The Flawed Moral Crusade Against Inequality

I’m just a soul whose intentions are good,
Oh Lord, please don’t let me be misunderstood.
—1960s pop song

The financial and economic crisis of 2007 to 2009 gave quite a boost to those who knew it was only a matter of time before free-market capitalism “collapsed”. Their undisguised joy was probably reminiscent of Darwinists celebrating the discovery of Archaeopteryx or Piltdown Man, or warmists basking in the corroboration of a torrid summer’s day. These believers are so sure of their ground that any confirmative event, however isolated or tenuous, is welcomed rapturously as proof at last.

But sooner or later most confected narratives lose their puff, and so it was with “the end of capitalism as we know it”. Fortunately for those perennially piqued by capitalism’s resilience there was an old standby—inequality—which has now become the great moral crisis of our time.

A first point to make is that there is no consensus on exactly what has happened to inequality over recent decades. The accepted view is that it has increased—but by how much? Among others, Chris Giles, the economics editor of the Financial Times, has cast doubt on Thomas Piketty’s data. He suggests that the steep upward trend in wealth inequality identified by Piketty since the 1970s is largely a product of the process he used to adjust the raw data. I want to steer clear of this debate.

What cannot be doubted, no matter how it has shifted in recent years, is that the distribution of wealth in whatever country you care to choose is distinctly skewed. Numbers of sources (official and private) back that up. For example, Edward Wolff concluded that in 2007 the top 20 per cent of households in the United States owned 93 per cent of non-occupied housing wealth (“Recent Trends in Household Wealth in the United States”, Levy Institute, March 2010). His data also showed a rise in wealth inequality over the period from 1983, slight though it was. The distribution of income was less skewed, of course, but the rise in inequality over the period was more marked.

Whatever wrangles ensue over the data, inequality as a political issue is not going away. It will figure prominently in the next US presidential election. Bill Gates, Warren Buffett and other like-minded billionaires (perhaps trying to squeeze through the “eye of a needle”) will continue rabbiting on about it. It has spread like a plague across the Atlantic to the UK and Europe and across the Pacific to Australia. Those on the Left can spot a gift when they see it. It is their moral crusade du jour. Accordingly, my concern is not with the accuracy or otherwise of statistical portrayals of growing inequality but with the plethora of proposals as to how capitalism should be “fixed” to curb inequality.

Capitalism in the form which arose out of the Industrial Revolution has always been in the firing line. Successful maybe but deeply flawed, say its critics. Malthus and his fellow under-consumptionists had their day. Marx saw it resulting in increasing industrial concentration and, when the time was ripe, a takeover by the workers—who would be ironically fitted for the task by the very regimentation and organisation that industry had imposed on them. Or, alternatively, he saw its internal collapse as the accumulation of capital annihilated profits. Keynes has had most influence; first by arguing that capitalism produces stagnation and severe cyclical swings but second, and more importantly, by suggesting that only government intervention could save it.

Throughout all of the criticism of capitalism there has been the recurring theme that the many have too little and a few have too much. In fact inequality has a far longer history than capitalism. Deuteronomy phrases it pithily: “For the poor will never cease from the land.” Undoubtedly, inequality goes back to the dawn of human history when the bigger and faster early hominids caught and got the best cuts of the roaming ruminants (and the girls, I suppose) while the less strong and agile made do with the scraps (and the odd date maybe).

None of this history dulls the appetite of those pursuing more equality. More equality is one of those feel-good aspirations that we can all connect with. Our mothers told us as young children to share our toys and lollies with our playmates. Moreover, no one would contemplate leaving little Johnny or Sally cake-less for the want of sufficient cakes. Better not to hand them out at all if any child had to miss out. No fancy psychological theories are required to explain this. It is just common decency.

So why should I take a different view from economists and politicians who argue that government intervention is needed to curb the propensity of capitalism to generate inequality? The only possible reason would be if most of the interventions proposed were likely to cause more harm than benefit. Ah, those pesky consequences that conservatives insist on taking into account!

It is a question of choice when it comes to assessing the remedies proposed by those who believe that inequality must be countered. Any respectable left-leaning economist, of whom there are many, will likely have something on the record. Prominence matters, as does the depth of their analyses.

