On Inequality

A divided Europe?

Perhaps we should first remind ourselves of Europe’s comparative strengths. It is a great place to live and work, a place of relative freedom and tolerance. It is among the best places in the world to face life’s troubles, like job loss, illness, or suddenly needing the care of others. The European model has been a success, combining a competitive market economy with a strong welfare system to underpin a high quality of life. As the European Union has expanded, it has facilitated upward convergence of living standards across the bloc. It remains one of the most egalitarian regions of the world.

Yet many feel that Europe has lost its way. The last few decades have witnessed a shift from a largely social-democratic and Keynesian big-state policy agenda, to a more neoliberal, small-state one. The Great Financial Crisis of 2008-2009 undermined the neoliberal consensus and reignited the controversy on the role of the state. In this context, the debate over inequality tends to be framed less about whether there is too much, or too little, than about whether recent events and policy shifts have caused it to increase.

For example, while incomes for the bottom 80% of the European population have grown by an estimated 40% on average since 1980, the top 1% have seen their pre-tax income more than double.[i] The Global Financial Crisis and its fallout was not a big driver of inequality in Europe. In fact, falling profits served to temporarily dent top percentile incomes, while the crises also increased hardship and economic insecurity among lower-income groups.

---

[i] Blanchet, T. Chancel, L. and Gethin, A. (2019), “How Unequal Is Europe? Evidence from Distributional National Accounts, 1980–2017”, WID.world Working Paper 2019/06.

Yet having learned this much, we also realise how little we know. Is inequality now too high in Europe, or should we rather follow America’s lead?  

The issue of inequality often serves as a proxy for an argument over economic policy paradigms. It is also a proxy for the discontent many people feel over much more tangible things: the fear of sudden unemployment or penniless old age, the stress of competing financial demands, the exhaustion of overwork, the resentment at others seeming to lead much easier lives and the anger at being talked over and ignored. Making “inequality” stand for all this fulfils the technocratic demand for simple measureable indicators, but many dimensions are lying behind the concern for abstract inequality and they all matter.

The labour market has a huge impact on equality of income and life chances. Employment across the European Union actually achieved record levels in 2019. Even before the pandemic, however, these aggregate figures hid a divergence in employment opportunities across countries and regions, age groups and skill levels. Whilst there has been convergence across EU regions on many social and economic indicators, the Global Financial Crisis triggered a sharp divergence with respect to unemployment rates.[i] These recently ranged from less than 2% in Prague to more than 20% in parts of Greece, southern Spain and southern Italy.[ii] In addition, rapid technological change seems to be leading to a process of job polarisation, with many medium-skilled workers feeling increasingly vulnerable and pushed to accept low-skilled jobs.

---

[i] Bending, T. and Bubbico, R. (2019), Three foundations: A competitive, sustainable and inclusive Europe, Luxembourg: European Investment Bank.
[ii] 2018 data, 15-74 year olds, NUTS2 level. Source: Eurostat.

The strains of combining paid and unpaid work are revealed in work-life balance indicators.

These concerns appear consistently to be getting worse for both women and men.[i] With societal ageing set to increase care responsibilities, this issue is only likely to grow in importance. 

In the 2019 Eurobarometer survey, when people across Europe were asked to name the two most pressing issues facing themselves personally, 18% mentioned health and social security, 15% pensions, 14% the environment and 13% their own financial situation. Other economic and social issues followed, with crime (6%), immigration (5%) and terrorism (2%) trailing at the rear.[ii] This emphasises the importance of public goods and services and social transfers to the amelioration of market-generated inequality, and to our actual well-being. More than abstract measures of inequality, public services in the areas of health, education, housing, childcare and long-term care are central to our perception of economic fairness.

---

[i] Eurofound (2017), European Quality of Life Survey, 2016, Publications Office of the European Union, Luxembourg; Bending and Bubbico, op. cit. p. 39.

[ii] https://ec.europa.eu/commfrontoffice/publicopinion/index.cfm/General/index

Contributions to global emissions are very unequal and correlated with income, simply because wealthy people consume more. Likewise, both climate disruption and the needed transformation of our economies will have very unequal impacts across different regions of Europe and the world. Just within Europe, some regions will face intensifying water shortages, others are very dependent on coal or carbon-intensive industries, while others are much better placed to reap benefits from the wave of innovation and new technologies that the energy transition will require. As with regions, the ability of households to adapt will depend a lot on their income and wealth. Not every family can afford to renovate their home, if they even own one, or to buy a new electric car.

