Yes, the Rich May Get Richer, But So Do the Poor

Worth A Look, Poverty, Frontier Centre

Last week there was a bit of debate about inequality.

The OECD published research showing income inequality is growing in New Zealand and other developed countries.

Here this was met by slogans about evil capitalism where the rich get richer and the poor get poorer. This was a pity as the research contained valuable insights that could benefit us as an economy. First, as the study pointed out, increased income inequality hasn't meant the rich getting richer and poor getting poorer.

What the OECD's figures show is that we are all generally doing better – the rich are getting richer and the poor are getting richer too.

Second, this is not evil. It's one of the great things about capitalism – it allows growth for everyone.

No other economic system can boast that. Think about feudal times – castles, lords, knights, peasants, and so on. Everyone was pigeonholed according to their station in life, with little opportunity for those at the bottom to advance.

Or more recent economic systems – socialism, fascism and other authoritarian states – which offer little potential, apart from corruption, for gaining wealth and advancing yourself through productive work. All these systems are essentially static – get born poor and you'll probably stay poor.

But our system is dynamic. Based on markets and the opportunity to advance by your own productive effort, it can offer opportunity to everyone. It's not a zero-sum game where someone's success means someone else must miss out. It offers opportunity for an ordinary person to use their skills, brains, time and labour to advance their income prospects.

Of course, not everyone will succeed equally. Unlike static systems, it doesn't ensure equal outcomes. But it does offer endless opportunity.

A well-known large-scale University of Michigan study revealed the ongoing nature of that opportunity. It tracked large numbers of people and their incomes across a couple of decades, and showed amazing mobility and ability of people to change their circumstances. The people with the lowest incomes in 1975 had, to a huge extent, moved into higher income brackets by 1991. Only five per cent of the original bottom segment were still there in 1991. The rest had all moved into middle and higher income levels, including into the top fifth of income earners.

This is dynamism at work.

Those who brandished slogans in the wake of the OECD report last week perhaps fail to understand how valuable that dynamism is.

They also confuse equal opportunity with equal outcomes.

Their outcry was prompted by the finding that while incomes have increased at the top and bottom of the scale, there has been faster growth at the top. But this can't be regulated away – trying to impose equality of outcome just leads to people becoming equally poor.

Certainly there's no shame in some managing to achieve faster growth than others. Among other things, they pay more tax to support everyone else. An interesting finding of the OECD report was that this form of "inequality" has been increasing since about 1980.

This reveals another interesting thing about economic dynamism.

The 1980s was when many developed countries undertook reform, which strengthened market competition, reduced unnecessary regulation, and brought more adaptable labour markets and fewer restrictions on people's ability to earn.

It was the beginning of globalisation – more trade and outward investment, a growing global market for goods, services and talent, and increased digital connection. In other words, since the 1980s the economies of developed nations have become more dynamic.

The OECD research shows these changes have been good for employment, with increasing specialisation, more use of performance-related pay and higher rewards for higher skills. Greater market competition brings stronger labour demand, meaning more employment opportunities for both high and low skilled workers.

This is the environment that has led to us all generally getting richer and is undoubtedly a force for good.

Given all this, what should our course of action be?

The sloganeers would have us increase taxes on higher income people to counteract "inequality".

This wouldn't be right – steeper taxes repress dynamism by removing incentives to work harder and more productively.

The OECD report has better recommendations, in three areas: First, it strongly recommends "more intensive human capital investment". This means skills – up-to-date, technical, work-ready skills relevant to high-priority areas of the economy. This requires an education system that works closely with industry to provide training in the areas most needed for competitiveness. It requires a passion for education and an environment where education and skills are highly valued.

THE OECD notes that education is the single most important factor in higher employment and wages. New Zealand could do much better here. While we do well in many areas of education, we need to do better in industry-focused training and forging better pathways between school and tertiary training.

Second, the OECD recommends "inclusive employment promotion" – better access to employment for under-represented groups such as youth, older workers and migrants. This also entails education policies focused on their circumstances and needs, along with sound human rights and other social policies. Here New Zealand's record is reasonably good, but would benefit from better-targeted programmes.

The OECD's third main recommendation is well designed tax and benefit policies.

The aim is a tax system that collects enough to support needed benefit policies while not being so steep that it represses productive enterprise. New Zealand has a history of providing a well- resourced welfare safety net from tax revenues. A delicate balance is required between the safety net and the taxes that support it, and we should continue to try for the best balance possible.

In summary, the OECD research is not a shocking revelation of evil inequalities.

Rather, it exposes the benefits of our dynamic economic system with useful pointers towards better outcomes for everyone.