countries. It may be good for those countries but it clearly wouldn’t work for all countries: who would Australia beggar?

Another type of growth is of the ‘sell your natural capital’ variety where countries sell what is in the ground. The small oil states and the high mineral countries (like Botswana, which is basically a diamond mine) belong to this group and also saw rising inequality together with high growth. The key thing about those countries though, to which Australia now also partially belongs, is that inequality is not inevitable at all, unlike the ‘beggar thy neighbour countries’. As Norway shows, it is perfectly possible for a country to tax the resource sector for the benefit of the whole population and thus get the growth and equality.

A third group of countries would the ‘catch-up’ countries (like China now or Australia in 1800) which first see a growing inequality as the more able take advantage of new opportunities but later on see a reducing inequality as mass-education lifts the bottom and the economy shifts to a new phase associated with a fourth group. That fourth group would be the developed high-skill countries (like Japan, South Korea, and Germany) where growth comes from high skills and thus primarily from high-quality mass education. Those countries have fairly low inequality and very high national wealth. The fact that many small countries hang around these ‘investing’ countries and are free-riding on them in terms of providing tax havens and poaching their skilled workers does not mean that inequality would be good for those countries. Indeed, it is fairly detrimental to growth in this fourth group to which Australia might well want to belong too. Certainly the narrative Andrew Leigh pitches his book in would have Australia move towards that kind of economy in which case he should really stop believing inequality would be good for growth in Australia!

Similar things can be said about inequality and education or health: without unpacking an aggregate simple relation between year-on-year changes in health and inequality one basically will have difficulty forming a considered opinion about what the underlying relation is between inequality and health in Australia. So whilst the academic literature focusses in the main on the more easily documentable short-run relation between inequality and health (including some of my own writings!), this doesn’t mean that the consensus opinion amongst health organisation and health economists is truly that inequality has no adverse effect on health. Quite the contrary: the consensus opinion is that it is most likely bad for health because of long-term impacts on stress, self-esteem, and even in-utero effects on the next generation. That type of consensus is driven more by the fact that the US has relatively low aggregate health concentrated amongst the poor compared to other rich countries, than an analysis of year-on-year variation which is the flavour of the moment in health economics simply because so many other things go on in the longer run that one can’t convincingly prove anything. Being unable to convincingly prove to academic referees and editors that inequality is bad for long-run health doesn’t mean that policy makers shouldn’t go with the best-guess anyway! Indeed, when it comes to the ‘bad things’ Andrew does connect to inequality he includes the bad habits that the poor give on to their kids. These of course include health-related habits around food, smoking, exercise, pregnancy, etc., so there is a long-run causal pathway between inequality and health right there that Andrew seems to not notice he believes in.

To an academic, a bit of theory (even expressed verbally) would have helped the argument and have tied a few disparate observations together. Andrew Leigh for instance notes the decline in the unions since the 70s, but misses the key reason for why unions exist: unions organise labour to share in the rent of the industries involved. They hence thrive when there is a deviation from perfect competition and hence when there are rents to be shared. Protected manufacturing industries and government bureaucracies are a case in point. Hence the decline in the unions and the reduction in the tariff walls of the 70s are two sides of the same coin. The current penchant for government-protected cartel-sectors (doctors, mines, hospitals, universities, etc.) similarly creates large rents which are shared by unions of administrators. This comes at the cost of open competition and thus likely longer-term growth. Etc. A bit of theory would really help the academic reader put the avalanche of facts in a single framework so that the real policy tradeoffs come into view.

But, to be fair, this book is not really aimed at academics. It is written for the general market of everyone interested in facts and stories around Australian inequality. For that group of readers, this is a very good book with lots of data that set you thinking about inequality and lots of affirming anecdotes as to why Australia should actively seek less inequality. I hope it is widely read and becomes a great success for Andrew.

15 Responses to On ‘Battlers and Billionaires’ by Andrew Leigh

  1. Andreas Ortmann says:

    Like.

  2. Ravi says:

    Paul,
    It sounds like a fascinating book, I will have to read it. I agree that inequality doesn’t cause growth, but would also argue that growth frequently causes inequality. Greg Mankiw makes the case that technological innovation (the greatest long-run factor to increase productivity) is spurred by low levels of taxation and regulation; http://scholar.harvard.edu/files/mankiw/files/defending_the_one_percent_0.pdf.
    For example, the populations of France, Italy, and Canada are more highly educated than the US average,(and taxed more heavily) but all display low levels of technological innovation. I agree that equality is a noble goal, but also think that there is a trade-off between equity and efficiency.

