A strategy for improving economic performance

June 12, 2014 12:00 am Published by Leave your thoughts

Many commentators have observed that a disappointing economic performance has often been accompanied by a widening inequality; indeed, international statistics suggest that the two go hand in hand. Those countries with higher levels of inequality, like the US and the UK, have performed worse in economic terms than those, like Germany and the Scandinavian countries, where inequality has been kept within reasonable limits.

Any strategy for improving economic performance should therefore be seen as a means of addressing at the same time the deleterious effects of greater inequality, and success in producing a better performing economy could be expected to reap benefits, both economic and social, from making full use of the economy’s human resources and ensuring that everyone has a stake in economic success.

The perception that inequality has widened in many countries over recent decades and that a price has been paid for that development is well supported by the statistical evidence and by recent studies such as The Spirit Level by Richard Wilkinson and Kate Pickett, and Joseph Stiglitz’s The Price of Inequality. The debate about inequality has, however, been galvanised by the recent publication of Capital in the Twenty-First Century by Thomas Piketty.

Piketty has analysed a huge volume of data – going back for a couple of centuries or more, that is, as far back as the data exists – to support his conclusion that the natural operation of capitalism, or of a free-market economy, is to produce a greater and greater degree of inequality. This is the result, he argues, of the inevitable tendency of an ever-increasing share of wealth in an economy to concentrate in the hands of those who own capital, with the further result that those without capital become increasingly disadvantaged. That conclusion seems justified by the experience of the past three or four decades, when almost the whole of the increase in wealth in western countries has gone to the richest tier of the population and the share of the national income accounted for by profits has risen while the share of wages has fallen.

This conclusion is of course unwelcome in some quarters and a determined effort has been made to cast doubt on Piketty’s methodology and accuracy in handling the statistical material. The Financial Times has published an analysis which suggests a number of errors and inconsistencies in Piketty’s data; this has been seized upon by those who would dearly like to see his conclusions undermined. One cannot help but wonder whether this is not seen as some kind of payback for the kind of fatal bow delivered to the thesis advanced by Kenneth Rogoff and Carmen Reinhart concerning the dangers of too high a ratio of public debt to GDP when their calculations were shown to be error-ridden.

But, allowing for the inevitability in handling such a huge volume of statistical material of the occasional lapse or unexplained assumption, the broad thrust of Piketty’s argument seems incontrovertible. It is supported not only by the statistical evidence he assembles but by practical observation and by arguments from first principles.

It is the inevitable tendency of all societies for power to concentrate in a few hands. The strong, the numerous, the rich, the well-connected, the lucky, those with social status, those inheriting advantage, will always find a way of making those advantages count; they will not only enjoy the privileges that the advantages bring but will use them to entrench the power that comes with them so as to protect them from challenge and increase their extent.

A capitalist society offers, par excellence, a context in which this inevitable concentration of power takes place. By far the best chance of succeeding in a modern capitalist society is to start with capital in the first place; and it is in precisely those economies where the unfettered market has the freest rein that inequality has grown most sharply. Piketty has done an excellent job in providing historical and comparative evidence to show the virtual universality of this tendency, but he has done no more in reality than to confirm through statistical analysis the conclusions that many others have reached through common sense and careful observation. He supports, in particular, the conclusion reached by Joseph Stiglitz that the incomes of the rich in today’s economy are those of the rentier – that is, they are returns on existing capital – rather those of the job creator and investor in new wealth-creating capacity of current capitalist mythology.

The important part of Piketty’s work, however, lies in his assertion that these outcomes are the inevitable features of a capitalist economy. He shows that the growing divide between rich and poor arises, not because the rich do anything remarkable or meritorious, or because the poor are feckless and undeserving, but because that is how a capitalist economy inevitably operates. This is because, he argues, the return on capital automatically (not of course in every case, but as a general proposition) grows faster than the rate of growth of the economy as a whole.

He goes on to argue that this is, with the single exception of the period immediately after the Second World War, the way it has always been since the dawn of capitalism, and he goes on to predict that the pace of this widening of inequality is about to speed up. The greater the concentration of wealth, in other words, the more rapidly those few who control it will use it to extend their advantage.

There are those who argue, with perhaps some justice, that there may come a time in a mature economy (though who can tell when an economy might be mature?) when the rate of return on capital might fall – for social or technological or political, as well as economic, reasons – and that the concentration of wealth and power in fewer and fewer hands may therefore slow down or not materialise at all. But it seems more likely that if the return on capital were to slow down, it would still not fall to a point where it was slower than the general growth rate; this would be because the rate of growth of the whole economy would have fallen even faster than the rate of return on capital, largely as a result of the debilitating impact on the overall economy of the increased concentration of wealth.

This represents, of course, a kind of doomsday scenario in which the rich and powerful, unconcerned at the performance of the economy as a whole, but prioritising the pursuit of their differential privileges and advantages, will intensify the concentration of wealth in their own hands, with the result that the economy deteriorates even further, so that we enter a vicious downward spiral.

The response of the privileged is to say, of course, that what Piketty demonstrates is that “this is the way it has got to be.” Not for nothing, they say, was Mrs Thatcher’s mantra that “there is no alternative.”

