Pearls and Irritations

When I met Andrew Leigh before his ‘Meet the Authors’ discussion of this new edition of his book, I had to ask him, ‘how on earth do you do this?’. Lyn Hatfield Dodds who moderated the discussion opened with the same question.

Andrew Leigh is not only an extraordinary politician but an extraordinary person. Another of his outputs this year, The Shortest History of Economics (published in the UK as How Economics Explains the World), is listed in The Economist’s best books of 2024. He also runs marathons, is a Government minister and personally answers emails!

He does get help from a ‘group of whip-smart young people’ identified in an appendix, along with a very lengthy list of academics and researchers in the Parliamentary Library. But somehow, he personally engages with every one of these people and paints his own picture from the accumulated evidence.

For the most part, the book is a balanced presentation, recognising the benefits as well as the costs of inequality, and also the complex issues involved in trying to contain inequality. There is a lot of evidence presented. At times, however, his political bias shows and important issues are glossed over. I can only hope that, at least in private, he may seriously consider my criticisms and suggestions.

With just 162 pages (excluding appendices), the book is an easy read. The first three chapters summarise the shifts in inequality in Australia from British settlement (and before) to the present. These are followed by chapters on the drivers of inequality and the consequences, on mobility (particularly intergenerational mobility) and what Australians think. A concluding chapter presents Leigh’s views on what should be done.

Trends in inequality

The historic picture begins with Australia’s high degree of ‘economic’ equality coupled with a high degree of ‘power’ inequality, both before and after white settlement. This honest appraisal of Indigenous communities is refreshing, acknowledging the tough life of hunting and gathering, particularly for women. Life was tough also in the penal colonies, where material wellbeing might have been relatively equal but pretty dire, and the power imbalance extreme. As colonial settlement expanded, economic inequality in the nineteenth century grew and fluctuated widely.

The post-Federation story is different with two quite distinct phases: what Leigh terms ‘the great compression’ until the 1970s and the subsequent ‘great divergence’ that is continuing today.

Economic inequality was high prior to the First World War with both super-rich living extravagantly and, even after the 1907 Harvester judgment, wages still low compared to those paid in the US at the time. Inequality was not as great as in the UK, and a culture of ‘egalitarianism’ by then existed in Australia. The introduction of age pensions in 1909 also provided important protection from poverty.

Leigh relies upon data on top income shares to reveal reduced inequality between 1910 and 1970, but the overall story up until the Second World War is not so clear, being complicated by the First World War (and the deprivations of returning soldiers and their families) and by the Great Depression of the 1930s.

There is little doubt however about the compression of inequality after the Second World War. The ‘social compact’ developed by a Parliamentary committee (not just the Labor Prime Minister, John Curtin, mentioned by Leigh) during the war led to changes to the Constitution and the introduction of a stronger social safety net. Post-war economic growth raised wages and held down unemployment. As Leigh mentions, the closed economy with high tariffs may also have helped to contain inequality (at least amongst white men), but also held down Australia’s growth rate.

At the same time, interestingly, there was a ‘near-absence of millionaires’ during the first decades after the war as professional managers replaced asset-owning proprietors and before managerial salaries took off. Social norms at the time also eschewed conspicuous consumption by the wealthy, and more people identified themselves as ‘middle class’ than in the US or UK.

The ‘great divergence’ since 1970 that Leigh refers to really began in the 1990s as annual earnings at low income levels grew more modestly than at median earnings and grew much faster at high income levels. At the very top end, growth was fastest, accelerated by the shift to incentive-based pay for CEOs (while recognising the case to align CEOs’ interests with those of shareholders, Leigh rightly refers to the tendency to overpayment for good luck and unwillingness to withhold bonuses for poor or average performance).

The divergence in Australia has also occurred in Canada, NZ, the UK and US (though the income share of the most affluent in the US was and remains twice that of those in Australia). This suggests global forces at work including both internationalisation and technology change.

