The YouGov polling presented at the start of this analysis demonstrated very clearly that voters in all parts of the world are more worried about poverty and unemployment than inequality or the existence of a super-rich elite. But friends of capitalism should not close their eyes to the gap between the top and the bottom.
INEQUALITY IS GROWING
The OECD has argued that inequality is still growing in developed nations. Thirty years ago the top 10% of earners received seven times as much as the bottom 10%. That multiple is nearly ten now – although some believe it reflects a growing gap between the top 0.1% and everyone else rather than the top 10% and everyone else. The "gap" is particularly wide in America. Janet Yellen, the chairperson of the Federal Reserve has noted that the average income of the top 5% of households grew by 38% over the last quarter century but grew by less than 10% for all other households. Some of these statistics are disputed. Inequality hasn't grown so much if you calculate final incomes (after benefits and other transfer payments) rather than market incomes (simple wages). It’s also better to measure inequality over the full length of economic cycles rather than at the beginning of a recovery. This is because inequality often widens during tough years of famine but declines during feastier years.
And then there’s the question of whether we should measure inequalities of income, wealth or consumption? Inequalities of wealth provide the most depressing picture (and have grown because of quantitative easing - £375 billion in Britain alone) but greater access to a whole range of consumer goods amongst even the lowest-paid provides the basis for arguments that this is an age of unprecedented equality. Even the poorest people in advanced nations have access to food, entertainment and medicine that a king or president couldn’t enjoy fifty years ago. All of us in the West are certainly richer than Pharaoh Ramesses II, the great pharaoh once regarded as the most powerful man on earth. Richer in access to medicine, culture and technology – even travel.
Any increase in inequality within advanced nations should also be examined alongside global reductions in inequality. Tyler Cowen has reported “good evidence” that the rise of Chinese exports has held down the wages of some parts of the American middle class – just as immigration of low-skilled workers into the US has had a negative impact on the wages of lower-skilled Americans. At the same time both changes have benefited the wealthy within America – because of the stocks they own in global companies that invest in China and because it’s cheaper for them to hire cleaners, home helps and other more menial workers. Overall it’s an encouraging picture – but not without some serious complications for lower income citizens of the more mature economies.
INEQUALITY SHOULD CONCERN FRIENDS OF THE FREE MARKET
At the end of the 1980s the British Tories did exhibit a tendency to diminish inequality and relative poverty. In a speech entitled “The End of the Line for Poverty” the then social security minister John Moore suggested that the war on poverty was over because the “stark Dickensian poverty” of the previous century had been abolished. On becoming Tory leader nearly two decades later, David Cameron begged to differ:
“Even if we are not destitute, we still experience poverty if we cannot afford things that society regards as essential,... The fact that we do not suffer the conditions of a hundred years ago is irrelevant… Fifty years from today, people will be considered poor if they don't have something which hasn't even been invented yet.”
In the third chapter of this Prosperity for All report I urged friends of capitalism to rediscover the moral seriousness of Adam Smith. That rediscovery should include his musings on inequality and his recognition that the nature of poverty changes over time:
“A linen shirt is, strictly speaking, not a necessary of life. The Greeks and Romans lived, I suppose, very comfortably though they had no linen. But in the present times, through the greater part of Europe, a creditable day-labourer would be ashamed to appear in public without a linen shirt, the want of which would be supposed to denote that disgraceful degree of poverty which, it is presumed, nobody can well fall into without extreme bad conduct.”
STRENGTHS AND WEAKNESSES OF THE PIKETTY ANALYSIS
The central contention of Thomas Piketty’s “Capital in the Twenty-First Century” is that capitalism inevitably increases inequality and some factors would appear to confirm his side of the argument:
· There are the new technologies that replace labour with machines – increasing unemployment whilst richly rewarding their inventors.
· There are, as Tyler Cowen noted above, the disproportionate benefits to the wealthy that flow from investments in emerging markets and because of some immigration.
· Then there are unequal rates of inflation for different social groups. Average rates of inflation have been higher for poor Americans in 139 of the last 168 months according to the Federal Reserve. Additionally, many of the poor, for example, get poorer because they pay more for their electricity than the rich – because they are unable to pay with direct debit or benefit from corresponding discounts. The pattern is repeated for other basic services.· They also pay more to borrow or cash cheques. A report by Matt Fellowes and Mia Mabanta for the Brookings Institution estimates that exclusion from basic banking services can cost a full-time worker $40,000 over their full career.
