Luc Vallée is chief operating officer and chief economist at the Montreal Economic Institute
How to address inequality is a question that preoccupies many people in our time. Yet excessive, inefficient redistributive policies are not the answer. Rather, the root causes of poverty and income stagnation must be addressed.
In a recent study, the Observatoire québécois des inégalités, a left-leaning Quebec-based research centre, concluded that in 2017, 43 per cent of the Canadian population were part of the middle class (household incomes between 75 per cent and 200 per cent of median income). Once taxes and transfers were accounted for, this proportion reached 61 per cent for Quebeckers and 57 per cent in the rest of Canada.
At the other end of the spectrum, the United States has high inequality, but even richer median and average households. Thus, in accordance with basic economic theory, more generous income-redistribution policies may result in lower income inequality, but they generally have a negative effect on economic growth (and thereby on the overall level of income) by reducing incentives to get educated, work and invest.
For instance, raising the minimum wage – a form of hidden tax on small companies – is often touted on the left as a direct means of reducing both poverty and inequality. However, such a measure leads to higher costs for companies while generating neither productivity gains for businesses nor economic growth.
On the contrary, the policy is likely to lead to layoffs, forcing the government to pay out more in employment insurance. It also encourages workers who earn only marginally higher-than-minimum wage to demand wage increases in turn, which eventually leads to inflation. Rising prices reduce the purchasing power of consumers, thus defeating the purpose of higher minimum wages in the first place.
Would it not be better to encourage low-skilled individuals to invest in increasing their productivity? They could then offer their services and be hired at higher wages by companies in need of skilled workers. By the same token, this would help households lift themselves out of poverty, raising overall productivity and economic growth as well as contributing to improved public finances.
By reducing the pool of available low-skilled workers instead of having the government mandate arbitrary minimum-wage hikes, market forces may induce existing businesses to raise all wages to attract workers sitting on the sidelines. With a rising labour force participation rate, government may get the fiscal boost it needs to invest more in social programs targeting those who really need help, while also balancing the books.
Case in point: While Donald Trump is touted as the president of the rich after cutting taxes for millionaires and corporations and promoting deregulation to help businesses, the American middle class is actually doing quite well. Real median income increased by 7.1 per cent during the first 31 months of the Trump Republican administration. Americans are getting richer, while there are fewer poor households. In particular, the poverty rate of households led by a single African-American woman fell 2.7 per cent in 2018, and by a Hispanic woman, 4 per cent.
Households belonging to the 15- to 24-year-old cohort, often attracted to the ideas of Democratic presidential candidates Bernie Sanders and Elizabeth Warren, saw their real incomes rise 9 per cent last year; those of the 25- to 34-year-old cohort rose 5 per cent. So a lot of people are better off even if, strictly speaking, inequality kept growing in the U.S. in the two years after the 2017 tax cut, as Alan Blinder recently pointed out in The Wall Street Journal.
In contrast, as government grows, it becomes the object of increasing lobbying by diverse interest groups, unions and corporations looking to obtain favours and protection through various programs, subsidies and regulations. By interfering with competition and social and economic mobility, this reduces long-term growth and opportunities.
Granted, competitive capitalism is messy. It creates winners and losers. But you only get good at competing if you maximize the number of players who invest in getting better. For this to occur, players must be given incentives to participate in the game. Eliminating inequalities by raising taxes and redistribution denies the proven benefits of competition. Trying to eliminate winners and losers through short-sighted policies reduces the incentives to compete to get ahead. And, without competition, you don’t get better. This is the harsh truth, and the real root of poverty.
Correcting for inflation mis-measurements, the size of households, and demographic biases, recent research shows that real median income in Canada has more than doubled since 1982, despite claims that the middle class is stagnating and that inequality has grown. The simple fact is that when public policies emphasize growth and opportunities, as opposed to explicitly targeting the reduction of income inequality through redistribution, everyone tends to get richer.