The Agenda

Did Europe Experience an Increase in Pre-Tax-and-Transfer Inequality?

The answer is yes. Was the increase in pre-tax-and-transfer inequality identical to the increase in pre-tax-and-transfer inequality in the United States? No. But that’s hardly surprising. There has been a secular trend towards increasing pre-tax-and-transfer or market inequality across all advanced market economies. We don’t know that this reflects skill-biased technical change. There is always a danger of relying too heavily on “proof by residual.” 

We do, however, know that market inequality has increased in Europe, and it’s increased in a pattern that is consistent with the advent of new general purpose technologies and that broadly reflects demographic differences across OECD economies, e.g., older and more educated populations tend to be more unequal, and younger European cohorts tend to be more educated than older European cohorts, etc. Because Europe has been gaining on the U.S. in educational attainment — younger European cohorts are at least as educated as younger U.S. cohorts, whereas that hadn’t been true of older cohorts — the trans-Atlantic divide may well narrow in the years to come.  

So what the heck am I talking about? Allow me to explain. Ezra Klein writes:

As Tim Noah’s series on inequality suggests, there are lots of questions when it comes to inequality. But what’s confusing people here is one particular question: skills-biased technological change. That’s where technology changes (we now have computers) and those who know how to use the new technology pull away from those who don’t. In this case, the scenario would be that the computer-literate start making a lot of money, while those who aren’t comfortable with laptops and Firefox lose out.

That explanation is intuitively appealing, but it doesn’t fit the facts. For one thing, Europe had the same technological revolution, but without the attendant increase in inequality. For another, the startling changes in inequality was between those at the 99th percentile and those in the 90th percentile. It was the tippy-top pulling away from the top, or what I like to call “the conehead economy.” If you imagine the economy as the person, it’s grown eight inches, and most of that growth has been in its forehead. [Emphasis added.]

This is imprecise. Europe actually didn’t have the exact same technological revolution for a variety of reasons. But of course Ezra is right that European firms had access to the same productivity-enhancing tools. They didn’t, however, have access to the same productivity-enhancing business practices in all cases. 

But even if Europe did have the exact same technological revolution, and that’s not too far from the truth, this wouldn’t have an impact on post-tax-and-transfer inequality if governments in Europe decided to increase transfers to mitigate the underlying increase in inequality. And that’s essentially what happened. Britain is a good case study. The New Labour government dramatically increased transfers to low-income households after 1997. The results in terms of family stability and medium-term social outcomes have been mixed, but the transfers have certainly left Britain with a more egalitarian income distribution than it would have had otherwise.

The relevant question about skill-biased technical change isn’t the shape of post-tax-and-transfer inequality but rather the distribution of market income. In 2000, market Gini in the U.S. and Sweden and and Germany were essentially identical. After taxes and transfer, inequality in the U.S. was much greater.

I’m writing an essay on this subject, so there will be more to come. This 2007 post from Stephen Gordon of Worthwhile Canadian Initiative is a helpful guide to at least some aspects of this phenomenon:

The national statistics agencies of CanadaSweden and the United Kingdom have annual series for gini coefficients going back to 1980 or so. Although cross-country comparisons of the levels should be taken with a grain of salt, the trends in these three countries are remarkably similar. 

In the graph Gordon presents, we see that Sweden actually saw a much bigger increase in market gini than Canada and the UK. Gordon then links to the following paper by economists Giulia FaggioKjell G. Salvanes, and John Van Reenen:

Over the 1990s, we document a rise in productivity dispersion in France, Norway and the UK. The rise in France and Norway has been smaller than that in the UK. The comparison is interesting because when a general purpose technology, like information and communication technologies, becomes ubiquitous, it should impact firms worldwide; our cross country comparison allows us to sort out this sort of general effect from more UK-specific changes.

The reasons for the productivity dispersion are interesting, and weren’t very well understood in 2007. Recent theoretical work on organizational capital and intangible assets suggest a possible answer. Regardless, we know that productivity dispersion and wage dispersion have increased across the developed world, and we have good reason to believe that SBTC was a significant contributor.  

Does this mean that SBTC was the only contributor? Of course not. And does this mean that political power had nothing to do with it? Of course not. Indeed, the more interesting question is why we see such wide variation in post-tax-and-transfer inequality. Alesina and Glaeser suggest that this is driven in part by racial heterogeneity, and others attribute the difference to the political power of the wealthiest U.S. citizens. That’s all very interesting and worth thinking through.

But again, SBTC would presumably impact market inequality.  

I happen to find this stuff very interesting, and I want to emphasize that there are no easy or obvious answers. The comparative data on market inequality isn’t as good as I’d like it to be. Rest assured, we’ll discuss this further. 

Reihan Salam — Reihan Salam is executive editor of National Review and a National Review Institute policy fellow.

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