· The rich meanwhile either buy private education for their children or buy themselves into the catchment areas of good schools. Advantage begets further advantage.
· They then help their children on to the housing ladder. The London property market provides a particularly good illustration of the Piketty thesis that capital earns more than labour. The daily increase in the value of some London homes exceeds the income that many people can earn from any salaried job. The tightly-regulated nature of land use in Britain – “socialism rather than capitalism” - might be the key causal explanation for this phenomenon but, whatever the cause, those already owning properties in major global hubs like London are getting much richer still – and at expense of those yet to get their feet on the housing ladder.
Not every trend validates the Piketty thesis, however. There are some powerful trends in the other direction, too, which suggest inequality need not grow. Reviewing Piketty, Bill Gates has blogged that there is still enormous social mobility and social churn in otherwise unequal nations like the United States: “Take a look at the Forbes 400 list of the wealthiest Americans. About half the people on the list are entrepreneurs whose companies did very well (thanks to hard work as well as a lot of luck). Contrary to Piketty’s rentier hypothesis, I don’t see anyone on the list whose ancestors bought a great parcel of land in 1780 and have been accumulating family wealth by collecting rents ever since.”
Blockbuster, the video rental company. Borders, the bookseller. Woolworths, the UK and US supermarket chain. Ratners, the jewelry chain. The DeLorean Motor Company – that survives today only in celluloid, as the time travelling car of the "Back to the Future" movies. Pets.com, the petfood seller that heralded the (first) dotcom bust. TWA, PanAm and Eastern Air Lines, the airlines that went bankrupt. Arthur Andersen, one of the big five accountancy firms that collapsed because of its role in “auditing” Enron. And, of course, Lehman Brothers. Capitalism is a system of constant (creative) destruction.
Gates chastises Piketty for only looking at the factors that increase inequality – rather than those that also erode it. He cites “instability, inflation, taxes, philanthropy, and spending”. By spending he means the conspicuous consumption of some rich people. Yachts and £10,000 handbags spring to mind. Research from the Williams Group wealth consultancy - highlighted by the Wall Street Journal - shows that family money doesn’t cascade down the generations for long. 70% of inherited wealth has evaporated by the end of the second generation and 90% by the third. The old proverb "shirtsleeves to shirtsleeves in three generations" – an American translation of the Lancashire proverb "there's nobbut three generations atween a clog and clog" - seems to be holding true.
THE LEFT THINK YOU CAN SOLVE THE DEFICIT PROBLEM BY TAXING THE RICH…
THE RIGHT THINK YOU CAN SOLVE THE DEFICIT PROBLEM BY SQUEEZING THE POOR...
THE WELL-FED ELEPHANT IN THE ROOM, HOWEVER, IS THE MIDDLE CLASS – AND THEIR ENTITLEMENTS
If public policy is to continue to ensure some fairness in “final incomes” some tough questions need to be asked of politicians and their current spending priorities. So much of existing public spending goes to marginal/battleground electorates rather than to the most deserving. It goes to pensioners who tend to vote rather than to young people who are more likely to stay at home – even though younger people are poorer on average than older people. It subsidises landlords through housing benefits rather than the next generation through the building of new homes. Those concerned about inequality should fix the priorities of the welfare state before they even begin to think of making government even bigger. Given tax competition across the world it might be the only option. Mark Littlewood of the London-based Institute of Economic Affairs believes that advanced nations like Britain may be at the limit of what they can levy on footloose business and high net worth individuals (see point 7 of this ten point briefing).
