Inequality, the crash and the crisis. Part 3: The Limit to Inequality

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Today we publish the last of three articles on inequality and the crisis by Stewart Lansley, visiting fellow at The Townsend Centre for International Poverty Research, Bristol University and the author of The Cost of Inequality: Why Economic Equality is Essential for Recovery, Gibson Square, 2012. He was one of the speakers at the 2012 OECD Forum session: How Is Inequality Holding Us Back?

The key lessons of the 2008 Crash are now becoming clear. For the last thirty years, some of the world’s most important economies have been applying a faulty theory on the way the economy works. Demand in most large economies is wage-led not profit-led. That is, a lower wage share leads to lower growth. This is also true in aggregate of the global economy.

The evidence from the last 100 years is that more equal societies soften, and more polarized ones intensify, the gyrations of the business cycle. Inequality is not just an issue about fairness and proportionality, it is integral to economic success. A capitalist model that allows the richest members of society to accumulate a larger and larger share of the cake merely brings a lethal mix of demand deflation, asset appreciation and a long squeeze on the productive economy that will end in economic turmoil.

Yet that model has survived the second deepest recession of the last 100 years largely intact. In contrast, the economic crisis of the 1930s was to give way to a very different model of political economy, one that eroded the extremes of wealth that had helped create the crisis.

Today, it is largely business as usual. The world’s rich have been the main winners from the global recession. In the United States, profits and dividends have risen since 2008 while real wages have fallen. According to the American economist, Emmanuel Saez, average real family income declined by a remarkable 17.4 per cent between 2007 and 2009.

Profits and dividends are up largely because wages are down. As JP Morgan Chase chief investment officer, Michael Cembalest, has documented. “U.S. labor compensation is now at a 50-year low relative to both company sales and U.S. GDP.”

A key consequence of this trend is that all income growth in the US in 2010 went to the wealthiest 10 percent of households, and 93 percent to the wealthiest one per cent.

In the UK, there has been a similar, if less extreme pattern. Real wages have fallen on average by seven per cent in the last two years and are set to continue to fall. Indeed, the independent Office for Budget Responsibility (the OBR ) has forecast that the wage share will have fallen by a further four percentage points between 2010 and 2006. In contrast, incomes at the top have continued to rise through the slump. In 2007, the ratio of the median earnings of FTSE 100 top executives to median wages stood at 92:1. By 2011, it had risen to 102:1. Not only did executive pay greatly outstrip average earnings growth up to 2007, apart from a slight blip in 2009, it has continued to do so.

There has been much talk about the need to tackle growing inequality, but little real action. Ending the present crisis and building a sustainable global economy requires a much more fundamental leap that accepts that there is a limit to the level of inequality – one that is still being breached in a majority of nations – that is consistent with stability.

The successful management of economies depends especially on securing a more equal distribution of market incomes, before the application of taxes and benefits. Tackling the unequal “pre-distribution” of incomes means elected governments taking more responsibility for both the distribution of factor shares and of relative levels of pay.

It is a role that most, if not all, governments have been and remain reluctant to play. For most national governments – and global institutions from the IMF to the OECD – reducing inequality has not been a central economic goal alongside say, controlling inflation, or tackling fiscal deficits.

In the US, the UK and most rich nations, the economic role and impact of inequality has been at best a side-issue in economic decision-making. Too many governments have, by default, allowed the relationship between wages and output to become dangerously imbalanced. They have permitted remuneration practices to emerge that have distorted incentives and sanctioned business activity geared more closely to wealth diversion than wealth creation.

Translating talk into action requires governments to set clear targets for a number of key economic relationships. These should include the balance between wages and profits, the pay gap between top and bottom and the degree of income concentration. In a majority of countries, the wage share is too low and heading lower; the pay gap, already at historic highs, is heading higher while income concentrations are above the limit consistent with stability.

