What's been happening to the distribution of our income

The single best explanation for the rise of Mr Crazy, Donald Trump, is that over the four years to 2013, the real income of the top 1 per cent of American households rose by 17.4 per cent, while that of the bottom 99 per cent rose by 0.7 per cent, giving the top few 85 per cent of the growth.

Another country where the gap between high and low incomes has widened markedly is Britain. And what crazy thing have the Brit voters just gone and done? You remember.

I think it's a case of what physiotherapists call "referred pain" - what you feel in some part of your body is actually coming from a problem somewhere else.

Many voters are conscious that their income doesn't seem to be growing and know something's badly wrong. But they don't join the dots the way an economist would.

They look around for something or someone to blame. They turn against their political leaders, who are "out of touch". Which they may well be.

But, as has happened many, many times before, voters also focus their resentment on the new migrants around them, especially those of a different race or creed. These people are taking all the jobs (especially those the local don't want), or they're all unemployed and getting too much help from the government.

Australia, it turns out, has also been acting strangely of late, turning against mainstream politicians on both sides, voting for populist protectionists like the Xenophones​ and resurrecting Pauline Hanson and One Nation, with new improved conspiracy theories.

So what's been happening to the gap between the top and the bottom in Oz? It's been widening but, fortunately, not nearly as quickly as in the US or Britain.

The Bureau of Statistics conducts a survey of the distribution of disposable income (that is, after allowing for income tax paid and welfare benefits received) between households. It's conducted every two years and the latest was for 2013-14.

Household disposable income that year averaged $998 a week, but with households in the lowest quintile (20 per cent block) getting $375 and those in the highest quintile, $2037 a week.

It's obvious that, if income were distributed equally between all households, each 20 per cent block of households would get 20 per cent of the total income of households.

In fact, the lowest quintile's share of total income in 2013-14 was less than 8 per cent. The share of the middle quintile (those households between 10 percentage points below the median and 10 points above it) was 17 per cent.

But the highest quintile's share was 41 per cent - more than twice what they'd get if income was distributed equally.

That's proof of the wide gap between high and low incomes in Australia.  It puts us above the average for income inequality among the member countries of the Organisation for Economic Co-operation and Development.

Even so, the bureau's figures show no significant worsening over the six years between 2007-08 and 2013-14 - the longest period in which its surveys can be compared on a consistent basis.

The most commonly used measure of the degree of inequality between households is the Gini coefficient - a scale running from 0, where income is equal between all households, to 1, where one household has all the income.

Our Gini was 0.34 in 2007-08 and 0.33 in 2013-14. You could call this a slight improvement, but I wouldn't - the change is too small to be taken literally.

Does that lack of change surprise you? It does me, especially as the Gini fell a little in the surveys of 2009-10 and 2011-12, before rising again in 2013-14. Huh?

Our base year of 2007-08 came just before the global financial crisis of September 2008.

Professor Peter Whiteford, of the Crawford School of Public Policy at the Australian National University, thinks the initial decline was caused by the Rudd government's big discretionary increase in pensions in 2009 and, on the other hand, the big fall in the sharemarket, which would have cut the incomes of higher income-earners.

Recessions usually hit the bottom of the distribution as well as the top by greatly increasing unemployment. But not this time because of the Rudd government's quick response and because the downturn's causes came more from the financial side of the economy.

Whiteford thinks the Gini's return to a more usual level in the latest survey is explained by the slow rise in unemployment in more recent years and the sharemarket's recovery.

But the stats bureau's practice of presenting the income distribution in quintiles tends to conceal an important development: the way income at the very top is growing much faster than it is even for people not that far from the top.

Economics professor-turned-politician Dr Andrew Leigh worked with one of the world's top experts in this field, British economist Sir Tony Atkinson, to develop a time series of movements in high incomes, based on data from the Australian Taxation Office. Leigh has handed it over to Professor Roger Wilkins, of the Melbourne Institute.

Wilkins' series shows that, between 1989 and 2013, the share of total individuals' income gained by the top 10 per cent of income-earners rose by 5 percentage points to more than 33 per cent.

But the top 5 per cent captured almost all of that increase. And the top 1 per cent claimed well over half the increase in the share of the top 5 per cent.