At a recent Georgetown University seminar on poverty President Obama advocated a number of investments to help the poor – notably in infrastructure - but Arthur Brooks of the American Enterprise Institute urged him to confront the elephant in the room – middle class entitlements. “Why,” he argued, “are cities like Detroit or the federal government facing serious fiscal problems? Not because they have low tax rates, or because they are spending exorbitant amounts on infrastructure and education. It is primarily because of guaranteed, middle-class transfers (pensions, Medicare, Social Security, etc.) that are crowding out the ability to pay for other public goods.” As Mitt Romney memorably opined: about half of Americans are “takers” rather than “makers” – at least for part of their lives. In Britain – according to the Centre for Policy Studies - 51.5% of households are receiving more from the State (in cash benefits and benefits-in kind) than they are paying in taxes. This may be a deep-seated “bug” in how democracy works. Most of us squeal when the government threatens our winter fuel allowance or child benefit, for example, but the stealthy taxes that politicians impose in order to fund those benefits hit us more gradually and are harder to notice.
When Congressman Paul Ryan – now Speaker of the US House of Representatives - came forward with a plan to bring America’s deficit under control a few years ago it was warmly received by the US Right and made a considerable contribution to him being chosen as Mitt Romney’s running mate for the 2012 presidential election. But the Ryan plan hardly touched entitlement programmes like Medicare (accounting for 16% of total federal spending) or Social Security (accounting for 37% of all federal spending) which benefit most Americans. In sharp contrast, wrote Derek Thompson for The Atlantic: “Medicare would hardly be cut and Social Security would see exactly $0.00 in cuts. In the next decade, Ryan's plan is essentially a vision of America where deficits fall because government assistance to the poor and sick rapidly shrinks. It solves our income inequality problem like a flamethrower helps a house fire.” But, as Alan Viard has argued in a briefing paper for the AEI, true entitlement reform has to hit upper and middle income groups, as much as lower income groups:
“The Congressional Budget Office’s latest long-run projection of current budget policy does show rapid growth for one low-income entitlement. Medicaid [targeted on lower income Americans], together with related health subsidies, is slated to grow from 1.9% of GDP in 2011 to 3.7% in 2035. But, that 1.8-percent-of-GDP expansion is overshadowed by the 4.3-percent-of-GDP expansion – from 8.5 to 12.8% – slated for Medicare and Social Security. Meanwhile, all other federal programs are slated to shrink from 12.3% of GDP to 8.5%...
It’s disturbing that the agriculture portion of the bill includes $36 billion of food stamp cuts while leaving subsidies for middle-income and upper-income farmers completely unscathed...
The long-term fiscal gap won’t be closed by undermining the safety net for the bottom 20%, any more than it will be closed by merely raising taxes on the top 1 to 3%. To close the gap, those in between – the middle class, broadly defined – will have to bear much of the burden, through a mixture of entitlement cuts and tax increases.”
British Conservatives are cutting more equitably than the “Ryan-ite” Republicans in the USA (and Ryan himself has been on something of a journey since his original plan) but are still struggling to tackle the biggest middle class entitlement of them all: the basic state pension. The Tory government has promised retired people a “triple lock” on their state pension. Under this “lock” their pension will grow by at least the rate of inflation, the average level of earnings or by 2.5%. This lock is both inequitable and hard-to-afford. It is regressive because the Institute for Fiscal Studies calculates that pensioners are now better off, on average, than the working age population, and the state pension is growing at a time when income supplements for low income workers are being cut back. The lock is also deficit-denying according to the British Government’s own Actuary Department. The Financial Times reported that “The extra cost of the triple lock, compared with an earnings uprating, is projected to add about 9 per cent to benefit expenditure by 2040, rising to around 23 per cent by 2070. But this figure could balloon to 11 per cent in 2040, and 41 per cent by 2070 under a “new normal” scenario of low inflation, low earnings growth. However, in a “Japan deflationary” scenario, triple-locked pensions could cost 238 per cent more than earnings-linked pensions in 2070, warned the report.”
THE INVERSE CARE LAW
Middle income groups have always been effective at maximising their take from government services. Julian Tudor Hart’s “inverse care law” was proposed four decades ago but it still holds true. Annette Hastings and Peter Matthews of the LSE recently identified, for example, the considerable evidence that middle class people are able to get more from universal services because of their social-cultural skills: “In schooling, it might mean getting your child prioritised for specialist educational interventions or in health longer consultation times with your GP. Planners might avoid siting controversial projects in your locality in anticipation of concerted protest.” But it is in protecting their benefits that the middle classes are most effective. One of the most politically difficult cuts made by the Conservative Chancellor George Osborne during the 2010 to 2015 parliament was a restriction of child benefit to those earning more than £44,000. Tory insiders say the organised resistance to this measure by sections of the electorate who are more likely to vote than poorer workers explains the subsequent failure to trim benefits for the better off.
