Income inequality erodes business growth and social mobility

The banking industry is a glaring illustration of inappropriateness of income

Now that we’re over the Christmas binge of giving and caring, it’s time for a sober discussion about why so many people are in such desperate need amid our relative plenty.

It’s tough to talk about poverty and income inequality together because, as World Bank economist Brank Milanovic told Reuters: “Charity is a good thing; a lot of egos are boosted by it and many ethical points earned even when only tiny amounts are given to the poor. But inequality is different: every mention of it raises in fact the issue of the appropriateness or legitimacy of my income.”

The banking industry is a glaring illustration of inappropriateness of income, although it really does know how to look after its people. The $10.3 billion in bonuses distributed by the big six Canadian banks in 2012 could have been paid out as a $37,591 bonus to every bank employee in Canada. Unfortunately, the banks’ model for who gets bonuses might not be the best.

What should concern businesses is the likelihood that excessively high income inequality is a brake on both economic growth and social mobility.

When the Washington Post asked a selection of smart people for their favourite infographic of 2012, Chrystia Freeland, editor of Thomson Reuters Digital, pointed to the Great Gadsby Curve, popularized a year ago by Alan Kreuger, chairman of the U.S. Council of Economic Advisors. It shows pretty clearly that as income inequality increases, social mobility declines: social classes are more differentiated and harder to bridge when incomes are farther apart; the bigger the space between the rungs on the income ladder, the harder they are to climb. Paradoxically, countries with the lowest levels of inequality, like Denmark and Norway (free university tuition!), had some of the greatest mobility.

The good news is that Canada’s levels of inequality are around the middle of the 21 countries on Freeland’s chart, and our social mobility is still respectable. The Fraser Institute recently released a study reassuring us that there’s plenty of social mobility in Canada: over 10 years, it found, four out of five of Canada’s lowest income earners moved up the income ladder.

That report has been criticized for measuring only people moving up from the bottom end to the middle, while the spread between top and bottom earners continues to grow.

It also uses a different way of dicing the data compared with looking at whether children will reach their parents’ position on the income distribution ladder.

When researchers at the London School of Economics looked at eight countries this way, they found that greater inequalities made it easier for rich parents to pass on their advantages.

Unfortunately, if we can believe the Conference Board of Canada, Canada’s level of income inequality is growing, which will result in less social mobility.

Canada only looks good in comparison with the U.S., where the top 10% take home a larger share of overall income than they have since the 1930s and the wealth of the 400 richest Americans has increased fivefold in the last 20 years, “leaving the middle class in the dust,” as Warren Buffett says.

Canada’s growth in income inequality between the mid-1990s and the mid-2000s was the second biggest of 17 countries the conference board studied, and the gap continues to widen (recently exacerbated by debt load inequalities).

What matters for our economy is that income inequality constrains economic growth. This is the finding of Kemal Dervis, vice-president of the Brookings Institute and co-author of Inequality in America. International Monetary Fund research suggests the same, estimating that widening disparity in the U.S. has pinched economic expansion by as much as a third.

You don’t have to be in the Christmas spirit to view growing income inequality as a bad thing. It hurts the economy too. •

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