Thursday, 9 August 2018

Focus on right measures of income inequality

Zeroing in on income of the top 10 per cent will yield suggestions of Robin Hood taxes on the rich. But, in fact, inequality has remained stable here, and the poor are making progress
By Nitin Pangarkar, Published The Straits Times, 8 Aug 2018

I read with interest Professor Linda Lim's article about income inequality and its debilitating effects on Singapore's growth ("How inequality and low wages can stall growth"; July 21). While I agree with several of her points, especially that too much inequality can have adverse consequences, I disagree with her on many others.

While Prof Lim alludes to the Gini coefficient, a fair bit of the data she cited - including from the World Inequality Report 2018 by a group of researchers, including French economist Thomas Piketty - is about the income garnered by the top 10 per cent of the population. The income garnered by this group is a flawed measure of income inequality and has very little bearing on how the average person is faring.

The Gini coefficient - which measures income distribution across a population as a whole - is a much more appropriate and widely accepted measure. A society of prefect equality where everyone earns the same income would have a Gini coefficient of 0; one where one person earns everything would have a Gini coefficient of 1. If 1 per cent of the population owned 50 per cent of a country's wealth, it would have a Gini coefficient of 0.49 or higher, depending on the distribution of wealth across the remaining 99 per cent.

To derive insights and policy implications from the Gini coefficient, one should also look at the trend over time and in combination with growth in income levels. Many analysts make the error of looking at the Gini coefficient in isolation and without considering time-based trends.

For example, income inequality may be high now but declining over time, which would be a sign of progress. This might happen when average incomes are growing, making the average person better off today than yesterday, which should reduce - though not eliminate - concerns about income inequality. If incomes are growing and the Gini coefficient is falling, it would mean that a country is making good progress and concerns about inequality should become less over time.

Looking at Singapore, I found data on the Gini coefficient between 1981 and 2014, published by the Government, using two alternative ways of calculation. The data shows that using the more stringent method - which gives higher values of the coefficient - there was an increase from 0.46 to 0.48 between 1981 and 2014.

The values based on the other definition of the Gini coefficient - used by the Organisation for Economic Cooperation and Development group of developed nations - are lower, ranging from 0.40 to 0.43. Admittedly, the coefficient did go down until 1990, after which its rise was faster, to a peak of about 0.48, before 2008.

If we look at the aggregate picture, the rise in the Gini coefficient has been hardly alarming, rising by 0.02 in 33 years. The above values do not take into account the effect of taxes and transfers, which should further soften the impact of a high Gini coefficient.

POOR NOT GETTING POORER

Thus, it seems that for the past three decades or so, Singapore was in a situation of rising per capita income levels with somewhat high Gini coefficient values before taxes and transfers. This is hardly a situation of the poor getting poorer. The rich may be getting richer, but the poor are also making progress.

Being a globalised city state means that Singapore's Gini coefficient is likely to be higher in value than for larger countries.

The presence of numerous small businesses in a globalised city state (where the businesses are exposed to international competition) could bump up the Gini coefficient when either of the extreme outcomes (complete failure or significant success) occurs.

Rapidly rising property prices - against which the Singapore Government has built a hedge in the form of Housing Board public housing - will also push up the Gini coefficient because higher-income groups who have access to capital for the down payment on properties are more likely to benefit from rising property prices.

Lacking capital, the lower-income strata, on the other hand, are unlikely to benefit to the same extent from rising property prices.

The Government provides its citizens with a number of "transfers", most of which benefit the poor disproportionately. Schooling for instance, is almost free, and housing is subsidised for the majority. Even tertiary education, after government subsidies, is comparable in costs to countries such as Japan and Canada and much cheaper than in the United States.

While healthcare costs have been going up and are higher than those of regional neighbours, they are much lower than those in other developed countries such as the US. Public transport, which lower-income groups tend to use more of, is much more extensive and cheaper than in most other countries.

