U.S. And China Share Problem Of Rising Income Inequality

by: Bondsquawk, CFA

By Rom Badilla, CFA

Growing income inequality can be a major issue as the gap between the rich and the poor can have long term implications on both a society and economy. Income inequality can create a class system that is determined by wealth, both earned and inherited, and de-emphasizes the importance of opportunity and innovation. Separation can lead to social tensions as the "have's" and "have nots" are divided with opportunity to bridge that gap becoming limited. Such tensions could lead to political instability as was the case in Egypt and in Syria that were driven by a young population seeking economic opportunity and a better way of life. Furthermore, economic growth and the benefits that come with it, are not being shared equally, specifically the middle class which comprises the bulk of the population. Those that are left behind and do not take part could lead to under-consumption on an aggregate level. For an economy such as the U.S., this is significant since consumer spending accounts for seventy percent of economic growth.

That said, income inequality in the U.S. has been rising for many decades. As mentioned in the New York Times article, "For Two Economists, the Buffett Rule Is Just a Start" by Annie Lowrey, income inequality has been an issue even before the Financial Crisis. Based off the work by economists, Emmanuel Saez and Thomas Piketty, she wrote the following:

From 2000 to 2007, incomes for the bottom 90 percent of earners rose only about 4 percent, once adjusted for inflation. For the top 0.1 percent, incomes climbed about 94 percent.

Furthermore and despite the collapse of the stock market and financial asset prices which typically affects the rich, she stated that the Great Recession did not derail the widening gap. The rich continued to become rich through higher income gains even after the recovery.

Data that the two economists released in March showed that the top 1 percent of earners got nearly every dollar of the income gains eked out in the first full year of the recovery. In 2010, the top 10 percent of earners took about half of overall income.

The U.S. is far from alone with this problem. China with all of its economic growth is experiencing a similar problem. In fact, China has a bigger problem that is growing at an alarming rate according to Societe Generale's Albert Edwards and Dylan Gracie. In their latest Global Strategy Weekly, they wrote the following:

Regular readers will know that we have been concerned about the social tensions that have resulted from 2008 The Great Recession and its aftermath. Our concerns were especially heightened by the extremely rapid rise in inequality in many countries in the decade running up to the crash most especially, but not exclusively, in the US. But not only is China more unequal than the US, it has become more unequal at a faster rate.

This is evident by using the Gini Coefficienet which measures inequality among values where zero represents perfect equality while a value of one represents maximum inequality. The Economist by way of Societe Generale provided the following chart showing Gini Coefficients on various countries with China at the top of the list.

In addition, Societe Generale cited the recent results from Pew Research which shows that Chinese citizens are becoming more concerned of government corruption and income inequality.

Rising income inequality and the potential for social unrest in China could have significant implications from an economic standpoint. Given the fact that China has been and should continue to be one of the main drivers of global growth, any disruption which would be exacerbated by the distribution of income could send waves around the world and to the shores of the developed world.