We’re on the road to self-destruction

Over the last 30 years, a growing share of the global economic pie has been accumulated by the world's wealthiest individuals. In both Britain and America, the share of income held by the top 1% over this period has more than trebled. Today, the world's 1,200 billionaires hold economic firepower equivalent to a third of the size of the American economy.

According to economic orthodoxy since the late 1970s, a stiff dose of inequality brings more efficient and faster-growing economies. This is because higher rewards and lower taxes at the top, it is claimed, boosts entrepreneurialism and delivers a larger economic pie.

So has the 30-year experiment in boosting inequality worked? The evidence suggests otherwise. The wealth gap has soared, but without the promised economic progress. Since 1980, British growth and productivity rates have been a third lower and unemployment five times higher than in the more egalitarian post-war era. The three post-1980 recessions have been deeper and longer than those of the 1950s and 1960s, culminating in the crisis of the last four years.

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The main outcome of the post-1980 experiment has been an economy that is more polarised and more crisis-prone. And the same pattern is true of America. Does this mean that the three-decade-long surge in the concentration of income was a key player in the 2008 crash and in today's lack of recovery? Not according to the only official account of the 2008-2009 crash, the 2011 report of the US Financial Crisis Inquiry Commission. This blamed pretty well everybody and everything for the meltdown, but did not mention inequality once in its 662-page report.

Yet history shows a clear association between inequality and instability. The Great Depression of the 1930s and today's slump were both preceded by sharp rises in inequality. Association is one thing, causation another. Yet a direct link between inequality and instability is strongly suggested by a key macro-economic relationship that between wages and output.

For the two-and-a-half decades from 1945, wages and output moved broadly in line across richer nations, with the proceeds of rising prosperity evenly shared. This was also a period of sustained economic stability. Then there have been two periods when wages have lagged behind output and at an accelerating rate in the 1920s and the post-1980s. Both ended in prolonged slumps. Since the late 1970s, the share of output taken by wages in Britain has fallen from 60% to 53%.

In America, real wages in the middle have been little better than stagnant over the last 30 years, creating an even greater wage-output gap'. There are at least two key reasons why inequality caused by a rising wage-output gap triggers economic crises.

First, falling wage shares suck demand out of economies heavily dependent on consumer spending. Consumer societies lose the capacity to consume. By 2007, British wage-earners had around £100bn (roughly equivalent to the size of the nation's health budget) less in their pockets than if the cake had been shared more equally as was the case in the late 1970s. In America, the sum stood at £500bn. As in the 1920s, the demand gap of the post-1990s was filled with an explosion of private debt that was never sustainable. This didn't prevent recession, it merely delayed it.

Secondly, concentrating the proceeds of growth in the hands of a small global financial elite leads to asset bubbles. In 1920s America, rapid enrichment at the top merely fed years of speculative activity in the property and stockmarkets. In the build-up to 2008, the rising corporate surpluses and burgeoning personal wealth that were the counterpoint of the falling wage share led to a mountain of global footloose capital. Only a tiny proportion of this ended up in productive investment that could have boosted demand in the real economy.

In the decade to 2007, bank lending for property development and takeover activity surged. While, as a result, the contribution to the economy made by financial services more than doubled over this period, manufacturing output fell by a quarter. Far from creating the new wealth that would have sustained higher economic activity, a tsunami of money raced around the world in search of ever-faster returns. This created bubbles in property, commodities and business while lowering economic resilience and increasing the risk of financial breakdown.

The evidence suggests that high levels of inequality slow growth and intensify the business cycle, raising the peaks and deepening the troughs. In the decade to 2008, a rising income gap led to an over-extended boom. Now that this has turned to bust, the same concentrations have led to the leveraging down of demand, thus preventing recovery.

The lesson of the last 30 years is that an economic model that allows the richest members of society to accumulate a larger and larger share of the cake will eventually self-destruct. It's a lesson, it appears, that has yet to be learned.

Stewart Lansley is the author of The Cost of Inequality: Why Economic Equality is Essential for Recovery (Gibson Square Books, £8.99).