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Why economic inequality leads to collapse

The lesson of the Great Crash was that unequal enrichment provokes asset bubbles, excessive demand for debt and, finally, economic failure. Now we are painfully learning that again

During the past 30 years, a growing share of the global economic pie has been taken by the world’s wealthiest people. In the UK and the US, the share of national income going to the top 1% has doubled, setting workforces adrift from economic progress. Today, the world’s 1,200 billionaires hold economic firepower that is equivalent to a third of the size of the American economy.

It is this concentration of income – at levels not seen since the 1920s – that is the real cause of the present crisis.

In the UK, the upward transfer of income from wage earners to business and the mega-wealthy amounts to the equivalent of 7% of the economy. UK wage-earners have around £100bn – roughly equivalent to the size of the nation’s health budget – less in their pockets today than if the cake were shared as it was in the late 1970s.

In the US, the sum stands at £500bn. There a typical worker would be more than £3,000 better off if the distribution of output between wages and profits had been held at its 1979 level. In the UK, they would earn almost £2,000 more.

The effect of this consolidation of economic power is that the two most effective routes out of the crisis have been closed. First, consumer demand – the oxygen that makes economies work – has been choked off. Rich economies have lost billions of pounds of spending power. Secondly, the slump in demand might be less damaging if the winners from the process of upward redistribution – big business and the top 1% – were playing a more productive role in helping recovery. They are not.

Britain’s richest 1,000 have accumulated fortunes that are collectively worth £250bn more than a decade ago. The biggest global corporations are also sitting on near-record levels of cash. In the UK, such corporate surpluses stand at over £60bn, around 5% of the size of the economy. This money could be used to kickstart growth. Yet it is mostly standing idle. The result is paralysis.

The economic orthodoxy of the past 30 years holds that a stiff dose of inequality brings more efficient and faster-growing economies. It was a theory that captured the New Labour leadership – as long as tackling poverty was made a priority, then the rich should be allowed to flourish.

So have the architects of market capitalism been proved right? The evidence says no. The wealth gap has soared, but without wider economic progress. Since 1980, UK growth and productivity rates have been a third lower and unemployment five times higher than in the postwar era of “regulated capitalism”. The three post-1980 recessions have been deeper and longer than those of the 1950s and 1960s, culminating in the crisis of the last four years.

The main outcome of the post-1980 experiment has been an economy that is much more polarised and much more prone to crisis. History shows a clear link between inequality and instability. The two most damaging crises of the last century – the Great Depression of the 1930s and the Great Crash of 2008 – were both preceded by sharp rises in inequality.

The factor linking excessive levels of inequality and economic crisis is to be found in the relationship between wages and productivity. For the two-and-a-half decades from 1945, wages and productivity moved broadly in line across richer nations, with the proceeds of rising prosperity evenly shared. This was also a period of sustained economic stability.

Then there have been two periods when wages have seriously lagged behind productivity – in the 1920s and the post-1980s. Both of them culminating in prolonged slumps. Between 1990 and 2007, real wages in the UK rose more slowly than productivity, and at a worsening rate. In the US, the decoupling started earlier and has led to an even larger gap.

The significance of a growing “wage-productivity gap” is that it upsets the natural mechanisms necessary to achieve economic balance. Purchasing power shrinks and consumer societies suddenly lack the capacity to consume.

In both the 1920s and the post-1980s, to prevent economies seizing up, the demand gap was filled by an explosion of private debt. But pumping in debt didn’t prevent recession: it merely delayed it.

Concentrating the proceeds of growth in the hands of a small global financial elite not only brings mass deflation – it also leads to asset bubbles. In 1920s America, a rapid process of enrichment at the top merely fed years of speculative activity in property and the stock market. In the build-up to 2008, rising corporate surpluses and burgeoning personal wealth led to a giant mountain of footloose global capital. The cash sums held by the world’s rich (those with cash of more than m) doubled in the decade to 2008 to a massive trillion.

Only a tiny proportion of this sum ended up in productive investment. In the decade to 2007, bank lending for property development and takeover activity surged while the share going to UK manufacturing shrank. While the contribution to the economy made by financial services more than doubled over this period, manufacturing fell by a quarter.

Far from creating new wealth, a tsunami of “hot money” raced around the world in search of faster and faster returns, creating bubbles – in property, commodities and business – lowering economic resilience and amplifying the risk of financial breakdown.

New Labour’s leaders were right in arguing that the left needed to have a more coherent policy for wealth creation. That is the route to wider prosperity for all. But the central lesson of the last 30 years is that a widening income gap and a more productive economy do not go hand in hand.

An economic model that allows the richest members of society to accumulate a larger and larger share of the cake will eventually self-destruct. It is a lesson that is yet to be learned.

Stewart Lansley is the author of The Cost of Inequality: Three Decades of the Super-Rich and the Economy, published by Gibson Square © 2012 Guardian News and Media Limited or its affiliated companies. All rights reserved. | Use of this content is subject to our Terms & Conditions | More Feeds