What causes inequality in wealth

Germany's high inequality causes economic damage

Science argues: Is the inequality of income and wealth in Germany an economic problem or is it not a normal phenomenon that reflects a functioning market economy? Is it a problem that market incomes are very unevenly distributed in Germany, although the state distributes disposable incomes almost equally as the OECD average through a comparatively high redistribution? And what does the relatively high and growing inequality of income and wealth reflect? These were some of the questions that were dealt with at a joint conference between Wirtschaftsdienst and DIW Berlin in November 2015.

For a long time, research into the causes and economic effects of inequality has been neglected. The important work of influential economists such as Atkinson, Stiglitz and Piketty and also the OECD has changed this.1 There is a growing international consensus that in many countries inequality of income and wealth has reached levels that have become a problem for the economy and have become society. This is especially true in Germany, as there is scientific evidence that the high inequality of income and wealth causes real economic costs - lower growth, more insecurity and poorer pension provision, an increase in the poverty rate, an increasing dependency on always more citizens from state benefits, less social and political participation and thus a dysfunctional democracy. Nevertheless, economists in Germany argue about the questions of whether the inequality in income and wealth is really that high in Germany and to what extent this inequality causes economic damage.

Poor rich Germany

Today Germany is one of the countries with the greatest inequality in the industrialized world. The country is subject to a “wealth puzzle”: Germany has one of the highest per capita incomes and a high savings rate. Nevertheless, the net wealth of the average German is one of the lowest in Europe.2 In 2011, the average German household (the median) had net wealth of 51,000 euros (including financial assets, real estate, stocks, insurance, consumer goods, minus debt) . The average Italian or Spanish household, on the other hand, had more than three times as much net worth. Contrary to what some German critics have falsely criticized, nothing substantially changes in this fact of the significantly lower net wealth for 60% of German households if household size, property valuation or pension entitlements are taken into account. So how can it be that in a country that is so economically successful and strong, people have so little wealth and private security?

At the same time, private wealth in Germany is extremely unevenly distributed. In no other country in the euro zone is wealth inequality higher (see Figure 1). The poorer half of the population has practically no net wealth. In fact, the poorest 20% have more debts than assets. But Germany is also more extreme than its neighbors at the top of the wealth pyramid: In hardly any other country in Europe do the richest 10% of the population own larger assets. Wealth inequality is almost as great in Germany as it is in the USA. 3

illustration 1
Wealth inequality in the euro area and the US in 2010

Sources: HFCS data, Gini coefficients by P. Mooslechner: Household Finance and Consumption Survey of the Eurosystem: Concept and results of the first wave of surveys in 2010, paper presented to the General Council of the OeNB, April 25, 2013; Data for the USA from E. N. Wolff: Household wealth trends in the United States, 1962-2013: What Happened over the Great Recession? NBER Working Papers, 20733, 2014.

There is also a puzzle when it comes to income. In terms of wages and incomes, the gap between high and low incomes in Germany is widening, even if this inequality stagnated at a comparatively high level temporarily after 2005 and until a few years ago.4 The lower half of German employees had to watch their own Wages have lost purchasing power over the past 15 years. Those with the highest wages, on the other hand, have seen significant increases.

After 2005, the increase in inequality in wages, market income and disposable income was curbed by the increase in employment. In Germany, however, it was primarily citizens who were able to use large business or financial assets to achieve high income. Rising inequality is also reflected in a sharp rise in the poverty rate - older and very young people in particular are increasingly at risk of poverty. The inequality of today's younger generations in terms of income and wealth is already significantly higher when they start their careers than was the case in the past.

In short, Germany is one of the industrialized countries with the highest inequality of market incomes. The German state tries to compensate for this high level of inequality through taxes and financial redistribution. However, this is only possible to a limited extent, since the German state redistributes a comparatively large amount, but also very imprecisely.

Figure 2 shows the level of inequality between market income and disposable income in different industrialized countries. Although the inequality of disposable income in Germany is roughly the same as the average for all OECD countries, the inequality in market income is one of the highest.5 The figure also shows that Germany is one of the countries with the highest redistribution across society. In hardly any other country is the spread between disposable income and market income greater.

Figure 2
Income inequality and redistributive effects 2012

Source: OECD Income Distribution and Poverty Database.

A third puzzle is the “mobility puzzle.” People with low incomes and low wealth are unusually seldom able to significantly improve financially and “advance socially”. A similar persistence can be found with high incomes and large fortunes: Anyone who has once managed to achieve a good income and amass large fortunes has much better chances of maintaining this position in Germany than in other countries. The risk of decline is much lower than the average for the OECD countries. This standstill in social conditions is most pronounced in the upper and lower 10%, i.e. in the richest and poorest tenth of the population. The strong interaction between income and wealth is also exceptional internationally: wealthy citizens also receive high incomes.