Thomas Piketty (Capital in the Twenty-First Century), whose book I reviewed in the June edition of Quadrant, gets a tick on prominence but not on the depth of his analysis. While he is the current poster child for those railing against inequality, his analysis of why inequality emerges out of capitalism and what should be done about it is superficial. His is a Marxian world in which capitalism is beset by a logical contradiction. Returns on capital (owned by the rich) chronically exceed the growth in national income. As a result, inequality inevitably grows. Taxation, particularly a global wealth tax, is his solution. There is nothing much here to grapple with. It is just too simplistic.

Happily, if that’s the right word, more erudite tilts at inequality have been made by prominent economists. I have chosen Joseph Stiglitz and Adair (Lord) Turner to fly the flag. Stiglitz is a professor at Columbia University and a Nobel Prize winner. He is often bracketed with Paul Krugman as a leading light among economists on the Left. Turner was the Chairman of the Financial Services Authority in the UK until its abolition in 2013. He is now a senior research fellow with the Institute of New Economic Thinking (INET) established by George Soros in 2009. No prizes for guessing that the new economic thinking envisaged is somewhere to the left of mainstream. And no surprise that Stiglitz is an INET board member.

Stiglitz and Turner have recently produced multi-faceted commentaries on what they believe to be behind the recent growth in inequality and what should be done about it. The Price of Inequality by Stiglitz was published in 2012 as the development of an article he’d had in Vanity Fair in May 2011 titled “Of the 1%, by the 1%, for the 1%”. “Wealth, Debt, Inequality and Low Interest Rates: Four Big Trends and Some Implications” was a lecture by Turner to the Cass Business School in March this year.

There are differences of scope and emphasis between the two. Stiglitz canvasses a wider array of contributors to inequality and a much wider array of remedies than does Turner. Turner’s commentary on inequality is somewhat tangential to his main thesis that excessive bank lending, particularly for real estate, causes financial instability. However, common to both is the view that globalisation of trade and capital flows; the relative decline of manufacturing industries; the rise of information and communication-based industries; and the emergence of super-sized executive salaries are central to rising inequality in advanced economies. At one level there is little to argue with.

Globalisation tends to depress wages in high-wage countries as capital seeks the best return and as industry shifts in accordance with comparative advantage. The displacement of workers as manufacturing declines is not matched by the needs of high-tech industries for fewer and differently skilled workers. All of this undoubtedly tends to depress wages overall and certainly for the low-skilled, and therefore shifts the share of national income away from labour towards capital; from wages to profits.

At the same time, the material rewards for senior management, with those in the financial sector leading the way, have also grown. It is a matter of conjecture why this has occurred. Part of the answer is that the chillier winds of competition as a result of globalisation have upped the ante for shareholders and boards in attracting those whom they believe to be talented managers. (But why top bankers are paid so much to oversee the relatively unchanging business of banking is a mystery to me and, I suspect, to them.)

A first question is whether rising inequality matters. A second is whether any such a trend can continue indefinitely. Finally, a third question is what, if anything, should be done about it. Before coming to these questions, I would like to lay some groundwork for shedding light on inequality by introducing (modestly) my three interconnected fundamental laws of capitalism.

Piketty had only two; and distinctly inferior ones at that. His “fundamental laws” simply come down to saying that the rate of capital accumulation will exceed the growth in GDP and produce growing relative returns to capital over those to labour. They describe at best a tendency under unrealistic and constrained conditions. My laws are self-evident tablets of stone in comparison.

1.  Capitalists, as distinct from criminals and commissars, only become rich when lots of people among the 99 per cent are able to buy and enjoy their products.
2.  Collectively capitalists become rich only if they employ enough people and pay them enough so that those people are able to buy and enjoy the products that the capitalists collectively produce.
3. The third law follows from the first two. It is that the impoverishment of the 99 per cent is incompatible with capitalists becoming rich.

Now, with these laws in mind, consider an extraordinary and fanciful observation often made by economists on the Left. For example, Turner compares the present day with the period 1830 to 1860 when “the lion’s share of rising prosperity went to capital owners, not workers”. He suggests that the mid-twentieth-century experience of rising prosperity for all may have been aberrant.

