THE INEQUALITY PARADOX IS THAT WHILE INEQUALITY HAS BEEN RISING within nations, especially in the West, poverty (and especially extreme poverty) has been falling.
Does this mean that the higher the level of inequality the lower the level of poverty?
Of course not. But the paradox draws attention to an uncomfortable fact – poverty and inequality are not the same thing and sometimes a third force (in this case mainly globalisation) can push world poverty down while at the same time increasing inequality in individual countries. In Chapter 6 we see that this has been associated with a reduction in the extent of inequality between countries.
The subtitle ‘Can Capitalism Work for Everyone?’ draws attention to the fact that at a time of increasing perceived inequality, liberal capitalism is under attack from Marxists on the Left and from those opposing migration and free trade and supporting various forms of protectionism on the so-called Right. Both blame increasing inequality in individual countries on liberal capitalism. This book considers the validity of the points made in these attacks and looks at what needs to be done to make capitalism work in ways that make it both more inclusive and more acceptable.
My experience, while growing up in Malaysia, of the difference in the standards of living between those of us with a Western background and those native to the Far East was what interested me in the related issues of poverty and inequality.
People often confuse the two.
By far the most important economic development in the past 25 years is that the number of people in extreme poverty (on the World Bank definition) has fallen from 1,958 million people to 769 million people between 1990 and 2013 (2013 is the latest year for reasonably hard data on this subject), from 37.1% to 10.7% of the world’s population.1 This statistical data is backed up by health indicators and life expectancy data. It has been confirmed by the late lamented statistician Hans Rosling who described what this data was starting to show in a highly acclaimed TED talk.2 It is also backed up by statistics on nutrition and health (see Chapter 6). It may seem perverse that while there is evidence in Western economies of increased poverty, total poverty in the world is decreasing. Moreover the fall in poverty appears to be continuing, at least in some countries. Chinese Premier Li Keqiang, at the opening meeting of the first session of the 13th National People’s Congress in March 2018, claimed that ‘more than 68.5 million rural people had been lifted out of poverty in China over the past five years’ with the ‘national poverty rate falling from 10.2 percent to 3.1 percent’.3 This is a fall from nearly 100 million people to 30 million. World Bank data on world poverty for the new base year of 2015 will be published around the time this book comes out.
Meanwhile globalisation has changed the geographical distribution of poverty. Poverty used to be a long way away and people in Western economies could ignore it if so inclined. While there is now much less poverty in absolute terms, much more of it is on our doorsteps, sometimes literally so with the number of rough sleepers in London having risen from 3,975 in 2010/11 to 8,108 in 2016/17.4 This amounts to 90 per 100,000 residents. The problem of homelessness in the US is rather more serious. The data shows New York’s problem as nearly ten times worse with 887 homeless per 100,000, with San Francisco nearly as bad with 795 homeless people per 100,000 residents.5 Most people would consider that even if (as is the case) global poverty is diminishing, poverty in their own area is a problem that has to be addressed if possible.
What is superficially bizarre is that this reduction in global poverty happened mainly at a time when inequality in most Western countries was increasing at its fastest rate ever.
It is the contrast between the apparent falling poverty and the rising inequality within countries in the West until about ten years ago that has generated the title of this book.
Thomas Piketty in his best-selling book, Capital in the Twenty-First Century,6 makes the case that the cause of the rise in inequality is essentially an increase in the extent of exploitation. In my view, this is responsible for substantially more than a negligible proportion (see Chapter 3 for a discussion about how much of the rise in inequality is due to this factor). And because it is the most blatant and offensive cause of inequality it is important to act to minimise inequality from this source.
But research from both Harvard University and the IMF supports my back-of-the-envelope calculations that this is by no means the most important cause of the recent rise in inequality in Western economies. The evidence seems to suggest that globalisation, particularly the combination of globalisation and the advance of technology, is a much more potent cause of both increased inequality and increased poverty in Western economies (again, see Chapter 3 for a discussion of the allocation of responsibility between different causes). Globalisation seems to have increased inequality within countries while at the same time reducing inequality between countries.
