Persistently high rates of income or wealth inequality are bad for social cohesion, political inclusion and crime. The evidence for this is overwhelming. Often, stubbornly high income inequality partly reflects deep historical injustice. Fortunately, history also provides some clues to how we might tackle it.
In some Western advanced countries income inequality is a lot higher than it was 37 years ago. In 1980 it had been stable and low in the UK for three decades. The period after World War II was one of inclusive economic growth. This Golden Age of low inequality is a reference period for many of us: it is when we grew up. But few can now remember the times that lead to it. The 1930s are too long ago.
The statistical record on inequality before the 1950s is quite thin, though research is continuing to improve it. We are fairly certain that income inequality fell and stayed low in most Western countries roughly between 1910 and 1980. What made it fall? Of course there was more than one cause, and surely different causes in different places. But some common features are present.
War and wages
In the earlier years of the 20th Century there was a clear trend of state intervention in the economy, albeit institutionalised differently across countries. It was generated by a mix of factors: social solidarity engendered by the wars, wartime experience of governing the economy, unemployment in the 1930s and the rise of socialist ideas. It accelerated for a decade or so after World War II.
Key features were nationalisation, increased provision of welfare, public health and education, and the development of public amenities. Scholars have discerned regional variants: the Nordic Model, Rhine capitalism and so on. Arguably the most important aspects that directly affected income inequality were state involvement in wage setting and redistributive taxes and transfers.
In many countries there were moves to centralise collective bargaining over wages and conditions of work. In the UK, Wages Councils which controlled wages in low pay sectors were introduced in 1909, and national wage setting was introduced during both world wars. From 1945, government-imposed ceilings on pay rises, agreed with unions and employers, were in place much of the time until 1979.
In other countries the process was different. In Sweden, national level bargaining between employers’ federations and unions was agreed initially in 1938 to avoid government intervention. In West Germany after World War II, employers’ confederations and unions were restructured along industry lines and wage bargaining took place nationally, by industry. In France, unions and employers organisations, together with government, were brought together in Le Conseil Economique in 1946.
You are getting the picture by now. Even in the US, the Treaty of Detroit of 1945 created a tripartite system aimed at maintaining industrial peace. Moderation and duty were virtues to be applauded. Historians record how in the 1960s the White House might publicly criticise executives granting themselves large pay rises. In the 1970s this interventionist tendency was criticised, with some justification, as being a partial cause of the stagflation of that decade. By the mid-1980s the political mood had shifted, particularly strongly in the UK and US.
The new mood in those countries was anti-interventionist, especially in industrial relations. Both President Ronald Reagan and Prime Minister Margaret Thatcher faced down unions rather than seeking compromise. In Britain the institutions of consultation were wound up. In the US, minimum wages were allowed to fall against average earnings.
Inequality in labour earnings rose quickly though the 1980s in both countries. The trend was slower in the rest of western Europe where, mainly, the wage setting institutions remained more intact. Most commentators argue that the inequality rise was due to the slow-moving forces of technological change and globalisation which favoured skilled and educated workers. But in the UK and US the shift in political climate meant that the wage setting institutions no longer worked to moderate those forces.
Taxation was changing as well. In most Western countries, income tax became a major revenue source in the early 20th century. As the political tide changed, both Reagan and Thatcher heavily reduced the progressivity of income tax – the extent to which the rate of taxation increases with income.
The Organisation for Economic Co-operation and Development (OECD) calculates the extent to which taxes and transfer payments moderate income inequality in its member countries. Their calculations illustrate what economic historian Peter Lindert calls the Robin Hood Paradox, which is that the highest levels of redistribution occur in countries with the least pre-tax inequality. For instance, among OECD countries, the highest levels of redistribution occur in the Scandinavian countries and the lowest in Mexico and Chile.
Can we infer from this that redistribution works? Could the Mexican government eliminate massive inequality with deep historical roots simply by increasing the progressivity of taxes and transfers? Their Progresa and Prospera programmes have made cash transfers to the poor conditional on them ensuring their children attend school and that the family receive preventative health care. Analysis of these programmes tell us they work well.
There is also international evidence that increases in tax and transfer progressivity do reduce income inequality directly. My own calculations have shown that changes in progressivity and changes in income inequality across the OECD countries 2007-2014 are strongly negatively correlated.
This message of the last one hundred years is unfashionable. In Britain and the US few political parties today with serious electoral ambitions would embrace a collectivist approach to the setting of wages and salaries or increasing tax and transfer progressivity. Even fewer would speak out against high salaries. Fashions do change, though.
This article has been co-published with the World Economic Forum.