Thursday, July 31, 2014
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21

The Bad Society

LONDON – How much inequality is acceptable? Judging by pre-recession standards, a great deal of it, especially in the United States and Britain. New Labour's Peter Mandelson voiced the spirit of the past 30 years when he remarked that he felt intensely “relaxed” about people getting “filthy” rich. Getting rich was what the “new economy” was all about. And the newly rich kept an increasing part of what they got, as taxes were slashed to encourage them to get still richer, and efforts to divide up the pie more fairly were abandoned.

The results were predictable. In 1970, the pre-tax pay of a top American CEO was about 30 times higher than that of the average worker; today it is 263 times higher. In Britain, the basic pay (without bonuses) of a top CEO was 47 times the average worker’s in 1970; in 2010, it was 81 times more. Since the late 1970s, the post-tax income of the richest fifth has increased five times as fast as the poorest fifth in the US, and four times as fast in the UK. Even more important has been the growing gap between average (mean) and median income: that is, the proportion of the population living on half or less of the average income in the US and Britain has been growing.

Although some countries have resisted the trend, inequality has been increasing over the last 30-40 years in the world as a whole. Inequality within countries has increased, and inequality between countries increased sharply after 1980, before leveling off in the late 1990’s and finally falling back after 2000, as catch-up growth in developing countries accelerated.

The growth of inequality leaves ideological defenders of capitalism unfazed. In a competitive market system, people are said to be paid what they are worth: so top CEOs add 263 times more value to the American economy than the workers they employ. But the poor, it is claimed, are still better off than they would have been had the gap been artificially narrowed by trade unions or governments. The only secure way to get “trickle-down” wealth to trickle faster is by cutting marginal tax rates still further, or, alternatively, by improving the “human capital” of the poor, so that they become worth more to their employers.

This is a method of economic reasoning that is calculated to appeal to those at the top of the income pyramid. After all, there is no way whatsoever to calculate the marginal products of different individuals in cooperative productive activities. Top pay rates are simply fixed by comparing them to other top pay rates in similar jobs.

In the past, pay differentials were settled by reference to what seemed fair and reasonable. The greater the knowledge, skill, and responsibility attached to a job, the higher the acceptable and accepted reward for doing it.

But all of this occurred within bounds that maintained some connection between the top and the bottom. Top business salaries were rarely more than 20 or 30 times higher than average wages, and for most people differentials were far less. Thus, the income of doctors and lawyers used to be about five times higher than that of manual workers, not ten times or more, as they are today.

It is the breakdown of non-economistic, common-sense ways of valuing human activities –framing them in larger social contexts – that has led to today’s spurious methods of calculating pay.

There is a strange, though little-noticed, consequence of the failure to distinguish value from price: the only way offered to most people to boost their incomes is through economic growth. In poor countries, this is reasonable; there is not enough wealth to spread round. But, in developed countries, concentration on economic growth is an extraordinarily inefficient way to increase general prosperity, because it means that an economy must grow by, say, 3% to raise the earnings of the majority by, say, 1%.

Nor is it by any means certain that the human capital of the majority can be increased faster than that of the minority, who capture all of the educational advantages flowing from superior wealth, family conditions, and connections. Redistribution in these circumstances is a more secure way to achieve a broad base of consumption, which is itself a guarantee of economic stability.

The attitude of indifference to income distribution is in fact a recipe for economic growth without end, with the rich, very rich, and super-rich drawing ever further ahead of the rest. This must be wrong for moral and even practical reasons. In moral terms, it puts the prospect of the good life perpetually beyond reach for most people. And, in practical terms, it is bound to destroy the social cohesion on which democracy – or, indeed, any type of peaceful, contented society – ultimately rests.

Read more from our "In Keynes's Footsteps" Focal Point.

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  1. CommentedAditya Unnikrishnan

    "In poor countries, this is reasonable; there is not enough wealth to spread round. But, in developed countries, concentration on economic growth is an extraordinarily inefficient way to increase general prosperity"

    I don't know why an approach that has so obviously been ineffective in increasing prosperity in developed nations is being touted as viable for developing nations.

