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The Equity Revolution within Economics and Australia's Cognitive Dissonance

In “The Republic”, Ancient Greek philosopher Plato lays out his ideal society: ‘the gap between rich and poor’, he stipulates, ‘would be at a ratio of four to one’.

Were it so, the wealth gap between the Aussie battler and Gina Rinehart (Australia’s richest person) would be around $500,000 Australian dollars. The real gap is over $10 billion. In fact, if net worth determined height, Gina would be five times taller than Mount Everest. A human ladder of around 500,000 of Australia’s poorest households (6 per cent of the population) would be needed to see her eye to eye. This gap between rich and poor has been rising in Australia and most other rich countries for the last 30 years.

The antecedent factors that have led to rising inequality amongst rich nations trace back to the writings of Adam Smith in 1776 in Wealth of Nations. He observed that the self-interested decisions of individuals often lead to an outcome that benefits society. Early 20th century economists took this notion much further, assuming that individuals are not just self-interested, but selfish.

With this stronger assumption, it could be shown that in a competitive market, selfish behavior maximizes economic gains. This analysis laid the foundations of modern economics - the quest for efficiency. The issue of distribution lay on the periphery of economic analysis, or was ignored entirely. Figure 1 illustrates this obsession with efficiency that commenced from the early 20th century.

Yet it was not until the early 1980s, when the great academic economist and neoliberal propagandist, Milton Friedman, convinced Ronald Reagan and Margaret Thatcher of the predominance of the market, that ‘trickle down’ economics began to permeate government policy. Whilst these reforms brought incalculable efficiency increases to many markets – for example the airline industry – they were applied overzealously. After Reagan came to power, social welfare was reduced, taxes on ordinary workers doubled whilst taxes on the super-rich were reduced by three quarters. Friedman leveraged his academic reputation to assert that such policies, despite increasing inequality, would eventually benefit the poor. Yet this claim had no theoretical basis; it was a guess. Subsequently, countries around the world, to varying extents, began emulating these trickle down policies, with the International Monetary Fund (IMF) propagating their transfer to the developing world.

In Thomas Piketty’s ‘Capital in the 21st Century’, he shows how the initiation of free-market policies coincide with the onset of rising inequality in numerous countries. In the US, despite a ‘golden age’ of growth, male median incomes were actually higher in 1973 than in 2013.

Yet the average American, believing this growth would trickle down, began consuming well beyond their means. Wall Street bankers, rationalising that selfishness was good for society, were happy to entertain this fantasy. The result was the global financial crisis.

Thus, inequality itself was a key driver of the crisis. IMF researchers, Ostry & Berg (2011) have since confirmed this empirically; finding a robust link between high inequality and macroeconomic instability. This has caused a fundamental shift within economics; attention to inequality is now a matter of prudent economic management, rather than of one’s intrinsic notions of social justice. As Nobel Laureate Paul Krugman puts it ‘the left was right’. Resultantly, the IMF and World Bank, known for their economic conservatism, have named ‘inclusive growth’ and the battle against inequality, a key challenge of the 21st century.

Yet unlike our rich world counterparts Australia’s experience of rising inequality has been tempered by a decade long commodities boom. This has seen median income growth of 3.3 per cent; almost twice the OECD average[1]. With wages rising at the bottom it is not surprising that the larger rises at the top have gone largely unnoticed. Yet Figure 2 shows just how large this differential is. In 2010, the average worker’s income rose $17,000 from its 1991 level, whilst the wages of the top 1 per cent more than doubled from $200,000 to $450,000.

Similarly, for wealth holdings, Figure 3 shows that from 2003 to 2010, the top quintile netted an extra $600,000 per household, compared to just $3,000 for the lowest quintile.

Whilst inequality has not yet reached the extremes seen in the US or UK, the rate at which the wealthy in Australia are increasing their share of national income is amongst the highest in the advanced nations; and yet, just the use of the word ‘inequality’ is eerily absent from the Government’s lexicon. It was used twice in official G20 reports whilst Australia was chair, and just once in the entire 2014-15 Budget (and as a footnote).

As such, the Government’s stance on rising inequality can only be gleaned from informal speech. In early 2013, Prime Minister Tony Abbott stated, “in the end, we have to be a productive and competitive society and greater inequality might be inevitable”. In a similar vein, Hugh Jorgensen of the Lowy Institute reports Joe Hockey’s response during a post-speech Q&A from April 2014:

Picking individual groups to benefit is not going to actually deliver the long-term gain. We have to have the structural changes to the global economy that lift the tide for all.

The economic argument being made is that inequality is a ‘necessary evil’ in achieving prosperity; synonymous with ‘trickle down economics’. Indeed the language Hockey employs stems from an aphorism used by the Reagan administration to justify rising inequality, that ‘a rising tide lifts all boats’.

In November 2014, Nobel Laureate Joseph Stiglitz arrived in Australia to remind us that the American model had failed most Americans, and it is certainly nothing to emulate. He further argued that the 2014 Budget is an unambiguous move in this direction.

A budget justified by trickle-down economics is oddly out of step with the myriad of international evidence that there is no trickle-down effect. Australia is unique to other advanced countries, in that, the topic of inequality has largely failed to ‘trickle’ into Australian debate, let alone government policy. Perhaps our strong growth has created an illusion that things are somehow different in the lucky country.

Yet with the commodity boom over growth has slowed sharply and unemployment is at its highest in 13 years. Without a growing economic pie, the increasing proportion of that pie going to the top may receive the recognition it’s received in the rest of the developed world. Australia should be proactive about stemming rising inequality. Not only does it fit with our egalitarian ethos, it is also vital for our future economic prosperity.

There is already a body of research from Oxford, the Paris School of Economics, Berkeley, Oxfam and the IMF on how such inclusive growth could be achieved. The main impediment is politics; established powers have much to benefit from the continuation of trickle-down policies. That is precisely why Nobel Prize winning economists are jet setting around the world, spreading this new evidence. Australia would be wise to take heed.

Charlton Martin is the International Trade and Economics Fellow at Young Australians in International Affairs.

This article can be republished with attribution under a Creative Commons Licence. Please email for more information.

[1] Median is superior to mean when assessing income distribution as mean has an upward bias through its inclusion of the super-rich.

Image credit: Kate Ausburn (Flickr: Creative Commons)

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