inequality ZEIT ONLINE op-ed column

The Shrinkage in Earned Income

This text was also published in German in ZEIT ONLINE on May 12 as part of the op-ed column “Fratzschers Verteilungsfragen“.

The International Monetary Fund (IMF) has attracted attention with its most recent World Economic Outlook. The report shows that the global workforce is receiving a decreasing proportion of economic output, whereas owners of capital are claiming a larger piece of the pie for themselves. Germany stands out as one of the countries where the proportion benefiting workers is comparatively low. More importantly, Germany is among the few countries in which the gap between earned and capital income has widened over the past 25 years. It is likely to continue widening in the future.

The IMF assessed which proportion of economic output benefits the labor factor of production (that is, employees via their earned income, including taxes and transfer payments) and which benefits capital (i.e., the owners of companies and other productive assets). The proportion benefiting labor in industrialized countries decreased from almost 54 percent in 1991 to 50 percent in 2014. From country to country, the differences are large. In 21 of the 50 largest national economies in the world, labor currently claims a larger portion of economic output than at the beginning of the 1990s; 29 of them claim a smaller portion. The largest national economies are predominant in this trend: the U.S., China, and Germany have experienced a marked fall (see Figures 1 and 2).

Yet a shrinking labor proportion is not in itself negative. Measured by GDP, China’s national economy has grown by over 400 percent in the past 25 years. And this growth lifted millions of Chinese citizens out of poverty while giving them a significant increase in income. Despite the enormous increase in economic output, the proportion of earned income simultaneously decreased.

But the picture is different in Germany. Compared to China, weak economic growth here has been such that both the proportion of earned income declined and just under a third of households have a lower income today than they did 25 years ago.

This trend does not affect all people in equal measure. The proportion of income for the richest has risen significantly, making the decline for the middle and lower classes all the sharper. The IMF analysis shows that while this polarization is indeed a global phenomenon, it greatly affects countries with a large industrial sector in particular, that is, countries such as Germany, where automation more easily eliminates jobs.

The strength of the German export industry is not without limitations. Germany’s large industrial sector means that automation and digitalization jeopardize an especially large number of jobs, which in turn puts pressure on middle-class incomes. The open character of the German economy and its industrial strength has a downside, too – not necessarily for company owners, but certainly for their employees.

Germany is also different in other regards. In most of the industrial nations studied by the IMF, technological change and globalization reduced employment levels, thereby contributing to higher unemployment. In Germany the opposite occurred: unemployment fell and the employment rate increased, especially among women and the elderly.

New jobs came to replace jobs lost to technology and globalization in Germany, mostly within the same economic sectors but with lower pay. In other words, the comparatively sharp drop in the proportion of earned income in Germany was not the result of job losses. Instead, employees earned less in their existing or newly created jobs.

Why is Germany different? The IMF has three answers to share. First, globalization and the openness of the German economy have shifted the negotiating power from workers to companies. In the context of an open economy, companies can more easily relocate their activities, or at least more credibly threaten to do so. According to the IMF, the explanation also lies partially in regulations and a tax system that taxes capital and assets at a lower rate compared to other countries.

The third reason is that assets and capital in Germany are distributed so unequally (in international comparison) that highly unequal capital incomes reinforce income disparity. In Germany, low-income earners have comparatively little capital (for example, in the form of stocks, which are partial ownership of a company) and capital mainly belongs to high-income earners. Income inequality and asset inequality are thus mutually reinforcing.

The IMF analysis implies a substantial continued increase in future income and assets. All prognoses show that the technological shift will accelerate, costing people many more jobs and changing the nature of their work. Given its economic structure and openness, Germany and especially its middle class will be more greatly affected than other countries.

Normatively interpreting the dwindling weight of earned income in Germany should be done with care. First and foremost, the IMF numbers are only expressive of the declining proportion of earned income and the increasing proportion for capital and asset owners. Whether this is “just” or not is an entirely subjective matter. Inequality is itself neither good nor bad, and is to a certain extent the natural, even desired, result of a functioning market economy.

The IMF admonishes nonetheless that the resulting increase in income inequality can cause substantial economic damage. A number of scientific studies, by the IMF and DIW Berlin among others, show that growing inequality reduces both economic growth and well-being and can instigate social and political conflict. Indeed, we should heed the warnings of our international partners instead of downplaying them as nonsense as we are wont to when someone abroad dares to criticize us Germans.

Alongside the IMF, many academics such as Thomas Piketty and others, have shown how important owning capital is for the balance of income and living conditions. Germany performs very poorly here. In very few other industrialized country are assets and capital so unequally distributed.

In the future no one should pretend they couldn’t see increasing inequality and social polarization coming. It is a self-broadcasting change. Policy makers should have reacted more decisively long ago – with fundamental reforms for the education system as the primary means of giving more people better opportunities and facilitating increased participation in the technological shift.

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