  2. CommentedCharles St Pierre

    "We can have democracy in this country, or we can have wealth concentrated in the hands of a few; we cannot have both." Louis Brandeis, 1856-1941 US Supreme Court Justice

  3. CommentedJohn A Werneken

    Balderdash. Until historically very recently there NEVER was a society with as MUCH equality as is found today. And what does relative degrees of wealth, income, and choice have to do with a "good life"? NOTHING.

    Take a look at two parallel trends: for generations from roughly the Glorious Revolution forward, political equality increased but GROWTH brought real prosperity to virtually every citizen of a 'developed' country. THEN political 'progress' became increasing the power of the State, decreasing the ability of doers to "do" without much concern for the effects on others, and above all a worship of security and entitlement and increasing calls for economic "equity" if not economic equality.

    What do we have now? Mental depression, economic recession, and an end to broadly-spread progress as we had known it for three centuries.

      CommentedZlati Petrov

      I think at least some psychologists and economists will disagree with you that relative wealth/income is irrelevant. It seems at least somewhat relevant, actually, though the literature, as always, is inconclusive.

      http://ibe.eller.arizona.edu/docs/2010/Martinsson/happiness_jel_2008.pdf

      http://www.economics.uci.edu/~mcbride/RelativeIncomeEffectsSWB_JEBO_2001.pdf

      Who knows?

  4. CommentedRaj Thamotheram

    What is particularly bizarre about this deeply dysfunctional trend you describe is that it is enabled by pension funds and insurance companies, ie the aggregated saving vehicles of the 99%!

    And add injury to insult many of these funds have strong trade union influence but even those funds continue to act as the enabler of widening wealth gaps.

    http://www.ipe.com/magazine/long-term-matters-executive-pay_43191.php?s=thamotheram

  5. CommentedRaj Thamotheram

    And his old boss, Tony Blair, has taken the advice to heart. Of course, he doesnt consider himself very rich! Nor does he consider it appropriate to disclose his income or even his clients. Yet he and his allies feel he has a right to continue to influence UK politics.

    http://www.newsorganizer.com/article/i-m-not-one-of-the-super-rich--74dc7bda5d52f38c1df541d20a513d48/

  6. CommentedZlati Petrov

    But people don't claim that CEOs who are paid 263 times more than an average worker add 263 times more value to the economy.

    Since Lazaer (1981) and the rank tournament, multiplicative productivity, and imperfect monitoring revolutions in labor economics, economists have known that extremely skewed compensation is a way to encourage productivity among lower-level employees in the presence of information asymmetries and common shocks to output

    To put it in overly simplistic terms- high CEO pay encourages those who might want to be CEO one day to work really hard relative to others vying for that position. So the CEO gets paid that much (1) as something of a reward for his past efforts in getting to that position and (2) in order to encourage others to work hard in the presence of imperfect information about performance.

    Multiplicative productivity also predicts high CEO pay, as organizations become more complex. The rise in executive compensation may be related to the exponential growth in the complexity of the firms they oversee, because more complex organizations "magnify" the decisions of the CEO, making them that much more sensitive to CEO competence.

  7. CommentedJohnny (MoneyWonk)

    I totally agree. We should invest more in human capital, and society as a whole would benefit from a more educated and productive system. Just two problems: nobody wants to pay for it, and most are too lazy to learn anything productive.

    Case in point: my mom always told me I could be an engineer. I chose private equity instead.