Access to these transfers, coupled with low tax rates (much lower than those of countries such as Japan and Canada), should alleviate some concerns about Gini coefficient values, because many of these transfers benefit the lower-income groups more than the higher-income ones.

In fact, the same source (data provided by the Government) shows that though the poor in Singapore lagged behind the other groups in absolute growth in incomes between 2004 and 2014, they were tops when it came to growth in incomes after taxes and transfers.

According to a 2017 report, the average annual government transfers per household member amounted to $10,245 for those residing in HDB one-and two-room flats versus $3,312 for those in landed properties. In fact, the drop-off is dramatic after the poorest category: The above figure for those residing in three-room HDB flats is only $4,408, 57 per cent lower than for HDB one-and two-room flat residents.

This is not to say that there is no room for improvement, nor that Singapore can afford to be complacent about inequality.

Providing equal opportunity to people of different socio-economic classes remains a work in progress, and work should continue in that respect. Managing healthcare costs is another big challenge, especially as the population ages and inflationary pressures on healthcare costs build up.

However, in discussing inequality, it is vital to look at indices that are relevant and useful for Singapore, not those that can paint a misleading picture that could lead to incorrect conclusions and policies.

Focusing on the wealth of the top 10 per cent would suggest a Robin Hood type of solution, increasing taxes on the rich. This was precisely what Prof Lim suggested in a follow-up article to her first ("How to reduce inequality: Curb foreign worker numbers, support SMEs, tax high-earners more"; July 28).

But, in 2014, 40.4 per cent of taxes were paid by the top decile (10 per cent) of income earners in Singapore. The bottom half of the population, in terms of income earned collectively, paid 21.6 per cent, or half the amount paid by the top 10 per cent.

Reducing income inequality should be about pulling up the poor and not bringing down the rich, through higher taxation or otherwise.

A World Bank report published in 2016 made the following comment about strategies for reducing inequality: "Taking on inequality involves human capital accumulation, income generating opportunities, consumption smoothing, and redistribution."

Consumption smoothing is about encouraging consumption by the lower strata, possibly through transfers such as food stamps to reduce the impact of poverty.

Much of the focus of the popular debate ignores the first three ways to tackle income inequality and focuses on redistribution (especially punitive taxation) which is a blunt - if populist - tool to tackle inequality.

Punitive taxation has many other toxic side effects as well. Most importantly, it blunts dynamism, innovation and entrepreneurship, without which Singapore could easily become more equal - and uniformly worse-off.

The French philosopher Voltaire once famously said: "Each player must accept the cards life deals him or her; but once they are in hand, he or she alone must decide how to play the cards in order to win the game."

Extending Voltaire's logic, the "cards" that Singapore has been dealt (small land mass, no natural resources and high population density) are very different from the cards that countries such as Norway, Finland and Canada (small populations, large landmasses and significant natural resources) have been dealt, and it would be disastrous for Singapore to follow the model followed by others in terms of income redistribution or otherwise.

Nitin Pangarkar is an associate professor in the department of strategy and policy at the National University of Singapore Business School.









How inequality and low wages can stall growth
Decades of globalisation have raised inequality. Recent research shows that unequal rewards have resulted in lower workers' wages, which reduces aggregate demand, thus slowing growth.
By Linda Lim, Published The Straits Times, 21 Jul 2018

Inequality - arguably the most important global economic issue of our times, blamed for feeding populism, protectionism, anti-migrant and anti-globalisation sentiments around the world - has motivated considerable recent research with analytical significance and policy relevance for Singapore.

One such useful piece of research is the World Inequality Report 2018 produced by a group of researchers, including French economist Thomas Piketty. The report shows income inequality has been rising almost everywhere since 1980.

Among high-income countries, the share of national income accruing to the top 10 per cent of income earners rose from 31-32 per cent in 1980 to 40 per cent in Britain and Germany, and 50 per cent in the United States in 2013-15.