Is inequality good for growth?

Moral arguments around inequality often focus on whether riches are deserved, or whether they represent, in some way, ill-gotten gains. Economics cannot really answer these moral and philosophical questions. It can only describe how economies work. As the philosopher G. E. Moore put it, you cannot get an “ought” from an “is”.

One thing economists can ask is whether an unequally shared cake leads to having a bigger cake to share amongst everyone in the future.

It means that the most important resource of an economy – the talents and skills of its workforce – are not allocated as efficiently as they could be, undermining productivity and competitiveness. The availability of skills is one of the most-reported barriers to investment by EU firms, with innovative firms more skill-constrained than most.[i] 

Inequality has both positive and negative effects on economic performance, therefore. It is difficult to say which is more important. But there is also a more fundamental question to be answered: whether high inequality – across classes, genders, geographies and so on – is really the best and most efficient way to use the output of our economy to satisfy our wants and needs.

Does anyone need a billion euros?

Many families struggle to heat their homes and pay rent. Others can jet off to tropical islands for their holidays. Is this an efficient way to use the current output of our economy? Given the resources we have, is this the best way to meet human needs and create human happiness?

This is actually an old controversy in economics, but one that has been rather brushed under the carpet. One of the roots of modern economics is the 19^th century utilitarianism of economist-philosophers like Jeremy Bentham and John Stuart Mill. They proposed that social and economic policy should simply aim to create the maximum aggregate happiness, or “utility”. This was a radical idea. Policy was not to be judged by moral principles or its contribution to the achievement of some long-term transformation, but simply by whether it maximised the sum of everyone’s happiness. In this sense, modern economics is still fundamentally utilitarian.

---

[i] EIB (2019), Investment Report 2019/2020: accelerating Europe’s transformation; EIB (2021), Investment Report 2020/2021: Building a smart and green Europe in the COVID-19 era.

In the tradition of Adam Smith, the utilitarians believed that aggregate happiness could be maximised by each individual competing to maximise their own happiness in the marketplace. They were neither anti-market nor anti-capitalist. However, in common with most classical economists, they also believed in diminishing returns.

Spending €110 on a bottle of wine, instead of €100, is unlikely to achieve the same increase in utility as having €10 to spend on a meal, when otherwise you would go hungry.

But this led the utilitarians to a conclusion that was perhaps inconvenient. As consumption achieves diminishing returns, spreading income out equally is likely to achieve greater happiness. It looks better to ensure that ten families can eat than to indulge one person’s penchant for expensive wine. Skewing the distribution of income towards a lucky few looks to be a hugely inefficient way of using economic output to meet needs and create happiness.

Unsurprisingly, these inconvenient conclusions came under attack, and it was an attack on liberalism itself.

Classical liberalism arose amidst the revolutions in England, America and France. Against the old feudal order, it declared that “all men are created equal”. But mid-19th century England – now the industrial heart of a global empire – saw the rise of a new anti-egalitarianism. Inspired by Darwin’s theory of natural selection, eugenicists proposed that the goal of public policy should not be the greatest aggregate happiness now, but a better human society in the future, one made of biologically superior humans.

These were not the views of cranks at the margins of public discourse.

One might offer charity for the poor at home or in the colonies, but such charity was often deemed wasted on people seen as naturally prodigal and indolent.

With humans increasingly seen as born unequal, many economists questioned whether people even have the same capacity for happiness. Maybe the extra €10 spent on expensive wine does create as much happiness for the refined palate of the wine connoisseur as €10 of cheap food for the hungry? F. Y. Edgeworth was one of the leading originators of modern, neoclassical utility theory. He was also a convinced eugenicist. What if, he argued, someone’s capacity for happiness is low? Then the utility they get from consumption might not outweigh the disutility of work, which would explain laziness and poverty. Rich people are rich, he suggested, because they have a greater capacity for happiness, find consumption to be more rewarding, and thus work harder and are, in Darwinian terms, “fitter”.[i]

---

[i] “[T]here appears a deeper sentiment in favour of aristocratic privilege – the privilege of man above brute, of civilised above savage, of birth, of talent, and of the male sex. This sentiment of right has a ground of utilitarianism in supposed differences of capacity. Capacity for pleasure is a property of evolution, an essential attribute of civilisation.” F. Y. Edgeworth (1881), Mathematical Psychics: An essay on the application of mathematics to the moral sciences, London: Kegan Paul, p. 77.

