Why Tackling Inequality Is An Economic Imperative

It has long been recognised that extreme inequality has many serious social consequences, as well as causing economic fragility and weakness – now the time has surely come to act.

There’s a lot of talk about inequality. From Pope Francis to the Bank of England’s Mark Carney, a rising number of global figures have declared verbal war on today’s yawning income gaps. But talk, it seems, is as far as it goes.

In the absence of action, inequality has continued to grow through the crisis, domestically and globally. In the UK, the gap between the top and the rest has continued to widen. In the United States, nearly all the gains from recovery – over 90% – have been colonised by the very top.

There are a number of reasons for this gap between rhetoric and reality. Although inequality has been racing up the political agenda, ‘inequality denial’ remains a potent force, notably but not just in the US. As the London Mayor, Boris Johnson, puts it the rich are a ‘put-upon minority` and should be feted and given ‘automatic knighthoods’.

Big corporations and the global financial elite retain an immense grip over the political classes, enabling them to dictate on swathes of economic policy, from tax to business regulation. As the distinguished American economist, Avinash Persaud, has put it, ‘the regulators have been captured by the regulated`.

What is at work is a form of double-speak. World leaders espouse anti-inequality sentiments, while being complicit in actions that aggravate the income divide. Time and again, the head of the IMF, Christine Lagarde, has made high profile attacks on inequality: ‘Excessive inequality is corrosive to growth; it is corrosive to society.’ Yet the New York based Fund continues to apply policies that greatly exacerbate the problem. In return for bail-out loans, for example, the IMF has enforced draconian austerity measures on a number of southern European states that have impoverished large sections of their populations.

In part because of the continuing failure to translate talk into action, the Paris-based OECD has warned that inequality is set to continue to grow. The average OECD nation, it predicts, faces ‘an increase in (pre-tax) earnings inequality by 30% in 2060, facing almost the same level of inequality as is seen in the United States today.’

This echoes the prediction at the heart of Thomas Piketty’s highly influential Capital in the Twenty-First Century, of ‘a fundamental force for divergence’. Piketty argues that the great narrowing across western nations – from the early 1930s to the mid-1970s – was a one-off and we are back to the historic norm of persistently high and growing inequality.

Does this mean that current levels of inequality are inevitable and can only continue to deepen? The answer is no. The historical process is not quite as deterministic as implied in these pessimistic scenarios. As recognised by Piketty, models of capitalism are not set in stone. Social and political forces are dynamic and do change direction. There have been two seismic shifts of political economy over the last century: the first, the shift from the pre-war classical market model to the post-war era of regulated, egalitarian capitalism; then, another fundamental turning point, triggered by the stagflation crisis of the 1970s, ushered in the era of inequality-biased market fundamentalism. That model is still largely in place.

Narrowing today’s yawning income gaps will require a similar dose of transformative politics. Tinkering here and there through minor changes on tax and the level of the minimum wage, slightly more generous doses of redistributive welfare and the like – will not be enough to turn the rising inequality tide.

So, might history turn again, bringing another shift in direction to a more progressive, pro-egalitarian era, and confounding the idea that the post-war era was a one-off, special case? The big shifts of the 1930s and 1970s were dependent, in each case, on four central forces: severe economic shock, the intellectual collapse of the existing model, a loss of faith by the public with the existing system and a ready-made and credible alternative.

All these factors are at work today, though to varying degrees. We have been through a severe global crisis. The market orthodoxy of the last thirty years has a decreasing number of friends, while most of its central tenets have been discredited. There is growing public disenchantment with the current model.

What perhaps is missing is a coherent, ready-made and widely endorsed alternative that would command sufficient public support. But this was also true of the 1930s and 1970s. The elements of a new model were being developed and debated in those decades but did not take a clear shape until many years later. Today, the precise shape of an alternative and progressive economic and social settlement is equally uncertain.

Nevertheless, the central elements of an alternative political economy are likely to include:

• A new democratic settlement aimed at spreading power as a counter to big business – to the workforce, town halls, consumers and small business. Taming runaway and unaccountable corporate power and rebuilding collective bargaining are essential to achieving greater equality.
• The dispersal of capital ownership more widely through encouraging alternative business models based around partnerships, co-operatives, social and mutual enterprise and the introduction of collectivised social wealth funds, drawing on other examples such as the Alaskan sovereign wealth fund and the Swedish wage earner fund.
• Accepting the centrality of the ‘distribution question` in economic and social policy making, with policies that raise the share of output going to labour, which raise the earnings floor and lower its ceiling, and which ensure that the proceeds of growth are more fairly shared.
• The remodeling of the financial services industry with new measures to check rent-seeking activity and steer more resources into wealth creation through greater financial support for investment and the establishment of a State  Investment Bank.
• A war on tax avoidance and the building of a more progressive tax system – through for example the greater taxation of unearned wealth, buttressed by a greater emphasis on international co-operation for dealing with tax avoidance.

