Stewart Lansley: The way out of crisis is to tackle inequality

Despite this, the orthodox economic view remains that greater equality would be a drag on economic progress. Two years ago, this view was spelt out only too clearly, ironically in what has become the symbolic epicentre of the debate – St Paul’s Cathedral.

The packed Cathedral had hosted a spirited debate on the role of the growing income gap in market-led economies. Sharing a platform with Nicholas Sagovsky, a canon theologian, and Vince Cable, then deputy leader of the Liberal Democrats, Brian Griffiths, the vice-chair of Goldman Sachs and a former adviser to Mrs Thatcher, defended higher inequality “as the way to achieve greater prosperity for all”.

Lord Griffiths – one of Britain’s leading bankers – was espousing one of the central claims of the still dominant free-market school: that the accumulation of large fortunes might bring a bigger divide, but, by encouraging business and wealth creation, they raise growth rates and make everybody better off.

Yet Lord Griffiths and his co-believers could not be more wrong. The evidence points in only one direction. The wealth gap has soared in the last 30 years but without the promised pay-off of stronger economic progress. On all measures of economic performance bar inflation, the post-1980 era of rising inequality has a much poorer record than the egalitarian post-war decades. Growth and productivity rates have both fallen sharply. Unemployment has been close to five times that of the two post-war decades. Financial crises have become much more frequent and more damaging, culminating in the crisis of the last four years.

The main outcome of the post-1980 experiment in markets has been an economy that is both much more polarised and much more fragile. So what does this tell us about cause and effect? Is inequality the real cause of the present crisis?

Not according to the only official account of the roots of the 2008-9 crash. The report of the US official Commission, published in January 2011, failed to mention “inequality” once in its mammoth 662-page report.

Yet, the historical evidence points to a clear link from inequality to instability. The two most damaging recessions of the last century – in the 1930s and today – were both preceded by sharp rises in inequality. In the United States in the 1920s, the share of income taken by the top one per cent increased from 14 to 24 per cent. From 1990 to 2007, there was a rise from 14.3 per cent to 22.8 per cent.

So why might excessive concentrations lead to economic turmoil? The explanation lies in the way, over the last 30 years, real wages for most of the workforce have been falling sharply behind the growth in output and at an accelerating rate.

Since the millennium, output has been rising at almost twice the rate of real earnings in the UK. In the United States, where pay has been lagging even further behind, the pay-output gap is even higher than in the UK.

If society allows inequality to rise above a certain limit, economies will eventually self-destruct. First, a falling wage share merely sucks demand out of economies: purchasing power does not keep pace with the extra output being produced. Consumer societies end up without the capacity to consume and simply seize up. In both the 1920s and the 2000s, the demand gap was filled by an explosion in private debt. This did not prevent recession, it just delayed it.

Secondly, high levels of inequality create asset price bubbles. In 1920s America, a rapid process of enrichment at the top fed years of speculative activity in property and the stock market.

In the build-up to 2008, rising corporate surpluses and burgeoning personal wealth led to a giant mountain of global footloose capital. A tsunami of hot money raced around the world at speed, creating the asset bubbles – in property and business – that brought the global economy to its knees.

The deepest economic crises of the last 100 years have occurred when wages have decoupled from output. In the relatively stable post-war decades up the end of the 1960s, wages and profits moved roughly in line with output. In the 1920s and the post-1980s, a sustained wage-squeeze and rising profits share merely brought a dangerous mix of demand deflation and asset appreciation which ended in prolonged economic turmoil.

These lessons have yet to be learnt. Real wages are on a downward slide while corporate surpluses and personal fortunes are back above record levels. If we are to avoid near-permanent slump, the great concentrations of income and wealth need to be broken up – as they were from the 1930s – and inequality reduced to its post-war levels.

Stewart Lansley is the author of The Cost of Inequality: Three Decades of the Super-Rich and the Economy, published by Gibson Square.