Over the same period, it rose from 22.8 to 30.6 per cent in Sweden, 24.2 to 32.1 per cent in Australia, 25.3 to 28.3 per cent in Norway, and 29.9 to 34.6 per cent in Switzerland. In Singapore, the income share of the top 10 per cent rose from 32.1 per cent in 1980 to 43.8 per cent in 2014. The share of the top 1 per cent rose from 10.6 per cent in 1980 to 14 per cent in 2014, higher than in all this subset of countries except Britain (14.5 per cent) and the US (19.6 per cent).

Other research with relevance for Singapore included recent International Monetary Fund and Organisation for Economic Cooperation and Development (OECD) studies which reaffirm research results showing that, on average, higher income inequality is associated with slower gross domestic product (GDP) growth.

This contradicts the earlier standard economic belief that inequality contributes positively to economic growth, by providing both the motivation and means to work hard and invest more for higher returns.

Higher inequality occurs with higher growth only in some lower-income developing countries, where inequality is relatively low (with the Gini coefficient net of taxes and transfers below 0.27), and over short time periods. The Gini coefficient measures income inequality in a society, with zero representing total equality and one, total inequality.

But over longer periods, growth and inequality are negatively correlated. In Singapore and other high-income economies, GDP growth was higher when inequality was lower, and slowed as inequality increased.

WHY INEQUALITY HAS RISEN



HIGHER PROFIT SHARE, LOWER WAGE SHARE

One market-based explanation for why inequality is rising is that as incomes rise and savings (capital) accumulate, capital-labour substitution - such as in the form of automation and "skill-biased technical change" - increases the returns to higher-income owners of capital and skills, while reducing demand for low-skilled, low-wage labour.

For example, a high-income factory owner may replace workers with machines. His profits go up as machines cost less than the labour he employs, but the workers he lays off suffer wage and job loss.

Globalisation aggravates this widening disparity in high-income countries, as their workers in labour-intensive sectors compete with imports made by lower-wage foreign workers and with lower-wage immigrants, while products that are capital-and skill-intensive find wider markets abroad.

Another measure often tracked is the share of wages in national income. This measures what proportion of a society's GDP goes to wages (for workers).

In Singapore, the wage share is 42 per cent, compared with over 50 per cent in other high-income economies.

Globally, wage share of GDP has been falling since the 1970s while the share that goes to capital, or corporate profits, has risen.

However, despite higher profit share, there has not been a corresponding increase in investment and productivity growth that would raise wages.

Instead, advanced economies have been struggling with low productivity growth, leading to stagnant wages.

Why are businesses not investing when profits are high and corporate taxes low like now?

One reason is weak consumer demand, as many workers' wages have stagnated in the face of corporate profits going to high-earners who save more and consume less of their income.

In this sense, economies are locked in a vicious circle: Growth generates unequal benefits, raising inequality, and such unequal growth means lower wages for many workers, resulting in weak aggregate demand. This is one way high inequality can slow growth.

RENT-SEEKING AND FINANCIAL SECTOR

Another reason cited for rising inequality is the increase in rent-seeking behaviour.

Nobel Prize-winning economist Joseph Stiglitz, among others, attributes high salaries and profits to rising rents - monopoly returns on scarce land, housing and other "non-productive" assets - which are not invested in increasing productive capacity, so do not raise productivity and wages.

He particularly blames the financial service sector for rent-seeking behaviour, criticising the actions of "people who have been successful in getting a larger share of the pie rather than increasing the size of the pie".

The financial sector also increases inequality through excessive salaries, which could explain the higher inequality found in the US, Britain - and maybe Singapore - as the financial sector's share of national income increased.

The US' exceptionally high inequality has been linked to the huge jump in executive compensation, particularly chief executive officers' pay multiples, resulting from pay-for-performance practices tied to company share values.

