The gap grows wider

The latest OECD report shows that Israel's income inequality is one of the world's worst.

By ZIV HELLMAN
December 20, 2011 17:29
Economic outlook.

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Israelis like to think of themselves as exceptional, standing out among the nations, especially in view of the country’s history of overcoming challenges.




They are unlikely, however, to be pleased with the way the country stands out in the latest Organization for Economic Cooperation and Development (OECD) report on inequality, titled “Divided We Stand.” According to the OECD’s findings, although inequality has grown in most of the OECD nations, it has increased most markedly in the US and Israel.




The Gini coefficient, a standard measure of inequality, in which a score of zero means that everyone in a country has the same income and a score of one means that only one person keeps all the country’s income, averaged 0.29 in the OECD countries in the mid-1980s. By the late 2000s, it had increased by almost 10 percent to 0.316. In the mid 1980s, Israel had a Gini score close to the average, around 0.31.




The current Gini household net income score of 0.36 puts Israel near the bottom of the pack, between Britain’s Gini coefficient of 0.35 and the US’s Gini score of 0.37. Apart from the US, only Turkey, Mexico and Chile have more income inequality than Israel.




Since 1985, the income situation of the lowest decile of Israeli wage earners worsened the most among all the OECD nations. Israel and Japan are the only countries, from among 34 OECD members, in which average income among the bottom 10 percent has dropped since the mid-1980s, with the Israeli decrease averaging 1.1 percent a year, while the richest 10 percent of earners in the country enjoyed income increases of 2.4 percent per year on average.




The average income of the richest decile of earners in the OECD is nine times that of the bottom tenth. In Israel, in contrast, the richest tenth of earners rake in 14 times as much as the lowest-paid 10 percent, roughly the same figure as that of the United States and Turkey.




“The gap between the 90-plus percentile and the bottom 10 percent has increased more in Israel than in the United States,” says Dan Ben-David, professor of public policy at Tel Aviv University and executive director of the Taub Center for Social Policy Research. “And it has been getting worse over the last 10 to 15 years. This can’t keep going on.”




There are many different opinions regarding what is driving the growth in inequality, both internationally and specifically in Israel. The OE CD report, addressing the general issue of inequality throughout the developed world, points to several possible reasons.




Technological progress, according to statistics gathered by the OE CD, has been more beneficial for workers with higher skills. People with much-demanded skills to deal with the new information and communication technologies or skills specific to the financial sector, for instance, have enjoyed earnings and income gains while workers with low skills have been left behind.




At the same time, regulatory reforms and institutional changes that intended to strengthen competition in the markets for goods and services succeeded in increasing employment opportunities and also contributed to greater wage inequality.




In addition, part-time work and “atypical labor contracts” have become more common while the coverage of collective-bargaining arrangements has declined in many countries. Changing family structures, especially more singleheaded households today than ever before, make household incomes more diverse and reduce economies of scale. Tax and benefit systems have become less redistributive in many countries, especially in Israel, where sharp reductions in the top marginal tax rates have been instituted over the past 15 to 20 years.




An explanation that may be dubbed the “diva” or “Michael Jordan” theory of inequality has recently been embraced by some observers and scholars in this age of increasing globalization. Based partially on a study titled “The Economics of Superstars” conducted in 1981 by Sherwin Rosen of the University of Chicago, the theory claims that for every stage star such as Lady Gaga or basketball legend like Michael Jordan, there are several other cohorts who are only slightly less talented than the famous superstars but are unknown and earn only a fraction of the immense sums the stars rake in.




If they had been born in a past age, these “silver medal winners” in the race for stardom might have been better off; there was a time in which if one wanted to hear music or see a sporting event, one was limited to a show headlined by the local town’s top fiddler or a match between the local sporting club and that of the next town over.




With modern technology, however, everyone has equal access to the very best that the world’s talents can offer, and if one is going to spend hardearned money on entertainment, one is naturally going to demand to see only the gold medalists and the top divas, to whom all the money therefore flows. The secondplace finishers scrape by giving private music lessons.




A similarly focused race for only the top talent has occurred in the business and financial worlds over the past three decades, claim proponents of this theory. Globalization, multinational corporations, communications and travel technology, and easy cross-border flows of people and capital have created an international class of business and financial executive superstars who can leverage the immense demand for “only the best talent” into eye-popping compensation packages.




They earn far more than even their closest junior executives, and their salaries look gargantuan next to the mundane earnings of rank-and-file workers, just as Elton John’s income from one concert dwarfs what the person pushing his piano on stage makes in several years. The only difference, it is said, is that when Madonna earns $100 million a year it is a cause for celebration on “Lifestyles of the Rich and Famous,” but if a hedge fund manager is similarly rewarded for successfully managing billions in investments it elicits cries of unfair income inequality.




Eytan Sheshinski is highly dubious of applying the “diva theory” as an explanation for why the top fraction of a percent of income earners is running away from the rest of us in earnings potential so fast. “When you talk about a singer like Joan Sutherland or a basketball player like Michael Jordan, I can understand the argument,” he says. “CDs and cable subscriptions easily enable everyone to see their talents. But when I look at the business world I do not see a comparable phenomenon.”




