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How inequality fuelled the crash – and is halting recovery

The Cost of Inequality - Stewart LansleyPolicy makers seem increasingly clueless about how to solve a crisis set to outdistance the Great Depression of the 1930s. The new measures announced by the Coalition government on Tuesday will have at best a marginal impact in preventing a slide into persistent slump.

The problem is that government response has been based on a misdiagnosis of the problem. Ignored in key policy discussions, the evidence is growing that the real roots of the crisis and of the lack of recovery lie in the surge in the income divide of recent times.

Economic orthodoxy holds that a stiff dose of inequality brings more efficient and faster growing economies. Today’s crisis says otherwise. Over the last 30 years, there has been a mass transfer of income – amounting in the UK to the equivalent of 7 per cent of economic output – from the workforce to business and to a tiny financial and corporate elite. In the US, there has been an even greater transfer.

Far from creating more robust economies, concentrating the gains of economic progress in this way creates a dangerous structural imbalance that makes nations much more prone to instability and crisis. This is in part because reducing the relative incomes of large sections of the workforce stifles demand and prevents economic output being sold. In the build-up to the crisis, rising inequality set a number of economies on a sustained course of deflation.

The political solution to the problem of consumer societies losing their capacity to consume was to pump economies full of private debt. In the UK, levels of personal debt rose from 45 per cent of incomes in 1981 to 157 per cent in 2008, much of it to fund everyday spending. In the US, debt also rose sharply to reach a third more than national income by 2008. None of this prevented recession, it just delayed it.

Moreover, the swollen corporate and personal wealth surpluses that were the flipside of these shrinking wage shares were used in ways which have greatly damaged the real productive economy. Despite rising profits, investment in the real UK economy fell from the millennium. Instead these surpluses ended up in activity – commodity speculation, financial engineering and hostile corporate raids – geared to transferring existing rather than creating new wealth, thereby reinforcing the shift towards greater inequality and greatly amplifying the risk of financial crisis.

The same factors were at work in the 1920s. Now the divide that drove the global economy over the cliff in 1929 and 2008 is killing recovery. In the UK, consumers have around £100 billion less in their pockets today than if the national cake was shared as it was in the late 1970s. That has meant around £100 billion less in consumer spending each year of the crisis. In the bigger economy of the United States – where the same forces are at work – the transfer amounts to a figure of around £500 billion.

In contrast, big business and the super-rich in both countries – and across much of the rich world – are sitting on larger and larger cash balances. Before the crisis, these surpluses – ultimately the product of the way the national cake is shared – were used in ways which weakened economic resistance. Today these surpluses – which have actually grown during the crisis – are mostly standing idle. Resources that could be used to kickstart the economy through productive investment are waiting for an upturn that is being pushed ever further away. When a recovery eventually comes, the danger is that this surplus cash will again be used in ways that will create the conditions for another crisis down the road.

Allowing the fruits of growth to be so unevenly shared in the name of greater efficiency is the real cause of this crisis. If the distribution of national output had been maintained at its level of three decades ago, idle surpluses would now be being spent by consumers, and we would be well on our way out of this mess.

Stewart Lansley is the author of The Cost of Inequality: Three Decades of the Super-Rich and the Economy.

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