Extreme wealth inequality signals global economic destabilization: Future of the economy P1
Extreme wealth inequality signals global economic destabilization: Future of the economy P1
In 2014, the combined wealth of the world’s 80 richest people equaled the wealth of 3.6 billion people (or about half of the human race). And by 2019, millionaires are expected to control almost half of the world's personal wealth, according to the Boston Consulting Group’s 2015 Global Wealth report.
This level of wealth inequality within individual nations is at its highest point in human history. Or to use a word most pundits love, today’s wealth inequality is unprecedented.
To gain a better gut feel for how skewed the wealth gap is, check out the visualization described in this short video below:
Aside from the general feelings of unfairness this wealth inequality might make you feel, the real impact and threat this emerging reality is creating is far more serious than what politicians would prefer you to believe. To understand why, let's first explore some of the root causes that brought us to this breaking point.
Causes behind income inequality
Looking deeper into this widening wealth chasm, we find that there isn't any one cause to blame. Instead, it's a multitude of factors that have collectively worn away at the promise of well-paying jobs for the masses, and ultimately, the viability of the American Dream itself. For our discussion here, let's do a quick break down some of these factors:
Free trade: During the 1990s and early 2000s, free trade agreements—like NAFTA, ASEAN, and, arguably, the European Union—became en vogue among most of the world’s finance ministers. And on paper, this growth in popularity is perfectly understandable. Free trade significantly reduces the costs for a nation’s exporters to sell their goods and services internationally. The downside is that it also exposes a nation’s businesses to international competition.
Domestic companies that were inefficient or behind technologically (like those in developing countries) or companies that employed a significant number of high salaried employees (like those in developed countries) found themselves unable to complete in the newly opened international marketplace. From a macro level, so long as the nation drew in more business and revenue than it lost by way of failed domestic companies, then free trade was a net benefit.
The problem is that at the micro level, the developed countries saw most of their manufacturing industry collapse from international competition. And while the number of unemployed grew, the profits of the nation's largest companies (the companies that were big and sophisticated enough to compete and win on the international stage) were at an all-time high. Naturally, these companies used a portion of their wealth to lobby politicians to maintain or expand free trade agreements, in spite of the loss of well-paying jobs for the other half of society.
Outsourcing. While we're on the subject of free trade, it's impossible not to mention outsourcing. As free trade liberalized the international markets, advances in logistics and container shipping enabled companies from developed nations to relocate their manufacturing base in developing countries where labor was cheaper and labor laws near non-existent. This relocation generated billions in cost savings for the world's largest multinationals, but at a cost for everyone else.
Again, from a macro perspective, outsourcing was a boon for consumers in the developed world, as it brought down the cost of almost everything. For the middle class, this reduced their cost of living, which at least temporarily dulled the sting of losing their high paying jobs.
Automation. In chapter three of this series, we explore how automation is this generation’s outsourcing. At an ever increasing pace, artificial intelligence systems and sophisticated machines are chipping away at more and more tasks that previously were the exclusive domain of humans. Whether it’s blue collar jobs like bricklaying or white collar jobs like stock trading, companies across the board are finding novel ways to apply modern machines in the workplace.
And as we’ll explore in chapter four, this trend is affecting workers in the developing world, just as much as it is in the developed world—and with much graver consequences.
Union shrinkage. As employers are experiencing a boom in productivity per dollar spent, first thanks to outsourcing and now to automation, workers, by and large, have far less leverage than they used to have in the marketplace.
In the US, manufacturing of all kinds has been gutted and with it, its once massive base of union members. Note that in the 1930s, one in three US workers were a part of a union. These unions protected workers rights and used their collective bargaining power to drive up wages needed to create the middle class that are disappearing today. As of 2016, union membership has fallen to one in ten workers with few signs of rebounding.
