The Peak of the Inequality Maze

Inequality has become the pinnacle of a labyrinth. The battle against inequality is a moral imperative that must be won

In Martin Wolf's latest book, The Crisis of Democratic Capitalism (2023), he highlights the recurring acute failures made by political and economic leaders, namely the pathology of escalating economic inequality.

As a result of this issue, the middle class suffers from the ailments of uncertainty and fear, concerning the significant potential for social collapse and economic exclusion.

This situation affects nearly all countries, including those considered to be advanced democratic capitalist nations. As an illustration, in 1980, the ratio between the salaries of top executives and the lowest-paid employees in the United States was a modest 42:1. However, by 2016, it skyrocketed to an astounding 347:1. From 1993 to 2015, the cumulative real income growth for the top 1 percent of the wealthiest group in the US amounted to 95 percent, while the remaining 99 percent of the population only experienced a growth of 14 percent. This phenomenon has nearly engulfed all countries, without exception.

The Catastrophe of Inequality

Economic growth is a fundamental requirement for economic progress. The economic development theories of the 1950s and 1960s all promoted economic growth as the main pillar of development. Savings and investment rates became the primary drivers to achieve economic growth. The implication is economic policies were formulated in a way that provided less opportunity for the lower and middle economic groups, while widening the economic gap for the upper class.

The argument is straightforward: the lower class does not create added value, and economic distribution is slow. Furthermore, proponents of economic development theories believe high economic growth driven by the upper class will pull along other economic groups through job creation and integration with small businesses. This is the initial source of the inequality disaster.

Currently, there is a strong sense of pessimism regarding the “integration” of economic growth and equitable distribution. The economic institutions that have been established for decades have failed to reconcile these two ideal goals of development. The current choice is to prioritize the improvement of political equality in order to level the playing field in the economic arena, including the labor market, corporate governance and other areas (Allen, 2021).

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> Incomes and Parasite of Inequality

> Middle Class and Economic Inequality

This option is pursued due to the impact of economic growth, which has predominantly benefited the wealthy, resulting in the concentration of power within this group, even in democratic capitalist nations that are currently experiencing a severe economic-political crisis. Moreover, taking this policy approach would ultimately lead to the abandonment of the ideology of high economic growth (degrowth).

Furthermore, the rapid advancement of technology and the extraordinary pace of innovation, particularly since the beginning of the millennium, have posed challenges for governments in creating jobs, as the intensity of digitization and automation cannot be restrained.

This issue is not only a concern in developing countries but also a source of anxiety in advanced nations. The level of unemployment in established countries (Europe and the US) has skyrocketed over the past few decades. Furthermore, the scarcity of quality job opportunities and economic unrest has fueled the growth of extremist groups (far right), disrupting social and political stability.

To exacerbate matters, the rise of authoritarian populism has further complicated the situation. In short, inequality has become the pinnacle of a labyrinth. One of the strategies currently being devised by policymakers is the reduction of capital incentives and the increase of subsidies for labor utilization.

Trimatra of Production

The source of the asymmetric well-being that pervades the world lies in the three pillars of production (Blanchard and Rodrik, 2021). First, there is pre-production inequality. This disparity stems from differences in skills, talents, access to education and healthcare and so on.

Unequal government policies in the fields of education and healthcare have resulted in suboptimal utilization of skills (and, to some extent, talents).

The case of child malnutrition (stunting) serves as an illustrative example, where limited literacy in nutrition and child development leads to difficulties in reducing the incidence of stunting. In Indonesia, the stunting rate remains at 21.6 percent (2022). This means that one in five toddlers is affected by this issue (a significant decrease from 37.8 percent in 2013). This generation, in the long run, is one of the triggers for inequality due to its low competitiveness.

Second, there is disparity in the production stage. This issue of divergence has been frequently discussed, namely the economic imbalance between capital owners and workers. In countries where labor unions are protected and empowered, economic inequality within corporations can be reduced because workers have significant decision-making power (especially in wage and bonus determination). Conversely, in countries with weak labor union protections, decision-making is monopolized by capital owners, potentially exacerbating inequality.

Also read:

> Poverty and Inequality Worsening

> The Complexity of Inequality

Another aspect to consider is the crucial role of state intervention, particularly in determining minimum wages and vocational education (Dustmann, 2021). These policies aim to prevent businesses from exploiting workers by imposing extremely low wages, thus avoiding economic extraction practices. At the meso level, industrial policies such as unionization and government involvement in wage determination become key factors in preventing the deepening of disparities.

Thirdly, there is post-production imbalance. Income differences are a consequence of inequality that arises at the pre-production and production stages. If disparities persist at these two levels, post-production divergence becomes inevitable. The group with access to education will continue to accumulate increasing prosperity (income), further widening the gap with other segments of society.

The income of the wealthy follows a geometric progression, while the vulnerable class experiences an arithmetic progression. Capital owners enjoy a much larger share of the economic pie through captured profits and skyrocketing salaries. Unless there are policies in place to limit wealth accumulation, such as implementing progressive taxation, and to alleviate the burden on the lowest-income groups, such as through income transfers, inequality will continue to proliferate.