Sheshinski, professor emeritus of economics at the Hebrew University of Jerusalem, is a world-renowned expert on public financing and taxation. His name became a household word in Israel last year when he headed a committee that recommended increasing the tax rate on oil and gas industry earnings despite a fierce campaign to discredit him and his committee waged by business interests who stood to lose from a tax rate hike.




“A market system is inevitably going to lead to some inequality in incomes,” he tells The Report. “That is a given. The state is supposed to correct this outcome of the market system to some extent through progressive taxation and transfer payments. But that is not the question here. The question is why has there been such a dramatic change in the incomes of the top percentile or even thousandth of the population, making so much more than even the averages in the top decile and the ninth decile. Why has there been a pronounced change in the ‘tail end’ of the distribution?”




Sheshinski agrees that there are equivalents of divas in the business world, but in his opinion they are as rare as their rock concert counterparts. He would include in that shortlist people such as Bill Gates, Steve Jobs, and the Israeli founders of Checkpoint Technologies, “people who changed the world, and correspondingly received very high compensation.” But extending that metaphor to model a broad swathe of corporate compensation packages, he says, is empirically wrong.




“This has been studied,” says Sheshinski. “People have looked for identifiable characteristics such as educational attainment or creativity and so on, that can be correlated to large compensation in the business world, but the correlations are weak if they exist at all. That does not seem to be the reason.”




What is going on, in his estimation, is the leveraging of power in the hands of controlling interests to gain hold of as much wealth as possible, a process called “rent seeking” in the economics literature. Moreover, says Sheshinski, this is to the detriment of corporate shareholders, who end up paying large sums to executives and directors whose performances do not justify their salaries.




This analysis is further justified, he points out, by differences in the extent to which the top percentile’s income has increased from one country to another. A truly global phenomenon of increased demand for scarce business talent would tend to make the income increases similar throughout the developed world. But it is much more pronounced in Israel and a few other countries, such as the United States, than in the main countries of continental Europe, and Sheshinski posits that the differences are due to different corporate governance rules.




The way to correct this, recommends Sheshinski, is to apply the tools usually applied for correcting market failures, namely passing laws reforming corporate governance along with government regulation.




“The ones who should be most active in seeking a change in this are the pension funds,” says Sheshinski, “because they are biggest holders of shares in the Israeli market. So far they have been passive. They need to be directly involved in getting executive compensation packages down to proper levels reflecting the true contributions of the people getting those salaries to business performances.”




In his analysis of growing inequality in Israel, Ben-David focuses not on the distinctions between the 99th and 98th percentile but on the income differences between the top decile and the bottom decile, because, he says, he regards that gap and the reasons behind it as a long-term threat to the country. The main driving factors, he says, are lack of investment in “human capital infrastructure” – meaning education – and physical infrastructure, chiefly transportation infrastructure.




Ben-David backs his analysis with plenty of facts and figures. In 1979, 90 percent of men of prime working age, defined as the ages between 35 and 55, were employed, whether they had only four years or 16 years of formal education. “Fast forward 30 years,” he says, “and only between 60 percent and 65 percent of men with only eight years of education are employed. The less education, the less chance you have of finding work. Those with an elementary school education earn substantially less than high school graduates, who earn substantially less than those with higher education.”




The clear lesson from this should be a major push to improve education for all, but the state is failing miserably in this task, says Ben-David. “We are below 25 other OECD countries in scholastic achievement, even if you concentrate on the scores of only the non-Haredi Jews,” he points out. “Even our top 25 percent of students are below 24 other OECD countries in mathematics, science and reading scores.”




In physical infrastructure, Ben-David sees many lost opportunities in the ongoing neglect of transportation networks, across the board. Israel has only half the number of motor vehicles per capita as the OECD average, but has road congestion that is two and half times worse than average.




“That makes it difficult to get to work. You either need to live in a large city, which is expensive, or live far away and be cut off from the jobs,” says Ben-David. “Arab villages often do not even have bus service that can get them to Haifa, or Beersheba, Jerusalem or Tel Aviv. Development towns also suffer from lack of transportation. So people in the periphery get no education, and if that were not enough, they have no access to the jobs.”




The influx of foreign workers is exacerbating inequality as well, by increasing the supply of unskilled and uneducated workers, who compete with undereducated Israelis. “It does not matter whether the foreign workers are entering legally or by cross-border infiltration,” says Ben-David.




Taking a long-term view, Ben-David stresses dealing with “root causes.” Contending with inequality by taxation policies is, in his opinion, treating only the symptoms in a cosmetic manner. What is important is giving people the tools and conditions to work in a modern economy.




“In the historical growth process there are structural changes all the time,” says Ben-David. “As economics went from agriculture to light industry to heavy industry to services, there was a continual increased demand for highly skilled workers. You need to keep increasing educational levels just to keep up with structural changes.”




In the context of this broad historical sweep, Ben-David is very concerned about the inequality that, in his analysis, is likely to continue to grow. “The Arab sector is at Third World levels, and the haredi students are below Third World levels, because they are not even studying those subjects,” sums up Ben-David.




“The demographics show that 52 percent of kids are below First World education standards. Look at what is coming down the pike! This is unsustainable.”



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