Meeting these targets means ditching many of the failed economic shibboleths – that inequality leads to faster growth, that allowing the rich to keep more of their own money boosts growth and tax revenue, that a larger pay gap reduces unemployment – of the last thirty years. It will require much tougher policy measures aimed at keeping economic elites in check. National governments need to develop a new contract with labour that raises the wage floor, bolsters the middle and lowers the ceiling. This means the taming of excessive corporate power and a rebalancing of bargaining power in favour of the workforce. It means moving towards more progressive tax regimes with much tougher global action on tax havens.

None of this will be easy. Despite the accumulated evidence that fairer societies and economic success go hand in hand, and the mounting pressure for change, the political and economic consensus remains rooted in the past. Radical change will be heavily opposed by those with most to lose. Yet a model of capitalism that fails to share the proceeds of growth more proportionately is not sustainable.

Useful links

Divided We Stand: Why Inequality Keeps Rising

Growing Unequal? Income Distribution and Poverty in OECD Countries

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6 comments to “Inequality, the crash and the crisis. Part 3: The Limit to Inequality”

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  1. Lou Gogan - 15/06/2012 Reply

    re: ditching many of the failed economic shibboleths
    There’s just one tiny little problem. Those who have the power to change things are in the pay of those who do not want any changes to come about. Those who abuse the system RUN the system. The real problem is not the financial system, it is the political system – how to take the power from the corporate dictators and return it to the citizens.

  2. Siena Denton (@fury12) - 15/06/2012 Reply

    Kiaora (Greetings) from Aotearoa (Land of the Long White, a lot Blacker these days, cloud), known globally as New Zealand.
    You say, “A capitalist model that allows the richest members of society to accumulate a larger and larger share of the cake merely brings a lethal mix of demand deflation, asset appreciation and a long squeeze on the productive economy that will end in economic turmoil.”
    My little nation, New Zealand suffered an economic crisis of our own back in the early 1990s. I refer to it as an economic crisis because it was the Mama and Papa taxpayer who had to bailout our Bank of New Zealand to the tune of $1billion.
    We have now a history of bailouts by the taxpayer, as there have been more bailouts, as Jenni McManus pointed out in April 2011.
    A $500 million taxpayer bailout of AMI amid revelations that the bill for failed South Canterbury Finance has jumped $300m, from $900m to $1.2 billion, coming hard on the heels of the collapse of another South Island insurer, Western Pacific, a Queenstown-based company with an estimated $30m exposure to the two Christchurch earthquakes.
    Taxpayers were forced to pick up the tab for South Canterbury after it collapsed into receivership.
    Investors were repaid $1.77b under the government’s retail deposit guarantee scheme – a protection put in place by then Prime Minister Helen Clark two months before the 2008 general election, as the global financial crisis began to bite.
    The scheme, designed to protect mum-and-dad investors in finance companies, ended in October 2010. During its two years of operation, investors in nine companies were bailed out by taxpayers.
    South Canterbury was by far the biggest, though taxpayers have also footed the bill for Allied Nationwide (about $130m) and Equitable Mortgage ($188m).
    Other smaller finance companies to be bailed out were Mascot, Strata, Vision Securities, Rockford, Viaduct Capital and Mutual Finance.
    Before that, the last big taxpayer bailouts were Air New Zealand ($885m in January 2002) and a $1b bailout of the BNZ in the early 1990s.
    The original deposit guarantee scheme had $133b under guarantee. An extended version of the scheme was put in place in October and ran to the end of 2011.
    Only three companies have cover: PGG Wrightson Finance, Fisher & Paykel Finance and the Wairarapa Building Society.
    To add more insult to our Mama and Papa taxpayers, after the bailout of the BNZ, the government sold it to Australia: Westpac Trust Bank which is Aussie owned is currently our NZ government’s bank.

    I concur totally with Lou Gogan’s last sentence: “The real problem is not the financial system, it is the political system – how to take the power from the corporate dictators and return it to the citizens”.

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