Looking forward, the jury is out on the extent to which inequality from exploitation will increase further. Piketty’s argument that it would do so because the rate of interest and hence the rate of capital accumulation would exceed the rate of growth has not been supported in recent years as ultra-loose monetary policy has kept interest rates at rock-bottom levels. But as more of the world’s economy shifts to countries with less well embedded traditions of law and anti-corruption, it is quite possible that so-called crony capitalism (unfair, really, to call it capitalism because it is really the antithesis of capitalism in that it is based on government controls and normally operates to exclude competition) will grow, leading to increased exploitation. In addition, the likelihood of super-high profits in tech and other monopolies could and probably would also lead to increased exploitation. But there are also trends going the other way. And there are also remedies that public policy could apply to reverse some of the trend towards increased exploitation.
My take on globalisation is that we are roughly halfway through the process of technological catch-up as the spread of education worldwide means that historic gaps between the East and the West disappear. It is likely (see Chapter 5 for a fuller discussion and explanation) that as the East continues to grow living standards will actually rise above those in the West, as they already have in Singapore and Hong Kong. So there is more impact from globalisation to come. But it is likely the biggest impact on low-labour-cost jobs has already been felt. Labour costs in many Eastern economies, especially China, are rising dramatically. The competition from the East is likely to affect work at much higher skill levels than hitherto and hence have a different impact on inequality in the West compared with that of the changes that took place over the past half century.
It is worth pausing at this point to consider whether any level of poverty is ‘acceptable’. Jesus is reputed to have said ‘the poor are always with us’.7 In most modern Western societies strenuous attempts are made with considerable amounts spent on welfare to try to stop poverty. Yet it still exists. Why?
There is a mix of reasons. Obviously if you believe that the size of the economy is predetermined and that the only issue is how to slice up the cake, any poverty at all seems unacceptable. But this is an extreme view shared by few and runs in face of the evidence that the size of the cake is dependent on how it is baked. Most attempts to impose massive redistribution by the state – e.g. in the USSR, China under Chairman Mao or more recently Venezuela – have not only led to brutality on a massive scale but have also been fairly unsuccessful. There are some examples of success in small cohesive societies in some parts of Europe, especially in Scandinavia, but even these successes seem now to be breaking down under pressure from migration (see Chapter 7 for an interesting discussion of why Scandinavia has seemed to work well despite appearing to flout the obvious rules for achieving growth). It seems difficult to redistribute on a sufficient scale to eliminate poverty even in relatively affluent Western societies. Where it does seem to work best is when the redistribution is carried out on a local scale or in a relatively small and cohesive society.
The greatest success in reducing poverty ever on a massive scale has been the result of the industrialisation of the formerly emerging economies over the past 50 years. As I point out elsewhere in this book, this is not a wholly capitalist phenomenon (or ‘supply side’, or whatever term one wants to use to describe a partly market-based approach). In China, particularly, the policy was a clever mix of using governments to provide infrastructure and education and other relevant background support and using export markets and private investment to provide the combination of skills, markets and technologies to fuel economic growth. So the issue is not so much ‘how much poverty if any is acceptable?’ but ‘how best to reduce poverty?’ As pointed out in Chapter 11, the main harvest from reducing poverty by economic growth has probably been picked. Looking forward, it seems that other methods (in particular ending the wars that are creating so much hardship in many countries) will be necessary to reduce extreme poverty further, though it is reasonable to predict as well as hope that continuing economic growth will continue to improve the prosperity of people who, even if above the extreme poverty line, are certainly still poor by most reasonable measures.
In the future the continuing impact of exploitation and globalisation is likely to be deepened by two factors that have until now had much less impact – technology and ‘superbabies’.
My experience from writing my last book, The Flat White Economy, and also from my time as Chief Economist for IBM (UK) is that we are now at a technological turning point as 12 key technologies leap forward – of which perhaps the most important are robotics, AI, autonomous vehicles, blockchain technologies, 3D printing and genomics.
Technology will bring back the problem of inequality and force us to think hard about solutions. It is important that we do not go for the wrong ones that would make our problems worse.