Besides directly increasing inequality, this incentivises corporate decisions - such as share buybacks, mergers and acquisitions, and cost-cutting - that push up stock prices but discourage long-term investments in increasing productivity and innovation that could raise wages.

At the low end, consumers taking on excessive debt to maintain consumption in the absence of real wage growth adds to the risk of future debt crises.

PUBLIC POLICIES

Public policies which increase inequality by favouring (relatively rich) shareholders - by taxing capital gains less than income, and providing "beggar my neighbour" tax breaks and other subsidies to corporations to induce their investment - also lower long-term growth by reducing tax revenues and diverting scarce state funds away from productivity-enhancing expenditures in public goods such as health, education, research and infrastructure.

DECLINING ROLE OF SOCIAL MOBILITY

In most developed countries, rising inequality has been accompanied by declining social mobility - the likelihood that an individual's economic or social status will change relative to his or her parents', and over his or her lifetime.

Low social mobility retards economic growth through "loss of human capital" (talent development at the bottom) and low productivity, as low-income parents lack the means and lose the motivation to invest in their children's education and health.

Low-income individuals also find it difficult to borrow to invest in better opportunities such as small-scale entrepreneurial ventures that can start them on the climb up the ladder.

Meanwhile, children from more advantaged families have a very high chance of retaining their parents' earnings rank, risking diminished motivation and, in the OECD's words, "persistent rents for a few at the expense of the many, at high efficiency costs".

In other words, the elite reserve privileged positions or jobs, income or assets for themselves, even though many others outside the elite circle may be more capable.

Beyond economic effects, a public policy brief of the OECD's June report on social mobility says that "perceived equality of opportunities can reduce the likelihood of social conflict", "weaken economic discontent", and avoid "feelings of social exclusion".

The OECD data shows that only Nordic countries combine high earnings mobility with low inequality, while France, Germany, Austria and Hungary have below-average inequality and lower earnings mobility.

No country combines high inequality with high mobility, and the major country with the highest inequality, the US, also has the lowest mobility.

POLICY IMPLICATIONS FOR SINGAPORE

Inequality in Singapore now ranks among the highest of other high-income countries, even after taxes and transfers. This is even though it lacks many of the conditions considered responsible for high inequality in other countries, such as high rates of single parenthood, incarceration, extreme racial and economic segregation, poor-quality public schools and very low unionisation rates, as in the US.

Singapore also has, or is implementing, many policies recommended to reduce inequality, such as public investments in health and education which reach children from lower socio-economic backgrounds, heavy state investments in public housing and subsidised social services for qualifying populations.

Yet inequality remains stubbornly high and social mobility is declining. This is clearly an issue that merits further examination.

Linda Lim is Professor Emerita of corporate strategy and international business at the Stephen M. Ross School of Business, University of Michigan.





How to reduce inequality: Curb foreign worker numbers, support SMEs, tax high-earners more
Pluck low-hanging fruit: curb foreign worker numbers that depress local wages; support SMEs so they can raise wages for locals; and tax the high-earners more
By Linda Lim, Published The Straits Times, 28 Jul 2018

International research on income inequality finds that higher inequality is associated with lower economic growth. Inequality in Singapore ranks on the high end among high-income countries. What could explain this, and what can be done about it?

WHY IS INEQUALITY SO HIGH IN SINGAPORE?

CITY AND SUPERSTAR EFFECT

One reason Singapore is more unequal than other rich countries is because inequality increases with city size and density.

An Australian study shows that the larger a city's population size and density, the more quickly higher incomes grow and outpace lower incomes, while a United States study shows that metropolitan inequality is more strongly linked to the presence of the wealthy than to poverty.

In large cities, incomes and wealth grow much more rapidly at the top than at the bottom, because of the concentration of highly-compensated skilled jobs - such as in finance, business services and research and development (R&D). These disproportionately reward the most talented people (what some call "superstars") but exclude those deemed "least talented", who benefit less because local spillovers from knowledge clusters turn out to be limited.