This low mobility also affects generations: in hardly any other country does social origin influence one's own income as strongly as in Germany. Half of the income of an employee in Germany is determined by the income and level of education of the parents.6 Children of wealthy parents can therefore not only hope for large inheritances or gifts, they also have significantly better chances of achieving an above-average income from work themselves. Children from low-income and low-wealth households rarely manage to be significantly better off than their parents. This already low mobility has even decreased in the past few decades.

Figure 3 shows how strongly the income of sons correlates with the income of their fathers. 75% of sons whose fathers are among the 25% highest-income employees have an income that is above the median market income. Similarly, almost 75% of the sons whose fathers are among the 25% lowest-income employees have a market income that is below the median. The figure also shows the comparison with the USA, a country that is characterized by low income and social mobility in an international comparison. Like many other indicators, the figure shows that this mobility is just as low in Germany as it is in the USA.

Figure 3
Income mobility in Germany and the USA

Source: D. Schnitzlein: Is It the Family or the Neighborhood? Evidence from Sibling and Neighbor Correlations in Youth Education and Health, SOEPpapers, No. 716, 2014.

Why inequality is an economic problem

From an economic perspective, inequality of income or wealth is initially neither good nor bad per se. Many scientific studies show that a certain inequality of income and wealth is a normal and in some cases also a desirable result of a market economy.7 From an economic perspective, dosed inequality is desirable to the extent that it reflects people's free decisions and provides economic incentives .

Inequality becomes an economic and social problem when it no longer reflects the free decisions of the citizens, but is the result of a market economy in which many people cannot use their talents and there is no fair competition. In such a country, productivity and economic growth are weakened. This is exactly the case in Germany: Scientific studies show how badly the inequality of income and wealth in Germany damages our economy and its productivity. The OECD estimates that the rise in income inequality since the 1990s has reduced German economic output by 6% today

This inequality increases poverty in the country. It makes social and political participation dwindle and also hinders people's provision for old age. It worsens health and dampens life satisfaction, increases the dependence of many citizens on the state and provides a fuel for increasing social conflicts.9 No democracy aims to guarantee all people the same wealth, income and employment - i.e. the same output. But every democracy wants to offer equal opportunities. Inequality becomes an economic problem when it restricts opportunities and social participation.

High inequality also provokes a distribution struggle within a society that reduces prosperity.10 This distribution struggle is evident in many aspects - for example in excessive lobbying, the enormous importance of specific interest groups and inefficient economic policy. The conflict ties up productive forces that are then not available to increase common prosperity. The distribution struggle unsettles companies and citizens, so that they invest less in the future and the prospects for growth are further worsened by the low level of investment. And the distribution struggle itself is not a zero-sum game, because it always generates costs, among other things because it changes the behavioral incentives for citizens.

Causes of inequality

Inequality of income, wealth and opportunities has increased globally over the past few decades. In Germany, however, the increase was particularly pronounced. Ongoing globalization is certainly one of the reasons for this increase, because it is primarily people with high qualifications who benefit from it. But the increase in precarious employment and increasingly different working conditions have also played an important role.11 The jobs of the middle class in particular are threatened by this development and could come under even greater pressure in the future.

Another reason for the long-term trend of increasing inequality could be the low level of redistribution of the state between different social groups. However, Germany’s problem is not that the state is not redistributing enough today - as Figure 2 shows. He tends to redistribute too much. Taxes and duties are high by international standards. The problem is rather that the distribution policy in Germany is quite inefficient and too seldom manages to benefit society and the economy as a whole

The greatest weakness and the greatest failure of German politics and society, however, is that we are unable to guarantee better equality of opportunity for people. The high inequality of opportunities prevents many people in Germany from fully developing their skills and from drawing the greatest possible benefit from them. There is hardly any other industrialized country where children from a socially disadvantaged, poorly educated, foreign or single parent environment have such poor opportunities to develop their talents as in Germany. Almost nowhere else do women have poorer career opportunities and are so disadvantaged in terms of pay.

Germany, for example, is a country that spends unusually little money on early childhood education, as the Federal Government's Poverty and Wealth Report shows.13 Figure 4 shows that Germany spends almost half less on early childhood education than the OECD average. Some Scandinavian countries spend three times as much on early childhood education as Germany. Even if these expenditures in this country have risen in the past few years, mainly due to the targeted expansion of day-care centers, Germany continues to be in a relatively poor position in an international comparison. Of course, it is not just the amount of expenditure that counts, but above all the quality and efficiency of the expenditure on education. But even with high efficiency, an education system with too limited resources quickly reaches its limits.

Figure 4
Public expenditure for the care of children under six years of age in an international comparison

Sources: OECD: In It Together, OECD Publishing, Paris 2015; BMAS: Living Conditions in Germany - The 4th Poverty and Wealth Report of the Federal Government. Belin 2014 (2014).

The task of politics

The distribution struggle in Germany will increase in the coming years and decades. Even without the sharp rise in immigration, it would have worsened. The less the economic pie that needs to be distributed grows, the greater the struggle to defend one's interests and interests. And the stronger the voice and influence of the economically inactive, the less willing and efficient the employees and employers, who have to help ensure prosperity for more and more people, become.

