the effects on rising income inequality and poverty
In 2017, readers might recall that this column featured an extensive series of articles dedicated to assessing the social and economic impacts of the restructuring programme of the sugar industry. This theme was examined on the macro and micro-level which highlighted the impact on the foreign exchange, extraction of wealth from more than 40,000 direct and indirect dependents on the industry, and the cost to the economy in terms of circulation of money when considering the multiplier effect on the banking system and other sectors.
In addition to this, it was reported in various sections of the media over the past few years, instances of repossession of lands – rice farmers to be specific – the increases in taxes which extracted billions from the disposable income of consumers that resulted in the loss of $74 billion in consumer spending over the last four-five years from $526 billion in 2014 to $454 billion at the end of 2018. This is $74 billion taken away from the pockets of the ordinary working-class people. The case of downsizing the sugar industry resulted in the extraction of over $40 billion from the economy, in terms of sustaining the village economies on the micro-level, income distribution, taxes that are paid over to the Government, National Insurance (social security), spending in the economy, losses in foreign exchange. The consequences, as highlighted herein and more extensively in previous writings, are akin to what this author describes as “unplanned restructuring of the economic system geared towards the redistribution of wealth from one section of the economic system and players within the system to another, rather than, generating new wealth”. Today’s piece, therefore, seeks to address empirical evidence of the impact of such policies on income inequality and poverty.
Explanations for the extent to which governments redistribute income through the tax and transfer system provide for an interesting example to contrast rational choice and behavioural perspectives, and how they differ in understanding human motivation. In a classical paper, Meltzer and Richard (1981) provide a theoretical ‘proof’ that individual utility maximisation and the vote-seeking behaviour of politicians under majority rule produce greater redistribution when inequality is high. The model exemplifies the deductive reasoning of rational choice and applies the median-voter theory of Schumpeter (1942) and Downs (1957) to a tangible question. As even critics would concede, the model is elegant and parsimonious, and its logic is intuitively compelling. Yet, it suffers from the shortcomings of its very foundations that behavioural economics has found wanting. By portraying humans as ‘rational fools’ (to use Amartya Sen’s term), rational choice ignores that people are embedded in a society and share values and perceptions of fairness and social justice. The empirical shows that the simple mechanism of rational choice is a poor guide to reality.
One caveat needs to be added to this analysis. People’s views on what is just and fair, and on how the government should intervene in market outcomes, are of course shaped (but not fully conditioned) by their socialization in a political system. Hence, the institutions that redistribute income — primarily the tax system and social security institutions — will influence voters’ views on redistribution and can often generate their own legitimacy through performance. The direction of causality is therefore open to debate, and it may well run in both ways.
In Easton’s (1965) terminology, the output of a political system is evaluated by the population and, through a feedback loop, influences the input that feeds into the system through elections or other forms of political participation. The central argument made in this paper is that, when analysing inputs into the system, observing and measuring what people want is a better guide to reality than simply deducting what they want on the basis of assumptions about their rational utility maximisation.
The failure of voters to demand sharp tax increases for the top 1 per cent of income earners who control almost a quarter of incomes (Atkinson et al. 2011) could be pinned down to plain ‘irrationality’, but historical explanations are richer and more useful to understand why Americans are so adverse to government redistribution (see eg Lipset and Marks 2001). Having established that beliefs in fairness matter, behavioural economics has broadened the perspective of economics to include such considerations.
The historical evolution of wealth and income inequality in Latin America is a case in point. The lack of welfare states in the region needs a complex explanation and is certainly not due to lack of public support for redistribution. Opinion survey data from Latin America, in fact, show overwhelming support for reducing income inequality, but the historical legacy and wealth concentration mean that inclusive social security institutions are largely absent. However, the upshot is that leaders such as President Lula da Silva in Brazil can ride on public opinion to expand social security schemes like as bolsa familia — and that even conservative opposition parties extend their support to them once they have become popular. Redistribution might not follow automatically where it is most needed to reduce poverty, but democracy opens up space for human agency to affect policy outcomes (Huber et al. 2006).