And technology is not the only new factor driving inequality. ‘Superbabies’, the progeny of highly educated people who meet at university, have the benefits not only of selective breeding but also the best parenting, good nutrition, regular exercise both physical and mental, as well as good education and sharp-elbowed parents determined to find the best for their children. Unless resources are deliberately channelled to the schools of the least advantaged, it is likely that the children of these meritocrats, and even more their future generations, will make it increasingly difficult for mobility to take place in society. On top of this will be the effects of genetic modification if it is allowed to take place (and it seems hard to prevent it). Any benefits from this are unlikely to be distributed evenly.
This book contains some detailed research on the persistence of wealth which suggests that it takes not three but five generations for most wealth to evaporate, but it also contains statistics on how mobility between classes is diminishing as a result of the entrenching of social positions, especially between the better and the less well educated.
The key thing with inequality is to look at the problem clearly and hardheadedly. It is understandable that those losing their jobs or seeing their pay fall back in real terms see the issue with minds that can be clouded with emotion, anger and frustration. But emotion, anger and frustration can be bad guides for action.
Perhaps the worst problems caused by inequality are those of exclusion and alienation. There is good psychological theory that suggests that if people’s psychological needs are not met, ultimately they are likely to develop damaging behaviour traits or other psychological problems. Especially in the developed world in the West, many people at the less privileged end of society have a sense of a society where things are getting worse for people like them, and they see their own position in life declining, with little hope for the future for either themselves or their children. They feel that they have no control over the events affecting them, and their frustration about this has an impact on their mental and physical health.
These problems are not easy to deal with, and just throwing money at them often does surprisingly little to help. Good education (it is important to realise that in the modern world education is not just relevant to young people) is probably the single most important way of breaking into the cycle of deprivation. Providing high quality social services can also help. Continental Europe is currently handling this problem much better than either the US or the UK, though at possibly unaffordable cost and to some extent by creating a generation some of whom feel little obligation to work hard to pay their way. The increasing alienation of this group is likely to pose a future problem which will also have to be handled.
In Part IV of this book I set out how some of the problems arising from the pressures for increasing inequality can be dealt with. My contention is that it is possible to counteract the driving forces that are otherwise likely to increase inequality, but that it will require three things:
First, any solution needs to ensure that the economy can prosper. It would be possible to have complete equality of misery with negligible economic activity and poverty widespread. One hopes that no one would find that acceptable. Anyone who does is wasting their time reading this book.
Second, a careful and accurate identification of the main driving forces behind the growth in inequality is needed, so that their effects can be understood and where possible counteracted.
Third, when those factors driving the growth in inequality cannot easily be counteracted (or where the cost of counteracting them is excessive), policies need to be put in place to compensate so that the increase in poverty can be circumvented.
What this means is that we are likely to need to rethink a whole raft of policies, from education, through welfare, taxation and labour market policy so that the radical changes in technology that will affect us in the very near future can be absorbed with less pain than otherwise would be the case. These huge advances in technology will destroy or change most existing jobs, but they will almost certainly create many new ones, mainly in areas that we cannot possibly imagine. The impact on existing jobs might lead to either unemployment or a huge increase in inequality. But neither has to be the case if we can build the right kind of flexibility into both the product markets and the labour market. This might be complicated since the instinctive temptation when faced with such pressures is to reduce labour market flexibility by protecting jobs rather than to increase flexibility, even if the latter would ultimately be better for both jobs and people.
At the same time there is no substitute for good education, and not just for counteracting the effects of ‘superbabies’. Moreover, it is vital that the schools for the most disadvantaged get the best teachers. Some may want private (or, as they are quaintly known in the UK, public8) schools shut down. I’m not keen on that because I hate banning things unless their side-effects are dangerously bad for society. The jury is still out on whether introducing such a disruption to the country’s educational system would be justified in order to improve social cohesion, particularly as there are plenty of unused large buildings in many other countries waiting to be put to good use.9 But something certainly needs to be done to channel the best resources into the education of the most disadvantaged. And education needs to be seen as a lifelong requirement – not just something that you do at the beginning of your life. Education needs to be backed by training and retraining to enable people to have the skills necessary at any point in time.
