Although economic growth, inflation and nominal incomes have all been sluggish for the last several years, asset prices have increased substantially. One consequence of this much faster rate of increase in asset prices than incomes is that wealth, rather than income has become the key driver of increasing inequality.
In an article posted yesterday (The Future of Monetary Policy, Pearls & Irritations), I argued that low interest rates and the rapid growth in the money supply, associated with recent monetary policy, is principally responsible for a relatively rapid rise in asset prices, while at the same time consumer prices, economic growth and incomes have continued to stagnate. As a result, wealth has increased substantially faster than incomes.
In this article, I want to discuss the implications of this divergence between the increase in wealth and incomes: particularly how this divergence has driven inequality in recent years, and then the policy implications.
The changing drivers of inequality
In the last twenty years the distribution of incomes has not changed by much. The standard summary measure of inequality, the Gini Coefficient for equivalised household disposable income has only increased from 0.303 in 1997-8 to 0.328 in 2017-18. Or to put it another way, in possibly simpler terms, the ratio of the equivalised disposable income of a household in the 90th percentile of the income distribution relative to the income of a household in the 10th percentile increased from 3.77 times in 1997-98 to 3.98 times in 2017-18 – not much of a change.
Unfortunately, it is not possible to compare the changes in the distribution of wealth going back to 1997-98, but a comparison of the distribution of equivalised household net worth shows that the Gini Coefficient increased from 0.565 in 2003-04 to 0.619 in 2017-18; while the ratio of the net worth of households in the 90th percentile of the distribution compared to those in the 10th percentile, increased from 34.49 to 60.06 over the same period. Clearly, household wealth is much more unequally distributed than household incomes, but also the increase in the inequality of wealth has been much greater in the last decade and more. And as I argued in yesterday’s article, the main reason for this faster increase in wealth is the rapid increase in asset prices.
A major part of this relatively rapid increase in asset prices reflects the increase in housing prices, and consequently income inequality is significantly greater if the (unavoidable) costs of housing are separately allowed for. For example, the Grattan Institute recently reported that between 2003-04 and 2015-16 the disposable incomes of the lowest and highest quintiles of households increased by 26 per cent and 36 per cent respectively, or a gap of 10 percentage points. However, the same comparison of the two quintiles’ disposable incomes after housing costs, showed increases of 16 and 33 per cent; that is a gap of as much as 17 percentage points, with the increase in the top quintile’s income after housing costs being twice that of the lowest quintile.
This increase in housing prices relative to incomes also means that housing affordability has declined dramatically, and home ownership has become progressively more and more beyond the reach of many households. According to the Grattan Institute:
Average prices have increased from around 2-3 times average disposable incomes in the 1980s and early 1990s, to around 5 times more recently. Median prices have increased from around 4 times median incomes in the early 1990s to more than 7 times today (and more than 8 times in Sydney).
As a consequence of this decline in home ownership affordability, ABS census data show that between 1976 and 2016, home-ownership rates among 25-34 year-olds fell from 65 per cent to 45 per cent. The percentage fall for those aged 35-44 was around 15 percentage points, and even for those aged 45-54 the home-ownership rate has fallen by around 10 percentage points since 1991. On the other hand, for those people aged 65 and over, their home-ownership rate has continued to remain high at close to 80 per cent. In effect, inter-generational inequality is thus increasing, which bodes ill for the future.
In addition, this relative increase in housing prices has also affected some suburbs much more than others, with the price rises favouring the inner suburbs with better access to jobs and services. As a result, those young households who are struggling most to afford home ownership, and who often cannot get help from their parents, are finding that the only home they can afford is on the city fringe. Spatial inequality is therefore also increasing, and this can affect employment opportunities over the long run. Thus while, wealth rather than incomes may have been the principal driver of increased inequality in Australia over the last decade or more, in future it could lead to greater inequality in incomes as well.
The Reserve Bank (RBA) has correctly recognised that low wage growth is the critical problem inhibiting Australian economic growth. Unfortunately, the RBA has consistently been far too optimistic in its wage forecasts for quite a few years now. Nevertheless, the RBA is still arguing that recovery is proceeding and as unemployment falls to 4.5 per cent, wage growth will recover, and economic growth will return to normal.
As I have written previously, I think this assessment by the RBA is far too optimistic. In my view the causes of low wage growth are structural and not just cyclical. In these circumstances we cannot expect monetary policy to fully restore income growth. Instead, it is more likely to further inflate asset values, thus driving wealth up relative to incomes and increasing inequality.
Instead, I agree with the RBA that fiscal policy must do more. But fiscal policy must address the low growth in household incomes and the increasing inequality between those who have substantial assets and those who don’t, if the economy is to regain its past potential. This requires a much more nuanced approach to fiscal policy than a time-limited acceleration of infrastructure investment. The future policy agenda must focus explicitly on creating equality of opportunity, while providing better support for the living standards of those who through misfortune cannot help themselves.
Michael Keating is a former Head of the Departments of Prime Minister & Cabinet, Finance, and Employment & Industrial Relations. He is presently a Visiting Fellow at the Australian National University.