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19/07/2011 - The real problem that needs fixing is the raid on middle income earners
In the book Freakonomis, the authors tell a story from folk lore about a land where a disease was wreaking havoc in a certain region. The emperor noticed that in that particular region there were also a large number of doctors. So his conclusion: get rid of the doctors and the disease will die out. Sometimes I reckon we all make the mistake of the emperor. We mix up cause and effect so often that it's a wonder policy makers are ever effective. I am going to tell you what I reckon is the real problem with the economy, right now. It is not debt, that is a symptom. It is not bankers' risk taking, that is a symptom too. It is something else, and it relates the declining fortunes of what I call middle income earners.
It was a video on the FT that prompted me to write today's piece. See Technology is squeezing the middle
In this video Prof Alan Manning from the London School of Economics looked at the trend we have seen over the last century or so, for middle income earners to see their wages as a proportion of GDP rise and then fall. Over the last few decades the very rich have been getting richer. The very poor have being doing okay (relatively, not that okay is ever an apt description of someone who is very poor), but those in the middle have been getting relatively worse off.
The Work Foundation produced a report recently drawing a similar conclusion. See 'Shrinking middle' labour market trapping workers in low salary, low-skilled jobs, according to new report
It is hard to quantify what has caused this development. In his FT interview, Prof Manning argued financial regulation had something to do with it. The gap between the super-rich and middle income earners was large before the 1929 crash, when financial regulation was minimal. After the crash, regulation tightened and the gap shrunk. By the 1980s regulation was loosened, and the gap grew. I am not so sure about that. I think he may be making the same mistake as our emperor from folk lore.
I reckon there were several forces at work. Firstly we saw a change in attitude. Two world wars and a Great Depression had created a change in opinion. I am reminded of an episode of Dad's Army when Captain Mainwaring told ex public school boy Sergeant Wilson, that the day when the country was run by people from a class elite was coming to an end. The day had dawned for people who can work their way up the ranks, he suggested. "I didn't know you were a communist," said Sergeant Wilson. "How dare you," replied the pompous captain/bank manager.
But for me that exchange summed up a change in attitude. Governments of the 1950s, 1960s and 1970s were all about social justice. They used to say Ted Heath was the best Conservative Prime Minister the Labour Party ever had. Then the UK suffered the turmoil of the 1970s and attitudes changed. So complete was this change that one of the first acts of both Tony Blair (and then Gordon Brown) as Prime Minister was to invite Mrs Thatcher around for tea. Peter Mandelson said he didn't have a problem with people "becoming filthy rich, as long as they pay their taxes."
But one thing got forgotten during this period. If GDP was being skewed in favour of the rich, where was demand going to come from to buy the mass consumer goods that underpin growth?
In his book, Fault Lines, former chief economist at the IMF, Raghuram G Rajan, said that the middle income earners, who were seeing their incomes fall , were appeased via rising house prices. Thanks to the surge in the value of their property, they didn't feel as if they were losing out.
And so, middle income earners may not have been seeing their income rise so fast, but they felt wealthier, and borrowed against some of this perceived extra wealth to fund their spending. And in that way growth was funded.
I believe another force was at work was technology. The IMF calls it the globalisation of labour. Two newish theories that help explain this are the Paradox of Toil and the Paradox of Flexibility. The first theory proposes that under certain circumstances, if people work harder the result is simply a rise in unemployment. A similar inference is drawn from circumstances when the labour market becomes more flexible. And what are these circumstances? The Paradox of Toil was suggested by Gauti Eggertsson, an economist who works at the Fed in New York. His theory is based on certain conditions: that the economy is suffering from deflation, there's declining output, and interest rates are zero.
Moving forward, there is a very real danger that innovation, of which I am a great fan, will be rendered impotent, and have minimal economic benefits. That is unless we can ensure that the fruits of this innovation trickle down and bump up income across the spectrum, so that demand will rise to allow the full exploitation of the potential implicit in all that innovation .
These views and comments are those of the author alone and do not necessarily reflect the view of The Share Centre, its officers and employees
These views and comments are those of the author alone and do not necessarily reflect the view of The Share Centre, its officers and employees.
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