Beneficiaries of Liberalization

This perspective assumes economic inequality is a result of closed political systems.

Beyond the asymmetries rooted in the production phase and modes of production, disparities are often examined from other sources as well. Firstly, democracy is considered a reasonable choice of political system to prevent the widening of inequalities by closing the door to monopolistic resource domination.

This perspective assumes economic inequality is a result of closed political systems, where a small political elite manages the allocation of business resources, leaving other economic actors out of the competition for factors of production. Cases in Latin American (South) countries, parts of Asia and Eastern Europe in the past are often cited to bolster this view. Indonesia's past also serves as a valid reference in discussions regarding economic imbalances. While the foundation of this idea is quite strong, recent research references deserve further examination to test this postulate.

Secondly, the celebration of globalization/liberalization. Globalization has fundamentally transformed the economic landscape of the world. Interactions between nations that were once tightly guarded through protectionist measures such as import tariffs, quotas, dumping regulations and others have been loosened through the opening of economic markets, freedom of population mobility between countries, investment, trade and so on.

It must be acknowledged since its widespread implementation in the 1980s, several countries have benefited from liberalization, including China, South Korea, India, Vietnam and to some extent, Indonesia. These countries have experienced significant economic growth, as evidenced by their GDP, and have become members of the Group of 20 (except Vietnam). Consequently, the wealth gap between developed and developing nations (external inequality) has narrowed.

On the other hand, within each country (internal), there has been a growing inequality. This represents the paradox of globalization with its two faces.

Thirdly, economists and governments have deep reservations about establishing progressive policies to address inequality, from top to bottom. The concentration of capital circulation and land ownership are often cited as examples, with very few countries making measurable efforts to limit ownership.

Land-reform policies are typically implemented solely to provide land to those who do not own it (even in very limited quantities), without curbing the economic actors who possess land beyond reasonable limits (ranging from hundreds of thousands to millions of hectares). Accumulated profits, massive gains from derivative transactions in the financial sector, and substantial inherited wealth have evaded progressive tax policies, enabling these groups to amass enormous amounts of wealth (Piketty, 2014). Scandinavian countries are relatively progressive in addressing this issue.

Illusory Development

Indonesia is a country that recognizes the detrimental consequences of unaddressed economic injustice on its development. Economic progress, when accompanied by growing economic disparities, erodes social cohesion and diminishes political trust. This phenomenon is commonly referred to as illusory development, wherein economic advancement coincides with social deterioration and political vulnerability.

Indonesia is currently grappling with this issue, as economic inequality has worsened in previous periods. The Gini coefficient has steadily increased, surpassing 0.41. As a result, systematic measures have been implemented since 2015 to mitigate this inequality. History also highlights Indonesia's significant success in expanding access to healthcare and education for its population, which is a pivotal achievement in the pre-production phase.

From an investment perspective, one of the factors contributing to economic disparities is the dominance of foreign direct investment (PMA), leading the Investment Ministry/Investment Coordinating Board (BKPM) to be mandated with increasing the share of domestic direct investment (PMDN). The results have been promising, as the share of PMDN has nearly reached parity with PMA since 2020. Furthermore, in 2022, the previous concentration of investment in Java (47.3 percent) has now been balanced with investments outside of Java (52.7 percent).

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> Inequality Remains Serious Issue

The Investment Ministry also mandates that every major investment venture collaborate with micro, small, and medium enterprises (MSMEs) and local residents. This managed investment plays a crucial role in reducing disparities between large and small investors, domestic and foreign investors, as well as the western and eastern parts of Indonesia. The country also continues to ensure the involvement of labor unions and state intervention in determining the annual minimum wage. This contributes to the avoidance of labor strikes. The seeds of these effective production-stage policies must be consistently nurtured.

In the post-production phase, progressive tax policies have been strengthened, particularly with the increase in the highest income tax rate to 35 percent (from the previous 30 percent). This is accompanied by an increase in the non-taxable income threshold (PTKP) to Rp 4.5 million (US$301.22) per month, ensuring individuals earning below Rp 54 million per year are not burdened with taxes. However, when it comes to taxes on profits, financial sector transactions, inheritance and land assets and others, there is still a lack of emerging progressive spirit.

On another note, policies regarding upstream issues, such as land and capital ownership restrictions, remain a significant challenge. It requires a strong political vision and affirmation to enter this arena, as it will undoubtedly face strong political forces. The battle against inequality is a moral imperative that must be won. "If we fail, the light of political and personal freedom might once again disappear from the world," Wolf remarked.

KOMPAS/TOTOK WIJAYANTO (TOK)

Ahmad Erani Yustika

Ahmad Erani Yustika, Professor at the Faculty of Economics and Business, the University of Brawijaya, Malang, East Java; senior economist at the Institute for the Development of Economics and Finance (Indef); head of the vice president's Secretariat.

This article was translated by Tenggara Strategics.