Keith Rankin: What to do about inequality

It's in the interest of the rich as well as the poor to nip the problem of excessive inequality in the bud, writes Keith Rankin. Photo / Thinkstock

Opinion

In his article "Auckland: A city divided by income" (6 February) Simon Collins stated one of the least said but most important truths of our difficult economic times. He wrote of "boom/bust cycles caused by excessive lending by people who have more than they need to people who need the loans but can't afford them".

We live in a world economic order best described as global industrial capitalism; a system in which I am fully in favour (especially when it operates sustainably). It's a system, however, that's subject to bouts of instability. And, as Collins suggests, excessive inequality is a principal driver of systemic instability.

Being a global system, the role of national governments to fix things that go wrong is limited, just as the role of doctors to create health is secondary to our private adoption of enlightened behaviour in our maintaining good health.

Certainly, it behoves governments to not make problems like excessive inequality worse. In this our governments do badly, whether it is European Union governments requiring many of the youth of Greece and Spain to live as outcasts, or the New Zealand government wanting to further block career opportunities for young New Zealanders by devolving much of its own service provision to Google.

Excessive inequality creates winners and losers. Thus, for individuals who see themselves as winners, or who aspire to become winners, high levels of inequality can be appealing.

However the instability that arises from excessive inequality only creates losers if the resulting race to the bottom is not stemmed. The rich in chronically unequal societies have to imprison themselves in gated communities and hire bodyguards for themselves and their children. And when social breakdown occurs, the rich often suffer disproportionately, given that they have more to lose.

So it's in the interest of the rich as well as the poor to nip the problem of excessive inequality in the bud.

In a system of 'industrial' capitalism, costs are low because of the industrial-scale production of goods and services for mass markets. In other words, the few very rich (the "one percent", if you will) make their fortunes by directly or indirectly selling goods and services to the non-rich (the "99 percent").

Collins writes of those "people who have more than they need". These are people who have high incomes and save for no particular purpose; they save in the full expectation that they will die leaving substantial unspent savings to adult children who in many cases will have similar expectations of themselves.

Such people are much more numerous than the super-rich "one per cent". Maybe we could call them the rich 'ten percent'? What we do know is that rising inequality has enlarged this group of rich savers, be they Belgian dentists, Japanese housewives, American lawyers or New Zealand managers. Further, rising inequality is substantially increasing the average level of savings held by those belonging to this group.

The problem that Collins writes of is the need to recycle the savings of these rich. The need arises because they earn much more than they can spend, and the non-rich earn less that they need in order to support the material standard of living that our form of industrial capitalism requires them to have.

Recycling spending power to the non-rich can be done in four ways. From 1894 to 1991 it was done in New Zealand mainly by paying regulated above-market wages. From the 1930s, and especially since the 1970s, it was also done through taxation and benefit payments. Increasingly from 1991, it has been done through the rich lending to the non-rich.

In the nineteenth century the principal method of recycling purchasing power was through private charity, including the philanthropy of the "one percent". The late Roger Kerr is on record quite recently as having favoured the replacement of the public tax-benefit system with an optional system of private charity.

The problem with the public welfare system is that the rich resist the level of taxes required to maintain a stable income distribution as capital displaces labour. The philanthropic system, on its own, can never achieve the level of income recycling required, given that the epithet "scrooge" can be applied to at least some of the rich. So instead the rich lend to the non-rich, through banks, under the belief that such lending entitles them to an annual 'risk-free rate of return' of five-percent or more.

If the money doesn't get recycled to the non-rich, then businesses lose their customers. A recession takes place. The instincts, of the rich in particular, are to spend even less in a recession, thereby aggravating the recession.

Thankfully, income recycling still takes place in New Zealand on a substantial basis; we note the continued financial success of our banks. Europe, on the other hand, is tearing itself apart.

* Keith Rankin teaches economics at Unitec