The Shape Of The Pyramid Why Income Inequality Happens & Its Consequences



1% of the world’s population owns 40% of its wealth. That, on a base of 6.5 billion, refers to 65 million people. The actual proportion of national wealth owned by the top 1% varies and is measured by the Gini Coefficient, reported in the CIA Factbook.

Declaimer: This article written was originally in December 2006 and some of the data points may be outdated.

Here is data on the US: the top 1% owns roughly 38% of all wealth, while the top 5% owns r9+8oughly 60%. The top 20% owns 80% of the wealth, down from 83% in 1998. Average income disparity, i.e., the skewness of income distribution has fallen continuously from 1929 (the year of the Great Depression) till 1970, but this (skewness) has doubled since then.

The bottom 20% has zero Net Worth, i.e. no savings. Median wealth is at $62,000 (at the 50th percentile), which looks very good by Indian standards ($1100 by rough estimates) but their top 1% have an average wealth of $ 12.5 million.

US GDP per capita is around $40,000-42,000 compared to India’s $650. With nearly 70 times Indian income, their wealth ownership is sharply lower, only about 55 times. My numbers are approximate, because the data taken is for varying years, but the ratio I want to calculate is important.

Total US wealth is about $55- 60 trillion, but a third of that, roughly $11 trillion, is in foreign hands. More important, the flow of savings is completely dominated by foreigners, with US savings at 1% (i.e.$125 bn on a total economy of $12.5 trillion). Foreigners bring in about $1.2 trillion, if you add up the Current Account deficit ($800 bn) and the Fiscal Deficit ($400-500 bn).

If you factor in indebtedness, you get a very different picture. The bottom 20% has no net assets, i.e. net of debt. Half of them are bankrupt, facing legal proceedings for debt default. The rest are on social security. Blacks and single women (including single women with children) have the lowest levels of Wealth:: Net Income. Blacks have 60% of average income, but only 18% of average wealth. Single women with children have the highest bankruptcy ratios, now running at nearly 15%.

Another significant trend thrown up is that of non-household wealth. If you strip out house ownership, the top 1% now owns over 50% of all non-house wealth. They are predominantly concentrated in equity ownership, both listed and private. 10% of the US population owns 85% of the listed equities, 85% of all financial securities, and 90% of business assets in the country. Compare this with the concentration of all kinds of wealth (38%) and you know where you need to be if you want to get seriously rich.

With a GDP per capita of $42,000, US median wealth is at $62,000, i.e. a Net Worth of roughly 1.5 years’ income. Much poorer India does far better: on a GDP per capita of roughly $650, we have a Net Wealth of $1100 per capita, 1.7 years. But we know that from elsewhere… our household savings rate is around 30%.

Actually, this key ratio of Net Worth:: Income is much better. You need to factor in US indebtedness, low savings, foreign ownership of US assets, and their very highly valued stock markets (1.8 times GDP). If one factors in all these factors, the US ratio will drop and the Indian ratio will rise much more.

So let me make my points.

The US is one of the most unequal among the developed countries, except the UK. The Gini coefficient (an Index of Income Inequality) is at 45, against India’s 32.5. It has been noticed that very high levels of inequality tend to slow down economic growth because it distorts the allocation of resources away from basic public goods to luxuries.

When a nation is dominated by excessively rich people, tax collection as a proportion of wealth drops because the rich are better tax planners. Millionaires in the US have taxable incomes of just 7% of Net Worth, compared to more than nearly two to three those levels for the rest of the populace.

Further, the quality of education (and public services) suffers because the rich are able to send their children to private schools, while the poor make do with public schooling, which is always starved of funds. We see this spectacularly in India.

Another important point is the role of innovative industries in exacerbating income inequality. Industries like IT, and biotech tend to concentrate wealth in the hands of the educated elite. This kind of income inequality may be better than the feudal kind seen in, say, Bihar, but it also distorts the allocation of resources to public goods, outlined above.

And the most important point is that markets accelerate income inequality, as the data shows above. Similar macroeconomic data for India is not available, but we can all see anecdotal evidence around us. Those who have large proportions of their wealth in equities tend to do better over time. I have argued this at the microeconomic level in previous articles, where I pointed out that real estate returns are random and more uncertain over long periods of time. Equities outperform, both in quantum and in predictability.

Equity returns measure entrepreneurship, the returns available to risk-seeking capital. High equity valuations are available to those countries that are relatively entrepreneurial and growth-oriented. The fruits of such growth get disproportionately distributed to the small, risk-taking class. These are usually the educated elite, leading to results very similar to the innovation- drivers outlined above.

Qualitatively, this kind of wealth inequality is much better than the kind seen in, say, North Korea or Zimbabwe, which is feudal, power-driven, and goes to the hegemonist. But still, thanks to a disproportionate control over the fruits of education, the educated elite in these democratic countries also tends to contribute their mite to the problem.

It has been argued, very reasonably, that income inequality is the biggest spur to entrepreneurship and innovation. Without the potential for relative outperformance, nobody would have any incentive to do anything useful. This was the biggest reason for the death of communism. That is acceptable.

But this is not an unmitigated virtue. Capitalism still bears the responsibility of ensuring that income inequality does not end up in the wrong hands. We need to look at Nigeria/ Zimbabwe and the tinpot nations of Africa and the Middle East to see what excessive concentration of wealth can do. Capitalism also needs to monitor who gets the wealth, and why? If the income inequality is happening, Bihar style, with wealth being captured through political or muscle power, then you will have the vicious cycle of political power capturing wealth, then that economic power consolidating itself into further political power, creating and endless morass which perpetuates itself. The Dons of Dhanbad started with crime, captured wealth, then political power, which created even further wealth.

So are the IT tycoons any better? They too perpetuate private monopolies, which just look better because they are white-collar in nature. But the distortion in resource allocation is the same. The physical slavery of Dhanbad is not much better than the slavery foisted by the US Dollar on the sweatshops of Asia…we make a container-load of garments, just to get back a CD with a computer program.

There are ethical and humanitarian dimensions to this problem, besides the usual economic and political arguments. The pursuit of innovation and entrepreneurship is of course a virtue, but you need to question whether you are doing too much if your Gini curve starts to look the same as Zimbabwe’s.

I have argued for a long that poverty in the US and London is far more debilitating than in Etah, UP, where everyone is poor. Poverty in the midst of riches creates far greater social problems than general, isolated poverty.

Sources: The Hindustan Times recently carried a survey of wealth around the world. That, and the CIA factbook, besides ratios mentioned in the “Millionaire Next Door” are the data sources for the arguments mentioned above. Also the Federal Reserve Board’s Survey of Consumer Finance.



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