Populism and Income Inequality in Europe

2016 shocked many with the election of President Trump in the US and the Brexit vote in the UK referendum. Since then, it is widely held that rising inequality may explain the march of populism in a number of recent elections, notably in Europe. Branko Milanovic´s famous elephant chart[i] is often used to support the notion that globalization, as suggested also by the Stolper-Samuelson theorem, has hurt the middle class in advanced countries to the benefit of China and other emerging countries. The Finnish think tank SITRA warns, however, that those who dominated the 75th-85th percentiles of the global income distribution in 1988 were not those in 2008. Then, that same bracket was primarily made up of middle class Chinese[ii].

Milanovic´s Elephant Chart

Source: Goodreads

A brilliant article in the New York Times[i] has just shown that the United States leads the income inequality league across OECD nations. There, the richest 1% to have roughly doubled their share of national income since 1980, to 20 percent in 2016. In Europe, it is in Britain where the richest 1% have extended their claim on national income the most during 1980-2016, from 6 to 14%. (The article also rejects some common misconceptions by showing that a rise in international trade - measured as a country´s import or export share of GDP - is associated with more income equality, not inequality.)

In 2017, however, the narrative that it is the rise in income inequality that explains populism has been scratched by election results in Austria or the Czech Republic, comparatively egalitarian countries that voted for populists nonetheless. Before that, fast growing Hungary and Poland with similar characteristics had turned to rightist populism.

The Timbro Authoritarian Populism Index claims to be the only Europe-wide comprehensive study that explores the rise of authoritarian populism in Europe by analysing electoral data from 1980. As their data show, “Authoritarian-Populism has overtaken Liberalism and has now established itself as the third ideological force in European politics, behind Conservatism/Christian Democracy and Social Democracy”. It provides numbers only for Europe.

 Top 1% Claim on National Income and Timbro Populism Index

Sources: Rothwell, NYT 17^th 11. 2017 (based on World Income Database); Timbro Authoritarian Populism Index 2016; own calculations based on Spearman´s rank correlation and rho test as in  http://www.real-statistics.com.

I have collected the numbers from the New York Times article and the Timbro index in the table above. It allows me to carry out a back-of-the-envelope calculation of the Spearman rank correlation[ii] between rise and level of income inequality and the Timbro Populism Index. Not less, not more. The formula used for Spearman´s Rho is

Rho = 1- (6∑Diff_Sq)/(n³ – n),

with n = 12 and Diff_Sq denoting the squared difference in country ranking between the Timbro Index and the rise 1980-2016, and 2016 level, respectively, of the percentage share of national income captured by the richest 1% of each country´s population.

The Spearman Rho values are negative, not positive as most would expect, but statistically insignificant. Between the Timbro Populism Index and the rise of the percentage share in national income captured by the top 1%, Spearman´s Rho is = -0.357; for the level of the percentage share in national income captured by the top 1%, Rho is almost zero at -0.052.  The results for Spearman’s Rho are lower than the critical value for two-tail tests (n=12 => 0.406). I therefore have to reject the null hypothesis that there is a correlation between the 2016 Timbro Authoritarian Populism Index with either the rise 1980-2016 or the 2016 level of Income Inequality in a panel of 12 European countries. My back-of-the-envelope calculation certainly does not imply any causality. It may suggest, however, that other explanations, such as homogeneity in a fairly egalitarian (often small-country) context may encourage populist voting when people think their way of living is under threat.

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[i] Branko Milanovic (2016), Global Inequality, Harvard University Press

[ii] SITRA (2017), Spoiler: It's not the rise of populism. What does the elephant chart really tell us?, Helsinki.

[iii] Jonathan Rothwell, Dispelling misconceptions about what’s driving income inequality in the U.S, New York Times, 17th November 2017.

[iv] When data is not normally distributed or when the presence of outliers gives a distorted picture of the association between two random variables, the Spearman’s rank correlation is a non-parametric test that is preferred over the Pearson’s correlation coefficient.

See http://www.real-statistics.com/correlation/spearmans-rank-correlation/

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Exit, Voice and Christian Lindner

Christian Lindner, the 38 year old leader of the German party FDP, has been loathed massively since he announced his party´s exit from coalition talks with the CDU, CSU and the Green Party (the ´Jamaica´ coalition for the party colours black, green and yellow). The FDP says that weeks of talks had failed to produce a shared vision of government and that it would have had to abandon cornerstones central to its election platform, namely a lower tax burden, the gradual shut-down of coal-fired plants and a managed immigration policy. The document to be agreed on contained many square brackets at the end, indicating deep disagreements at the coalition talks.