The rise of specialists. The flip side of automation is that while AI and robotics limit the bargaining power and the number of job openings for lower-skilled workers, the higher skilled, highly educated workers that AI can't (yet) replace can negotiate far greater wages than was possible before. For example, workers in the financial and software engineering sectors can demand salaries well into the six figures. The growth in salaries for this niche set of professionals and those who manage them is contributing heavily to the statistical growth of the wealth inequality.
Inflation eats away at the minimum wage. Another factor is that the minimum wage has remained stubbornly stagnant in many developed nations over the past three decades, with government mandated increases usually trailing far behind the average inflation rate. For this reason, that same inflation has eaten away at the real value of the minimum wage, making it increasingly difficult for those in the lower rung to eek their way into the middle class.
Taxes favoring the rich. It may be hard to imagine now, but in the 1950s, the tax rate for America’s highest earners well north of 70 per cent. This tax rate has been in decline ever since with some of the most dramatic cuts happening during the early 2000s, including substantial cuts to the US estate tax. As a result, the one per cent grew their wealth exponentially from business income, capital income, and capital gains, all while passing on more of this wealth from generation to generation.
Rise of precarious labor. Finally, while well-paying middle-class jobs may be in decline, low-paying, part-time jobs are on the rise, especially in the service sector. Aside from the lower pay, these lower skilled service jobs don't offer near the same benefits that full-time jobs offer. And the precarious nature of these jobs makes it exceedingly hard to save and move up the economic ladder. Worse, as millions more people are pushed into this "gig economy" over the coming years, it will create put even more downward pressure on the already wages from these part-time jobs.
On the whole, the factors described above can by and large be explained away as trends advanced by the invisible hand of capitalism. Governments and corporations are simply promoting policies that advance their business interests and maximize their profit potential. The problem is that as the income inequality gap widens, serious fissures begin to open in our social fabric, festering like an open wound.
Economic impact of income inequality
From WWII well into the late 1970s, each fifth (quintile) of income distribution among the US population grew together in a relatively evenhanded way. However, after the 1970s (with a brief exception during the Clinton years), income distribution between the different US population segments grew apart dramatically. In fact, the top one per cent of families saw a 278 per cent increase in their real after-tax income between 1979 to 2007, while the middle 60% saw less than a 40 per cent increase.
Now, the challenge with all this income concentrating into the hands of so few is that it reduces casual consumption across the economy and makes it more fragile across the board. There are a couple of reasons for why this happens:
First, while the rich may spend more on the individual things consume (i.e. retail goods, food, services, etc), they don't necessarily buy more than the average person. For an oversimplified example, $1,000 split evenly among 10 people may result in 10 pairs of jeans being purchased at $100 each or $1,000 of economic activity. Meanwhile, one rich person with that same $1,000 doesn't need 10 pairs of jeans, they may only want to buy three at most; and even if each of those jeans cost $200 instead of $100, that would still about to $600 of economic activity versus $1,000.
From this point, we then have to consider that as less and less wealth is shared among the population, less people will have enough money to spend on casual consumption. This reduction in spending decreases economic activity at a macro level.
Of course, there is a certain baseline that people need to spend to live. Should people's income fall below this baseline, people will no longer be able to save for the future, and it will force the middle class (and the poor who have access to credit) to borrow beyond their means to try to maintain their basic consumption needs.
The danger is that once the finances of the middle class reach this point, any sudden downturn in the economy can become devastating. People won’t have the savings to fall back on should they lose their jobs, nor will banks freely loan out money to those needing to pay rent. In other words, a minor recession that would have been a mild struggle two or three decades ago could result in a major crisis today (cue flashback to 2008-9).
Societal impact of income inequality
While the economic consequences of income inequality may be scary, the corrosive effect it can have on society may be much worse. A case in point is the shriveling of income mobility.