Deficit cutting might become fairer across the generations and across different income groups if voter turnout was more even. It is far from representative at present. About 76% of pensioners cast a ballot at the 2010 British general election but only 44% of first-time voters did. 76% of higher income voters in the better-off AB social class turned out, but only 57% of DE voters did. It’s similar in the USA. Turnout can reach 78% amongst those earning over $150,000 pa but be as low as 41% amongst the poorest. 41% of 18 to 24 year olds turned out to vote in the 2008 presidential election but 70% of over 75s exercised a vote. One way of addressing this problem would be to introduce compulsory voting. Belgium, Brazil and notably Australia are among about 30 nations that already require their citizens to turn up at the ballot box and the new Prime Minister of Canada, Justin Trudeau, has promised to consider introducing it for his country. Anyone who loves freedom will be at least a little bit uncomfortable at the prospect of compelling people to vote (ballot papers would have to include a “none of the above” option) but a greater problem would be if advanced nations became a modern equivalent of gerontocracies where older and richer people decide the political and fiscal priorities of a nation. Compulsory voting isn’t primarily about compelling voters. It’s about compelling politicians to reach beyond their comfort zones. It’s a 20-minute burden for voters once every four or five years but it might compel our politicians to change in fundamental ways and to build much broader and more representative voting coalitions. Short of introducing full compulsory voting would be a reform that required just first-time voters to turn up at polling booths. There is some evidence that this encourages the voting habit. Another more radical solution to this problem would be “Demeny voting”. Based on an idea from 19th century demographer Paul Demeny this would give parents extra voting power so that they could ensure the interests of minors were reflected in a government’s priorities. Reihan Salam examined “a conservative case” for enfranchising children in the National Review. Personally I like the idea but readily recognise its chances of being enacted equal about zero!
The bailouts only increased the middle class dividend. As Andrew Lilico has observed, the primary beneficiaries of the bank bailouts were the banks themselves but the middle classes:
“The main people the bailout saved were ordinary savers, pensioners, homeowners, folk with net assets of £200,000 to £1m.They are the key origins of “capital”, not some “1%”. If you want a system that is properly fair and just, you need to be willing to see those with £200,000 fall back to having £150,000, or those with £1m sometimes fall back to £400,000 or £100,000. Just as “intergenerational justice” regarding house prices is nothing to do with £20m Chelsea mansions but everything to do with £600,000 houses in the shire counties, so economic justice with respect to capital versus work is little to nothing to do with a few billionaires but, instead, everything to do with hundreds of thousands to millions of people with £200,000 to £1m net assets.”
Confronting middle class entitlements rather than Piketty’s unrealistic idea of a global wealth tax is a more likely path to affording anti-inequality policies (notably early intervention and housebuilding programmes). The one country that did embrace a super tax on the wealthy – Piketty’s native France – has already decided it was counterproductive and has abandoned it. It would need to be global in order to stop the rich jumping from high tax jurisdictions to low tax climes but the chances of any worldwide agreement on a super tax is next to nil. Even Demeny voting would be easier to introduce. The same governments that for twenty years have failed to agree action against climate change are unlikely to all suddenly join hands and sign up to a global tax regime.
Insofar as tax policies can be used to tackle inequality it will have to be imposed at the level of nation states, modestly and shouldn’t be focused on income. Already in Britain the top three thousand income taxpayers pay more tax than the nine million lowest-paid income taxpayers. Inequality is greatest in wealth and property rather than income and that’s where any new taxes should fall. According to Janet Yellen the lower half of US households (by wealth) held only 3% of all wealth in 1989. By 2013 they only held 1%. Any new taxes should be imposed on properties because they can’t be hidden or, as Bill Gates suggests, luxury consumer goods. In Britain that could and should include new council tax bands for higher value properties. Ideally progressive property and consumption taxes would be replacement rather than new taxes and should fund reduced income taxes for the low-paid. There is certainly no global demand for higher taxes overall. A plurality or majority in 22 of the 44 electorates surveyed by Pew Research want lower rather than higher taxes. Electorates in 13 of the 44 nations preferred high taxes with slow growing European electorates most ready to accept the state extracting more. Tigerish Asian and African nations were most enthusiastic about low taxes.
