Inequality: Global Problem, Global Solutions?

Better than official statements or opinion polls, the global success of Thomas Piketty's latest book Capital in the 21st Century is indicative of a rising global discontent over the distribution of income. Inequality and more specifically the ascent of the super rich are back on the radar screen. In many countries, they have become social and political issues that no party or government can afford to neglect.

Empirically, the cause for concern is overwhelming. In the last two or three decades within-country inequality has risen almost everywhere – in rich as well as in developing countries. True, most European countries have been less affected than the U.S., the UK or China. But this is a matter of degree, not nature. Moreover, there is growing evidence that social mobility is also at stake, which is even more serious. Meritocratic values and a society's investment in education are under threat when the wealth of the parents becomes an accurate predictor of the children's' professional achievements. As Piketty reminds us, there was a time, in 19th century Europe, when inheritance and marriage, not work, were the best conduits to affluence. Few people want this type of society back. Yet we are witnessing its rebirth.

Many blame globalization for the rise of inequality. Indeed the correlation is unmistakable. The comprehensive data assembled by Piketty and colleagues unambiguously indicate that in the 20th century, the decline of the super rich started in the early 20th century with the end of the first globalization and that in most countries, it is in the first post-World War II decades, after world trade and financial flows had ebbed, that the distribution of income was most egalitarian. Then, in the 1980s, the reversal started. Openness increased, financial autarky ended, and top incomes rose disproportionately. No wonder people in several rich countries look back at these post-war decades and picture them as a golden age.

This relation is not entirely causation: in part, inequality and globalization have resulted from common factors, such as technical progress. But there is a link. Actually, the controversy over globalization and inequality is not a new one. It developed in the 1990s already and trade economists have been honest enough to recognise that there are losers in the openness process – such as unskilled advanced-countries workers whose jobs and wages are challenged by competition from developing countries. But globalization advocates have consistently made two points in defense.

The first was that whereas inequality may rise within countries, it also decreases across countries, so that the net effect globally is likely be inequality-reducing. This has proved correct: as shown by Christoph Lakner and Branco Milanovic in a World Bank paper there is less inequality across the citizens of the world now than 20 years ago. Of course, China's development has been, and continues to be a big part of this global story: in 2013, according to the International Labour Organisation's Global Wage Report, not least than half of the growth in global real wages originated in China alone. But China is not the only explanation for what has been aptly termed the rise of the global middle class.

The second point has proved less convincing. The pro-globalization claim was that although there are losers in the openness process, the overall gains for participating countries can be redistributed through taxation and transfers in such a way that nobody loses in the process. By taxing the winners and compensating the losers or spending on public services, governments can ensure that everybody is better off. This claim has proved naive. In some European countries, especially in Scandinavia, the state has basically played the role it was expected to fulfill. But this has not been the in the U.S. and several other Anglo-Saxon countries, where the redistributive government came under attack at the very moment when it was supposed to tax and transfer. The same has applied, to a lesser extent, to a number of European countries.

The truth is that the trade advocates seriously underestimated the correlation between globalization, tolerance vis-à-vis inequality and political aversion to redistribution. They wrongly treated openness and redistribution as complementary choices whereas there has been a political correlation between openness and the acceptance of growing inequality. Although they are economic complements, openness and redistribution have conflicted politically.

One major reason for this state of affairs is that in an open world, well-off individuals benefit from an exit option. They can walk out from their country where they are liable to taxation and settle in another one. Or even easier, they can stay and relocate their wealth. This indeed has happened on a much more massive scale than anybody anticipated. In a recent paper, Gabriel Zucman of the London School of Economics reckons that at least 8 percent of the global financial wealth of households is now located in tax havens. This may look a relatively small number but it is not, as the total includes all bank accounts held by all households worldwide.

For too long, tax avoidance was treated by the globalization advocates as a second-order phenomenon. Tax havens were allowed to prosper, without being subject to sanctions or even moral pressure. Bank secrecy was considered an unavoidable evil. The result was that both the governments' ability to redistribute and the moral case for openness were seriously undermined in the process. It is only when receipts dwindled in the aftermath of the crisis that the U.S. government started to get impatient and that things began to move. The Organization for Economic Co-operation and Development has now become the hub for a global crackdown on tax avoidance.

Europe unfortunately has not been at the forefront of this battle, at least not the EU institutions. On the contrary it has for long remained complacent, as EU treaties require unanimity on tax matters and as the block includes countries such as Luxembourg that have benefitted massively from corporate and individual tax avoidance. For decades, the EU was dominated by an unholy alliance between three types of governments: those that rejected the very principle of international tax coordination as an infringement on sovereignty; those that benefitted from tax competition; and those that used it as a way to overcome domestic reluctance to the reduction of redistribution. For an institution supposed to be based on values and that hails the European social model, this is humbling and the EU is now paying a political price for its long inertia.

Will current efforts change things fundamentally or only on the surface? Some, starting with Piketty himself, advocate global taxation. But this is not a proposal for this decade or the next one. What is at hand is a set of more modest solutions based on transparency, exchange of information, the adoption of common principles, and pressure on offshore jurisdictions. The hope is that they will make tax avoidance much more difficult and costly.

Things have started to change. Switzerland, long a staunch defender of bank secrecy, has given in. Luxembourg is following suit. Yet many more jurisdictions, including in Asia, are part in a global competition to attract wealth. In the battle for a fairer globalization, it is far too early to claim victory.

Jean Pisani-Ferry teaches at the Hertie School of Governance in Berlin and serves as commissioner-general for Policy Planning in Paris. He is a former director of Bruegel, the Brussels-based economic think tank