Reining in Economic Inequality by Frank Stilwell

(Professor of Economics, Uni Sydney)

Imagine that we are standing out at Railway Square watching the whole of the Australian population pass by in a parade. The parade only lasts one hour and the people pass by in order of their height - and their height in this case relates to their income. Can you imagine what the parade would look like? In the first couple of minutes of the parade there wouldn’t be anything to be seen at all. These are people who in effect are passing underground not because they are poor but because, typically they have reorganised their affairs so that they appear for taxation purposes to have got worse off during the year using bankruptcy laws and other procedures to present themselves as actually declining in income.

But after a few minutes small, tiny midgets appear and by about ten minutes you see people about one and a half feet tall when you are thinking that people’s height is 5 cms for every thousand dollars they have earned in that year. These are tiny people by any standards and indeed the rate by which the height of the people increases is very slow at this stage of the march past. Indeed by the 18 minute mark when nearly a third of the whole population has filed past, the average height is still only about 3 ft. It’s starting to look like an endless parade of midgets. In this part of the march women headed single parent families are well represented, so too are elderly people. Recent school pupils and other young people are not much in evidence though many don’t have secure incomes because they’re deemed to be dependent on older members of their households and therefore are not separately represented in this parade.

But gradually taller people start to appear, people who are in regular paid employment, some of them in households with more than one income but often with one householder in irregular or casual jobs. But even with this regular income from employment people are still quite small so that by the time of the 30 minute mark, exactly half way through the parade, the average height is still only about 4 ½ feet. This is middle Australia. Some visitors in the crowd who are watching this march past have come from poorer countries in Asia, South America and Africa and are quite impressed by the height of these people.

The next 12 minutes sees a steady increase in the average height of about seven and a half feet , people with regular, reasonably paid employment , some wearing clothing suitable for industrial work, but mostly in business suits, some running their own small business, although the height of this group varies very significantly. People of European appearance now dominate over people of Asian or of Aboriginal appearance. Indeed the Aboriginal people have filed past long ago, being very close to the ground indeed.

More rapid increases in height have started to occur in the last few minutes that by the 54^th minute, the average height has risen to nearly fourteen feet. And then even more rapid changes take place in startlingly quick succession as the richest 10% of the population comes into view. The average height increases in the next 2 minutes equal to what took half an hour earlier in the march past. The average height leaps even more dramatically in the next 2 minutes as extremely wealthy people stride by - surgeons, lawyers, other highly paid professionals, and also executives in large corporations. But a significant number of these people don’t work at all deriving their wealth from the ownership of land and capital. They look massive compared with the long sequence of dwarfs that preceded them earlier in the parade.

And then in the last minute giants come into view. Some are chief executives in large corporations, their stature boosted by huge remuneration packages. But it’s quite difficult to gauge exactly how tall these giants are. As one bystander in the crowd remarked, ‘There’s a notorious tendency for very tall people to try to disguise their height, particularly when they may be observed by tax collectors. By any estimate, though, the figures that passed by in the last few seconds are truly enormous, towering above skyscraper buildings and bringing up the rear is a veritable colossus named Kerry Packer. The upper part of his body is hidden by clouds.

Last November the Sydney Morning Herald published a nice supplement called Power Salaries that listed the incomes of chief executives in Australian companies. I’ll pick a few at random. Peter Kirby from CSR, annual income $10.9 million; Frank Lowy of Westfield Holdings, $13.4 million; Rupert Murdoch pays himself $24 million and pays his chief executive Peter Chernin in News Corporation $28.6 million; Hugh Morgan $9.6 million and many, many others in that range. Indeed looking at the list as a whole, the average remuneration for the top earners in Australia in around 250 companies is now around two and a quarter million dollars annually.

Ten years ago this group received 22 times the average earnings of Australian workers, but now it’s about 75 times the average income of Australian workers. I note as an aside that only two of the 146 people listed here were women. Gender equity, anyone?