Globalisation and technological change further increase the returns to "superstars" through larger market demand for their specialised skills, while expanding supply-side competition for the "least talented", especially if there is significant immigration of low and middle skills.

Population density also increases housing costs, a major negative externality faced by rapidly-growing, high-income urban areas like Silicon Valley. This reduces what the moderate-and low-income can invest in themselves and their children to improve their employment prospects, while rising transport costs limit the number of potential jobs they can access.

In Singapore, the HDB's public housing programme mitigates some of the housing affordability problems, and there are good transportation and school systems, and publicly-funded skills training programmes. Still, the channelling of high compulsory savings via the Central Provident Fund into housing, with rapid population increase and extreme land scarcity, diverts investment into an asset class which Nobel prize-winning economist Joseph Stiglitz calls a "non-productive" asset - holding down productivity and thus wage increases.



TAX AND OTHER POLICIES

Other public policies also impact inequality. For example, capital subsidies and low taxes to attract foreign investment and talent serve to concentrate incomes at the top. Promotion of financial services and research-intensive high-tech sectors require highly-skilled professionals employed at global salary rates. When the numbers of such highly-paid professionals increase, inequality numbers rise.

Meanwhile, importing large numbers of low-and middle-skilled foreign workers depresses wages at the bottom and increases the income gap between middle-and high-wage workers. This also exacerbates inequality, as inequality typically measures the gap in income share between the top, middle and bottom wage rungs.

Research elsewhere shows that increases in incomes at the top are associated with declines in incomes of low-and middle-income households; and immigration of low-skilled workers increases inequality.

Given these conditions, it is no wonder that Singapore has high income inequality. Singapore's Gini coefficient rose from 0.41 in 1990 to a peak of 0.482 in 2007, before dipping to 0.464 in 2014 and further to 0.458 in 2016.

Households in the top two income quintiles saw higher real income growth from 2004 to 2009 than those in the lower quintiles.

But from 2009 to 2014, households in the lowest two quintiles saw the fastest real income growth, particularly after taxes and transfers, although this was from a low base and the share of income remained small.

What can be done about inequality? For economists, the first-best policy is to rely on market forces, with government intervening only where market failure or externalities exist.

In Singapore, being exposed to market forces that have widened income inequality has economic, social and political costs - negative externalities justifying government policy intervention.

WHAT POLICIES MIGHT BE HELPFUL TO REDUCE INCOME INEQUALITY?

Education policy is largely a tool for improving social mobility within an unequal system, but by itself can do little to reduce systemic inequality. Fortunately there are some low-hanging fruit in other policy areas.

LABOUR AND INDUSTRIAL POLICY

Low-end wages and productivity would be boosted by further reducing reliance on low-skilled foreign labour. The wage (and status) gap between workers in low-skilled occupations (such as driving, food service, janitorial, personal services) in Singapore and similar workers in other developed countries is striking.

In a speech in January, Monetary Authority of Singapore managing director Ravi Menon cited the wages of four jobs - plasterer, baker, childcare worker and security guard - and noted that in Singapore, the average pay of these four jobs is 30 per cent to 60 per cent of the local median wage, whereas in Australia, the US and Britain, they fetch close to the national median wage.

Legislation should also be enacted to prohibit ethnic and gender discrimination in recruitment and remuneration, which contribute to overall inequality and the higher rates of poverty and low incomes among women and ethnic minorities.

Removing or reducing other corporate subsidies and tax breaks for the wealthy will narrow the domestic income gap at the high end, and be more market-conforming internationally, which is politic given growing global intolerance of "tax havens" and "targeted industrial policies".

Singapore should not encourage investment here by businesses which would be uncompetitive without substantial tax incentives, artificially cheap labour and other public subsidies.

