The Cost of Inequality (Extract)

Vast income disparities could deter economic growth and undermine social stability

05poor (photo credit: Esteban Alterman)
(photo credit: Esteban Alterman)
Extract of an article in Issue 5, June 23, 2008 of The Jerusalem Report. To subscribe to The Jerusalem Report click here. Dina, an employee of a community center in Jerusalem, often puts in 12 hour days at work, juggling the administrative demands of dozens of public programs. For her efforts, she takes home about 60,000 shekels (approximately $18,000) a year. Nohi Dankner, CEO of the Tel Aviv-based IDB Development Corporation, an investment company, earns 1.5 million shekels, or $447,000 - a month. In Israel circa 2008, the 500 wealthiest Israelis have an estimated combined fortune of $26 billion, equivalent to about a fifth of the country's annual domestic product, while more than 20 percent of the population live under the poverty line, defined as 2,028 shekels ($605) in monthly income for a single person, and 3,244 shekels ($970) for a couple. As recently as three decades ago, Nobel Prize winner Paul Samuelson's highly influential introductory economics textbook listed Israel as the non-communist country with the greatest income equality. Today, Israel is nearer the other end of the spectrum, resembling the United States in its growing income disparities. Israel has greater income inequality than all OECD (Organization for Economic Co-operation and Development) nations except for the United States, Mexico and Turkey. Those in the wealthiest decile in Israel today earn twelve times more than those in the poorest decile in income. The top fourth of households earn more than the other three-fourths combined. Moreover, since 1988, Israel's middle class has been in decline in relative size and share of overall national income, dropping from a third of the population to less than 29 percent today, according to studies by the Adva Center, a Tel Aviv-based policy analysis organization. According to the Central Bureau of Statistics, Israel's 2.7 million workers earn an average salary of about 8,000 shekels per month before taxes. But workers at the Israel Electric Company receive an average wage of more than 18,000 shekels ($5,300) per month, while those in the finance sector earn an average of about 15,000 shekels ($4,500). In contrast, construction workers take home only 6,800 shekels ($2,000) a month, and teachers 5,800 shekels ($1,700). The lower earners don't face starvation, and the national health system enables most Israelis to attain decent health care; life expectancy in Israel is 10th highest in the world, and its infant mortality rate is lower than that of the United States, Canada and the United Kingdom. But a persistently high - and growing - percentage of the population lives below the poverty line. A growing chorus of observers - from the secretary-general of the OECD to visiting Goldman-Sachs analysts - have recently expressed marked concern at the extent of income inequality in Israel. Economists studying the subject note that chronic income equality can lead to resentment, social instability, and possibly slow down overall economic growth. The concentration of wealth in few hands also increases the danger of rich individuals buying influence over politicians - an especially acute concern given recent allegations of corruption at the highest levels of Israel's government. But the allure of wealth can also corrupt decisions at lower levels, especially if there is a "revolving door" between administrative positions and high-paying jobs in the private sector. Given the large income inequalities that characterize the country, Israel was a fitting venue for a recent international conference on income polarization sponsored by Bar-Ilan University and the Van Leer Institute, a Jerusalem academic institute for interdisciplinary studies. The conference was attended by over twenty scholars from France, Spain, Germany, China, Britain, Canada, Israel, Italy and the United States. What emerged from the Jerusalem conference was that new measurements of inequality point not only to greater disparities in income but to an even more worrying trend: polarization of society into different groupings with divergent income levels. The most salient example of this is the fact that 60 percent of Israelis living below the poverty line are from the ultra-Orthodox or Arab sectors. But experts are hard pressed to agree on why inequality has been growing in recent decades, or what can effectively be done to reduce it. The traditional measurement of inequality in a society, invented in 1912, is called the Gini coefficient, named after Italian statistician Corrado Gini. The formal mathematical definition of the Gini coefficient is complicated, but in principle it can be expressed as a number between 0 to 100, where a low Gini coefficient indicates more equal income distribution and a high value indicates greater disparity. According to United Nations statistical tables, the countries with the lowest Gini values - and thus the greatest overall income equality - are Denmark and Sweden, at 24.7, followed closely by Japan, at 24.9. The Netherlands is typical of European countries, with a Gini score of 30.9. The United States stands out as the Western industrialized