Dickensian scenes come to mind depicting the wretchedness of the poor whose plight could surely be relieved by the wealthy if they were not so selfish; not to say wicked.The only fly in the ointment is that capital owners don’t get wealthy unless people buy their products. A corollary of the three laws above is that wealth takes the form of goods and services. Thus, if capitalists produce iPads or shoes or shirts or umbrellas they will only earn profits if many people are able to purchase them. It is therefore silly to say of any period that most of the gains accrued to capitalists. That cannot be so. It would only have been so during any period of the Industrial Revolution if most of the railway tracks and trains and better roads and better and more variety of clothes and foodstuffs were commandeered by the capitalists for their sole use. That would not produce much profit. And on what precisely would the workers producing all of these goods spend their wages? This is a conundrum that only left-wing economic experts can solve by suspending logic.

Turner is actually referring to savings of monetary wealth; to pieces of paper, not to real wealth. It is brusque to say that Turner and his fellow travellers don’t know what they’re talking about. But it is true nonetheless. And error has a habit of begetting error, as I will come to when briefly considering what Turner and Stiglitz think should be done about inequality.

To the first question posed above. Does inequality matter? Poverty matters. There is little doubt of that. High unemployment matters. Falling real incomes matter. But none of these things are caused by inequality. Inequality is a derivative, not a driver. Inequality of income tends to decline in booms, as businesses compete for labour, and rise in recessions. Mass immigration tends to depress wages and increase profits, as also does labour-saving and labour-displacing technological change. Rising or falling inequality is driven by a mishmash of secular and cyclical economic and social forces. At its most elemental, rising inequality is a symptom of there being many applicants for each available job. More jobs or fewer applicants and the perceived problem would disappear.

Importantly, the extent of inequality is invisible to ordinary mortals in the complex societies in which we now live. No one would know about it if it were not publicised. Someone unemployed in the global recession of 1975 wouldn’t have known and wouldn’t have been told that inequality had declined steeply since 1910, and would have drawn no cheer from knowing. But someone unemployed following the global recession of 2009 might well feel aggrieved to hear that inequality had increased steeply since 1975. And this time there are plenty of economists and politicians eager to tell this tale. It is a sophisticated form of rabble-rousing played out in academia and in political forums.

The second question is whether inequality can go on increasing indefinitely. The short answer is that it can’t unless it is helped along by inept and interfering government. Poorly controlled immigration, like that into Western Europe from Africa, Asia and Eastern Europe and into the United States via Mexico will depress wages and lead to greater inequality. Regulatory and taxation barriers to economic development will also lead to fewer jobs and lower wages. But, in the normal course, increasing inequality will have an end point.

Profits will not go on growing if the purchasing power of the populace continues to fall. See my three laws above. “Something’s gotta give”, as another old song goes. Usually profits are put to work to take advantage of lower wages, and the resulting economic growth dampens inequality. However, increasing inequality over lengthy periods might well result from deep changes to the industrial make-up of economies or from high rates of immigration. In such circumstances, the freer and more responsive market forces are, the fewer years it is likely to take before the emergence of increased and well-spread prosperity and reduced inequality. There is no magical shortcut.

The third question is: What should be done about inequality? From what I have said so far a quite respectable answer would be nothing directly, except for removing unnecessary impediments to market forces. But let’s be expansive. Certainly education and training are important when the industrial landscape is changing. Corporate welfare is always worth tackling, as is the redistribution of middle-class welfare to the genuinely needy. And, of course, taxation has a role to play in tempering inequality, provided that proper account is taken of the effect of increased taxation in reducing private savings that would otherwise be available to fund private investment.

It is vital to understand that a measure of inequality is essential to underpin growth. In his book Battlers and Billionaires: The Story of Inequality in Australia the federal MP Andrew Leigh reported being surprised to find from research he undertook with Dan Andrews (of the OECD) and Christopher Jencks (of Harvard) that increased income inequality was associated with a subsequent lift in economic growth (B.E. Journal of Economic Policy & Analysis, Vol. 11, Issue 1, Article 6, 2011). He should not have been surprised. Only the well-off save much. Savings fuel investment, which drives growth. Complete equality would in fact be equality of subsistence. All things considered, a presumptively relaxed attitude to inequality seems apropos; though that attitude is clearly not shared by everyone.

