Poverty and inequality: Views from two Swiss investment banks

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Inequality was high on the agenda at the World Economic Forum at Davos last week. The world’s richest and most powerful are finally starting to pay more attention to the issue. In this post, I look at how two Swiss banks, UBS and Credit Suisse, have discussed poverty and inequality in their recent publications. It is commendable that both banks have felt compelled to educate their mainly rich customers on the latest ideas and research on such an important topic.

However, in the case of UBS, their report raises many additional questions about how the rich see and understand poverty, in addition to the role that they feel they can play in combating it. Most concerning are some of the “findings” and “recommendations” which are likely to reinforce the status quo…

George Soros talked about it. Oxfam highlighted it. As widely reported, the hot topic at Davos this year was inequality: how it continues to rise across the world and how the economic structures in place are acting to reinforce this undesirable outcome. We often hear perspectives on these topics from NGOs, academics and activists, but what is the view of the rich?

Given that Davos is in Switzerland, a very rich country, I decided to take a closer look at relatively recent publications produced by the country’s two leading investment banks: UBS and Credit Suisse. UBS published their “thought leadership” piece entitled Furthering the fight against poverty in July 2014. Meanwhile, Credit Suisse published their annual Global Wealth Databook in October 2014. The latter was used as an important source in Oxfam’s headline-grabbing publication at Davos.

UBS: re-skilling and job creation as the “keys” to success

My initial reaction to coming across Furthering the fight against poverty by UBS was one of surprise. Authorship of the paper is attributed to UBS “Opinion Leaders” who work in various investment functions across the firm. But why on earth would a Swiss bank, whose customer-base is generally very rich (at least on a global relative basis), be interested in dedicating 18 pages of glossy ink to a topic relating to those at the opposite end of the income and wealth distribution?

UBS seem to have two main reasons. The first is to educate their clients on the topic so that they can better understand the risks that the “surge in populism” relating to inequality may have on longer term economic growth and (by implication) the livelihood of  their clients. The second is to highlight ways in which “the private sector can make a tangible difference”, mainly through education and job creation.

Encouraging greater awareness of issues relating to poverty is a very positive step, but some of the findings and recommendations presented by UBS have shortcomings, which will be discussed further below.

I won’t dwell on their economically liberal biases (Piketty is “controversial” whereas Friedman and Kuznets have made “important contributions” to our understanding of income distribution), but I am disappointed that UBS didn’t allow themselves to agree with the obvious: that worsening inequality in many ways acts to reinforce poverty and this has negative economic and social consequences. Instead, they attempt to dodge the bullet by arguing that:

… while income inequality is a complicated, controversial and multi-faceted issue, we believe that the social and economic advantages of policies that help create jobs for the poor are both simpler and clearer.

Essentially, their argument is that education and job creation will be what takes people out of poverty and that inequality should be considered as a secondary issue. What is missing is any acknowledgement of the problems caused by structures within many poor countries and across the world that act to reinforce inequality and entrench poverty. This is despite UBS recognising that inequality can be harmful to economic growth and potentially destabilising.

Dreams of Gini

I also have issues with the selective way in which UBS has used anecdotes and data to effectively play down the issue of inequality. For example, UBS emphasise that “… 85% of the world’s population now lives in countries with a GDP / capita above USD 10,000”, which completely ignores the fact that many people within those countries actually have a significantly lower share of GDP.

In another example, China is viewed as a “success story” as “90 million people in China have an income above the European average”. So this means that the top 7% of China’s population earns above the European average, is that really progress? What about the other 93% or over 1.2 billion people? I’m not sure if I would call the top 7% of earners “upper-middle class”.

China comes in for more praise in the way it has “climbed up the value chain – all the way from an agricultural economy to a producer of smart phones”. As discussed in my previous post, I’m far from convinced that this is the right type of development. China’s ascent has taken many out of poverty, but there are many undesirable features of how it has done so. Would other countries really want to copy this template or can those in developed countries contribute to a better way?

Further, UBS make the triumphant claim of “World inequality: down, actually!” Well, yes if you calculate your Gini coefficient over time by using each country’s GDP per capita as your input, quoting the method used by Ravallion and Chen (2012). A closer read of Ravallion and Chen’s blog post shows that UBS seem to be misinterpreting the methodology used: the measure is not a true measure of global inequality as it does not take into account inequality within countries.

The issue with this approach is that two countries may have exactly the same level of GDP per capita and this methodology will imply that there is no global inequality. However this misses the bigger issue that all of the wealth in one country may be owned by a single person with everyone else having nothing. Is that a satisfactory measure?

“It’s the share of the rich, stupid!”

Staying on this point, UBS try to back up their point by producing analysis very much in the spirit of Kuznets by looking at:

… the correlation between Gini coefficients and levels of national development. The chart below shows that Gini coefficients decline rapidly when countries are very poor and their economies are growing rapidly, but that the effect of additional growth on income distribution diminishes as countries get richer.

This predictive assertion is problematic as highlighted by a very interesting paper by Palma (2011):

… homogeneity restrictions that are required to hold for ‘prediction’ are visibly not fulfilled. In other words, not only analytically but also statistically there is no reason to ‘predict’, for example, that Latin America and Southern Africa will improve their remarkable inequality as their income per capita continues to increase simply because countries in other regions have done so before.

