A similar mechanism was at work in the build-up to the great depression of the 1930s, with a great surge in the concentration of wealth in the United States.
Our guest writer is Stewart Lansley, the author of “How Soaring Inequality Contributed to the Crash” in Soundings this month
Although excessive bank leveraging and reckless financial risk-taking triggered the meltdown of 2008/09, these are symptoms of a crisis that has its roots in the rising wealth gap, and in the way a new domestic and global super-rich elite created economic fragility. The rise in inequality of the last 30 years has been driven by a steady fall in the share of wages in UK national output – from a high of 65 per cent in 1975 to 53 per cent in 2007 – while the share going to profits has soared.
The wage squeeze and profits boom have been key drivers of financial instability. This is because instead of boosting productive investment, the rising profits pool fuelled the personal wealth boom of the last two decades. Faced with mounting wealth portfolios, he new super-rich elite turned to financial speculation as the source for quick gains. In doing so, they aped financial institutions, leveraging their wealth by borrowing – sometimes by huge amounts.
Record returns together with cheap credit encouraged the wealthy to borrow not to finance consumption but to take large speculative bets. Money poured into hedge funds, private equity, takeovers, commodities, rare art, commercial and private property in a speculative frenzy that created the multiple bubbles that triggered the credit crunch and the subsequent recession.
A similar mechanism was at work in the build-up to the great depression of the 1930s, with a great surge in the concentration of wealth in the United States and in the volume of speculative loans during the 1920s. During that decade, the poor and the middle stagnated while the rich prospered, as they have in the UK and the US in recent times, and soaring profits poured into real estate and stock markets, leading to the 1929 crash.
The role of inequality in fuelling financial instability has long been recognised. Keynes made it clear that because of the lower marginal propensity to consume of the rich, and their propensity for speculation, wealth inequality increases the risk of financial instability and economic collapse. In his book “The Great Crash”, John Kenneth Galbraith identified “the bad distribution of income” as the first of five factors causing the crash and the great depression.
The global distribution of wealth today is almost as uneven as it was in the 1920s. And its speculative element and impact has been accentuated by both greater leveraging and the rise of an avalanche of footloose capital owned by the world’s nomadic super-rich. The combined wealth of the world’s richest 1,000 people is almost twice as much as the world’s poorest 2.5 billion.
The central lesson of the crisis is that there is an economic limit to the degree of wealth inequality consistent with economic stability. Beyond that limit – one heavily breached in the post-millennium years – economies implode. It is a lesson that has yet to be learnt. The global super-rich have largely bounced back from the slump in their fortunes.
Wages are still being squeezed and profits are showing signs of recovery. The banks are back to their old ways funding the next wave of speculative investment – witness the loans secured for the £11 billion Kraft takeover of Cadbury’s – while starving efficient small businesses of essential funds. Nothing has changed. Without measures that tackle the global and domestic wealth imbalance, the next wave of destabilizing speculative frenzy will soon be with us.
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