The FDP had claimed a rapid phase-out of the so-called solidarity tax that is still raised to fund the economic development in eastern Germany - almost three decades after reunification. Partly the result of Merkel´s Energiewende, German industry still relies too heavily on coal and embarrassingly did not sign the Powering Past Coal Alliance at COP23. The freeze on family reunifications of refugees runs out next year, raising the prospect of a spike in new arrivals. These were substantial reasons for the FDP discontent with the coalition talks, although this motive is being widely denied by the smart alecks. Obviously though, the FDP felt that they did not have enough voice vis-à-vis the other parties so they preferred to exit the talks.

In his seminal Exit, Voice, and Loyalty: Responses to Decline in Firms, Organizations, and States, Albert O. Hirschman (1970) suggested that individuals dissatisfied with the performance of an organization they belong to or do business with may try to improve their lot either by ‘exiting’ from the organization and thus forgoing the goods or services it provides, or by remaining with the organization but attempting to improve its performance by ‘voicing’ their discontent. Political scientist Scott Gehlbach has provided a fertile game-theoretic model that treats the choice between exit and voice as a decision between costly policy options[1]. The model may shed some light on the static and dynamic effects of Lindner´s exit from the coalition talks.

The coalition talks can be represented as a bargain between four parties over policy outcome x for the new government. The bargaining game is not zero-sum, which means that all four parties have a common interest in avoiding exit. One peaceful outcome would be the Nash bargaining solution – gains from talks are split 25:25:25:25 between the four parties. x stands for ministerial portfolios and fringe benefits, for power to implement policies for the respective voter groups, etc. In this setting, Lindner´s FDP does not exit the talks.

In reality, there is a conflict of interest and programs between the potential coalition partners. To formalize Lindner´s exit decision, it is easier to use a reduced-form way of the bargaining model. In fact, ex post it could be argued that Lindner´s FDP has viewed the other parties as a (sort of social democratic) bloc. Assume that policy can take any value x between 0 and 1, where the FDP receives x and the three other parties (1-x) as long as there is no exit. In the event that the parties exit the coalition talks, the FDP receives payoff f and the other parties r.

In the Hirschman-Gehlbach model there are gains from trade: 1 - (f+r), with (f+r) < 1. Under the Nash bargaining solution (in the reduced form), the surplus from the coalition bargain is divided along (1 + f – r)/2. The surplus received by the FDP ((1 + f – r)/2 – f) equals that received by the other parties ((1 + f – r)/2 – r). As emphasized by Hirschman, ‘the effectiveness of the voice mechanism is strengthened by the possibility of exit’. The possibility of exit (the payoff f from exit) increases the power of the FDP at the bargaining table, since the others must leave them with more to keep them from exiting. Hence, voice and exit are complements.

The payoff f for the Lindner´s FDP can be thought of as representation (of FDP ideas) and thus reputation (of keeping to the party line). This is an important payoff for a young, ambitious political leader. After all Macron exited the socialist Hollande government only to become President of France later. At the age of 38, Lindner is unlikely to limit his sight on the ongoing coalition talks.

Exit from coalition talks has always been a declared option for the FDP, which felt pushed into coalition talks as a result of the immediate (and perfectly understandable) SPD denial to even participate in coalition talks with Merkel´s CDU (the “vacuum cleaner of social democratic ideas”, according to Martin Schulz). Those who feel free to exit can use the threat of exit to magnify their political influence, or ‘voice’. Unless they would have felt ´loyal´ to the failed Jamaica coalition, that is. Loyalty (or ´responsibility´) is now a demand targeted at the FDP, a demand which is highly popular with the public media and those who never thought of voting for the FDP in the first place.

The Hirschman-Gehlbach model shows clearly that ´loyalty´ does not improve welfare unless it is heavily subsidized.  An increase in loyalty leaves bargainers unambiguously worse off when defined as an exit tax, while they may benefit from greater loyalty if it instead takes the form of a voice subsidy. An increase in loyalty – a decrease in f – would have allowed the other parties to take advantage of FDP reticence to exit by offering a less favorable treatment and less representation in a ´Jamaica´ government coalition. This may have been possible in the past under former FDP leadership; not for Christian Lindner. His exit payoff was just too big.

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[1] Scott Gehlbach (2006), A Formal Model of Exit and Voice, Rationality and Society, Vol. 18(4): 395–418.