Even more interesting in many respects is a recent report prepared by John Shields for the Labor Council of NSW which looked at the relationship between these extremely high incomes of chief executive officers and the performance of the companies that they managed. Now you might presume that there is some correlation. But in fact this is not the case, Beyond a ratio of about 20 to 1 in terms of corporate executive remuneration to the salaries of the average worker, there is no correlation at all between corporate performance and CEO income. Up to 20 to 1 there is some correlation but afterwards the higher paid corporate executives are generally in charge of larger and more profitable corporations. But beyond that ratio of 20 to 1 up to the average of 75 or so there is no correlation at all. In other words these people are not being paid for superior performance. So the so-called incentivation argument that John Howard has commonly used - the argument that if you don’t pay good money you don’t get good people - if you pay peanuts you get monkeys - well, the evidence doesn’t bear it out. The evidence is much more consistent with snouts in the troughication than incentivation.

But of course it’s not just in the inequalities associated with chief executives that is at issue here. There is a broader tendency to growing polarisation of incomes and wealth within Australian society. I did some comparisons internationally to see how we fare in relation to other countries which suggest that Australia is indeed fairly middle ranking in terms of inequalities. If you take for example the ratio of the top 10%of incomes to the bottom 10 % - in Australia that’s a ratio of about 12 to 1 on average. It’s a bit higher in the US - about 16 to 1, a more unequal society; it’s higher still in South Africa, the legacy of apartheid etc where the ratio goes over 40 to 1 ; and in Brazil it goes over 65 to 1 - they have a president there now who wants to do something about that - but the task is enormous. Those societies in Brazil and other parts of South America , Africa too, are societies in which a fabulously wealthy elite lives side by side with a desperately poor stratum of society living in shanty towns around the major cities and also in desperate conditions of rural poverty.

But at the other extreme there are countries much more equal than us - so for example a ratio of 5 to 1 is much more typical in the Scandinavian countries, Sweden, Norway, Denmark, Finland. So Australia should not be complacent about its middle ranking internationally. Indeed there’s a lot to be learned from other societies that have achieved a lot more equity in this regard.

Does it matter anyway? That’s the fundamental question.

Let me make 4 points about the principle of equity.

1.The first comes quite conventionally from economic theory. It’s the so-called principle of diminishing marginal utility. It is ironic that the more you have of something the less satisfaction you get out of having a little bit more.

This is the central principle within orthodox economic principle about consumer behaviour. And it has a remarkable economic twist when applied to income because the presumption is that you get enormous satisfaction from the first dollar of income for subsistence - and yes the 100^th dollar is nice - the 10 millionth dollar, though, you hardly notice.

And if of course you subscribe to that principle it follows that a dollar taken away from a very rich person and given to a very poor person, makes the society as a whole, better off because the loss of satisfaction from a very rich person is far outweighed by the satisfaction gained by the poor person. So what is at the core of conventional economic thinking gives quite a radical position about the case of income redistribution. As you might understand orthodox economists have been rather uncomfortable about that application of that analysis and have argued that it is illegitimate reasoning because you don’t know that the dollar taken away from the rich person is of no material significance - the rich person may be a miser who is counting every last dollar and who will be incredibly pained by the loss of a dollar whereas the poor person to whom it is given may be an ascetic person who has no interest in material things. So if you take the view that interpersonal comparisons of utility are illegitimate, you cannot take the view that redistribution of income makes the society as a whole better off. Well, the reasoning is clever, but the fundamental nature of the logic still stands.

2.The second proposition is that our perceived well being is a relative concept. Beyond a certain level of satisfying our material needs for subsistence, how well off we are depends on our comparisons with other people in society And so even if you are getting richer in absolute terms, if other people are getting richer even more rapidly you’re likely to feel worse off. So even in a society that’s becoming more affluent like Australian society over the last half century or so, if at the same time, the income disparities are increasing it’s very likely that people are going to feel more dissatisfied about their material circumstances.