nation with the highest Gini coefficient, a whopping 40.8, reflecting how different its basic socioeconomic model is from the one adopted in Scandinavia and Western Europe. And Israel seems like a near twin of the United States in this chart, with a Gini value of 39.2 - a far cry from the situation in the 1950s, when its Gini coefficients were neck and neck with those of Sweden's. "But even the European countries cannot be overly complacent," says Gerald Schneider of the Department of Politics and Management at the University of Konstanz in Germany, who delivered the closing lecture at the Van Leer conference. "The United Kingdom is marching down the same road that the United States did 15 years ago, in terms of increasing income differences, and the other European Union nations, including Germany, are also going to experience this phenomenon. This is inevitable in an era of globalization, rapid technological change and open borders. Unequal birth rates, which are bringing about the growth of the less productive sectors of society, only make the problem worse." But according to conference lecturers, the Gini coefficient may not be a sufficiently subtle tool for measuring the growing phenomenon of income polarization, in which disparities in incomes are strongly correlated with race, sex, educational attainment or other sociological categories. "If people begin identifying income differentials as stemming from their association in particular groups, there is a danger of instability," warns Schneider. "In such situations, there can be resentment in both directions - the members of one group resent the greater wealth of the other group, while the more productive elements develop a sense of resentment at the extent to which their taxes support the welfare of the less productive." One strong indicator of income polarization in Israel is the correlation between religious observance and lower income. "What is interesting is that this correlation holds true in the Arab sector as well as the Jewish one," Schneider tells The Report. "In Israel today, a religiously observant person, of any religion, will statistically be more likely to have a lower income than a non-religious individual. This might stem from individual decisions taken by people to choose one lifestyle over another, but in the aggregate it has society-wide effects." The religiously observant sectors in Israel tend to be characterized by large families, only one wage-earner per family, and a stress on religious studies in education over core subjects such as mathematics, science and foreign languages that can lead to higher-paying jobs. Widespread resentment over state support of ultra-Orthodox men who choose to learn in religious seminaries instead of working for a living has, in the past, propelled political parties, such as the now defunct Shinui, to significant Knesset representation. The effects of income polarization, say a growing number of economists, may extend to the point of dragging down the economy for everyone, rich and poor alike. This view contrasts with the classic "trickle-down" theory that posits that income inequality might be necessary for sustained economic growth - essentially a claim that it is better to accept a smaller slice of the pie today in exchange for a larger slice as the pie itself expands. "The idea that income inequality is good for economic growth goes back at least as far as Adam Smith [the 18th century founder of modern economics]," says Omer Moav, an economist at the Hebrew University and a research fellow at the Shalem Center, a political-economic think tank. "The basic logic there is that the wealthy save a greater proportion of their income, so that inequality - or the concentration of wealth in the hands of a few - increases the overall savings and investment rate in the economy," explains Moav. "Second, gaps themselves create powerful incentives to invest and make efforts to climb higher. The reward for success is what creates the ambition to succeed, to take risks and even to invest in your own human capital." Despite this mantra, repeated to generations of economics students, econometric research conducted in recent years has at times yielded the exact opposite conclusions. For example, in a book published four years ago by Avi Ben-Bassat of the Hebrew University and former director-general of Israel's Finance Ministry and Momi Dahan of the Israel Democracy Institute, in which they extensively reviewed several studies from the 1990s, the authors concluded that in most cases, inequality actually hinders growth. "Income equality, growth and democracy go hand in hand," wrote Ben-Bassat and Dahan. "In the past it was assumed that these goals were mutually contradictory, and hence it was considered necessary to distinguish between them. Studies undertaken in the 1990s of the relations between these variables have shown that in many countries they actually reinforce one another." This is certainly true in Israel's case: The 1950s and 1960s, which constituted the period of greatest income equality, were also marked by tremendous rates of economic growth, with income per capita growing at an average annual rate of 5.7 percent Extract of an article in Issue 5, June 23, 2008 of The Jerusalem Report. To subscribe to The Jerusalem Report click here.