In this post, former Stone Center postdoctoral scholar Bilyana Petrova, who is currently an assistant professor in the Department of Political Science at Texas Tech University, explains the paper she coauthored with Marco Ranaldi, also a former Stone Center postdoctoral scholar, who is now an assistant professor of economics at University College London and the director of the UCL Centre for New Economic Transitions. Their paper, “Determinants of Income Composition Inequality,” was published in the July 2024 issue of Comparative Politics and is also a Stone Center Working Paper.
By Bilyana Petrova
The last four decades have brought about a steep rise in economic inequality and a fundamental shift in the balance of power between capital and labor in advanced industrial democracies (Baccaro and Howell 2011, Piketty 2014, OECD 2015). Nevertheless, recent studies indicate that modern capitalist societies look somewhat unusual when examined in historical perspective. While in the past the very rich derived their income exclusively from property and investment, today they fund a significant part of their consumption through salaried work (Milanovic 2019). Similarly, a growing fraction of the middle classes, which have traditionally relied on wages, also earns capital income through participation in rental and stock markets. The portfolios of the rich and the rest are therefore more similar than what they used to be.
This reflects a social structure characterized by lower income composition inequality (ICI). ICI captures the extent to which income composition varies over the total income distribution. In other words, it reveals the degree to which different economic classes rely on different types of income. High compositional inequality implies that different economic groups — the rich and the poor — draw exclusively on different sources of income (capital income or wages). Low ICI, on the other hand, suggests that economic groups have more similar income portfolios. Contemporary capitalist societies seem to have evolved in this direction.
What explains this trend? Our work explores the political determinants of ICI. In particular, we focus on the partisan composition of government. Consistent with existing scholarship on political economy, we expect governments dominated by left-wing parties to be associated with lower compositional inequality. This is because left-wing parties have traditionally shared a commitment to greater egalitarianism. The policies that they pursue while in office are generally compatible with democratized access to capital assets, which diversifies the portfolios of the lower and the middle classes. Left-wing parties have also advocated for higher corporate, capital gains, and top marginal tax rates, which can decrease the concentration of capital income at the top. As a result, modern left-wing parties’ profiles are consistent with policy action that decreases the gap between rich capitalists and poor workers.
We test this expectation with a cross-sectional time-series analysis of thirty European countries between 2003 and 2017. Using high-quality individual-level data from the European Union Statistics of Income and Living Conditions (EU-SILC) database, we show that compositional inequality varies both across space and over time. ICI is particularly high in Czechia, Denmark, Estonia, Finland, Hungary, Lithuania, and Latvia. In contrast, it remains relatively low in Austria, Belgium, Germany, Croatia, Ireland, Italy, Slovakia, and the UK. Temporally, compositional inequality registers a noticeable increase in most countries in our analysis after the Great Recession, suggesting that the economic crisis induced substantial wealth destruction among the lower and the middle classes.
In line with our argument, we find that left-wing parties are indeed linked to lower ICI. Compositional inequality decreases when left-wing parties are in office. Longer-term representation by the Left in government, measured through the cumulative share of left-wing seats in the legislature over a twenty-year period, is also related to lower ICI. This is because left-wing governments direct capital income toward the bottom of the income distribution. Left-wing party incumbency is associated with a higher proportion of individuals — especially among the bottom three quintiles — holding capital income, rental income, and capital gains. This suggests that the modern Left has been more successful at democratizing access to capital than at redistributing labor income over the last twenty years. Our findings are robust to different model specifications and estimation strategies.
Overall, our work suggests that European countries have moved away from the early capitalist model of complete separation between capital and labor income holders. Indeed, the distance between rich capitalists and poor laborers has shrunk in the modern age. Stronger left-wing parties seem to accelerate the transition to a multiple-sources-of-income economy.
This raises questions about the types of economic redistribution and inequality alleviation that we might expect to see in the future. While exacerbating fiscal constraints and heightening international integration might make generous social policies unfeasible, the development of financial and real estate markets might provide policymakers with additional channels to shape the income distribution. Future research should explore how the socio-economic cleavages and political coalitions that are currently emerging shape the policy choices that incumbents from different political stripes pursue.
Read the Paper:
Determinants of Income Composition Inequality