The gap between poor and rich has grown in the last thirty years. According to a recent report by Oxfam Novib and Development Finance International the eight richest people have as much wealth as the poorest 3.5 billion people in the world. Inequality is not a natural phenomenon. Governments can take various measures to reduce inequality.
In a scientific article that we recently published in the Journal of Happiness Studies, Bjorn Lous and I analyze what the impact is of government policy on income inequality. In this article, entitled Economic Freedom, Income Inequality and Life Satisfaction in OECD Countries, we estimate how different dimensions of government policy have influenced income inequality in 21 countries within the OECD (a socio-economic partnership established in 1948) during the 1990s-2014. The estimates show that, as the government reduces tax, income inequality in a country is higher. When higher income groups pay relatively more tax than low income groups, inequality decreases. The tax system will in that case provide a redistribution of income from rich to poor.
Income inequality also increases when a country is more open to free trade. In OECD countries free trade encourages exports of high-quality goods and services, thereby promoting employment among highly skilled people. The increased imports of goods made possible by free trade, however, concern products that require more low-skilled labor. As a result, free trade causes upward pressure on wages of highly educated people and downward pressure on those of low-skilled people, which also increases income inequality.
A third factor that promotes income inequality is the degree of regulation of markets for goods and services and of the labor market. With respect to the latter, for example, the rate of the minimum wage is a factor. In countries with a very low minimum wage the wages of low-skilled workers are often lower than in countries with a higher minimum wage.
A factor of influence with regard to the regulation of product markets is governmental anti-trust policies. To the degree that the government is more effective in combating the economic power of large companies and is preventing them from pushing small businesses out of the market, competition will be livelier and the profit margins will therefore be smaller. This prevents businesses like Google and Facebook from controlling a large part of the market (for example, in online ads). Because it is often the rich who possess such large companies, helping to combat the economic power of large companies is also a way to counteract inequality.
Fighting inequality is of great social significance. In the article mentioned, Bjorn Lous and I find it to be one of the factors that affect human happiness in society: the more inequality, the less happy people are on average.
Income inequality is a source of all kinds of other forms of inequality, such as inequality in health and access to health care, inequality in education and inequality in the quality of the direct living environment of people.
Trust in government institutions is also being affected. It is very important that citizens feel that they count in society. As income equality grows, a larger proportion of them will feel more excluded. This not only affects their happiness, but also provides fertile ground for behavior that rejects society.
Our article contains various points of reference for government policy that can establish the right balance between free market and corrective action.
If we put our findings next to President Trump’s economic policy, we see that the glass is both half full and half empty. On the one hand Trump increases the power of large companies by lowering tax on profits. High income groups benefit as well, as tax rates fall for them. Furthermore Trump weakens business regulation, including earlier measures taken precisely in the aftermath of the credit crunch, to prevent repetition. All of these policies lead to more income inequality and are at the expense of happiness in America. However Trump also imposes restrictions on free trade. According to our analysis, that may provide some counterweight.