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9 March 2013

The Inequality Crisis

Tag(s): Politics & Economics
I recently attended a lecture at the RSA, of which I am a Life Fellow, given by Stuart Lansley FRSA, the well-known economist and journalist, TV producer and author of The Cost of Inequality.  That inequality has reached unacceptable heights has become increasingly widely accepted, even at the highest levels. Stewart Lansley argues that a new battle line has been drawn over the relationship between inequality and growth.

Lansley argues that, while personal fortunes at the top have soared to levels not seen since before the Second World War, living standards for most Britons have fallen well behind general rises in prosperity. In the United States, nine -tenths of the population has faced stagnant incomes over the last three decades. As a result, the big divide in British and American society is now less between the top, the middle and the bottom, than between a tiny group at the very top and nearly everyone else.

Although recent years have seen several hard-hitting, and hotly debated, critiques of this deepening gulf, these have concentrated on issues of social injustice and fairness. Rewards at the top of finance and business, their authors argue, have become increasingly disproportionate and undeserving, the product of an increase in the concentration of political and market power rather than a greater economic contribution.

Such arguments deal mainly with the moral and social consequences of the surge in polarisation. Stewart's thesis is that an equally important issue, but one that has been largely ignored, is the impact of rising inequality on the way economies function. There is a limit, he argues, to the degree of inequality that is consistent with economic stability and dynamism and that limit has been exceeded in recent times.

Over the past three decades Britain and the United States, increasingly followed by a number of other developed nations, have divided into two-track economies. The first track is one which makes money out of money and is controlled by a small group of a few thousand bankers, financiers and corporate executives running the world's largest companies. Nearly everyone else find themselves in what has become the slow lane of the economy. But this track, the 'productive economy' - where new businesses are built, new products devised and wealth and jobs created - is the one on which economic success depends.

This is not an attack on capitalism per se but on the type of capitalism that has evolved. In the 1920s a similar trend emerged. Incomes for the great majority stagnated while a plutocracy took the bulk of the profits to such an extent that they could not consume enough to support the general economy by themselves. Instead the extra cash spilled into speculation, asset bubbles were created and the Wall St. Crash was the consequence. Despite extensive public spending to correct the impact it was only Wartime public expenditures that pulled productivity and income levels back to a previous level of equilibrium.

In Britain there were fewer millionaires in 1953 than in 1938 and for a long period a model of 'managed capitalism' developed that saw by the early 1970s a level of equality that ensured that the majority benefitted from a steady increase in prosperity on both sides of the Atlantic. Then a series of events and policy mistakes by Nixon in the US and Heath in the UK triggered a rise in inflation kicked off by the OPEC oil shock in 1973. Trade Unions reacted to this in a less than constructive way and Thatcher and Reagan were elected with mandates to restrict bargaining rights and remove apparent barriers to economic development. However, the result of their deregulation of the markets was a change from 'managed capitalism' to 'market capitalism' and the fruits of this were increasingly harvested by a dwindling few.

Lansley demonstrates that while the top 1% of the population in the UK took 17% of the income in 1937, and just 6% in 1977 this has reverted to 16% in 2009. The curve is similar in the US and most other rich countries. While Lansley is undoubtedly sympathetic to left-wing points of view he does not exempt the New Labour governments of Blair and Brown from criticism and shows how inequality rose dramatically under their rule. Indeed, he accuses them of a Faustian pact with the forces of this ‘market capitalism’. Wages have effectively remained stagnant since 2000. In the UK 20.6% of employees are now in low wage work, a proportion that has doubled in 20 years. The proportion is similar in Germany (20.2%) while in the USA it has risen to 24.8%.

Lansley posits that this is the result of a New Right dogma that in the 1970s egalitarianism had gone too far and what was needed was a stiff dose of inequality. While the idea was started by the New Right it became broadly accepted and emerged as the new economic orthodoxy. This was that there was a need to choose between more equal and more efficient societies. The share of the economy that went to profit rose steadily from 20% in 1975 to 30% in 2009. At the same time the rate of productivity in the economy declined to two thirds that of the 1950s and 60s. Recessions became deeper and longer. The growing wage/productivity gap stifled demand. The solution was to pump economies full of debt leading to unsustainable bubble economics while Gordon Brown announced that the cycle of boom and bust had been abolished.

Such corporate surpluses that were generated went to M+A activity, financial engineering and property speculation. It would have been fine if it had been soundly invested in productive growth. Instead a practice of wealth diversion prevailed rather than wealth creation.

So what lessons can be learned?

1. We have been running a fundamentally flawed economic model. Growth is wage led, not profit led.

2. More equal societies are less turbulent. 

Have we learnt the lessons? Well, yes, if you believe that we're all in this together. Following the Lehman shock the gap between productivity and compensation narrowed in 2008/9 but has since grown again. Between 1990 and 2011 in the US 90% of growth went to the top 1%. Top executive pay continues to accelerate. In 2011 President Obama said that “inequality is the defining issue of our time” while Christine Lagarde, head of the IMF says that “excessive inequality is corrosive to growth, it is corrosive to society”. While they are politicians of the Left Albert Edwards of Societé Generale says “Capitalism may not have it quite so easy in the next phase. Labour will fight back to take its proper (normal) share of the national cake, squeezing profits on a secular basis.”

In questions afterwards, to the question that globalisation and technology could explain this Lansley told us that they only accounted for perhaps half of this.  There were two other critical factors: 1. the decline in bargaining power of labour with only 7% of the private sector workforce in unions in the US, 14% in the UK, and 2. What he calls Financialisation. But hadn’t organised labour lost the argument?  Yes, Lansley replied, they responded to oil price inflation. We need a new model.

Lansley contends that we are restricting the economy's ability to grow because wages have been suppressed in real terms for some considerable time. There is no shortage of cash in the economy. Governments in various jurisdictions have bailed out banks with massive injections of liquidity and pumped in huge quantities of new money. But that money now sits on corporate balance sheets both in the banking sector and in other large corporations. Chief Financial Officers are nervous about releasing these funds as post-Lehman Brothers they prefer to maintain high reserves against a repetition. But the chances of a repetition are increasingly likely as many of these banks still sit on unreconstructed piles of bad debts.

His proposed solutions inevitably sound like a left wing manifesto for the return of collective bargaining rights, a so-called living wage, curbs on executive powers to pay themselves extraordinary bonuses, a transaction tax and so on. But the case for some of this is much more persuasive when couched not in terms of social justice or fairness but in terms of a dysfunctional economy that rewards a few and suppresses the majority. I certainly found it food for thought and do not reject it out of hand. His book is more than just another polemic on social injustice but a well-considered analysis of how we got into this mess and how we might get out of it.

However, if wage inequality restricts growth consider what might happen to China. It emerged this week that, while the average annual wage for Chinese urban workers is less than $7,000, 83 of the delegates to China’s parliament this year are dollar billionaires.

Copyright David C Pearson 2013 All rights reserved





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