  8. CommentedBen Leet

    The total wage income of 75% of U.S. workers (112 million workers) was $1.702 trillion in 2011 -- the total personal income of less than 1% of U.S. households was $1.734 trillion. And the wage income of half of U.S. workers (75 million workers) is only 7% of all personal income for 2011 --- 7% of $11.468 trillion. I compare the Joint Committee on Taxation total personal income figures with Social Security Administration wage and salary incomes for 2010. There is a limit to inequality after which it becomes injurious or toxic to society -- not only is it unjust but it decreases employment since workers cannot buy products which then kicks of a negative spiral of employment cuts. Wage income, as reported by Floyd Norris at the NYTimes, is below 44% of GDP, when in 1970 it was above 53%. Theoretically the income/wealth imbalance has not created a danger point signal. Intuitively we see that we are regressing to feudalism where only a few hold money. Recently Lawrence Mishel of the EPI wrote from the FRB recent document on wealth distribution, the new SCF, showing that 50% of the US population owned 1.1% of all wealth, down from 3.6% in 1995. Now the average wealth/savings for the lower 50% is below $11,000 per family, while the top 1% has on average more than $17 million per family. At some point it becomes clear that this is unhealthy, but like M.F. 2 days ago, "we" are not at that point yet. It doesn't engage his moral priorities yet. http://benL8.blogspot.com, my blog.

      CommentedZlati Petrov

      Remarkable numbers, but what should those numbers be?

      In other words: if they are a deviation from some normal level, what is that normal level?

      Perhaps Amartya Sen can answer that question by saying that it's no use trying to find an optimal distribution of income, but that we can say that the current distribution is unfair and that we can level it out a bit without having any exact number to aim at. Put succinctly: even if we don't know the optimal distribution of income and wealth, we can still confidently alter the current and know we are improving welfare.

      Maybe.

      But that seems risky somehow. How can we know that our aversion to the current income distribution isn't merely due to some kind of anchoring bias: we are used to a more equal distribution so we fixate on the way things were in the 60s even if the world has changed a lot since then and the income distribution changed as a legitimate response to new technologies, globalization, etc.?

      How can we tell that we are not suffering from some sort of Golden Age syndrome, wherein we think the way things were in the past was right only because the past has some kind of mythical pull on our imagination and psychology?

      These things bias our intuition. We need to filter them before we make normative statements about the income/wealth distributions.

  9. CommentedTed Peters

    The growth of inequality leaves ideological defenders of communism unfazed as well. Hmm, perhaps it's just a fact of life... like say realtive sizes, weight, intelligence, athleticism, looks..... etc etc. So maybe we should conmcentrate more on simply growing the economy, so that there are more opportunities for everyone, rather than pandering to the human tendency for envy.

  10. CommentedFrank O'Callaghan

    This is a common sense view. What is remarkable is how rarely it is heard. Most rational honest people have expressed it though not in such a clear manner. It is excluded from mass media. The anger expressed in opposition to it is disturbing.

  11. CommentedProcyon Mukherjee

    Much is said in favor of the 'Bad Society' than against it, so I guess the social acceptance for such a denouement is growing at a time when fair pricing of opportunities has much to be desired as allocation of resources that are scarce and limited is done in a manner that leaves lot less for those who need them the most. The question has shifted to moral arena as well where we take refuge in an imagery that self-righteousness gets the better of. What does it leave us at the end, an unfair exchange where self-fulfilling prophesies drain us from the moral positions with enormous allowances for individual aggrandizement while leaving scarce little for a shared sacrifice.

    I do not know whether there is any single example of any successful society (from the Romans to the current) who survived this dilemma without taking a road that leads to the greater common good.

    Procyon Mukherjee

  12. CommentedSabko Sabkov

    Very interesting article, Mr. Skidelsky. I, however, have a few notes that might serve to counterbalance your position:
    1. If rich people help poor people live a better life, are the poor people better or worse off? (i.e. referring to the rich people, who gave the world something even poor people can take advantage of - most relevant - technology)
    2. The wealth of the rich works in poor people's favour as well. Think about it - what happens with the rich people's money? It goes for the usage of other people, in the end - either by being lended over by banks, or by paying the salaries of the producers of the goods rich purchase - etc etc.
    3. Finally, it is people who make other people rich. Bill Gates became rich, because people recognised the value of his creations, not because the social system is dysfunctional.

    Of course, people might say that there are numerous unfairly rich people among us. But who made these people rich? Ultimately, it is always us.

  13. CommentedCharles Travis

    What is this the product of and what has it produced? These are the relevant questions. I've seen discussions about boards rife with mutual back scratching and unnecessary coziness with management as one likely culprit, among others most likely. We do see record corporate profits, at least on this side of the Atlantic so it may be difficult to argue it hasn't produced results, unless one can isolate other factors as an explanation.