It cannot be denied that the inequality of private wealth, income, mobility and opportunities in Germany is unusually high in an international comparison. We can still deny the scientific evidence that this inequality and the resulting struggle for distribution are causing significant economic damage. The discourse in science, too, should rather be about the question of how the harmful part of this inequality can be reduced and its consequences mitigated.

Not too little redistribution by the state, but the lack of equal opportunities is Germany's problem and cause of our high inequality in income and wealth. It is highly inefficient and counterproductive to deprive people of their opportunities and opportunities so that the state then tries to compensate for the result of this lack of equal opportunities through taxes and social benefits. However, when people have the chance to develop and contribute their skills and talents, the economic potential of the whole country increases. If equality of opportunity rises, it is not only the people concerned that benefit. Companies and all other citizens also benefit, because greater equality of opportunity creates better qualified and more motivated employees, increases the mobility of the employed and the purchasing power of consumers, and improves international competitiveness of companies and thus creates more prosperity for society as a whole.

  • 1 A. B. Atkinson: Inequality: What Can Be Done ?, Cambridge, MA 2015; J. E. Stiglitz: The Price of Inequality, New York 2012; T. Piketty: Capital in the 21st century, Cambridge, MA 2014; OECD: In It Together, OECD Publishing, Paris 2015 or OECD: The effects of pro-growth structural reforms on income inequality, Chapter 2, Economic Policy Reforms, OECD Publishing, Paris 2015.
  • 2 See European Central Bank (ECB): The Eurosystem Household Finance and Consumption Survey: Results from the First Wave, Statistics Paper Series, Vol. 2, April 2013.
  • 3 M. Fratzscher: Distribution Struggle - Why Germany is Becoming More Unequal, March 2016.
  • 4 J. Goebel, M. Grabka, C. Schröder: Income inequality in Germany remains high - young people living alone and young professionals are increasingly at risk of poverty, in: DIW Wochenbericht, Volume 82 (2015), No. 25, p. 571 -586; M. Grabka, J. Goebel: Decline in income inequality stalls, in: DIW Wochenbericht, Volume 80 (2013), No. 46, pp. 13-23; M. Grabka, C. Westermeier: Real net wealth of private households in Germany has shrunk from 2003 to 2013, in: DIW Wochenbericht, 82.Vol. (2015), No. 34, pp. 727-738.
  • 5 Cf. OECD: In It Together ..., loc. Cit.
  • 6 D. Schnitzlein: Is It the Family or the Neighborhood? Evidence from Sibling and Neighbor Correlations in Youth Education and Health, SOEPpapers, No. 716, 2014.
  • 7 See e.g. OECD: Divided We Stand: Why Inequality Keeps Rising, OECD Publishing, Paris 2011, http://dx.doi.org/10.1787/9789264119536-en; OECD: In It Together ..., loc. Cit.
  • 8 Cf. OECD: The effects of pro-growth ..., loc. Cit.
  • 9 Cf. e.g. R. Rajan: Fault Lines: How Hidden Fractures Still Threaten the World Economy, Princeton 2010.
  • 10 OECD: Divided We Stand ..., loc. Cit .; T. Piketty, supra .; A. B. Atkinson, ibid.
  • 11 OECD: Divided We Stand ..., loc.
  • 12 Cf. S. Bach, M. Grabka, E. Tomasch: Tax and transfer system: high redistribution, especially through social security, in: DIW weekly report, 82nd year (2015), No. 8, pp. 147-156 ; M. Förster, A. Llena-Nozal, V. Nafilyan: Trends in Top Incomes and their Taxation in OECD Countries, OECD Social, Employment and Migration Working Papers, No. 159, OECD Publishing, Paris 2014.
  • 13 Cf. poverty and wealth report of the federal government, various years; See also K. C. Spieß: Investing in Education: The Early Childhood Area Has Great Potential, in: DIW Wochenbericht, Volume 80 (2013), No. 26, pp. 40-47.

Title: Germany’s High Inequality Causes Economic Damage

Abstract: “Welfare for everyone”, according to former chancellor and economics minister Ludwig Erhard, has been the credo of Germany’s economic and social policy for the past 60 years. However, Germany is increasingly failing to achieve this objective.

Germany is a country of enormous inequality - income, wealth and opportunities are distributed more unequally in Germany than in almost any other industrialized country. This inequality imposes huge economic costs for Germany, as evidenced by lower economic growth and declines in other indicators of well-being. And it has triggered a harmful fight among groups of society for public resources. This fight will further intensify with the dramatic changes Germany is currently undergoing, from demographic change to globalization to the migration challenge.

The main culprit for the high and rising inequality is not a lack of public redistribution of income and wealth, but rather the unusually high inequality of opportunity, through which an ever higher share of citizens is deprived of the chance to develop and use their talents and skills. Such barriers have become massive, beginning already in early childhood.

JEL Classification: D3, O52