Why income inequality is the policy issue to make or break governments

The “Growing Together” report launched yesterday by the Labor Party brings the issue of inequality back to centre-stage in the policy debate.

One of the most worrying socioeconomic trend a country could experience is the increase in income inequality across its citizens.

The process of human development; that is, the process through which individuals and communities improve their wellbeing by achieving greater financial security, better health and education, is the result of two key drivers: economic growth and declining inequality.

Economic growth is the progressive and sustainable expansion of a country’s wealth. Declining inequality is the necessary condition to ensure all individuals have access to this wealth or, equivalently, that nobody is excluded from the benefits of growth.

Sharpening inequalities significantly reduce the extent to which economic growth leads to an improvement in life expectancy, immunisation rates, school enrolment, and monetary poverty. That is, sharpening inequality neutralises the effect of growth on human development.

And there is more. As inequality increases, growth itself is likely to weaken. This is because a more unequal society is less capable of generating the type of innovation that fosters long-term growth.

The long-term economic prosperity of a nation is therefore critically dependent on policymakers’ ability to tackle inequality.

Does Australia have an inequality problem ?

Three statistics are available to assess the inequality situation in Australia:

• The “Gini Coefficient” is a measure of income that takes the value of zero in a country where everyone has the same income and value of one in a country where a single person has all the income
• The “Relative Income Poverty” is the share of the population with income of less than 50% of the respective national media income
• The “Top 10% vs. bottom 10%” is the average income of the top 10% as a multiple of the average of the bottom 10% of the income scale.

OECD data suggests Australia is above the OECD average in terms of relative income poverty (14% vs 11% average) and just around the OECD average in terms of the other two indicators.

However, the picture is actually gloomier than what might appear at first sight, particularly in relation to the dynamics of the Gini coefficient.

First of all, while close to the OECD average, Australia has a higher Gini coefficient than most other economies at comparable levels of GDP per-capita, the most notable exceptions being the US, UK, and Japan.

Second, and perhaps more importantly, as documented by Peter Whiteford in a previous article, Australia’s Gini coefficient is on an upward sloping trend. A report recently published by ACOSS confirms inequality is on the rise in Australia.

Third, Australia’s inequality is taking a particularly bad turn against the elderly. According to the OECD, relative poverty in Australia is well below the OECD average among 18-25 year-olds, slightly above the OECD average among 26-65 year-olds, and second highest of all OECD countries for those aged 66 or older.

All in all, it does look like there is something to worry about.

The need for full employment

The centrepiece of Labor’s agenda to combat inequality seems to be “full employment”. The report is indeed an articulated discussion of policies to achieve this full employment goal.

The notion of full employment itself is quite elusive. In fact, an economy where no-one is unemployed is unrealistic and probably even undesirable. For this reason, many economists have tried to provide a more practical definition of full employment.

A notion that has become increasingly popular in this debate is the one of Not-Accelerating Inflation Rate of Unemployment (NAIRU). The NAIRU is the rate of unemployment that corresponds to a stable rate of inflation. In other words, when the economy reaches the NAIRU, no further reduction in unemployment is possible without causing an acceleration in inflation.

While the NAIRU does seem to offer a suitable quantitative target for policymakers, the problem is it is not observed and hence has to be estimated. For Australia, a recent RBA paper locates the NAIRU somewhere between 5% and 5.5%; that is, about 1 percentage point lower than the current actual unemployment rate.

The weak performance of the Australian labour market is evident also from other indicators. Youth unemployment is currently at 12.8%, still almost four percentage points above pre-financial crisis level.

The duration of unemployment is also increasing. The number of workers who have been unemployed for more than 13 weeks has increased from 299,700 in January 2011 to 405,900 in January 2015 and it is currently sitting at 422,400.

And while overall employment has kept growing (largely thanks to moderate wage growth at a time when actual GDP is below potential), the loss of jobs in traditional sectors like manufacturing, mining and agriculture calls for a faster transition towards a broader-based economy.

Full employment, broadly defined as the reduction in current unemployment rates across sectors and age groups, is a sensible policy priority for Australia at this point in time.

Diversification is critical

The action ought to be articulated along several dimensions. There is certainly need for more active labour market policies that support the re-employment of the unemployed. There is also need for greater investment in training and requalification of workers of all ages to facilitate their transition from declining sectors to new emerging sectors.

More broadly, Australia needs to embrace a comprehensive approach to economic diversification. The government ought to provide support to any new activity, but this support must be temporary and linked to clearly defined performance benchmarks. In this way, the market will decide which new activity is self-sustainable.

Finally, there is need for a more flexible approach to government spending. Within the parameters of medium-term fiscal stability, the government should use the budget as a tool to stabilise the fluctuations of the economy.

It is indeed a lot to take on board. But at least here we are, talking about inequality. And this is already an important step forward.