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Is Growth Only Possible Through Inequality?

by Mark Schieritz Wednesday, Oct. 28, 2009 at 10:08 AM

Does capitalism make the rich richer and the poor poorer instead of creating prosperity for everyone as promised? Inequality declined considerably between 1930 and 1970 in western industrial states.


By Mark Schieritz

[The gap between rich and poor has become greater. Mark Schieritz explains who is really responsible for this. This article published in: DIE ZEIT, 8/20/2009 is translated from the German on the Internet,]

The rich enjoy a constant upswing. For decades, their incomes rose and their stock portfolios gained value. If an American in the 1970s had assets of million, he would have been on the list of the 400 richest persons of the country compiled every year by Forbes magazine. In 2007, more than a billion dollars was needed to be on that list.

The poorer have a harder time. The annual income of a middle class American male is ,113. Corrected for inflation, this is even lower than in the 1970s. At that time a middle class employee earned ,879.

Does capitalism make the rich richer and the poor poorer – instead of creating prosperity for everyone as promised?

Development in the past 30 years suggests this conclusion. The gap between poor and rich expanded in the US and elsewhere. In Germany, average real wages fell in the upswing years 2004 to 2008 while the profits of businesses and sponsors soared. In Britain, the investment stars of London City pocketed ever-higher bonuses while the wages for the broad population stagnated.

In threshold countries, poverty declined in absolute numbers but the social differences grew dramatically. Simple employees are mostly the losers and coupon-cutters the winners. In China, wages and salaries amounted to half of economic benefits ten years ago. Now it is only 40 percent. In India, the top income sectors profited from the economic reforms of the 1990s. “Inequality has increased in all states with the exception of the poorest countries,” the International Monetary Fund wrote recently.

This has not always happened. There were phases in capitalism when the income differences in the population were leveled off. Inequality declined considerably between 1930 and 1970 in western industrial states. In 1928, the super-rich in the US amassed over five percent of the national income. In the 1970s, they received one percent. In the last years, this share has climbed again.

The phase of leveling was a time when powerful unions gained high wages. They ensured that simple employees received back a larger share of the benefits. The state that robustly redistributed income provided for more equality. Governments granted their citizens generous social benefits and wangled from the rich a larger share of their income. In Britain, the top tax rate in the late 1970s was a steep 83 percent – more than twice as high as today. The state invested in education and financed access to the university for workers’ children. There was not much to get on the financial markets. International capital transactions were strictly regulated. Bankers hardly earned more than engineers.

At the end of the seventies, this system reached its limit. The unions lost all moderation in wage negotiations and started an inflation spiral. Strikes paralyzed the economy. Sometimes the social benefits were so sumptuous that accepting work was hardly rewarding any more. The international monetary system collapsed. A U-turn was imminent. This reversal was prepared by a new generation of liberal economists at the University of Chicago. One of them, the later Nobel Prize winners Robert Lucas, urged turning from “seductive and poisonous” distribution questions.

Redistribution, strict rules for markets and high taxes paralyzed the economy, Lucas and his fellow-combatants insisted. Whoever can rely on state support has less incentive to work and invest in his training.

In this regard, allowing inequality is the prerequisite for growth and prosperity. At the end the poor also profit from a dynamic economy. A rising tide lifts all boats. Whoever sees the world this way sees equality in the sense of equal opportunity as the goal of economic policy.

Ronald Reagan and Margaret Thatcher appealed to this doctrine when they set out to drive back the state and smash unions. Hardly was that carried out when inequality shot up. The market does not ensure equality. The market rewards the wealthy who gain interests on their capital. The market simply delights those who work in a boom branch and punishes those who are less productive or learned the wrong occupation.

The world economy after the drastic Reagan-Thatcher cure did not grow faster than before the radical reforms. Some of the richest countries – the Scandinavian states – still have extremely high taxes and a watertight social net.

How can this be explained? Some argue people do not only exert themselves for money but from passion in the cause or for acknowledgment. The real key to prosperity is access to good training, social stability and quality of the infrastructure. This is much more important than the incentive from great income differences.

You may have heard the argument that technical progress and globalization create more and more inequality in the long run. However this connection is not as clear as once presumed. Inequality is low in high countries with open borders like Finland and Sweden. Using machines and border-crossing exchange of goods and services destroy jobs but according to experience jobs arise in other places. In principle, the state can always ensure that everyone becomes richer, not only some.

There are even economists who argue excessive concentration of wealth in a few hands could be harmful for growth. The higher the salary, the more will be saved and the less the demand for consumer goods, they say. The greatest disparity of incomes is the reason for the consumer renunciation over years in Germany, the German Central Bank recently remarked.

Americans tried to maintain consumption despite lower wages. Citizens shopped on credit. This has not gone well. For the Nobel Prize winner Joseph Stiglitz, the unequal income distribution in the US is one of the most important causes for the global financial crisis. This began when many US citizens took out mortgages, re-packaged them and then financially could not afford their real estate credits any more.

Scholars ask today whether the all-out attack on the welfare state was really necessary for economic reasons -- and whether or not a correction of the worst excesses of the late 1970s would have been enough. Capitalism can obviously live with both equal and unequal.

Therefore the question of optimal distribution is a question to politics, not to capitalism. Emmanuel Saez, economist at the University of California, sees it this way: “We must decide as a society whether we find the increase of inequality acceptable – and if not what institutional reforms are needed to counter it.”

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