It is important to understand that the problem of growing inequality, is not just specific to the UK – it’s a worldwide problem. At least it is a sort of worldwide problem, in fact the last decade or so has seen a huge number of people lifted out of poverty, the proportion of the world’s population who are starving has been falling. We can blame globalisation for exacerbating the problem of inequality, but without it, it seems the only solution to helping the world’s poor would have probably had something to do with Bob Geldoff and Bono.
There is also the issue of the of reward to capital versus reward to labour. Throughout most of the world, including China, by the way, we have seen the share of GDP enjoyed by company profits grow, and the share going to wages fall.
As it happens, the UK has seen less change than most. This article makes the point well, compare the ratio of wages to GDP and we find that the percentage fall since 1975 has been 14 per cent in France, 12 per cent in Japan, 10 per cent in Germany and the Netherlands, six per cent in the US and three per cent in the UK.
This is a global phenomenon, but is less acute in the UK.
The rise in profits to GDP matters for multiple reasons, but what is not commonly understood is that just because companies are making more profits to GDP, it is does not mean they are making more profits than would otherwise have been the case.
Imagine the economy is a cake, then the slice taken up by profits has been growing. But would it not be better if the cake just got bigger?
The big problem with rising profits to GDP is that this has not been matched with a corresponding rise in investment. Instead, we get massive corporate cash piles. This money sloshes around the global monetary system, and contributes to what Ben Bernanke, the former FED chair, calls a global savings glut. It is important to point out that the idea of this global savings glut is controversial, not all agree with it. But those who do say that rising corporate profits is one of the key drivers – alongside changing demographics and other global developments such as the rise of China – and explains why global interest rates are so low – or at least why central banks, after looking at economic conditions, have set such low-interest rates.
Low-interest rates may seem like good news if you are a borrower, but if they are a symptom of global potential output exceeding global aggregate demand, then they are actually telling us that something is fundamentally wrong.
As for inequality, there is an issue here that is also not fully understood. Too much inequality is bad for the economy – the reason is simple. On the whole, the richer you are the more you save. So, as inequality rises, so does savings – leading us back to the global savings glut.
It depends on the degree of course. It is important that companies make a profit, some inequality is not only inevitable, it may be essential as a way to drive aspiration. Cleary an economy that sees profits make up 100 per cent of GDP is unsustainable, so is an economy that sees wages make up 100 per cent of GDP. It is a question of finding the right balance, but it does seem that right now, the balance has swung too far in favour of profits. Note, by the way, that profits to GDP in the US swung to a then all-time high in 2006, with the only other occasion when they were similarly high being 1929. After the 2008 crash, profits to GDP fell for a short while, and then surged again, hitting a new all-time. The lesson of history, looking at 1929 and 2006, is a period in which profit to GDP rises, is followed by a period of economic turmoil.
It is also possible we focus too much on inequality of income, and not enough on inequality of wealth. It seems that if you look at how wealth is divided this is a far bigger issue than how GDP is divided. The rise in company profits to GDP is surely linked to the rise in wealth inequality. But others blame QE and low-interest rates, saying that this is what had led to growing wealth inequality. But if rising profits to GDP and growing income inequality also led to lower interest rates, and lower interest rates are exacerbating wealth inequality, we end up with vicious self-fulfilling downwards spinning circle.
But we need to add to the debate the question of poor productivity, the truth is that growth in output per hour has been lousy across much of the developed world for years. This has led some to conclude that technological progress is slowing, reducing the potential for economic growth. Some people, including the author, just can’t get their head around such an argument. The idea that technological progress is slowing feels absurd, yet the likes of Robert Gordon, an economics professor at North Western University near Chicago, makes that precise point.
So, if, like the author, you believe in the idea of accelerating technology, how do you square this with weak growth in productivity, and indeed weak growth in GDP across the developed world for the last ten years?
Is it simply that the crisis of 2008 left a long shadow, one we are still living under?
A new idea is developing. We may be seeing a winner takes all business environment emerge. Take Facebook as an example – the more people who use Facebook the better it becomes for users. If there was a serious rival to Facebook in the West, and half the population used Facebook and half used the other service, we would end up with something quite unsatisfactory, we would only be able to communicate with half our friends at any one time. Facebook’s success relies on what some call a network effect – the bigger that network, the more compelling its offering is, so it may be a natural monopoly.
Nobel Prize winning economist, Paul Krugman has suggested that we may be seeing the emergence of two types of companies.
Company A is highly productive, and makes full use of technology but it employs a small number of people per unit of turnover.
This leads to a glut of labour, leading to lower median wages.
Company B finds that labour is so cheap that it does not need to invest in machinery or other technology so much, so it tends to throw people at activities rather than invest – hence its contribution to productivity growth is very small – maybe negative.
Ideas such as this are evolving.
No one understands what is really going on with the economy right now, why is it that growth is so weak while technological advances seem so remarkable? But the emergence of a winner takes it all economy may provide one explanation – or maybe it is the emergence of a two-tiered economy – large, highly profitable winner takes it all type companies which do not employ a large number of people relative to turnover, and service orientated companies which employ lots of people but see very low productivity per unit of hour per worker.
The solution is clearly complex.
But the debate that has been reverberating around the media is not helpful.
The long term solution may lie with some kind of universal basic income, a much higher minimum wage, or a tax system that encourages much wider share ownership.
Higher corporation tax may help alleviate the problem of rising profits to GDP, but this would only work if it was applied worldwide, and right now there seems to be popular discontent with the idea of global rules, a global tax would be seen by many as an anathema.
Maybe, though, rising tax on income is not the answer. If wealth inequality rather than income inequality is the key challenge, the solution may lie with some kind of wealth tax, property tax, or much higher inheritance tax.