Such a mix would  represent a major departure from the existing Anglo-Saxon model of capitalism and from New Labour’s third way politics. So what are the chances of another key turning point that would usher in a more progressive and pro-equality model of capitalism? There are, perhaps, two key potential catalysts for such a change.

The first is the intensity of political pressure for a progressive alternative. As the American labour journalist, Sam Pizzigati, has argued in his book The Rich Don’t Always Win the evolution of a more equal and fairer society after the war depended on the way ‘egalitarians had battled, decade after decade, to place and keep before us a compelling vision of a more equal – and better – society’. Across large parts of the globe, the post-2008 crisis has brought an upsurge in grass roots political protest in opposition to the status quo and in support of a broadly social democratic and egalitarian alternative.

In the UK, there have been high profile citizens’ based campaigns against tax dodging companies, for the living wage and in opposition to austerity measures. Students from 25 countries are rebelling against the dominance of narrow free-market theories in university economic courses. The US has seen a sustained wave of co-ordinated industrial walkouts demanding a higher minimum wage.

Yet, while these protest movements have pushed the inequality question up the political agenda, they have, to date, been too piecemeal to trigger the unstoppable momentum for change necessary to force a more significant rupture in political and economic thinking. While some have dismissed such movements – the writer John Gray, for example, claims they show ‘the impotence of opposition and the absence of alternatives` – such protests are a sign that public patience with the status quo is thinning and that we may be getting closer to the political and social limits of inequality. If so, governments are likely to face a much harder ride unless there is a more even sharing of the economic pie.

Nevertheless, more, much more, is needed to force the political hand of what one group of Belfast anti-poverty campaigners has called ‘the big people`. For that reason, the most significant catalyst for change is likely to come from the impact of  inequality on economic stability. There is now a growing body of evidence that extreme inequality breeds fragility, weakens growth and promotes instability. It was a central factor in driving the global economy over the cliff in 2008 and has contributed to the depth and longevity of the crisis.

Over the last three decades, the rise in inequality has been driven in the main by the steady shift in economic rewards away from labour and in favour of capital. The OECD has shown that, from 1990 to 2009, the typical wage share across all 34 OECD nations fell from 66.1 per cent to 61.7 per cent, resulting in a great surge in corporate and private cash holdings and leading to what Guy Ryder, the Director-General of the ILO, has called  a ‘dangerous gap between profits and people.’

According to market orthodoxy, this shift from wages to profits should have led to faster growth and more stable economies. Instead, it has created a number of highly damaging distortions, fracturing demand, promoting debt-fuelled consumption and raising economic risk. Static and falling real wages have cut wage-financed consumption while booming profits have been associated with a catastrophic fall in investment.

The effect has been to make growth increasingly dependent on artificial stimulants, from the mass printing of money by central banks to the growth of personal debt. While these provide a temporary economic boost, they eventually lead to unsustainable hikes in property and business values and stock markets and so to economic collapse.

Today’s model of capitalism is dysfunctional. Because of the power of capital, too much economic activity is geared to the extraction of existing rather than the creation of new wealth with consequences that have been toxic for consumers, the workforce, taxpayers and the wider economy. The distinction between wealth creation and wealth diversion has long been recognised. As Adam Smith warned in 1776, because of their love of quick money, ‘the prodigals and projectors’ could lead the economy astray. In the 1930s it was Keynes who called for the ‘euthanasia of the rentier`.  In a modern-day equivalent, the leading World Bank economist Branko Milanovic has distinguished between ‘good’ and ‘bad’ inequality.

Despite these long acknowledged dangers, the ‘distribution question` – of how the cake is divided – once central to economic thinking, has been buried by the post-1979 counter-revolution in economic thinking. ‘Of the tendencies that are harmful to sound economics, the most poisonous is to focus on questions of distribution’, wrote Robert E Lucas, Nobel Prize winner and one of the principal architects of the pro-market, self-regulating school, in 2003. Today, that question is creeping back onto the agenda, but too slowly to have yet rebalanced the application of policy.

If we are to build a fairer and more sustainable economic model, the distribution question needs to be restored to the heart of economic management. Economies built around poverty wages and huge corporate and private surpluses are unsustainable. In that sense, restoring the balance between wages and profits, and cutting the great income divide, is not just a matter of social justice and proportionality it is an economic imperative. As long as national economic cakes are divided so unevenly, economies will continue to slide from crisis to crisis.

This column was first published on OpenDemocracy