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October 14, 2011updated 10 Jan 2016 3:28pm

Mind The Gap

By Spear's

Stewart Lansley on why the growing chasm between rich and poor is not only a social disaster but an economic one, too
of the downturn in October 2009, St Paul’s Cathedral hosted a spirited debate on the subject of ‘The place of morality in the marketplace’. At the heart of the discussion was the role of the growing income gap in more market-led economies. One of the speakers, Brian Griffiths, the vice chairman of Goldman Sachs and a former adviser to Mrs Thatcher, defended higher inequality ‘as a way to achieve greater prosperity for all’.

With the global economy flatlining and the prospect of further dips in living standards, inequality is emerging as one of the big issues of the 21st century. For some commentators, it was the rising income gap that was the real trigger of the riots that exploded unexpectedly across Britain in August. For almost 50 years from the early Thirties, most richer nations were set on a course of greater equality. Top personal fortunes fell and wages rose. Then, in a historic reversal, what had become known as ‘the great levelling’ gave way, from the early Eighties, to the great widening. Although this reversal was at its greatest in the US and the UK, similar if later and shallower trends have occurred in most developed nations.

In recent years the question of the social consequences of this widening gap has been hotly contested. But what about the effect on the economy? Rising inequality has been defended as a necessary condition for greater economic success. Higher rewards and the accumulation of large fortunes might bring a bigger divide, but, it is argued, by encouraging an enterprise economy, they would raise the growth rate and thus make everybody better off.

So is Griffiths right? Has greater inequality brought an economic renaissance? The evidence is pretty unequivocal. The wealth gap has soared, but without the promised pay-off of wider economic progress. In my new book, The Cost of Inequality, I show that on all measures bar inflation, the post-1980 era of rising inequality has a much poorer record than the egalitarian postwar decades. In the UK, growth and productivity rates since 1980 have been sharply down. The average level of unemployment since 1979 — 8 per cent — is more than three times that of the two postwar decades.

Most important, financial crises have become much more frequent and more damaging, culminating in the increasingly intractable crisis of the past four years. So, to what extent can the crisis be attributed, at least in part, to the growing wealth divide? Not at all, according to the only official account. The bipartisan US Financial Crisis Inquiry Commission into the causes of 2008-09 crash, which published its findings in January 2011, blamed pretty much everybody and everything for the meltdown but failed to mention ‘inequality’ once in its mammoth 662-page report.

Yet there are powerful reasons to believe that inequality played a central role both in the build-up to 2008 and the stagnation that has followed. Since the late Seventies the spoils of growth have gone disproportionately to big business and a small group of financiers, bankers and business executives, not just in the UK but also in the US and a number of other richer nations. As a result, ordinary citizens across much of the rich world have been living with an increasingly smaller share of the economic cake.

As shown in figure 1 opposite, the share of output in the UK going to wage-earners has been falling sharply since it reached a peak during the mid-Seventies. By 2008 it had fallen to 53 per cent, not much higher than the level that prevailed in the much less regulated economy prior to the First World War. Moreover, this squeeze has been felt most heavily by middle and low earners, both of whom have experienced much lower rises than those on the highest pay.

One of the most important economic consequences of this trend has been that real wages for most of the working population have been falling behind the growth in productivity (the increase in economic capacity), and at an accelerating rate. Between 1980 and 2007, real wages in the UK rose by an annual average of 1.6 per cent while economic capacity grew by 1.9 per cent. Figure 2 shows that this decoupling began in the Nineties and accelerated from 2000. Since the millennium, productivity has been rising at almost twice the rate of real earnings.

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In the US, wages have lagged even further behind productivity growth. Until the end of the Seventies, real wages for most of the population moved, as in the UK, in line with economic growth, doubling roughly every 35 years. That progression started to falter from the early Eighties. Since then, the incomes of the middle and low earning have done little better than stagnate. While productivity rose by 71 per cent between 1980 and 2007, median real wages grew by only 9 per cent.
Illustration by George Leigh
THE SUSTAINED SHRINKING of the wage-share has been, in part, the result of the rise in the supply of global labour and a decline in the relative pay of the unskilled. But it has also been driven in the UK and the US by the shift in bargaining power from the workforce to business with the adoption of a more market and ruthless economic model.

This decoupling of wages and output — the primary cause of the growing divide of the past three decades — has had a big impact on the way economies function. 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 lost 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 gap. In the UK, levels of personal debt rose from 45 per cent of incomes in 1981 to 157 per cent in 2008. This may have helped to fuel a domestic boom from the mid-Nineties, but it was never going to be sustainable.

Secondly, as the concentration of wealth intensified, bigger and bigger financial surpluses emerged in the global economy, leading to a giant mountain of global footloose capital — a mix of corporate surpluses and burgeoning personal wealth. Instead of being used to expand productive investment and create new wealth, a tidal wave of hot money caromed around the world in search of the quickest returns. It was this combination of the erosion of ordinary living standards in the UK, the US and in a majority of richer nations and the accumulation of massive global cash surpluses that created the bubbles — in housing, property and business — that eventually brought the British and global economies to their knees.

The market experiment that began in the early Eighties grew out of the economic turbulence and stagflation of the Seventies. But in place of the mix of rising inflation and stagnant output of that decade, the modern economy has been built around an equally toxic mix — a combination of demand deflation, rising debt and asset inflation. All have their roots in the growing wage-output gap.

Despite the findings of the US Commission, the role of inequality has now been accepted by some of the world’s most influential players. In a significant paper by the IMF, two of its research economists, Michael Kumhof and Romain Ranciere, argued that ‘the crisis is the ultimate result, after a period of decades, of a shock to the relative bargaining powers over income of two groups of households, investors who account for 5 per cent of the population, and whose bargaining power increases, and workers who account for 95 per cent of the population (and whose bargaining power has fallen).’

A similar view has been advanced by Juan Somavia, the director-general of the International Labour Organization, who has pinned some of the blame for the crisis on the ‘failure of wages to keep pace with rising productivity’. With the global economy sinking back into crisis, this is a debate that is far from over. 

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