Thorstein Veblen, the great political economist, pointed out these tendencies a hundred or so years ago when he pointed out that consumption is not jusy about satisfying material needs it’s about social standing too, it’s about conspicuous consumption.

3. The third argument relates to what has sometimes been called positional goods, those things that even in an affluent society we simply can’t all have because they are inherently limited in supply. We might all wish to live in Vaucluse, for example, but we cannot. There is an inherent limit in the number of houses in that locality, or more generally in attractive, high status areas. So what is the effect of more people wanting to live in such areas - it simply pushes up the prices there. They don’t become more widely available to us all, they simply become more expensive and so more exclusive for a wealthy elite. So the quest for positional goods is inherently problematical and inherently doomed to failure in a society with growing inequalities - it is that quest for positional goods that is part of the driver of the inequalities associated for example with the high housing prices that cause such difficulties for so many people achieving decent, affordable housing.

4. Finally there is the broad question about social cohesion. I would argue that an increasingly unequal society is a society in which we’ll observe less co-operative behaviour. Back to some quite conventional economic thinking, if you want high productivity, if you want economic decency, if you want a prosperous society people have got to co-operate in the process of producing goods and services , reproducing social order and so forth. An increasingly unequal society is one in which that spirit of co-operation breaks down as is evident, for example, in the United States, where the wealthy take refuge from the poor in their gated communities, spending ever more of their resources on security and social control. And I fear we’re heading down that road too.

By way of conclusion let me comment on the politics and policies that flow from this chain of reasoning. Certainly there are policies that could be used to rein in economic equality were we minded as a society to do so. We could have more progressive forms of taxation. We could augment our income taxation with more emphasis on the taxation of wealth conspicuously lacking in Australia’s tax arrangements by comparison with those Scandinavian countries. Inheritance tax is completely absent on the Australian scene and that is one of the major reasons for the intergenerational transfer of the wealth inequalities. Land tax is another very important means of capturing increments of wealth that have accrued to people simply by virtue of private land ownership without any productive effort. That’s unearned income par excellence and there’s a strong case for land taxation to be at a higher rate and more nationally uniform as a means of capturing that wealth for public purposes. Indeed were we to do so and to put more taxes on the use of other environmental assets then we could well lower the taxes on labour and even capital. In other words shift the taxation system so that it captures unearned income and wealth rather than the incomes generated through creative and productive efforts. Of course as a society we could try to attack the inequalities at source through the redistribution of the ownership of such assets and also by putting limits on the extent to which, for example, payments to those corporate executives are allowed by companies to be set against their company tax liabilities.

Well, what’s the likelihood of any political party picking up such progressive policies and running with them. In the case of the Liberals, well forget it; John Howard I must say has from time to time made some tentative observations about these inequalities getting out of hand. But of course he’s done nothing about it. As for the ALP under the leadership of Mark Latham, a former student of mine, well we’ll see what he learned.! But to

date most of his statements about matters of equity have been to do with equality of opportunity, which is a fine liberal principle. Indeed climbing those ladders of opportunity should be available to all sections of our society irrespective of location, gender, ethnicity. This is a marvellous small "l" liberal principle - but it’s quite consistent with gross inequalities in the distribution of income and wealth. In other words, there’s a marked difference between the liberal concept of equality of opportunity and the socialist principle of equality of outcome. If the Labor Government comes into power we’ll see how it manages with these different, but not incompatible principles.

That leaves the Greens - and I’ve become increasingly involved with the Greens because it seems to me that the Greens of all the players on the current political landscape are the ones most open to considering new policy interventions in this area, linking concerns of equity with sustainability. But other smaller parties on the political stage, for example the Progressive Labour Party have an important role to play here.

So that’s my overview on the issues - the parade, some comments on the patterns, the principles, the policies and the politics.

But just to finish with one little quotation, one I used years ago in the preface of a book about economic inequality - it comes from Francis Bacon in 1610 using a somewhat agricultural simile: "Money is like muck, not good except it be spread".