The interesting aspect of Piketty’s thesis, however, is not his persuasive explanation of the phenomenon of an increasing concentration of wealth and its inevitability, but his acknowledgment that there was a period of two or three decades when that inevitability did not seem to obtain. The exception was of course the immediate post-war period – particularly in countries like the UK – when, for a brief time, the share of income and wealth of the richest fell by comparison with the rest of society.

Piketty explains this exception to what he postulates as the general rule by pointing out that the Second World War had destroyed or decimated the value of many of the assets – both physical and financial – previously owned by the rich, so that their capital base was much reduced. This meant that the balance of advantage between rich and poor in most of the economies affected by the ravages of war was substantially redressed in favour of the disadvantaged. This is undoubtedly true and offers a substantial part of the explanation for the shifting balance of advantage. But, as Piketty also acknowledges, there were other factors at work – many of them political rather than strictly economic, and designed rather than accidental.

It is those political factors which are of particular interest to those who might wish to challenge the supposed inevitability of the concentration of wealth. The war had necessarily, by requiring a combined effort from all parts of society, reduced social divisions; there was far less disposition to accept that some were better than others or that the lower classes should “know their place”. Working people, and women in particular, had learnt to have more confidence in their abilities and in the value of their contribution. They were determined to learn the lessons of the period after the First World War when the interests of working people were sacrificed on the altar of the Gold Standard and the supposed need to prioritise the rebuilding of the assets of the wealthy.

The end of the war was marked, in the UK, by an election result that was almost incomprehensible to the rest of the world. British voters rejected Winston Churchill and his Conservatives in favour of a relatively untested Labour government. There can have been no more dramatic evidence of the determination of the people who had won the war that democracy would make a real difference to the way the country was run in future – and in whose interests.

The result was a drive to increase taxation on the wealthy (and on their unearned income from capital as well as on their high salaries), to increase the rights of working people at work through strong trade unions, to improve the services available to ordinary people through major initiatives like the National Health Service, and to place the government’s responsibility for the maintenance of full employment, in accordance with Keynesian principles, at the centre of economic policy.

When Anthony Crosland wrote The Future of Socialism in 1956, it was possible to describe a consensus in the UK to the effect that these goals were not only desirable but achievable. And, as Piketty discovered, the effect on the distribution of wealth was unmistakable. For the first time, it seemed, a capitalist economy could be managed in such a way as to distribute wealth more equally throughout society.

It became an article of faith that capitalism and democracy could co-exist and support each other, and that the outcome was both an efficient economy and social justice. The natural tendency of a market economy to concentrate wealth and power in fewer and fewer hands had been reined in. Democracy, it was thought, had fulfilled its true purpose by ensuring that the otherwise overwhelming economic power of the rich and their ability to exploit the market to their advantage was offset by the political power of a government enjoying the legitimacy of popular support and therefore able to regulate the market so that freedom and choice were more fairly distributed throughout society.

It was this apparently ideal world that Francis Fukuyama celebrated in his famous essay The End of History in 1989. But, even by the time that the essay appeared, the seeds of a counter-revolution had already been sown and capital was well advanced in finding a way of circumventing democratic restraints – a process I describe in Myths, Politicians and Money. In that sense, Piketty was shown to be right – there did seem to be an inevitability about the capitalist resurgence and its production of increasing privilege for the rich.

The important message from this sequence of events, however – a sequence that is easily discernible by simple observation of events but that is now given strong statistical support by Piketty’s work – is that it shows that, if the political will is there, the apparently inevitable concentration of wealth can be resisted and turned back. If we want a society that is more equal, in other words, and an economy that is more efficient in the sense of utilising all of its resources, and especially its human resources, then political intervention in the market process is absolutely required.

What is now desperately needed is an economic strategy provided to democratic politicians that provides a means of doing exactly that. The failure of democratic politicians to honour their contract with the voters – that is, to protect them against the depredations of the rich and powerful – has arisen because those politicians have lost confidence in their ability to deliver an economic performance that will justify the voters’ trust in them. They have accordingly found themselves cast adrift, able to navigate only where the free-market current takes them, and therefore unable to resist the increasing dominance of the “free-market” economy by the powerful forces of capital.

We need a strategy that would rescue them from this predicament – one that offers a way of improving economic performance and one which, by virtue of that improvement, will disperse income and wealth more fairly throughout society. We need an increased provision of credit for investment that will help to spread capital more widely and to reduce the banks’ monopoly power to create money; we need a boost to employment and wages that will lift incomes across the board and especially for wage-earners; we need direct action to improve competitiveness and strengthen margins and markets for exporters; we need a government to reclaim responsibility for full employment and for a proper level of public services that would lift living standards amongst the disadvantaged; all in the context of a conscious effort to create a more inclusive and rewarding economy for the population as a whole.

A government committed to this strategy could promise in good faith to make life better for the majority of voters; we might thereby re-create the kind of market economy, regulated in the public interest, that promised so much in the post-war decades. The post-war Labour government showed that it could be done, and that political democracy, properly directed, can protect and advance the interests of ordinary people against the otherwise over-riding claims of the fat cats. This time, however, we would be on notice to watch out for the inevitable counter-offensive from vested interests and be ready to apply the necessary responses and remedies when it comes.


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This post was written by Bryan Gould

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