The top 1 per cent's share of total individuals' income is now 9 per cent. That is, their incomes average nine times what they'd be if incomes were equal.

Fortunately, this isn't nearly as extreme as it is in the US, or even Britain. But it does show Australia is moving down the same road as the others, suggesting the causes are international: technological change and globalisation.

Read more >>

Why much success comes with a slice of good luck

How important is luck in monetary success? A lot more than a lot of successful people are willing to admit – even to themselves.

Is luck as important as hard work in becoming successful? No – but, in the end, yes.

These are important questions – we ponder them often – that economists rarely bother to study. Except for one of my favourite economists, Robert Frank, of Cornell University in upstate New York. His new book is Success and Luck: Good fortune and the myth of meritocracy.

The case for believing that success is due overwhelmingly to talent and hard work – something every successful person wants to believe – is simple. Leaving aside a few lottery winners and rich heirs, almost every materially successful person is someone with ability who's worked hard for what they've got.

But the weakness in that argument is equally apparent: the many talented and hard-working people who haven't amassed much wealth.

What separates the two groups is good fortune. Some talented and hard-working people have enjoyed the additional benefit of a lucky break or two, some haven't, or have suffered unmerited setbacks of one kind or another.

Some have had the good fortune simply to have avoided any misfortune. And, of course, there are talented, hardworking, lucky people who aren't all that outwardly successful because they haven't given material success a high priority. (Don't bother feeling sorry for them – they've probably enjoyed far more personal satisfaction than those who measure their worth in dollars.)

It's easy for us to forget how much our success is owed to good luck. Everyone living has been born into the world at its most prosperous point. Everyone born in Australia starts with an enormous advantage over most other people in the world, in terms of free schooling and healthcare, freedom to choose their own path and freedom from predation.

When we joke about the importance of choosing the right parents, we acknowledge the role of inheritance in influencing future success.

Even when our parents have no great wealth to pass on, a big part of intelligence is inherited and academic success is greatly influenced by whether your parents were readers and valued education.

I've long believed that the example set by parents produces hardworking children.

Frank has no desire to undervalue talent or discourage hard work. Of course they play a major part in success. Nor is he opposed to meritocracy, where jobs go to the most able candidate.

His point is just that, for success, talent and hard work are, as they say at university, "necessary but not sufficient". Those who "got there on merit" shouldn't forget the lucky breaks they've had.

"Chance events are more likely to be decisive in any competition as the number of contestants increases," Frank argues. That's because winning a competition with a large number of contestants requires that almost everything goes right.

This, in turn, means that even when luck counts for only a trivial part of overall performance, there's rarely a winner who wasn't also very lucky.

In the topical case of athletics, luck can come in the form of wind. It would be stupid to deny that anyone winning a world record in the 100 metres, the 100-metre hurdles, the long jump or the triple jump was both physically gifted and had done years of training.

But Frank notes that of the eight current world records (men's and women's) seven occurred in the presence of a tailwind and none with a headwind.

To show the importance of luck even when it's only a small factor, he uses a computer to conduct a numerical simulation.

Say there are 100,000 participants in a contest where luck counts for just 2 per cent of performance, with ability counting for 49 per cent and effort for 49 per cent. For each contestant, the computer draws a number at random separately for each of the three components of their total performance.

The computer repeated this game many times (just as repeated tossing of a coin brings the result closer to 50/50).

The average luck score of the winners was 90 out of 100. And 78 per cent of winners did not have the highest combined ability and effort scores.

But if luck plays such an important role in success, why do the successful so often want to deny it? Frank offers two explanations, one charitable and one not.

We downplay the role of luck so as to motivate ourselves to try hard. When I wish Year 12 economics students good luck in the exams, I sometimes add: "You know how to be lucky? Make your own. The harder you work, the better your luck."

But there's often another, less worthy reason for denying our debt to good fortune. We use it to sanctify our wealth and justify our reluctance to pay high rates of income tax.

I'm well off because I made the right choices, studied when I could have played, saved when I could have spent and worked damn hard. Those people in the outer suburbs are poor because they didn't work and sacrifice the way I did.

I earned all I've got and it's quite unfair to tax me extra to give handouts to people who're too lazy or undisciplined to do what I've done.

That's why it's so important for successful people to acknowledge their good fortune.

Read more >>