Growing Income Inequality as a Challenge to 21st Century Capitalism

Income inequality has increased in both developed and developing countries, and this growing inequality is in large part due to a shift in factor shares in favor of capital and to the detriment of labor. Factor shares have varied systematically over the post-World War II period, rising until the late 1970s and then falling until now. Explanations for the decline in labor’s share include technical progress, globalization, a decline in labor’s bargaining power, and increasing energy prices. These drivers of income change are likely to persist for the foreseeable future, meaning that income inequality will continue to increase. We show that growing inequality tends to reduce political stability and the ability of governments to protect citizens against predation and also to reduce education attainment. Since good institutions and education are key drivers of the growth of total factor productivity, growing inequality thus poses a serious risk for the capitalist system.