One Century of Inequality

Figure 1: Composition of US Income Inequality.

In the last few years, substantial research from Piketty, Saez, Atkinson and others has brought the topic of inequality back to the front page of economics. They use extensive data, including tax records in some cases, to analyze the evolution of (mainly top) income inequality for a long period of time. Charles Jones has updated and summarized some these studies, which is the basis of this article. The starting question is then: How much inequality is there? 

Figure 1 shows the share (and composition) of income held by the top 0.1% of the population. The first striking finding is that there is a long U-shaped pattern: (Top) Inequality was very high before the Great Depression (with the top 0.1% holding as much as 10% of the total income); Lower and steady inequality after WWII; Rising inequality since the 1970s (reaching pre-1930 levels).

Taking into account that GDP can be theoretically split into labor income (e.g. wages, salaries and business income) and capital income (capital income and gains), we can divide the analysis of inequality in a similar fashion. This shows that most of the initial decline is due to a reduction in capital income, while most of the sequential increase is due to labor income (and capital gains possibly). The returns on capital seem to have become relatively smaller for the top 0.1% of the population, while wages and business income have become more important. (A big driver of of this might be the importance of land rents in the income of this part of the population) 

If you have read about Piketty's book, you may have heard about the magnitude of wealth inequality. Wealth inequality is much greater than income inequality. While the top 1% of the population hold about 17% of income, the share of wealth held by them in the US is estimated to be above 40%. The cutoff to be in the top 1% of income is 330 thousand dollars a year, while 4 million dollars are needed to be among the wealthiest 1%. Figure 2 shows the path of wealth inequality for the France, the US and the UK. It is seen that wealth inequality was a lot higher before WWI than it is today. However, this hides the fact that wealth inequality has started to increase in the 1960s. On the positive side, (at least for UK and France) it still remains smaller than in the 19th century.

Figure 2: Wealth Inequality.

So far we have discussed how inequality has behaved within labor income and within wealth. Given the importance of inequality within wealth, the remaining question is how has the share of income taken by capital evolved over time. Since most of the capital income is captured by a small number of people, a tiny change in the share taken by capital (instead of labor) can lead to substantial effects on general levels of inequality. While most of the previous plots focused on the top 1%, this is now more about the top 10% (which holds 3/4 of the wealth in the US) versus the bottom 90% (which holds the other quarter, most of which is actually held within the 50-90% range). Figure 3 shows that the share of income taken by capital had either decreased or remained stable until the 1980s. However, since then, the share of income (think of this as the share of the revenues taken by capital and property owners) taken by capital has increased in all three countries.

Figure 3: Capital share of payments.

Inequality is a big concern. However, its causes and consequences remain a puzzle. On the causation side, much research remains to be done. On the consequences side, many views are possible. Regarding the individual level, inequality might affect the chances some people have of making progress, for example through access to education. If children lack basic needs (like food), they most likely won't attend school. Regarding the aggregate level, inequality might also hinder general economic growth. For example, through reduced access to education, innovation might be damaged. However, it has also been claimed that inequality might be necessary for growth. For example, in a very poor country, if wealth is split equally no one might be able to invest. However, higher inequality might allow the richest people to be able to use their extra resources to invest and generate growth. Later, opportunities for the poor ones might flourish, leading to lower inequality. This is known as the Kuznets curve. Whatever your hypothesis is, careful thinking and proper research are probably necessary. 

Based on a working paper by Charles Jones.