How do you solve a problem like inequality?

The ideal of income equality seldom fails to attract fervent support in society. It is one of those concepts that every reasonable person can advocate.

It is now apparent that income inequality has been rising over the past decade. Figure 1 from the OECD’s  2015 report In It Together: Why Less Inequality Benefits All illustrates how the top 10% of income earners have seen their income rise at a higher rate than the rest of the 90% in three quarters of the OECD nations. What has changed in the past few years is that there has been a relative stagnation in income growth for low-middle income earners.

So, while inequality is undoubtedly a fact in our modern economic system, it’s worth asking why is this such a deeply rooted phenomenon.

The most compelling reason to allow income inequality is to encourage innovation and productivity. Innovations are not carried out for the sake of innovation but because they yield some economic benefit for those who develop it. For instance, just look at pharmaceutical companies that invest billions in developing a new drug, expecting and reaping a healthy return from their investment. While this motivation might seem like a trivial point, its importance is realised when we scrutinise history’s grandest experiment in collectivism, the Soviet Union. The USSR was formed on a Marxist foundation of striving to bring about total income equality, while trying to maintain economic improvement and group.

Successive Soviet governments set up centres dedicated to science and innovation (the notion of being innovative and agile is not a 21st century invention by any means). The directors of these institutes were given bonuses based on their discoveries. This system did not produce monumental leaps in innovation, but rather smaller improvements to existing technology. This is because the incentive to take risk was very small while the cost for doing so (losing your bonus) was very high. This is a crucial area in which capitalist markets have the advantage. Niall Ferguson articulates this characteristic in The Ascent of Money, where he stipulates that bankruptcy process in many capitalist economies allows people to take large risks, and walk away from failure with comparatively few consequences. This thus encourages them to try new things at the same time while maximising the benefits if an idea proves to have legs. All of this arises out of the pursuit of profit and the quest to be relatively better off than someone else.

While moderate inequality is necessary to encourage innovation, there are many pernicious consequences to rampant inequality. Firstly, inequality has many political and social consequences. Increasing the wealth of the richest people gives them sway over government policy, achieved through donations and lobbying. One Grattan Institute report estimated that up to 80% of the wealth created in Australia by the richest was through rent-seeking aided by political connections. The economic effects of income inequality are also significant. The OECD report mentioned above outlines how inequality has acted as a damper on economic growth as it restricts people’s access to economic resources, effectively hindering their ability to contribute to production. For instance, poorer people are less likely, in a more unequal society, to obtain skills through education,which both worsens the problem of inequality and reduces productivity. The aforementioned report found that the 2-point rise in the Gini coefficient (Figure 2) across 19 OECD countries from 1985 to 2005 resulted in 4.7 lost percentage points of cumulative growth from 1990 to 2010.

A novel way to balance equity and inequity may lie in Gandhian trusteeships. This was a philosophy purported by Mahatma Gandhi, that encouraged businesses to be trustees of the people’s wealth. Business owners were encouraged not to hoard profits to make themselves extremely rich, but rather distribute their wealth back to the community. This is akin to the notion of corporate social responsibility we see today, which to a far lesser extent encourages the sharing of (some) corporate wealth.

Another Gandhian model lies in cooperative enterprises. A notable business that follows this model is Amul, one of the world’s largest dairy producers. The cooperative concept means that Amul is partly owned by the various independent farmers that supply it. These small dairy farmers all benefit from the profits of the company. This means that people see their incomes rise at a faster rate. This concept of democratic ownership was employed after Hurricane Sandy. People formed cooperatives to rebuild houses and restart businesses. This resulted in increases in wages for workers from $9.5/hr to $25/hr. Furthermore, the difference between the highest and lowest earners of cooperatives were typically 5 to1 whereas this is something like 600 to 1 in typical businesses. The cooperative movement can help reduce the gap between the rich and poor.

However, it is questionable whether this can truly be carried out on the scale required to alleviate this problem. While inequality is a fact of life, there can be no question that the level of inequality in today’s society is approaching (or indeed already at) a level that has adverse consequences for both society and the global economy. In some ways, inequality might be characterised alongside climate change as the defining issue of the 21st century. How governments tackle inequality will have immense consequences for all of our futures.