As the number and quality of jobs shrink, income mobility shrinks with it, making it more difficult for individuals and their children to rise above the economic and societal station they were born into. Over time, this has the potential to cement social strata into society, one where the rich resemble the European nobility of old, and one where people's life opportunities are determined more by their inheritance than by their talent or professional achievements.
Given even time, this social division can become physical with the rich cloistering away from the poor behind gated communities and private security forces. This can then lead to psychological divisions where the rich begin to feel less empathy and understanding for the poor, some believing they are inherently better than them. As of late, the latter phenomenon has become more culturally visible with the rise of the pejorative term ‘privilege.' This term applies to how children raised by higher income families inherently have more access to better schooling and exclusive social networks that allow them to succeed later in life.
But let’s dig deeper.
As the unemployment and underemployment rate grows among the lower income brackets:
What will society do with the millions of working age men and women who derive a great deal of their self-worth from employment?
How will we police all the idle and desperate hands who may be motivated to turn to illicit activities for income and self-worth?
How will parents and their grown children afford a post-secondary education—a critical tool to remain competitive in today's labor market?
From a historical perspective, increased rates of poverty lead to increased school dropout rates, teen pregnancy rates, and even increased obesity rates. Worse yet, during times of economic stress, people revert to a sense of tribalism, where they find support from people who are ‘like themselves.’ This can mean gravitating to family, cultural, religious, or organizational (e.g. unions or even gangs) bonds at the expense of everyone else.
To understand why this tribalism is so dangerous, the important thing to keep in mind is that inequality, including income inequality, is a natural part of life, and in some cases beneficial to encourage growth and healthy competition between people and companies. However, the societal acceptance of inequality begins to collapse when people begin to lose hope in their ability to fairly compete, in their ability to climb the ladder of success alongside their neighbor. Without the carrot of social (income) mobility, people begin to feel like the chips are stacked against them, that the system is rigged, that there are people actively working against their interests. Historically, these kinds of sentiments lead down very dark roads.
Political fallout of income inequality
From a political perspective, the corruption that wealth inequality can produce has been fairly well documented across history. When wealth concentrates into the hands of the very few, those few ultimately gain more leverage over political parties. Politicians turn to the rich for funding, and the rich turn to politicians for favors.
Obviously, these backdoor dealings are unfair, unethical, and in many cases, illegal. But by and large, society has also tolerated these secret handshakes with a kind of disillusioned apathy. And yet, the sands seem to be shifting beneath our feet.
As noted in the previous section, times of extreme economic fragility and limited income mobility can lead voters to feel vulnerable and victimized.
This is when populism goes on the march.
In the face of declining economic opportunity for the masses, those same masses will demand radical solutions to address their economic plight—they will even vote for fringe political candidates who promise swift action, often with extreme solutions.
The kneejerk example most historians use when explaining these cyclical slides into populism is the rise of Nazism. After WWI, the Allied forces placed extreme economic hardships on the German population to extract reparations for all the damage caused during the war. Unfortunately, the heavy reparations would leave the majority of Germans in abject poverty, potentially for generations—that is until a fringe politician (Hitler) emerged promising to end all reparations, rebuild German pride, and rebuild Germany itself. We all know how that turned out.
The challenge facing us today (2017) is that many of the economic conditions the Germans were forced to endure after WWI are now gradually being felt by most nations around the world. As a result, we’re seeing a global resurgence in populist politicians and parties being elected into power across Europe, Asia, and, yes, America. While none of these modern day populist leaders are anywhere near as bad as Hitler and the Nazi party, they are all gaining ground by proposing extreme solutions to complex, systemic issues that the general population is desperate to address.
Unfortunately, the previously mentioned reasons behind income inequality will only get worse over the coming decades. This means that populism is here to stay. Worse, it also means our future economic system is destined for disruption by politicians who will make decisions based on public anger rather than economic prudence.
… On the bright side, at least all this bad news will make the rest of this series on the Future of the Economy more entertaining. Links to the next chapters are below. Enjoy!
Future of the economy series
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