Back in 1975, income inequality in Britain on the standard economic measure stood well below the rich country average. Then something changed. During the following decades, the gap between rich and poor in Britain grew more rapidly than in any other advanced economy to a point that is now well above average and second only to the United States among the big developed countries.
Three questions follow. Why has this happened? Does it matter? And if it does, what’s to be done?
Joseph Stiglitz, a Nobel prize winner in economics, would have no hesitation in answering question one. His new book, The Price of Inequality, is mainly about the US, but his arguments apply with equal force to the UK. His main message is that inequality is at least as much the result of political forces as it is of economics. Governments set and enforce regulations that shape the market place; they distribute resources; they use taxes and social spending to influence the way in which money flows around the economy; and they alter the dynamics of wealth, for example by taxing inheritances or providing free public education.
So Stiglitz would not think it a coincidence that the steepest rise in inequality in the UK, at least as measured by the OECD, occurred during the Thatcher years. They brought massive changes in the structure of the economy—away from manufacturing, with the loss of large numbers of blue collar jobs spread across the country, and in favour of finance, with a relatively small number of highly paid jobs in the south east. They saw radical changes in the labour market: the labour share of GDP hit a peak in the late 1970s, and then fell steeply to a level from which it has never recovered. And the top rates of personal taxes were cut back sharply, on the view that this would stimulate growth across the wider economy. Unfortunately, according to Stiglitz, there is not “a grain of truth in trickle-down economics.”
In his view, “we have a political system that gives inordinate power to those at the top, and they have used that power not only to limit the extent of redistribution but also to shape the rules of the game and to extract from the public what can only be called large ‘gifts’.”
By this he means what he calls rent-seeking activities, whereby the new rich use their power to grab a larger slice of the economic pie without doing anything to increase its size. A long-standing critic of liberal capitalism, Stiglitz concedes that there may be a few decent business bosses, and even bankers, in the world. But for the most part, people who get to the top in business are willing to skirt or reshape the law, to take advantage of the poor, to exploit monopoly power, and to play unfairly when necessary.
He overstates his case by quite a margin. Income inequality has been rising steeply even in countries like Germany, Denmark and Sweden that have a strong bias towards social and economic equality. Other explanations for what’s happening include the way that information technology increases the productivity of those with the skills to use it, and replaces the jobs of those who can’t. And globalisation has played a part, by hugely increasing the supply of labour in the market economies of the world, and shifting jobs to the low income countries of Asia.
But it is true that unless governments are willing to lean against these big trends by adjusting their domestic policies, income inequality is likely to go on increasing.
So does this matter? Here, Stiglitz is much more convincing. A degree of inequality is inevitable in a modern economy. But taken to extremes, he argues that it leads to social, economic and political instability, and to lower growth.
Rich people consume a smaller proportion of their income than do the poor—they save around 15 to 20 per cent of what they get, while those at the bottom of the pyramid have to spend it all just to keep going. So if the rich get a much larger share of the cake—which is exactly what’s been happening in the US and the UK—domestic consumption in the economy will be lower than otherwise would have been the case. Unless something else happens, such as a rise in investment or in exports, total demand will be lower than what the country is capable of supplying, and unemployment will be higher. Stiglitz reckons that if you could engineer a relatively modest shift in the share of income away from the richest Americans in favour of the less well-off, you could cut the unemployment rate by a full two percentage points from the 8.3 per cent at which it stood in the US earlier this year.
Excessive inequality has other less direct but still serious economic consequences. For example, the OECD has shown that intergenerational earnings mobility is low in countries with high inequality, which means that talented people do not get the opportunities they need to rise to the top. The IMF, which used to argue that faster economic growth lifted all boats, rich or poor, now acknowledges that this may not be the case.
Then there are the social and political consequences. Stiglitz describes a grim future, in which society is divided into haves and have-nots: the rich living in gated communities, the rest in a world marked by insecurity, poor healthcare and mediocre education. At the bottom are millions of young people alienated and without hope.
So what’s to be done? Perhaps unsurprisingly, his final chapter is a long shopping list of proposed reforms, with little weight given either to the practical possibilities or the possible adverse trade-offs. For example, a top personal tax rate “plausibly in excess of 70 per cent” would certainly have an impact on economic dynamism. A less ambitious programme would have better chances of success. From a UK perspective, such an approach might concentrate on three broad themes.
One would cover education and skills. There is a closer correlation between relative deprivation and poor academic outcomes in the UK than in other advanced economies, and tackling this weakness must be an overriding national priority. Another vital task is to help young people from the growing number of households where no one works to find their way into jobs.
A second priority would be to increase the incentives for businesses to take on and train British workers. It is rational for an individual firm to bring in migrants from central Europe with the skills and aspirations that are needed to do well. But it can’t make sense for a whole economy to work that way.
Tax is the third big area for consideration. The starting point would be a simpler, more transparent system with much less scope for avoidance. A more progressive approach would make sense, especially when it comes to wealth—where the inequalities are much greater than is the case with income. The UK also needs to think again about the costs and consequences of allowing London to become a tax haven for rich people from around the world.
It’s obvious that the politics of redistribution, always hard, are much more difficult in a period without growth. But that’s not a reason for doing nothing now.
Stiglitz’s book shows signs of being written and edited in a hurry, in response to the Occupy Wall Street movement, and his ideology can be irritating. For example, he thinks that capital gains tax is paid by idle speculators, rather than by people who actually work for a living—not a line to take with entrepreneurs who have sweated blood to build their businesses.
But his book is valuable for two important reasons. First, it explains the serious economic consequences of excessive inequality. And second, it shows that this trend is not irreversible. Wise policymakers can and must make a difference.
