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UK Inequality – How much and why does it matter?

BY JOHN WEEKS 19/02/2015

Bosses of the Senate
“The Bosses of the Senate” by Joseph Keppler

Economics and Distribution

From the 1950s to the early 1980s discussions of income and wealth distribution had had an important place in mainstream economics, for both developed and underdeveloped countries. For example, Simon Kuznets was one of the most prominent economists of the 1950s, and his work on income distribution and development was cited in awarding him the Nobel Prize in Economic Science from the Bank of Sweden (Kuznets, 1955).

In the 1980s and subsequently, interest in distribution fell victim to the ideology of markets – that market outcomes were efficient and therefore there is no justification for challenging the income and wealth distribution generated by markets (see Weeks, 2014). This idea that market operations are the process and distribution is the outcome reflects an intellectually simplistic misunderstanding of a capitalist economy.

Prices and quantities arising in market exchanges produce the incomes of labour and capital. These incomes feed back into markets to affect a range of variables, most obviously the structure of household demand and incentives to work and save. Not until recently has the interaction of markets and distribution again become a major research area for economists, in part through the best-selling book of French economist Thomas Piketty (2014).

Piketty’s re-discovery of the central role of distribution should rekindle interest in the two great classical economists, David Ricardo and Karl Marx. In Ricardo’s most famous work, “On the Principles of Political Economy and Taxation”, distribution appears in the first page, defining economics itself: “To determine the laws which regulate this distribution is the principal problem in Political Economy,” (Ricardo, 1821). In Marx’s work analysis of growth – the accumulation of capital – is inseparable from the functional distribution of income (i.e., between wages and profit).

The absence of distribution as a major research topic during the decades after 1980 both reflected and contributed to the degeneration of our subject into vulgar defence of market processes that justifies the rise of unproductive financial activities. Integral to this absence was the return to the Cloud Cuckoo Land of full-employment, price constrained theory, and an explicit rejection of the less than full employment theories of Keynesians.

Income and Wealth Distribution in the UK

A wealth of statistics facilitates both teaching and research on distribution in the United Kingdom. From the 1950s through the early 1980s, the UK size distribution of income hardly changed. The second half of the 1980s brought an extraordinary increase in inequality across individuals and households, which has continued at a slower but relentless pace for the last 25 years (Weeks, 2007).

Figure 1 shows the change in nominal household income by percentiles from the 1992/1993 tax year through 2007/2008, the year before the Global Financial Crisis struck. These 15 years coincided with strong growth of the economy, which should have provided favourable conditions for broad-based growth – falling unemployment ‘tightening’ the labour market.

Notwithstanding these favourable conditions for the general welfare, this decade and a half witnessed a regressive pattern of gains from growth. All households below the median had nominal income increases of less than 50 percent, with the bottom 1 percent having the lowest increase of all. In contrast, the richest 90 percent enjoyed a nominal income growth of 57 percent, the top 5 percent a gain of over 60, and the eponymous 1 percent raked in income growth of almost 90 percent. Changes by percentile are available for 2000-2008 and reveal a continuous decline in income gains moving down the income distribution.

Weeks Graph-page-001
Source: UK government

A general law of distribution predicts that greater inequality characterises the size distribution of wealth rather than the size distribution of income. In part this results from home ownership representing the only net asset for the great majority of households. Figure 2 verifies this for Britain during 2010-2012 (income measured on the left and wealth on the right).

The poorest income decile received an annual average of £11,400 while holding assets slightly greater, £13,100. At the top of the distribution the richest 10 percent had an income of £80,700 and assets over 10 times that amount, just below £1 million.  This overwhelming concentration of wealth at the top of the income distribution drives inequality. The so-called wealth generators at the top of the income distribution do indeed create wealth, for themselves, making wealth generators the inequality generators.

Weeks Graph2-page-001
Source: Office of National Statistics.

Reducing Inequality

A second almost invariant law of income and wealth distribution is that the private sector drives inequality and the public sector moderates it. This generalisation holds for Britain as Figure 3 shows. For the 2011/2012 tax year, inequality in pre-tax income distribution substantially exceeded that of the post-tax distribution. For the lowest decile, tax revenues reduced household income by a mere 3.7 percent, by 12 percent for the median household, and almost two-fifths for the richest 1 percent.

While the effect of taxation on reducing inequality remains substantial, it is considerably less than in the past.  In addition to major reductions in marginal tax rates at the top of the distribution, the increase in indirect taxes such as VAT makes the revenue system more regressive. The present UK recovery, long delayed and sluggish due to fiscal austerity (Portes, 2014), contains the essential elements to increased inequality – employment growth concentrated in low-productivity, low-wage activities, an increase in the VAT rate (BBC News, 2011), and a reduction in income tax rates (see Woodcock and Cordon, 2012).

This approach to recovery provides a clear strategy for greater inequality of income and wealth. It should come as no surprise that the goal of the current government is to reduce the public sector, an essential step towards increasing the income gains of the rich(see The Guardian, 2014).

Weeks Graph3-page-001
Source: UK government, Table 3.1.

Why Does Distribution Matter?

Objections to growing inequality are frequently attacked as reflecting moralistic value judgments rather than sound analysis. A branch of the economics profession, now in ideological control of the profession, has long argued that distribution is a technical outcome, and that altering it is a political decision that implies efficiency costs (Okun, 1975). While dominant, this view is quite old fashioned.

A growing amount of research including from the International Monetary Fund (IMF 2014) and the Organization of Economic Cooperation and Development (see Cingano, 2014) indicates that inequality undermines economic outcomes, especially growth. Equally strong is evidence indicating a negative correlation between health indicators and inequality, at both household and country level (Deaton, 2003).

More important than both of these and additional negative impacts is the political consequence of growing inequality. Concentration of income and welfare increases the control of politics by powerful private individuals and institutions(Weeks, 2014) . The ability to influence an election with money undermines democracy. When I grew up in Texas, there was a common saying: “the basic difference between a local councilman and a US Senator is that the councillor is cheaper to buy.”

Income and wealth inequality can make that true in Britain as well.

JOHN WEEKS

Professor Emeritus of Economics, SOAS University, and recent author of the book “Capital, Exploitation and Economic Crisis” 

 

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