Sunday 19 October 2014

Income inequality - the spanner in the works of economic recovery

Inequality has long been a bother to anybody concerned with social justice. The economic crisis and the subsequent drive for austerity across Europe framed this issue as one of blame for the economic crash, contrasting decreasing benefits with steadily rising wages for top earners in the public and private sector.   The Labour Party took up this issue and ran with the 'cost of living' theme. So far, it has struggled to make much headway with this debate. One reason may be that 'cost of living' implies low wages and rising prices, a pincer movement from both sides that is squeezing family incomes. Whilst this was true for previous economic crises, one element was missing this time round: mortgages. In fact, since 2008, because of the specific constellation of this crisis as one of lack of financial liquidity, central banks pumped large amounts of money into the economy which ensured that mortgages remained low or even tumbled for many house owners after 2008. Anybody on a variable mortgage rate, such as a 'tracker' which shadows the interest rate of the Bank of England, all of a sudden had more cash available at the end of the month. The economic crisis from 2008 to 2012 was a good crisis indeed for those with steady jobs and property.

So, does this mean that the debate about income inequality was a red herring? The historian Thomas Picketty argued that the long term trend in developed countries is worrying indeed as the income generated by assets tends to be larger than that generated by employment (wages). The rift opening up between the two, so Picketty, allows income inequalities to be cemented into the social and economic fabric of Western societies, reducing the chances for social mobility.

As some have pointed out, Picketty's argument assumes wages lagging consistently behind income generation through assets (such as shares). Something that cannot last forever. In fact, wages are known to lag the economic cycle in any case only for a time, simply by virtue of the fact that investment into production reduces the need for labour and deteriorates employment chances for the work force in the wake of an economic crisis. That does not mean however that wages always fall behind other types of income. On the contrary.

As the economy starts to grow, subsequent shortage of qualified labour often kickstarts aggressive wage negotiations by trade unions. There are some countervailing factors, to be sure. Immigration of skilled workers can temper the drive for higher wages, something Britain has painfully experienced following the accession of Eastern European countries to the EU.

But the concern of eminent economists and political leaders such as Federal Reserve Chair Janet Yellen and the Chief Economist at the Bank of England is that the 'normal' cycle of economic boom, increasing wages and improved confidence and domestic consumption cannot be taken for granted anymore. This is where income inequality becomes a worry beyond the immediate social justice issue. If wages do not rise, consumption will either stay down or will draw on credit, which would set in motion a circle we all wanted to avoid.

The last piece of the jigsaw of impending gloom is the surprise by all economic observers that, contrary to expectations and experiences from previous economic crises, the lack of inflation has prevented a significant reduction of debt, public and private. Which means, as we are starting on the road to a 'normal' economy again, that nothing is normal indeed. If this economic crisis will make it into economic textbooks it will be for its inability to bring about the macro-economic adjustment that was thought to be the main function of economic crises.

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