Although this book points out that exploitation is not even the major cause of inequality, it is vital that those excesses of capitalism that do exist (and there are many) should be ruthlessly extirpated. Not only are they damaging to both economic activity and inequality, they are damaging in a particularly offensive way. Moreover they stir up opposition to the economic system and to business. There are ways of making it much more difficult to exploit the rest of society through means such as crony deals between businessmen and politicians, crooked banking and overpowerful tech companies.
A new Teddy Roosevelt is needed to bust the trusts and ensure that politicians around the world work harder to resist the pressure of lobbying from such sources. I don’t have much hope for politicians discovering backbone where none previously existed, but the best way of reinforcing good intentions is for public opinion to understand the problem and for the public to be seized with the need to ensure that their elected representatives deal with it effectively. This means an electorate who use their muscle when appropriate but who also are prepared to study issues sufficiently closely to reject unworkable and oversimplistic solutions.
Government itself needs to be careful that, through the law of unintended consequences, it does not itself cause or exacerbate inequality by imposing the wrong or excessive taxes or regulations that ossify the status quo, or by adding to costs and prices and so squeezing the standard of living, or by restrictions of supply through rental policies, planning policies, inefficient provision of public transport and other measures with less obvious effects, such as the impact of lax monetary policy on asset prices, or by keeping prices high by weak competition policy or lax regulation of so-called natural monopolies.
Western societies need to take advantage of opportunities to reduce inequality by permitting new technologies to bring down the cost of living. When Western societies had little competition we built quite a high cost way of life through strict regulation and high taxes. We may need to curb some of the practices that were affordable when we competed only with people as wealthy as ourselves. We are also likely to need to focus an increasing proportion of public expenditure on redistribution, so we will need to economise where possible on other areas to ensure that the maximum is available for this purpose.
It is worth noting that Singapore has a much higher GDP per capita than the UK yet its cost of living (despite high house prices) is about two-thirds of that in the UK. It would be worth learning from countries such as Singapore and its best practices in some areas, especially public administration and government. In many areas such as health, defence, infrastructure, education and housing Singapore manages the amazing trick of providing high quality services at relatively low cost.
High prices in the West are often added to by regulations (often gold plating prudential requirements for safety and health), tariffs, taxes and lack of pro-competition policy. And some high prices in the UK result from charges imposed by government itself, often taking advantage of its own monopoly power to raise revenues from those who cannot avoid the charges. The same is true but to a lesser extent in the US. Policy can be changed to bring down these excess charges though there will be an impact on public finances.
Technology is also driving some products and services into the world of ‘post scarcity’. I was at a conference in Berlin last year where the head of one of the largest businesses in Europe openly speculated about the likelihood of energy being free (other than connection costs) within a quarter of a century as renewable resources are properly harnessed. Post scarcity in theory should make it possible for prices of some products to fall to negligible levels. It is important that this is allowed to happen so that the cost of living can be reduced.
Fifth, it seems likely that there should be a gradual introduction, as it becomes affordable, probably in the 2030s and 2040s, of a Universal Basic Income. This won’t solve inequality but it will make some of the inevitable inequality less intolerable. It will also allow people to do the low (measured) productivity service, craft, lifestyle and caring jobs that will increasingly be the sensible choice for many but are at present ruled out by the combination of selective welfare and minimum wages. The fact that the premature pilot scheme for Universal Basic Income in Finland has been scrapped should not be seen as an indicator of whether this idea might or might not be appropriate at the right time. Currently the costs are not affordable, but as technology develops they should become so.
Finally, our whole system of taxation is likely to need to change. In most countries the current system of taxation mainly focuses on incomes and especially on labour incomes. This is likely to need to be rebalanced if production becomes more capital intensive and relatively less labour intensive. The first reason is that if increased labour market flexibility is required, high rates of labour and income taxation may need to be reformed. The second is that it is likely that, as technology becomes more dominant, capital incomes will become a growing share of GDP and the current focus on labour and employment taxes would mean a declining yield. The third reason is that an increasing role of the tax system will have to be the need for redistribution.
