Inequality, the crash and the crisis. Part 2: A model of capitalism that fails to share the fruits of growth
Today we publish the second 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 driving force behind the widening income gap of the last thirty years has been a shift in the distribution of “factor shares” – the way the output of the economy is divided between wages and profits. In the first two decades after the Second World War, a transformed model of capitalism emerged – across the rich world – in which it was accepted that the fruits of growth should be more evenly shared than they had been in the pre-War era. In the US, the share of output allocated to wages rose and stayed high. In the UK the “wage-share” settled at between 58 and 60 per cent of output, a higher rate than achieved in the pre-war era and the Victorian age. It was this elevated wage share that helped drive the “great leveling” of the post-war decades.
From the late 1970s, the capitalist model underwent another transformation, one characterised by a backward shift in the way the proceeds of growth were divided. By 2007, the share of output going to wages had fallen to 53 per cent in the UK. In the US, the fruits of growth became even more unevenly divided, with the workforce ending up with an even smaller share of the economic cake. There were similar, if shallower trends in most rich nations.
This process of decoupling wages from output has led to a growing “wage-output gap”, with a very profound, and negative, impact on the way economies function. This is for three key reasons. First, by cutting the purchasing power needed to buy the extra output being produced, the long wage squeeze brought domestic and global deflation. Consumer societies started to lose the capacity to consume.
The solution to this problem – which would have brought a prolonged recession much earlier – was to allow an explosion in private debt to fill the demand gap. In the UK, levels of personal debt rose from 45 per cent of incomes in 1981 to 157 per cent in 2008. In the US, debt reached a third more than national income by 2008. This helped to fuel a domestic boom from the mid-1990s but was never going to be sustainable. Far from preventing recession, it just delayed it.
The same factors were at work in the 1920s. The 1929 Crash was preceded by a sharp rise in inequality with the resulting demand gap also filled by an explosion in private debt. In 1920s America, the ratio of household debt to national income rose by 70 per cent in less than a decade.
Second, the intensified concentration of income led to the growth of a tidal wave of global footloose capital – a mix of corporate surpluses and burgeoning personal wealth. According to the pro-inequality theorists, these growing surpluses should have led to a boom in productive investment. Instead, they ended up fuelling commodity speculation, financial engineering and hostile corporate raids, activity geared more to transferring existing rather than creating new wealth and reinforcing the shift towards greater inequality.
Little of this benefitted the real economy. Of the £1.3 trillion lent by British banks between 1997 and 2007, 84 per cent was in mortgages and financial services. The proportion of lending going to manufacturing halved over the same period. It was this combination of the erosion of ordinary living standards and the accumulation of massive global cash surpluses that created the bubbles – in housing, property and business – that eventually brought the global economy to its knees. Again there are striking parallels with the 1920s when swelling surpluses in the US were poured into real estate and the stock market creating the bubbles that triggered the 1929 Crash.
Third, the effect of these trends has been to intensify the concentration of power with wealth and economic decision-making heavily concentrated in the hands of a tiny minority. In the US, such is the concentration of income, 5 per cent of earners account for 35 per cent of all consumer spending. A new elite has been able to exercise their muscle to ensure that economic policies work in their interest. Hence the inaction on tax havens, the blind-eye approach to tax avoidance and the scaling back of regulations on the City and Wall Street, policies that have simultaneously accentuated the risk of economic failure.
Not only did the growing income divide help to drive the global economy over the cliff in 1929 and 2008 it is now helping to prolong the crisis. UK wage-earners today have around £100 billion less in their pockets (roughly equivalent to the size of the nation’s health budget) than if the cake was shared as it was in the late 1970s. In the bigger economy of the US the sum stands at £500 billion. In contrast, the winners from the process of upward redistribution – big business and the top one per cent – are sitting on growing corporate surpluses and soaring private fortunes that are mostly sitting idle. This is a perfect recipe for paralysis.