  14. CommentedAndrew N Mason

    Ultimately, each country will set its "acceptable differential". Inequality just cant keep growing indefinitely, so at some point society itself will dictate the proper range

  15. CommentedGary Marshall

    Hello Mr. Skidelsky,

    So if most people within a nation were poor, starving, and living in conditions that would make the Neanderthals flinch, how much better off we would all be? Too bad we couldn't all be like North Korea where income equality abounds!

    GM

      CommentedZlati Petrov

      Hmmm, I suspect actually that income inequality in North Korea is absolutely monstrous. Based purely on intuition, I'd imagine that almost all the wealth in that country belongs to maybe 10 or 20 people.

      If anything, then, North Korea is a terrifying example of how unfair rent extraction and wealth redistribution by the few can decimate a society.

  16. CommentedZsolt Hermann

    I think when we look at such important questions as social inequality we should try to remain factual and scientific as much as possible, thus morals, personal emotional impressions will offer very minimal help as they are completely subjective.
    The next question is if we view the global human society as a loose collection of unique individuals with total freedom to do whatever they want, or we view global human society as an interconnected, integral network, functioning as a single living system. Through recent research and especially the practical living events of the global crisis we can all see and agree that global human society is indeed a single, interdependent network, where we cannot isolate individuals, or even nations from each other, but we have to consider the whole when examining any activity or specific phenomenon.
    Thus regarding social inequality too we need to see if it is positive or negative in terms of the function of the whole system.
    What we see is that regardless of what we think about the 1% or the 99%, the growing inequality is destroying the very layers of society, especially the middle class that is supposed to drive the whole system through production and consumption. Thus in view of the long term prosperity of the system, including the long term benefits of the top layer, growing social inequality is harmful, bringing the development of the whole system to halt. And this is what we observe through the global crisis.
    And we also observe that even the initially democratic institutions, structures are gradually distorted and twisted in favor of the top layer removing even the remaining chances for the lower social layers to catch up or succeed.
    This is nobody's fault, this comes from the nature of our desire for pleasure, pleasure is never enough if we receive something today, we need double the amount tomorrow to maintain the same satisfaction, thus those on top drive faster, and further away from the rest of the society using any means they have. It is the classical case of an alcoholic who simply cannot stop, even if he knows he kills himself, or the case of a cancer cell that has to consume everything even it leads to the death of the whole system including the cancer itself.
    What is the solution?
    Very difficult since the solution also has to come with the right motivation, since if we try to solve the problem with force, coercion, or trickery as we have always done though our history, we will keep repeating our mistakes, and sink deeper and deeper into crisis.
    The solution is twofold. On one hand we need to experience a blow, a failure to see that what we do right know leads to disaster. People simply do not listen until they are hurting, if they feel good they want to remain where they are. The global crisis and the potential disasters embedded in it can provide this awakening. On the other hand there has to be information, a global, integral education program explaining to everyone, from the top layer down to the last human being what happened, why we ended up in crisis, what the nature of our interconnected and interdependent human system is, and in what way we could build a different system that could offer prosperity to everyone without exploding into the same unequal system.
    The first part, the crisis and the potential blows are ahead of us. What we need to do is to organize and set up the education system for all of us ASAP.

  17. CommentedJ. C.

    In any case, what is "bad", are people´s preferences and how much they are willing to pay for them (I probably agree on that)... As long as people want´s Ipods and Footlball there will be Steve Jobs and Messi...

    The article is too soft (as most of Skidelsky's are) and based in "known facts and impressions" and not fundamented with proper research.

  18. CommentedJ. C.

    so who should set the "acceptable" differentials?? who are the "iluminados" that know how much you should worth in the market??

  19. CommentedJ. C.

    Comparing 70´s to 10´s is wrong since basically demand for talents became global in that period, so probably an american CEO has much more alternatives than he had years ago...

  20. CommentedJ. C.

    " This must be wrong for moral and even practical reasons..." it depends on which your moral and practical priorities are doesn`t it...???

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