It should not facilitate tax arbitrage by footloose foreign corporations, as its citizens are the ones who bear the opportunity cost of foregone (tax) revenues and the real cost of negative externalities like rising rents, especially as foreign profits and savings are likely to be repatriated rather than reinvested locally for growth.

HELPING SMES

Research in other countries has shown that widening disparities in profits and wages paid among more and less successful (often respectively large and small) firms are a major contributor to rising inequality.

This is likely to increase with "winner-takes-all" technological and business developments that generate monopoly rents for the fortunate few.

So the government should focus more strategic and targeted government assistance to make small and medium-sized enterprises more efficient and competitive, to enable them to scale up and pay higher wages, and have other developmental benefits for the economy.

A dedicated SME agency, an SME bank, and more supportive government procurement policies are among the suggestions that have been made here.

REDISTRIBUTIVE SOCIAL POLICY

A study by the Ministry of Finance notes that Singapore's after-taxes-and-transfers Gini coefficient of 0.37 has been stable despite the rising before-taxes-and-transfers Gini from 1990 to 2014. This would not have happened without the expansion of social policies since 2007, such as the Workfare Income Supplement, GST vouchers and Pioneer Generation subsidies.

But the resulting 14 per cent reduction in inequality is less than the Organisation for Economic Cooperation and Development (OECD) average of 26 per cent, and even the highly unequal US's 19 per cent reduction. This is because "Singapore has followed a different approach... with a lower tax burden overall and on the broad middle class... while providing targeted subsidies for those in need".

In particular, "middle-income households in Singapore are net beneficiaries of the fiscal system. For every dollar of tax paid, they received about $1.70 in benefits in 2014" ($1.98 in 2015), more than in other rich countries.

Higher-income households in Singapore pay far less of their income in taxes than in other rich countries, with a top marginal personal income tax rate of 22 per cent, and a corporate tax rate of 17 per cent. Overall, tax revenue amounts to only 15.7 per cent of Singapore's GDP versus over 40 per cent in most European countries, 32.9 per cent in the UK and 25.4 per cent in the US in 2014.

High-income earners are generally less sensitive to a marginal loss of income, Singapore's tax rates are very low, and its citizens have a fabled work ethic, and among the world's largest proportions of millionaire households (many of whom collect rent on a second property).

So raising individual income tax rates on the wealthy should not have a negative impact on work effort. Academic research has also found no evidence that taxing capital income discourages savings, investment and economic growth.

Singapore can also afford to be more generous in welfare payments. In the US, studies show that the safety net has little or no effect on work effort by low-income workers; and in developing countries, cash transfer programmes have not been found to discourage work. A 2014 World Bank study also found that "contrary to popular stereotype", cash assistance was "not typically squandered on things like alcohol and tobacco".

Redistributive tax-and-transfer programmes are effective in reducing income inequality. They do not reduce growth, and can increase it by stimulating demand, reducing rents and increasing productivity.

There is also abundant evidence that growing up poor hurts child development, while more cash welfare early in a child's life improves the child's longevity, educational attainment and nutritional status, and income in adulthood (thus reducing future welfare claims).

Early intervention programmes to help the children of low-income parents by providing infant care, childcare, and support for single parents and victims of domestic abuse reduce poverty directly and by increasing female labour force participation, which the OECD finds particularly effective in reducing inequality.

Singapore's high inequality is inefficient, inequitable and hurts economic growth and social cohesion. Status quo policies have failed to significantly diminish inequality, so it is time to try a different multi-pronged approach, including changes to labour, industrial and competition policy, and a more effective redistributive system. Much research and policy experimentation is going on in other countries to devise innovative solutions in the face of demographic and technological challenges. We can learn from these to come up with our own bold ideas. But to do this, we must first acknowledge that we are "all in it together", and be willing to make marginal sacrifices if necessary for our own and the common good.

Linda Lim is Professor Emerita of corporate strategy and international business at the Stephen M. Ross School of Business, University of Michigan.


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