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A new form of radical centrist politics is needed to tackle inequality
without hurting economic growth
BY THE end of the 19th century, the first age of
globalisation and a spate of new inventions had transformed the world economy.
But the “Gilded Age” was also a famously unequal one, with America’s robber
barons and Europe’s “Downton Abbey” classes amassing huge wealth: the concept
of “conspicuous consumption” dates back to 1899. The rising gap between rich
and poor (and the fear of socialist revolution) spawned a wave of reforms, from
Theodore Roosevelt’s trust-busting to Lloyd George’s People’s Budget. Governments
promoted competition, introduced progressive taxation and wove the first
threads of a social safety net. The aim of this new “Progressive era”, as it
was known in America, was to make society fairer without reducing its
entrepreneurial vim.
Modern politics needs to undergo a similar
reinvention—to come up with ways of mitigating inequality without hurting
economic growth. That dilemma is already at the centre of political debate, but
it mostly produces heat, not light. Thus, on America’s campaign trail, the left
attacks Mitt Romney as a robber baron and the right derides Barack Obama as a
class warrior. In some European countries politicians have simply given in to
the mob: witness François Hollande’s proposed 75% income-tax rate. In much of
the emerging world leaders would rather sweep the issue of inequality under the
carpet: witness China’s nervous embarrassment about the excesses of
Ferrari-driving princelings, or India’s refusal to tackle corruption.
At the core, there is a failure of ideas. The right is
still not convinced that inequality matters. The left’s default position is to
raise income-tax rates for the wealthy and to increase spending still
further—unwise when sluggish economies need to attract entrepreneurs and when
governments, already far bigger than Roosevelt or Lloyd George could have
imagined, are overburdened with promises of future largesse. A far more
dramatic rethink is needed: call it True Progressivism.
To have or to have not
Does inequality really need to be tackled? The twin
forces of globalisation and technical innovation have actually narrowed
inequality globally, as poorer countries catch up with richer ones. But within
many countries income gaps have widened. More than two-thirds of the world’s
people live in countries where income disparities have risen since 1980, often
to a startling degree. In America the share of national income going to the top
0.01% (some 16,000 families) has risen from just over 1% in 1980 to almost 5%
now—an even bigger slice than the top 0.01% got in the Gilded Age.
It is also true that some measure of inequality is
good for an economy. It sharpens incentives to work hard and take risks; it
rewards the talented innovators who drive economic progress. Free-traders have
always accepted that the more global a market, the greater the rewards will be
for the winners. But as our special report this week argues, inequality has
reached a stage where it can be inefficient and bad for growth.
That is most obvious in the emerging world. In China
credit is siphoned to state-owned enterprises and well-connected insiders; the
elite also gain from a string of monopolies. In Russia the oligarchs’ wealth
has even less to do with entrepreneurialism. In India, too often, the same is
true.
In the rich world the cronyism is better-hidden. One
reason why Wall Street accounts for a disproportionate share of the wealthy is
the implicit subsidy given to too-big-to-fail banks. From doctors to lawyers,
many high-paying professions are full of unnecessary restrictive practices. And
then there is the most unfair transfer of all—misdirected welfare spending.
Social spending is often less about helping the poor than giving goodies to the
relatively wealthy. In America the housing subsidy to the richest fifth
(through mortgage-interest relief) is four times the amount spent on public
housing for the poorest fifth.
Even the sort of inequality produced by meritocracy
can hurt growth. If income gaps get wide enough, they can lead to less equality
of opportunity, especially in education. Social mobility in America, contrary
to conventional wisdom, is lower than in most European countries. The gap in
test scores between rich and poor American children is roughly 30-40% wider
than it was 25 years ago. And by some measures class mobility is even stickier
in China than in America.
Some of those at the top of the pile will remain
sceptical that inequality is a problem in itself. But even they have an
interest in mitigating it, for if it continues to rise, momentum for change
will build and may lead to a political outcome that serves nobody’s interests.
Communism may be past reviving, but there are plenty of other bad ideas out
there.
Hence the need for a True Progressive agenda. Here is
our suggestion, which steals ideas from both left and right to tackle
inequality in three ways that do not harm growth.
Compete, target and reform
The priority should be a Rooseveltian attack on
monopolies and vested interests, be they state-owned enterprises in China or
big banks on Wall Street. The emerging world, in particular, needs to introduce
greater transparency in government contracts and effective anti-trust law. It
is no coincidence that the world’s richest man, Carlos Slim, made his money in
Mexican telecoms, an industry where competitive pressures were low and prices
were sky-high. In the rich world there is also plenty of opening up to do. Only
a fraction of the European Union’s economy is a genuine single market. School
reform and introducing choice is crucial: no Wall Street financier has done as
much damage to American social mobility as the teachers’ unions have. Getting
rid of distortions, such as labour laws in Europe or the remnants of China’s
hukou system of household registration, would also make a huge difference.
Next, target government spending on the poor and the
young. In the emerging world too much cash goes to universal fuel subsidies
that disproportionately favour the wealthy (in Asia) and unaffordable pensions
that favour the relatively affluent (in Latin America). But the biggest target
for reform is the welfare states of the rich world. Given their ageing
societies, governments cannot hope to spend less on the elderly, but they can
reduce the pace of increase—for instance, by raising retirement ages more
dramatically and means-testing the goodies on offer. Some of the cash could go
into education. The first Progressive era led to the introduction of publicly
financed secondary schools; this time round the target should be pre-school
education, as well as more retraining for the jobless.
Last, reform taxes: not to punish the rich but to
raise money more efficiently and progressively. In poorer economies, where tax
avoidance is rife, the focus should be on lower rates and better enforcement.
In rich ones the main gains should come from eliminating deductions that
particularly benefit the wealthy (such as America’s mortgage-interest
deduction); narrowing the gap between tax rates on wages and capital income;
and relying more on efficient taxes that are paid disproportionately by the
rich, such as some property taxes.
Different parts of this agenda are already being
embraced in different countries. Latin America has invested in schools and
pioneered conditional cash transfers for the very poor; it is the only region
where inequality in most countries has been falling. India and Indonesia are
considering scaling back fuel subsidies. More generally, as they build their
welfare states, Asian countries are determined to avoid the West’s
extravagance. In the rich world Scandinavia is the most inventive region.
Sweden has overhauled its admittedly huge welfare state and has a universal
school-voucher system. Britain too is reforming schools and simplifying
welfare. In America Mr Romney says he wants to means-test Medicare and cut tax
deductions, though he is short on details. Meanwhile, Mr Obama, a Democrat, has
invoked Theodore Roosevelt, and Ed Miliband, leader of Britain’s Labour Party,
is now trying to wrap himself in Benjamin Disraeli’s “One Nation” Tory cloak.
Such cross-dressing is a sign of change, but
politicians have a long way to go. The right’s instinct is too often to make
government smaller, rather than better. The supposedly egalitarian left’s
failure is more fundamental. Across the rich world, welfare states are running
out of money, growth is slowing and inequality is rising—and yet the left’s
only answer is higher tax rates on wealth-creators. Messrs Obama, Miliband and
Hollande need to come up with something that promises both fairness and
progress. Otherwise, everyone will pay.