A very good summary of this paper can be found in this blog post. It’s worth taking a short segway to discuss Palma’s main conclusions. Essentially, Palma demonstrates that across most countries, it is the share of the top decile relative to the bottom 40% which determines the extent of inequality. Meanwhile, those in the middle and upper-middle classes between the top decile and the bottom 40% (ie the 40th to 90th percentiles) are able to extract a roughly similar share of the income distribution.

In Palma’s words:

Since the middle classes are normally able to appropriate — and defend — a share of national income that is similar to their counterparts in other parts of the world, countries with high inequality are simply those in which the rich are more successful at subsidising their insatiable appetite with the income of the bottom 40 per cent.

Palma also provides some additional counterarguments to some of the assertions made by UBS. For example, UBS argue that “improving the standard of education is a precondition for creating a more diversified and advanced economy”. They also argue that:

Developing countries in particular must leverage the falling marginal cost of education being driven by information technology. Millions of students do not have access to an expensive, traditional university infrastructure, and could profit from a more distribution-oriented digital education system.

However the impact of improved educational opportunities is likely to have a much lower impact on inequality than policies that actively redistribute from the richest 10% to the poorest 10%. More on this from Palma:

So, in terms of the (overemphasised) role of education in the distribution of income, it is important not to lose sight of the multifaceted nature of the relationship between increased ‘equality of opportunities’ in education and increased ‘distributional equality’ in terms of income — and of the fact that education (or any other factor that may be influencing the distribution of income) can only operate within a broader institutional dynamic.

And:

The similar income shares in the middle and upper-middle deciles across regions also raise some serious doubts about many mainstream distributional theories, especially those that give pride of place either to education, or to ‘skill-biased’ technological change.

To be fair to UBS, I don’t think that their clients would be very happy reading that the best way to reduce inequality is to transfer income and wealth from the rich to the poor! Regardless, the facts do seem to point to Palma’s quote of Bill Clinton’s campaign strategist that “It’s the share of the rich, stupid!”

Positive impact?

The third and final recommendation from UBS is to encourage more impact investing. Their main suggestion is to provide incentives to widen the participation in socially responsible investments. I really struggle with two of their assertions:

Incentives must be used to address the perceived difference between impact returns and general investment returns.

And:

Strengthen policy and tax incentives for corporates to engage in “quality employment” generating projects.

The problem with providing these financial incentives is that they are effectively subsidies which socialise the risks while leaving the upside for those who are in the fortunate position to have investable capital. We’ve seen this before with the bank bailouts during the financial crisis!

Why not the opposite: penalise those who don’t engage in and can demonstrate their use of “quality employment” or use higher tax rates to disincentivise investment in non-socially responsible activities? If investors, as providers of capital, will not contribute to enabling better social outcomes, then surely that is a market failure which should be addressed through regulation? Otherwise, using tax or other subsidising incentives will simply take from the wider populace (most of whom are not rich) and give even more to the rich. Surely that’s not the way to fight against poverty!

Credit Suisse: “Comprehensive and up-to-date”

Fear not, all is not lost. Credit Suisse’s approach to wealth and inequality is very different from that of their compatriot. First of all, the authorship of the report is attributed to Professors Anthony Shorrocks and Jim Davies, neither of which are Credit Suisse employees. Secondly, at 157 pages in total (mostly data) the volume and transparency of the information collated and methods used is a refreshing change from the selective approach used by UBS.

Third and possibly most compelling is that Credit Suisse don’t attempt to make value judgments on the basis of their findings. Rather, they simply present and interpret the data they have collected, highlighting any discernible trends. This is the type of approach which I find very appealing given my background as a statistician (when I’m not being hypocritical by preaching about the shortcomings of others!)

As mentioned earlier, Oxfam used the data in this report to calculate their statistic that the world’s 85 richest people have more wealth than the poorest 50%. There’s an important caveat required in understanding that claim as explained by Vox:

Oxfam presents the statistic… as a measure of wealth. But it’s technically a measure of net worth: assets minus debts. As such, what it’s picking up isn’t just massive inequality in wealth, but also massive inequality in the ability to access credit.

To their credit, Oxfam don’t shy away from the shortcomings of the measure and Vox highlights why Oxfam’s assertion still has merits:

The top one percent controls an eye-popping amount of global wealth, but more to the point, they’re the ones who have much more wealth than they have debt — and so they’re the ones who can deploy their excess wealth towards discretionary ends like electing political candidates and lobbying legislatures.

Nevertheless, as rightly pointed out by Oxfam’s Ricardo Fuentes-Nieva, global inequality is so extreme that it doesn’t reall matter how you cut the data, very similar conclusions can be made.

Regardless, these comments aren’t being made by Credit Suisse, but the analysis is being enabled by making such a rich collated dataset available for others to reference and further analyse.

So kudos to Credit Suisse in their contribution to shedding light on inequality. Unlike their competitor UBS, they don’t claim to be the opinion “leaders” who can make recommendations on how to alleviate poverty or reduce inequality. Quite sensibly, Credit Suisse leave that to the experts.

I wonder how many of the rich will follow that example?

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Poverty and inequality: Views from two Swiss investment banks

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