The economic thrust of the last thirty years – greater reliance on markets, the weakened bargaining power of labour and hiked fortunes at the top – was aimed at dealing with the crisis of the 1970s, a mix of “stagflation” (stagnation and rising inflation ) and falling productivity. It succeeded in squeezing out inflation but replaced these fault lines with an equally toxic mix – global deflation, rising indebtedness and booming asset prices – that eventually brought economic collapse.
Part 3 looks at the lessons to be drawn for these trends.
Regular Insights blogger Brian Keeley is in Beijing, from where he sends this post.
You can sum up the hottest question on China’s economic future in just four words: Hard or soft landing.
At the moment, most people seem to think China’s economy isn’t about to hit a brick wall. Yes, the phenomenal growth rate since the 1990s is slowing, but it’s still at a level most mature economies would envy. After a decade in which GDP rose by at least 9% a year, it slipped back to “only” a bit above 8% by the end of last year, according to the OECD. For the next decade, the OECD forecasts annual growth will hover at around 7%.
To some extent, such a slowdown is inevitable as any economy matures – after all, you can only build so many roads, bridges and airports. But some fear it could be a sign of worse things to come – in other words, the much-feared hard landing. As China is now in many ways the engine of the world economy, that would be bad news not just for Beijing but for the rest of us too.
These questions on the mind of speakers at last weekend’s China Development Forum in Beijing, not least that of Dr. Nouriel Roubini – the economist whose all-too accurate forecasts in the run up to the financial crisis earned him the nickname “Dr. Doom”. Given his track record, it probably wasn’t surprising that he saw a hard landing as “possible” but, he insisted, “not inevitable”. To guard against it, he argued, China must undertake economic reforms, most notably to encourage Chinese to spend more and save less.
Dr. Roubini pointed out that China was the only major exporter to avoid a recession in the wake of the financial crisis. That was due in large part to massive programme of investment in things like infrastructure and property development. But, he warned, that’s not sustainable. Indeed, to some extent, the chickens from this spending are already coming home to roost, most notably in falling property prices and signs of a credit crunch as a result of loose lending.
Combine this with weaker demand in China’s export markets, most notably in Europe, said Dr. Roubini, and it’s inevitable that “the model of growth has to change”. That makes reforms essential, he stated, and those reforms must aim to turn the Chinese consumer into a much more powerful driver of the country’s economy.
So, why do Chinese prefer to save rather than spend? There are many reasons, but one of the most important is the lack of an adequate social security net. Fall ill or lose your job in China, and you quickly realize the benefits of having a few yuan under the mattress. There’s a similar problem when it comes to pensions, a major concern for China’s ageing population; the one-child policy means many elderly parents and grandparents will have to rely on just one or two breadwinners for support.
Another factor is China’s currency, which is widely perceived as undervalued, although there’s debate over the scale of this. A relatively weak currency is good for China’s exports, but it makes imports more expensive than they should be, further weakening Chinese consumers’ spending power.
The valuation of the yuan is controversial, but in many respects much of what else Dr. Roubini had to say is not. Just last week, China’s outgoing Premier, Wen Jiabao, said the need for reforms was urgent, while China’s most recent five-year plan focuses a lot of attention on expanding the social security net and on reducing inequality.
Such concerns have been widely echoed in OECD work and were repeated again at the weekend in Beijing. Speaking at the forum, OECD chief Angel Gurría called for a bigger share of profits from state enterprises to go on social spending, and for more resources to go on education and training. Such measures would deliver both short and long-term benefits for workers and the economy, not least in the form of a more highly skilled workforce.
Encouragingly, there may already be some signs that China is beginning to rebalance its economy towards a greater dependency on domestic demand. An OECD report released at the forum pointed out that real household incomes rose by 10% in 2011 (and by more in the countryside), while the share of overall consumption in GDP increased for the first time in a decade, albeit only slightly. Nevertheless, there’s no question that the task ahead will be challenging. As Yang Weimin, a vice-minister for economic policymaking, stated at the forum, “these things cannot be achieved overnight”.
The OECD’s Chinese-language site – 网站 (中文)