Leigh mentions that politicians and judges have shared this boom at the higher end but disappointingly does not question why. He might also have referred to departmental secretaries and university vice chancellors. A closer study would reveal Australian exceptionalism as remuneration for many of these public sector leaders now exceeds that for their OECD counterparts. A Remuneration Tribunal led by private sector ‘experts’ using highly questionable market comparisons bears much of the responsibility, something Leigh and the Government could fix.

Leigh also shows how wealth inequality has increased since the 1960s more than incomes inequality, property assets leading the way (interestingly, it seems that wealth inequality fell more than incomes inequality in the earlier period). The cost of housing has escalated in particular since the 1990s in terms of the number of years’ earnings required.

The divergence is not just about the rich getting richer: the bottom has also been falling away from the middle according to research on ‘relative poverty’. This began in the 1980s and has continued through to the 2020s. Again, the story is less extreme here than in the US but arguably of greater concern than the divergence at the top end. The truth is that holes have been emerging in our social safety net – more on that later.

Drivers and consequences

Leigh highlights the role of globalisation and technology, allowing talented workers to affect more people and command higher incomes. He also notes that technology often advantages those at the top and not those providing personal services such as hairdressing and childcare. Technology also tends to replace routine work more than cognitive work. Surprisingly, Leigh does not refer to the theory that globalisation widens gaps between skilled and unskilled incomes in both developing and developed countries (while narrowing gaps between the average incomes of different countries).

Other drivers of increased inequality explored are the collapse of unions and the lowering of top marginal income tax rates (and associated tax measures to ‘broaden the base and lower the rate’). While education is a great equaliser, improving opportunities for employment and higher incomes, stagnation of education as technology advances may work in the opposite direction, as do gaps in education performance amongst different groups of students. Recent relatively poor education performance in Australia, and continuing gaps in education performance, are therefore of concern.

Leigh is not concerned about globalisation or technology per se, recognising their roles in improving productivity and community living standards (in fact, he notes the evidence that countries with higher income inequality experience more rapid economic growth), but he is concerned about aspects of the consequential increases in inequality. One of these is the impact on intergenerational mobility, another the potential impact on democracy as the rich are able to exploit their power.

More generally, Leigh has concerns about concepts of fairness and social solidarity, that ‘wellbeing’ is about more than money. Here he draws not only on Rawls but also John Stuart Mill and Adam Smith. The primary concern about inequality might be the impact on the poor, but the evidence also points to palpable discomfort amongst humans at high levels of inequality anyway.

The chapter on mobility expands upon the adverse impact of high levels of inequality on intergenerational mobility, while also exploring the sensitive issue of how the role of families can also affect mobility. The evidence shows that mobility in Australia is greater than in the US, but that both countries face serious challenges from the growth of single parent families particularly amongst the poor and black communities. Stable relationships are particularly important and, interestingly, marriage is a genuine indicator of stability.

This reminds me of the policies in the 1980s that I thought got sole parents’ support about right – not the moralistic approach of the 1960s that disappeared over the 1970s (under the Whitlam and Fraser Governments), nor the new punitive approach which emerged in the 2000s forcing sole parents to join the paid workforce. Sole parents pensions were paid for whatever the reason for sole parenthood; child support from absent parents was well regulated; and the JET (Jobs, Education and Training) program was explained as ‘Now You Can Go Back to Work Without Neglecting Your Most Important Job’. Stable parenting was the priority.

Leigh does not mention how the failure of our maturing superannuation system to convert accumulated savings into income in retirement is also exacerbating intergenerational inequality. Helping retirees to do so, such as by offering government annuities to retirees, would in fact reduce both measured wealth inequality (because older people are wealthier than younger people) and measured income inequality (because retirees’ incomes are lower than the incomes of workers).

What is to be done?

Leigh presents ten recommendations in his final chapter to address what he sees as widespread belief amongst Australians of excessive inequality threatening our culture of egalitarianism.