    • Yes, I know the US houses many economists believing in that tradeoff but the arguments they put forward dont convince. Take the ones you attribute the Mankiw: inequality boosts technological innovation. I think this is nonsence for several reasons:
      – by the ‘low tax and low regulation’ logic, innovation should have been fantastical during our long hunter-gatherer period as humans, or in the zero-tax completely unregulated country of Somalia right now. Any simple ‘low tax is good for growth’ argument is thus pure ideology and misses the complicated relationship between the organisation of society and technological growth.
      – a lot of innovation in the US is done by foreigners whose education is mainly paid for by their egalitarian homelands and their education systems. That the US benefits from a brain drain and thus in some sense plays beggar-thy-neighbour does not mean inequality is good for innovation. It means beggar-thy-neighbour can pay off.
      – you need a lot of infrastructure for technological innovation: education, knowledge retainment systems, information dissemination systems, a connected production chain such that innovations can have wide applicability and thus make sense to look for and implement, etc. In turn, getting people educated aint simple because they need to believe education makes sense, be sufficiently fed in the meantime, have parents who dont need their labour to get by, etc. You dont need to be a genius to figure out that technological innovation needs a lot of regulation and taxation. Only in the fantasyland of some academics dont you need it, and of course on the margin there will always be a point of too much regulation and taxes but by historical standards all modern countries are extremely high-tax, high regulation societies.

      • Ravi says:

        Dear Paul,
        Thanks for the thorough response. I have a few points of contention with your argument.
        1. Tribes of hunters and foragers frequently faced marginal tax rates of 100%, with all food being redistributed amongst the tribe. Somalia is very poor, but it’s GDP per capita has increased by threefold since 1991 (http://www.bbc.co.uk/news/world-africa-12285365). I am claiming that all things being equal, lower taxes and regulation frequently increase growth. Eg. Bangalore is more liberal than Kolkata and experiences faster growth and less rent seeking. The same is true of New Hampshire and Vermont.
        2. The US certainly benefits from immigration and it is certainly a large factor for innovation. However, Canada has an even larger percentage of foreign students at its universities than the US (it’s even a large source of university funding,) and it is not a significant producer of scientific research or other innovations. Clearly the ease of starting and running a business has an impact on innovation.
        3. I agree with you that social structure and infrastructure are essential to innovation, low taxes are not enough. I see the market of capable, in many cases, of providing that infrastructure in a superior cost-benefit ratio to government. For example, US railways were mostly built using private capital, while Canadian, Indian, and European railways were built directly by the state. Today, US freight has the cheapest rates in the world, and have been constantly expanding. Freight rail costs 8 times as much in Germany, and slightly less in Canada.
        I am not an anarchist; the state is useful for some things, like self-defense and protection of property. I just think that the market and civil society can frequently solve issues left to the government with less inefficiency and rent seeking.

        • Paul Frijters says:

          sure, you can redefine tax to include all within-group transfers, but then one should make that same demand of the current literature and ask scholars to work out what they think determines those transfers, many of which are not under government control. So the ‘100%’ tax by hunter-gatherer groups forces you into completely rejecting the current empirical approaches as missing the point and measuring only part of the truth!
          Similar things can be said about the issue of migrants: per capita Canada is doing great, at least as well as its southern neighbour so its an odd country to pick as a counter-example. It also benefits form migrants!.

  3. Sean says:

    A good read but a little disappointed with the partisan pot shots which come across as Labor spin. I was hoping that as an economist Andrew Leigh would be more immune to the temptation.

    Acemoglu & Robinson’s ‘Why nations fail’ does a better job of explaining the power dynamics and the long term impacts on economic well being. Fred Hirsch’s ‘Social limits to growth’ also probably does a better coverage of the problems of social relativity.

    While rationale for salary capping in sport is interesting, explaing how the equivalent can be done with CEO & executive pay would have been even more interesting.

    The link between inequality & GDP growth is very interesting, especially for Australia over the last couple of decades. Is this a globalisation dividend? Increasing the size of pie at the same time giving the top 1% a greater share? But does it go the other way when GDP falls? Probably not but would be interesting to see what the data shows.

  4. Peter S says:

    Not sure I agree with you Paul. Andrew Leigh, in my opinion, is pretentious as his new (redeemed) boss.

  5. Ravi says:

    Paul,

    You make a very good point with regards to the measurement of nongovernmental transfers. Canada is certainly a rich and prosperous country. However, it is clearly not as wealthy or innovative as the US (http://www.oecdbetterlifeindex.org/topics/income/). Canada has traded some wealth in exchange for greater equality and security. Given the decreasing marginal utility of wealth, this may be a good idea. I was using Canada add an illustration of that tradeoff.