Who was right? So economists switched approach, all but abandoning the idea of measurable “cardinal” utility and turning instead to observable preferences or “ordinal utility”: the order in which things are preferred. Abandoning the idea of aggregate happiness, economists have ever since held up Pareto efficiency as the ideal. An economy is Pareto-efficient when no one can obtain a more preferred outcome without causing someone else to obtain a less preferred outcome.[i]

The problem is that we keep talking as if economics could say something about actual cardinal utility or happiness, when all it can talk about is the order in which people prefer things.

And by proceeding as if market outcomes are efficient at creating happiness, we tacitly side with eugenicists like Edgeworth; we tacitly declare that, yes, for the sake of maximising happiness overall, some people really do need a billion euros more than a billion people need a euro.

But what if the truth is closer to the assertions of the classical liberals and utilitarians? What if we are born equal, with equal capacities to contribute to society and to enjoy its fruits? Then the inequality we see could be a massive waste of resources and a vast lost opportunity to meet need.

---

[i] Pareto efficiency (or Pareto optimality) is typically expressed as the possibility of making someone better off without making someone else worse off. This is, in fact, an example of how economists speak as if they are talking about actual welfare or cardinal utility, when in fact Pareto efficiency is only concerned with orders of preferences and says nothing about efficiency in achieving actual welfare or happiness. See Amartya Sen “Markets and Freedoms: Achievements and Limitations of the Market Mechanism in Promoting Individual Freedoms”, Oxford Economic Papers, New Series, Vol. 45, No. 4, p. 519-541.

Democracy, Europe’s answer to the problem of inequality

Europe does have an inequality problem. At the very least, it is a problem of legitimacy. For while economics can answer questions about the relationships between inequality and innovation, social mobility and growth, it cannot show that the current distribution of income is at all efficient at meeting our needs and fostering our collective happiness. Meanwhile, ever fewer people believe that it does. 

The political theorist Benjamin Barber has written, “politics is not the application of Truth to the problem of human relations, but the application of human relations to the problem of truth”.[i] As a technocratic discipline, economics has tried to apply Truth to politics, advising decision-makers on the best policy. But on inequality, we need to declare the limits of our knowledge and turn the question over to the body politic. For as participants in society, we do indeed have something meaningful to say.

We can reflect on our own experience. If we spent ten times more on food, on our car, or on our summer holiday, would we get ten times the satisfaction? How much happier would be we be if we had twice the income, or 100 times? How less happy would we be if our income was halved and we struggled to make ends meet? We can reflect, maybe, on times when we did struggle to make ends meet, or on times when things were easier.

We can also listen. We can turn our attention to how others try to express what it is like to encounter success and hardship. We cannot see into the subjective experiences of each other, but we can work to imagine what it must be like to be in their shoes, through a process of dialogue and empathy. No expert can measure the happiness of everyone, but each of us may have something meaningful to say about how any outcome may harm or benefit others and ourselves. Such reflection does not generate a Truth that can be fed into an economist’s model, but it does give meaning to the process of democratic deliberation. This is politics applied to a problem of truth. It is also the old classical and utilitarian idea of democracy as a mechanism to solve moral problems of political economy. 

Economics needs to answer questions about the technical relationships between inequality, the size of the economy and growth. How much does inequality spur innovation? How much does inequality block social mobility?

---

[i] Barber, B. (1984) Strong Democracy: Participatory Politics for a New Age, Berkeley: University of California Press, p. 64.

It is then up to democratic deliberation to answer the moral questions, those that have to do with happiness and harm, for others and ourselves. And how much should we weigh these considerations against the need to spread the fruits of economic activity according to our collective judgement of how we can create the most happiness?