Stiglitz and Turner are far from relaxed about inequality. It is a great moral and economic challenge to them both. They think much too hard about “fixing” the operation of the free markets which have produced unparalleled prosperity for the Western world and which are lifting a large part of the rest of the world out of poverty. It is as if Fangio had just won the formula one world championship in his Maserati and a brainstorming session ensued on what went wrong with him and his car.

Turner connects the lower capital requirements of modern high-tech industries with resultantly lower interest rates which, in turn, play a part in fuelling over-lending for desirable real estate. Not only does this make the system more vulnerable, he argues, but it also increases inequality as desirable real estate owned by the few increases in value. Meanwhile, those earning lower wages as a result of the changing industrial landscape are forced to borrow to maintain their lifestyle. “Let them eat credit” is the way Turner put it in a lecture in February titled “Escaping the Debt Addiction: Monetary and Macro-Prudential Policy in the Post Crisis World”.

Stiglitz and Turner propose a variety of measures to counter the excesses of the financial sector. These include: imposing much greater capital requirements on banks; applying controls to reduce real estate lending and otherwise “managing the quantity and mix of credit creation”; curbing bonuses which “encourage excessive risk taking”; reforming bankruptcy laws to make lenders “bear the brunt” of defaults. The problem with all of this is that it would simply make things worse.

Imposing heavy capital controls on banks would lead to the growth of shadow banking and in all likelihood more reckless lending. Controlling and managing the direction of lending would seem to require a degree of wisdom not so far discovered among regulators. Would they mess things up? You can bet on it.

Shareholders might wisely try to tie executive bonuses to proven performance, but that should be left to them, with all of the entailed difficulties. For example, the sub-prime crisis was a decade and more in the making before coming to light in 2007. So shareholders would need to have been unusually far-sighted in judging performance; particularly as prominent US politicians like Barney Frank were insisting up until the brink of the crisis that everything was fine.

I don’t think much need be said about Stiglitz’s puzzling suggestion that lenders should bear the brunt of defaults. Effectively that would dry up credit to those of limited means, those who are already at the wrong end of income distribution. And, depending on the extent of its application, it would hamper the vital process of financial intermediation more generally.

The character of proposals to reduce inequality gets no better. Heavier taxation bulks large for Stiglitz, without any attention to the economic impact this might have on savings, investment and jobs; or to the social impact of redistributing income and creating dependency rather than jobs. Just to show how little jobs seem to matter, Turner advocates “high minimum wages or guaranteed citizenship incomes”. Do-gooders should try to understand that putting people out of work by increasing minimum wages or, alternatively, keeping them dependent by tying them to the apron strings of taxpayers, might well produce more inequality not less; quite apart from the intergenerational despair that experience tells us it engenders.

Stiglitz makes a number of suggestions that few would disagree with in principle. These include ending crony capitalism and ensuring competition laws work effectively. He also raises the important matter of wealth being used to buy political favours. But, really, this perennial human failing is far from peculiar to capitalism, and probably has little to do with inequality. In any event, it is questionable whether better policing of the rules of the game would make anything but a marginal difference to the dispersion of wealth and income.

Those wanting to tinker with the outcomes of free-market capitalism have a major problem. Because of the sheer complexity, fluidity and interconnectedness of market processes it is impossible to predict the consequences of intervention. For example, would higher minimum wages reduce inequality or increase it by putting people out of work? Who knows? Will the imposition of more controls on banks reduce reckless lending or increase it as shadow banking fills the slack? Again, who knows?

Aiming for prosperity is a feasible endeavour because we do know, with a good measure of certainty, that freer markets produce more of it. Examples abound: Eastern Europe versus the West, North versus South Korea, and the economic rise of China. On the other hand, we simply don’t know what will produce more equality, nor do we know the consequences or costs of trying to achieve it. Fools rush in where angels fear to tread.