The first, refreshingly, is to ‘maintain the policy expertise that has delivered solid economic growth’. While this would keep unemployment low and thereby limit poverty, it also implies accepting a significant level of inequality.

Second is education and equality of opportunity.

Third is acknowledging the role of family structures, looking in particular to light touch interventions that would encourage stability and avoiding adding stigma to the already tough lives of sole parents.

Fourth is to recognise the role that unions play. I suspect this is largely a lost cause, partly self-inflicted by some union leaders allowing personal self-interests to outweigh the interests of members. But there is a continuing role for civil society more generally.

Fifth is to make sure welfare spending continues to be means tested. As explained below, this is too simplistic. Right now, the priority should be on addressing the inadequacy of Jobseeker and rental allowance.

Sixth, to maintain a progressive income tax system. I agree, and was pleased with the restructuring of the Stage Three tax cuts, though disappointed that the bottom threshold was not fully indexed, and that indexation of the scale into the future was not legislated.

Seventh is Leigh’s healthy obsession with evaluation. All strength to his arm.

Eighth is to keep a check on monopoly power. I was surprised he did not give this more weight. Schumpeter’s ‘creative destruction’ incentivises innovation by allowing monopolies under patents. But such monopolies operate for too long creating mega-rich people wielding excessive power.

Ninth is to recognise the link between inequality and social isolation.

Tenth is to keep egalitarianism at the heart of our national story. I could not agree more.

As mentioned, Leigh could add to this list a couple of measures his Government could take now: change the Remuneration Tribunal membership and ask for a review of public sector leaders’ pay, and help retirees to convert their super into lifetime incomes.

Means testing

I cannot let this review go without also challenging Leigh’s comments about means testing.

First, he claims Labor has a history of supporting means tests and the Coalition of supporting universal welfare. Medicare is the most obvious counterexample. The Whitlam Government also abolished the means test for those over 70 and tried hard to introduce universal social insurance schemes for superannuation and compensation. Such programs have traditionally received support from social democratic parties to promote social solidarity and avoid stigma.

Second, his list of examples includes some terrible means testing initiatives as well as some universal payment measures that were fully justified.

Despite the universality of Medicare, Leigh criticises the Howard Government’s universal PHI rebate and implies support for the Gillard Government’s decision to apply a means test. But the latter was a pea and thimble trick combining the means test with an increase in the Medicare Levy Surcharge. This crude measure increased financial incentives to take up PHI amongst those no longer eligible for the rebate and diluted any pressure on funds to deliver value for money. Sensible reform would keep a universal PHI rebate, limit it strictly to the extent that PHI membership reduces Medicare costs, and abolish the MLS.

Leigh refers favourably to the Hawke Government’s introduction of an assets test to supplement the pension income test. We are almost alone in having two distinct tests. Henry (and others) have long favoured a single more comprehensive income test which includes income deemed to be available from assets; that was the basis of the ‘merged means test’ in the 1960s. Two separate tests not only adds to complexity but runs the risk of inconsistency between the tests. That occurred in spades with the 2017 Morrison changes to the assets test, radically increasing thresholds but applying a much higher taper. The result is a mess, hopelessly complicated and making it almost impossible, even with financial advice, for singles and couples with assessable assets between about $400k and $1 million (a growing number) to identify the optimal way of managing their assets.

Leigh also favours the means testing of all family benefits. When the Hawke Government means tested family allowances, that was in fact against the advice of the Social Security Review led by Bettina Cass. While supporting a more generous means tested supplement, the Review recommended keeping a universal payment recognising that, at all income levels, the presence of dependent children reduces capacity to pay tax. The means test also imposed high effective marginal tax rates affecting mothers in particular.

Leigh is critical of the universal Jobkeeper payment during COVID. As economists Hamilton and Holden make clear, however, that measure was critical to Australia’s successful economic management of the pandemic.

My point is not that means tests are bad, but that they have their place, as do universal programs, and they need to be carefully designed. We means test too much, and too often badly design the tests we impose.