By Stewart Lansley. [From the most recent issue of The Tablet: The International Catholic Weekly (published in London):]
In the 1920s and 1930s the wealthy were prospering amid economic upheaval. With the same happening today, a new study of inequality argues that gaps in wealth are the cause of instability and are deeply damaging as well as unjust
Over two years before the current occupation by anti-capitalist protesters of nearby land, St Paul’s Cathedral was the scene of another event about the merits of contemporary capitalism – a spirited debate on the role of the growing income gap in market-led economies.
Sharing a platform with canon theologian Nicholas Sagovsky and then deputy leader of the Liberal Democrats Vince Cable, the vice chairman of Goldman Sachs and a former adviser to Mrs Thatcher, Brian Griffiths, defended higher inequality “as the way to achieve greater prosperity for all”.
Lord Griffiths was espousing one of the central claims of the still dominant free-market school: that the accumulation of large fortunes might bring a bigger divide, but, by encouraging business and wealth creation, it raises growth rates and makes everybody better off.
While recent years have seen several hard-hitting and hotly debated critiques of the growing divide, these have concentrated on issues of injustice. But another equally important, but largely ignored, issue is that of its impact on the way economies function.
Are Lord Griffiths and his co-believers right in claiming superior economic benefits from higher levels of inequality? The evidence suggests otherwise. The income gulf has soared, but without the promised pay-off of wider economic progress. On all measures of economic performance bar inflation, the post-1980 era of rising inequality has a much poorer record than the egalitarian post-war decades.
The main outcome of the post-1980 experiment has, as a result, been an economy that is both much more polarised and much more fragile. So what does this tell us about cause and effect? Is the rise in inequality the real cause of the present crisis? No, according to the only official account of the causes of the 2008-09 crash. The report of the US official commission, published in January 2011, failed to mention “inequality” once in its mammoth 662-page report.
Yet, the historical evidence points to a clear link from inequality to instability. The two most damaging recessions of the last century – in the 1930s and today – were both preceded by steep rises in inequality. In 1920s America, the share of national income taken by the top 1 per cent of the population increased from 14 to 24 per cent. From 1990 to 2007, there was a near-identical rise from 14.3 per cent to 22.8 per cent. In contrast, from the late-1930s to the mid-1970s – a period of much greater economic stability – the income gap narrowed sharply. There is thus a clear historical correlation between the concentration of income and economic stability.
Why is this? The evidence suggests that when the richest one per cent secure more than around a sixth of national income, the natural economic processes essential to stability cease to work properly. Essentially a model of capitalism that fails to share the proceeds of growth evenly between different sections of society will eventually self-destruct.
In the last 30 years, the distribution of the economic pie between the workforce and business owners has become excessively skewed in favour of the latter. Profit levels and top fortunes have soared, the direct result of a sustained and deliberate squeeze on real wages. Since the millennium, economic output has been rising at almost twice the rate of real earnings in the United Kingdom. In the United States, pay has been falling even further behind the rise in the size of the economy.
The first crucial effect of a rising pay-output gap is to suck demand out of economies: purchasing power does not keep pace with the extra output being produced. If demand does not rise in line with the growth in economic potential enabled by productivity gains and business investment, consumer societies end up without the capacity to consume and simply seize up. In both the 1920s and the 2000s, the solution to this problem of a growing shortage of demand was a mix of cheap credit and an explosion of rising personal debt.
In the 1920s rising debt became the means by which the workforce could pay for the increased output of cars, radios and the other new consumer goods of the time. The same process was at work from the late 1990s. Spiralling levels of personal debt funded everyday living costs – from clothes to utility bills – as well as a swollen demand for housing. Without this debt, the mass consumption on which the economy depended would not have been forthcoming. In neither case did this prevent recession, it just delayed it.
Secondly, allowing a small financial and business elite an increasing share of the pie eventually leads to asset-price bubbles. In 1920s America, a rapid process of enrichment at the top created an increasingly unsustainable five-year-long property- and stock-market boom. In the build-up to 2008, the burgeoning levels of personal wealth that were the counterpart to the rising wage-output gap led to a giant mountain of global footloose capital. A tsunami of hot money raced around the world at speed, creating the asset bubbles – in property and business – that eventually brought the global economy to its knees.
The deepest economic crises of the last 100 years have occurred when wages have been decoupled from output. In the relatively stable post-war decades up to the end of the 1960s, wages and profits moved roughly in line with growing output. In the run-up to the crisis of the 1970s, wages began to take a rising share of economic output in the UK (and in most other rich nations) creating a profits squeeze that threatened the sustainability of the capitalist model.
In the 1920s and the post-1980s, a prolonged wage-squeeze and rising profits share merely brought a dangerous mix of demand deflation and asset appreciation, which ended in economic crisis. These lessons have yet to be learnt. Today, real wages are on a downward slide across the globe while personal fortunes are back to record levels. If we are to avoid a near-permanent slump, the rising income gap needs to be capped and reversed, just as it was from the 1930s.
In the post-war era, the “great levelling” process was achieved in two main ways. First, by the emergence – across rich nations – of a set of new social and political mores hostile to an excessive divide. Rewards at the top of business and finance became more modest, business accepted a greater sense of social responsibility and crucially allowed the workforce to share in the proceeds of rising prosperity. Second, by the introduction of a sharply progressive system of taxation.
There is nothing inevitable about today’s level of polarisation. But achieving greater equality means a transformation on four fronts: the shaping of an alternative political and social climate that caps runaway greed at the top; a shift in today’s primary business goal away from the maximisation of short-term profits; a re-modelled tax system that claws back a higher proportion of top fortunes; and a global attack on tax avoidance. None of this will be easy, but there will rarely be a more opportune climate and a greater urgency for action.
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