  6. The key point here is that the tax burden has shifted under the pressures of tax competition, powerfully worsening inequality within countries. The tax situation of the world’s wealthy elites is improving as a result of tax competition. This problem has been particularly acute in poor countries (see Cobham, 2007), whose governments are far less able to adjust to the pressures of tax competition. The relative tax burden on corporations has fallen, while the tax burden on labour and spending has had to rise, which has demonstrably increased inequality. Concerns about inequality are evident across the political spectrum from left to right, as evidenced by the example of the IMF deputy managing director’s speech, described above, or an article in the prestigious American journal Foreign Affairs co-authored by Matthew Slaughter, a former economic advisor to President George W. Bush.

  7. Let us thus think about the different types of economic growth underlying the economies of different countries and their growth experience the last 50 years. Loosely speaking, one type of growth is of the ‘beggar thy neighbour variety’ where you have countries growing fast because they undercut the taxation of other countries. Switzerland, the Virgin Islands, Luxemburg and others are good examples of these. They saw fast growth combined with rising inequality, helped by laws encouraging greater inequality, i.e. laws that attracted the very rich to park their money in those countries. It may be good for those countries but it clearly wouldn’t work for all countries: who would Australia beggar?

  8. The advanced economies do indeed deserve a disproportionate share of the blame. But as economist Simon Evenett of Switzerland’s University of St. Gallen has observed, “the beggar thy neighbor game is not confined to North-South trade.” The African Development Bank recently reported that only about one-tenth of the continent’s total trade is neighbor-to-neighbor. The numbers for Latin America and Asia are higher (22 percent and 50 percent respectively). Poor countries complaining about commerce-impeding barriers would be well advised to check the mirror to see where their troubles lay.

  9. Olivier Blanchard, of the Massachusetts Institute of Technology, sees Spain as a plausible next victim of what he calls “the rotating slumps under the euro”. In his view, the euro area is characterised by a succession of booms and busts, each in a single country. A typical stop-go cycle starts with a localised increase in demand, which in turn leads to higher wages, lost competitiveness and finally to a protracted downturn. Since short-term interest rates in the euro area are not tailored to individual countries’ cycles, monetary policy can attenuate neither boom nor bust.

  10. Paul Frijters says:

    Summer,

    your comments and the next 3 just got rescued from the spam filter, so sorry for the late supply. The filter probably got stumped by the names used.
    Agreed though on the tax competition. It makes the mining saga all the more important, for taxing that which cannot run away (like minerals in the ground) is so clearly optimal. Leigh didnt want to go there though.

    Forest,
    I must be missing a trick, but fail to see the link between within-Africa trade and beggar-thy-neighbour financial piracy.

    Eliseo,
    I would tend to blame previous public sector inflation for much of what happens now in Southern Europe. Inflation used the be the way that governments could play Father Christmas with jobs, pensions, welfare, public works, and public wages, and yet on balance end up doing the same thing as the countries with less ‘Father Christmas’ tendencies. Being in a single currency zone killed the inflation safety-valve that re-set both relative prices and debts, leading to a massive build up of public and private debt. When the borrowing constraint came into view, downward nominal public price movements were politically too hard to do quickly, which got the Eurozone into this protracted demand slump. To get out of it, I am a warm advocate of the ECB giving every Eurozone citizen, say, an account with 5000 Euro.

  11. Robert Macdonald says:

    Paul, it’s a pretty narrow argument to suggest the decline in unionism is simply due to increased product market competition. If people has the propensity to unionise they would, but that is partly shaped by experience and opportunity. Labour law reforms across the longer-term, where there has been an equally substantial removal of protections to the removal of tariffs, both remove the compulsion to unionise and allow employers to exercise greater pressure on employees to not unionise.

    • Paul Frijters says:

      Hi Robert,

      yes, there is probably a bit more going on, but I do think the big driver is the underlying incentives to unionise, which is basically given by the existence of some industry rent that is locally contestable. Internationalisation in a broad sense (including the tariff reductions) has made it harder for the labour movement to share in the rents of their industries. I think the movements in law and habits are just derivative in the longer run of the degree of unionisation. Laws are less favourable now, true, but think of how unfavourable they were when the unions arose!

      There is of course also a bit of re-labelling going on that hides the true level of unionisation. The medical associations of specialists are also unions in all but name, and there are a few others (doctors, accountants, etc.). Their main lobby target is the government rather than a local employer, so we often don’t see that they really are just unions too.

      Anyhow, the point I made in the review on this topic was that unless one brings up these inter-relations and works them into a single causal story, one is essentially just looking at a cloud of loose empirical observations of which one cannot conclude anything.

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