ASSET-BASED SOCIAL POLICY
Mrs Thatcher had the right idea in the 1980s when she transferred the ownership of local authority housing and nationalised companies to private ownership. A larger middle class emerged as more people owned their own homes and shares. Wider ownership of such assets gives more people a stake in the success of capitalism. Margaret Thatcher’s mistake was not to do a lot more to encourage replacement housebuilding. The decline in housebuilding has left millions of people living in insecure, often cramped and usually expensive private rented accommodation. That’s bad for family life, bad for social justice and bad for faith in free market systems. Capitalism won’t survive in democracies if fewer and fewer people own capital.
INEQUALITY IS A MUCH MORE INGRAINED PROBLEM THAN THE LEFT REALISES
Building on the theme of chapter four and the importance of society this chapter should end by reinforcing the importance of social capital. The truth is that, if the Left is correct about the rise of inequality, it ignores the social roots of the phenomena. The liberal economist Noah Smith has come to accept the diagnosis of the libertarian social commentator, Charles Murray. In 'Coming Apart' Murray documents the growing gap in moral behaviours between the elites of America and the lower middle classes. Between elites that marry and non-elites that do not. Between elites that embed their children in strong social networks and non-elites that are isolated and members of weak social groups. Worse of all, complains Murray, the elites don't preach what they practice: they support forms of public policy that undermine marriage. The Marriage Foundation has found the same trends in the United Kingdom.
In an essay for Foreign Affairs, entitled “Capitalism and Inequality” (2013), Jerry Muller, Professor of History at the Catholic University of America, notes that the inequality that exists today does not result from inequality of opportunity. Most formal and informal barriers that once might have prevented ethnic minorities or women from advancing are heavily eroded – if not entirely overcome. (There is probably still much further to go in empowering people with disabilities). Today’s inequality largely stems from unequal abilities to exploit opportunity. He presents the case that those with strong, nurturing families are given huge advantages in being able to enjoy what free societies have to offer. He notes that education – the preferred panacea of many on the liberal Left – is not a sufficient answer. “One of the most robust findings of contemporary social scientific inquiry,” he writes, “is that as the gap between high-income and low-income families has increased, the educational and employment achievement gaps between the children of these families has increased even more.”
Robert D Putnam is another left-of-centre thinker who realises that the relational isolation of poorer American children is crippling their life chances. Speaking to US National Public Radio as part of the launch programme for his latest book, “Our Kids: The American Dream In Crisis” (2015) he explained the challenge:
“It's one of the things that we discovered when we talked to rich kids and poor kids around America, that we didn't expect - but kids, like my grandchildren and, like, you know, probably, like, your children or grandchildren, all across America have a lot of adults in their life that are reaching out to help them. They tell them about what it means to go to college... They describe, you know, how you can get through high school properly and where you can find a fellowship and - the bottom line of all of the statistics in our study is that poor kids are increasingly isolated from everyone. They just don't have stable, responsible adults in their lives much of the time. And that means they're just really ignorant. Not because they're stupid, but because they don't have mentors and adult helpers that most of us had when we were growing up.”
Yet again we learn that materialism is not enough. Relationship breakdown and economic hardship are not, of course, unrelated. If libertarian and liberal politicians need to end their indifference to family structure some change is also needed from cultural conservatives. Low pay, the deskilling of the working class and the consequences of high incarceration rates have all reduced the pool of “marriageable men” – men that women would like to marry and are candidates to be good fathers.
The “Marriage Opportunity Council” has been established in the United States – bringing together people of Right and Left – to discuss what a pro-marriage agenda might look like in an era when the divisive issue of same-sex marriage is moving towards being settled and new opportunities for co-belligerence can arise. When economists from the Federal Reserve estimate that 52% of new forms of inequality reflect changing family structure it is vital that public policy does take a relational turn. A more relational public policy was the focus of Chapter Four.
The menu page of Prosperity for All.
The homepage of the Legatum Institute.
Go to next chapter: On infrastructure.
