Inequality in the United States and China

Income inequalities in the United States and China are not only high, and similarly high (which has been the case for a decade already), they are also becoming a serious political problem in both countries. President Obama in his 2012 State of the Union address called inequality a “defining issue of our time.” It subverts democracy and imperils equality of opportunity, arguably the two pillars on which the American Dream has been built. In nominally socialist China, the newly selected President Xi in his last year’s address to National Congress promised that tackling inequality will be his administration’s “top priority.” In China, high inequality threatens to undermine the Communist Party’s key justification to unchecked claim to power.

The turning point for both countries, launching them into ever rising inequality, took place at almost the same time: late 1970s and early 1980s. With the election of Ronald Reagan to the U.S. presidency and the policies of high real interest rates and lower taxes on “unearned” (capital) income, income inequality in the United States jumped and then kept on rising throughout the 1980s and the 1990s, before eventually plateauing at a very high level in the naughts. The overall outcome was that, measured by the Gini coefficient, U.S. inequality went from around 35 to 45 Gini points—that is, from a mid-range OECD inequality level to an OECD outlier surpassed only by Mexico and Turkey.

China, under Deng Xiaoping, introduced private ownership of land in 1978, and thus began its 35-year period of unprecedentedly high economic growth and rising inequality. During that same period, Chinese inequality increased at a tempo outpacing even that of the United States: inequality in China rose from a level lower than in the United States to a level equal or slightly exceeding that in the United States today.

In the United States, the growth of inequality is, in terms of explanatory factors used by economists, over-determined. There are many factors that have been adduced, and in some cases empirically shown, to have contributed to greater inequality. But they can be usefully divided into three groups: technological progress, globalization, and economic policy. Technological progress by favoring highly skilled labor to the detriment of the low-skilled, might have led to the increase in the wage premium (for the highly educated) and to widening inequalities. Globalization might have, by providing cheaper imports from China and allowing U.S. companies to hire cheaper labor abroad, led to a decrease in low-skilled wages, and likewise increased the gaps between the high- and low-skilled workers. In addition, globalization, by letting capital move much more freely than before, allowed entrepreneurs to find more profitable uses for their capital and to keep profit rate up, shifting the distribution in favor of capital and the well-to-do. Finally, economic policy, by reducing taxes on the rich has exacerbated these disequalizing trends.

What is the likely evolution of these three forces in the medium-term? The form that technological progress will take is, by definition, impossible to predict, but nothing seems to suggest that we are likely to enter an era of pro-unskilled labor innovations. Some innovations may be of this kind, as for example the use of cell phones to allow small farmers in Africa to get much more accurate and up-to-date information about prices, thus increasing their incomes. But nothing suggests that similar innovations are around the corner to help U.S. workers without a college degree. Globalization, as far as we can see, is also here and likely to stay. There may be minimal retrenchments, but the forces it has unleashed are too powerful, and the people who benefit from it are too numerous (particularly in Asia) that, short of a major war on the scale of the World Wars, it is unlikely to be put back in the box.

Which leaves us with economic policy. But there the news is rather bleak. Three decades of ideologically driven pro-market change, combined with an ever-greater ability of the rich to influence the political process, has created a stranglehold for the top 1% on the political agenda. Having invested several decades worth of effort and money into think tanks and lobbying to argue for low taxes on income and wealth, it’s unlikely that the rich will suddenly change their mind. Although the economic policies that could reduce inequalities are well known—higher minimum wage, cheaper public education, and above all higher taxes—the probability that they will be implemented is rather small.

The medium term in the United States will thus continue to look more or less like the present. But farther afield, the very foundations of democracy may be shaken by the plutocratic turn in governance and by the continued hollowing out of the middle class. Inequality may not change US way of life too much right now, but it might render its democracy vacuous, and sow deep the seeds of discontent with its political system.

The causes of inequality in China are different. There, the increase in inequality is primarily due to a transition of labor from low-productivity agriculture to a higher productivity industry, not dissimilar from the evolution in the United Kingdom between the mid-1800s and early 20th century or for that matter in the United States between the late 1800s and 1927. China, like the United Kingdom and the United States, is following an intense inequality upswing of the Kuznets curve (named after Russian-American statistician and economist Simon Kuznets), characteristic for all, or most, fast industrializers. But after a certain points, or so Kuznets’s theory suggests, equalizing elements kick in: urban-rural gap declines as agriculture becomes more productive, more people get educated (and the skill premium declines), and greater wealth as well as the aging of the population lead to increased demand for social welfare and thus redistribution. This is basically the path that the US and the UK both took after they passed the (previous) peak of their inequality some 100 years ago. On that reading of Chinese inequality, one can be optimistic: there are strong forces that may curb it in the future. We already see some first signs of it: from rising wages to the demand to extend the social safety net beyond urban state-sector workers.

But there are reasons not to be so sanguine. Chinese inequality is truly spectacular in the sense that it has exacerbated all cleavages: the urban-rural gap in China is greater than in any country in the world; the gap between the rich maritime provinces and the poor Western regions is growing; the gap between capital-owners (in a nominally socialist state!) and farmers is enormous. Reversing inequality means reducing some of these gaps, and this is a very arduous task: who is going to stop a Shanghai-based highly educated technician from earning more or compel him to share it with a Hunan farmer? How will far-away poor provinces become more developed? Will rich provinces be willing to fund the needed transfers?

More importantly, the single-party political system has led to massive corruption at all levels of government, but particularly at the top. The recent scandal that revealed secret bank accounts in the Caribbean belonging to the families of the top politicians underlines the massive extent of corruption throughout the system. As with the top 1% in the United States, it is hard to see that those in China who have profited the most from inequality will vote for lower benefits, lower premiums, and fewer opportunities for corruption for themselves

Thus, politics in both China and the United States seems to work against any realistic solution to stop or curb the rise in inequality.

The Chinese situation is more serious, however. Dissatisfaction with inequality can easily spill into the demands for political liberalization. That democratic alternative is especially attractive because the corruption of the rulers coexists with a justification for their rule – Communism – that is obsolete and that the elite themselves clearly ignore. The woes of the Chinese politicians are compounded because the gap between the official ideology and reality is huge and a political alternative to address this gap exists. In the United States, the gap between ideology and reality is smaller, and a political alternative is less clear, or at least commands less support among the population.

The solution to high inequality in both countries lies in the political sphere, but the chances for a short-term fix are low. Over the longer-term, change may hinge on democratic revolt in China and democratic renaissance in the United States.

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