I am not a great believer in high taxes, which often cost more money than they raise as a result of their impact on incentives and hence the tax base. But despite this, there is scope for making tax itself much more redistributive, and in many countries (largely in emerging economies) there remains scope for higher rates of direct tax to finance redistribution without damaging growth and destroying incentives. Elsewhere, however, the focus needs to be more on reducing high marginal rates of direct taxes, which in many countries are above the revenue maximising rate, and moving the focus of taxation to taxing wealth instead, particularly through death duties. I believe that if the idea was sold carefully, it would also be possible to raise considerable sums through voluntary taxes, particularly voluntary death duties. It would be important for these voluntary payments to be visible, at least for private individuals.
What is interesting here is that many previous studies of inequality have focussed on great macroeconomic solutions for the problem. My take is different. The problem cannot be completely solved without throwing the baby out with the bathwater and in particular worsening poverty. But there is a lot that can practically be done with micro measures. I apologise if these don’t appeal to those of a utopian disposition, but often the so-called best is the enemy of the good.
There is a growing industry of writing about inequality. In preparation for this book I have analysed more than 40 books or major articles on the subject (see Chapter 2) and I suspect many more have been left unread.
This book tries to look at the issue from a broader perspective than some. It makes a clear distinction between poverty and inequality. Sometimes increasing inequality goes hand in hand with increasing poverty. Sometimes it doesn’t and, as in the recent past, the same process that has on occasions led to increasing inequality within countries has also reduced global poverty. When there is a trade-off between the two, I’m very much on the side of reducing poverty, which seems to me to be more important than reducing inequality. On the other hand, it is inequality rather than poverty per se that seems to lead to increased alienation.
The book distinguishes between three different types and four different causes of economic inequality, all of which have different policy implications, some of which are contradictory.
I make an important distinction between the psychological and material aspects of inequality. The people amongst whom I grew up in Malaysia were often amazingly poor by Western standards. But they had hope in the future. People in menial jobs, such as domestic servants, would often invest nearly half their take-home pay in private education to give their children a better life. That degree of self-sacrifice humbled me.
The contrast is the despair and alarming decline in life expectancy in white working-class males in the US, a trend I noticed first when the same thing happened earlier in Glasgow. These people in Western societies whose health is declining are in absolute terms much better off than those in Malaysia who were investing so heavily in the future. But they have lost hope. It will be important for a healthy society to address the psychological needs of these people and give them back hope.10
I doubt if many who have lost hope will read this book. But if some of its messages can be transmitted to them and understood by them, it may reduce their despair to a degree as they realise the causes of their frustrations and what might be done to minimise them. In some cases there is little that will actually work for them other than cushioning some of the worst aspects, which is very sad. But at least the ideas in this book should help limit the extent to which their problems are transmitted to the next generation.
Finally, this book incorporates new research into the transmission of wealth and inequality between generations. It does appear that there is some truth in the old saying ‘Clogs to clogs in three generations’, though the research indicates that the time taken for 95% of an initial increase in wealth to disappear is more like five generations. But the ‘superbaby’ phenomenon may already be starting to offset that in entrenching inequality across the generations. Already there is increasing evidence that educational inequality is much deeper rooted than income inequality.
Some of the biggest dangers from inequality are in the political backlash that it is likely to generate. If inequality causes voters in democracies to pull down the relatively liberal economic order that underpins their current living standards, even Western civilisation itself could be at risk. The Western economies are already losing their place in the economic pecking order to an Eastern world imbued with the single-minded focus and determination that comes with a still fresh knowledge of recent poverty. But the Western world still sets the moral and cultural norms for much of the world. I don’t think Westerners are superior, but these norms have evolved over a long period and have advantages over the less legally based and more dictatorial approaches common in the East.
The chapters in this book are divided into four parts. Part I ‘Setting the scene’ defines the question that the book tries to answer. It asks whether we are more worried about poverty than simple differences of economic outcome. And its answer is ‘Yes, but’; Part II ‘Analysis and implications’ looks at inequality and its economic impact; Part III ‘The deserving and the undeserving rich’ looks at the new rich and whether they contribute to society; and Part IV ‘Fixing the problem’ looks at what solutions might work in reality.
Although the chapters in this book are self-standing, their ordering is deliberate. The reasons why the solutions in Part IV are likely to work are based on the analysis in the earlier sections. It therefore makes sense to read them consecutively.