UK: Deloitte Monday Briefing: The Rise Of Inequality

Last Updated: 3 February 2014
Article by Ian Stewart

* Inequality has moved to the top of the political agenda across much of the industrial world in recent years.

* In his State of The Union address last week, President Obama announced a raft of measures to fight inequality, declaring - "After four years of economic growth, corporate profits and stock prices have rarely been higher, and those at the top have never done better. But average wages have barely budged. Inequality has deepened. Upward mobility has stalled".

* In the UK, the Labour Party has pledged to raise the top rate of income tax to 50p and to freeze utility prices. Labour's focus on the "cost of living crisis" is at the heart of its electoral strategy.

* Yet inequality has been on the rise across much of the West since well before the financial crisis and, in the case of the UK and the US, since the late 1970s. So, why has the issue only now reached the top of the political agenda?

* Before the crisis, rising inequality was accompanied by growth in real incomes for most of the population. The majority of people were benefiting from the system, even if some were getting rich much quicker than others.

* The global financial crisis has caused a major squeeze on consumer incomes. In a number of countries, including the UK, a large chunk of the population are worse off today than they were at the start of the crisis. The greatest squeeze has occurred in the periphery of the euro area. In Greece, the worst affected nation, real disposable incomes dropped a staggering 25% between 2008 and 2011 alone.

* In the UK, real incomes actually rose during the recession, in 2008-09. The puzzle is that the big income squeeze kicked in with the recovery. Since 2010, as the UK economy moved back to growth, consumers have had to contend with low or no pay rises, above average inflation, rising taxes and a squeeze on state benefit. Real incomes have been falling consistently since 2010, the longest period for 50 years.

* Real incomes have fallen in a job-rich recovery. Since 2010, the UK economy has created more than a million new jobs, a 3% increase in the size of the workforce, but the real value of incomes has dropped by 7%. More people are in work, but on average they earn less. The unusually weak productivity, or output per person, of recent years, helps explain the weakness of wage growth.

* Inflation has hit low income groups especially hard. Increases in the prices of food, energy and rents in social housing – items which account for a large share of the spending of those on low incomes - have far outstripped general inflation in the last five years.

* But how can we explain the much longer term rise in inequality? A series of powerful forces seem to be at work. Technological progress, globalisation, the expansion of financial markets and the decline of unions have reduced the relative value of unskilled labour and bolstered the returns to high level skills and to capital. Indeed, the wage squeeze is part of a bigger story which has played out across the world for the last three decades in which labour's share of GDP has shrunk and the share going in profits have risen.

* In this sort of a world, expertise, education and experience are at a premium. The most conspicuous examples are in the financial sector but this process has been at work across the economy. Since 1978, real incomes for UK doctors have risen 153%, for lawyers 114% and for quantity surveyors by 65%. Over the same period, incomes for fork lift truck drivers have fallen 5% and pay for unskilled production line workers has dropped 3%.

* Such inequalities reflect, in part, widely differing levels of educational and training achievement not just across social groups but across generations. Recent OECD research came up with the alarming finding that that England is the only country in the developed world in which adults aged 55-to-65 outperform those aged 16-to-24 in literacy and numeracy tests. This fact may help explain why, since 2007, the number of under-24s in work has shrunk by almost half a million even as the number of over 55s in work has increased.

* The good news is that the worse of the squeeze on incomes in the UK is probably past. The UK's official forecaster, the Office for Budget Responsibility, believes that stronger growth in earnings, and lower inflation, will deliver increases in real incomes over the next five years. The OBR's forecasts, do, however, assume a continued squeeze on benefits which is likely to bear particularly hard on lower income groups.

* Given the powerful long term forces at work it seems quite possible that income inequalities will continue to widen over coming years, even if average earnings growth reassume their upward trajectory.

* But what could actually reduce inequality?

* Aggressively redistributive tax and benefits policies, the like of which have not been seen in the UK since the 1970s, would make a big difference. But in a world of increasingly freely-flowing capital and labour the long term economic consequences could be ruinous. The alternative is the long haul of boosting the productivity of low income earners through improvements in education and training. In a world where expertise commands a premium, this hardly revolutionary path seems to offer the surest way of improving the prospects of those at the bottom of the income distribution.

MARKETS & NEWS

UK's FTSE 100 ended the week down -2.3%, on continued fears about growth in emerging markets.

Here are some recent news stories that caught our eye as reflecting key economic themes:

KEY THEMES

* The US economy grew at an annual rate of 3.2% in the last quarter of 2013, with exports up by 11.4%
* German business confidence rose in January to its highest level since July 2011
* Japanese inflation benchmark inflation rate rose by 1.3% in December, moving closer to the Bank of Japan's 2% target rate
* Investors withdrew money from emerging market equities at the fastest rate since 2011 according to data by EPFR Global
* The Financial Times reported that US purchases of European shares rose to levels last seen in the run-up to the launch of the euro in 1999
* Two French executives who had been held for 18 hours as part of an escalating dispute over severance pay were released by striking workers
* The International Energy Agency said high European energy prices mean Europe will lose a third of its global market share of energy-intensive exports over the next two decades
* Investor brothers Cameron Winklevoss and Tyler Winklevoss called for a sheriff to police the "wild, wild west" of virtual currencies
* Cocoa prices rose to two and a half year highs as worries about global inventory levels of cocoa hit markets
* Stoke council sold the first "£1 homes" under a £3m scheme enabling local residents to buy derelict properties in exchange for paying £30,000 for their restoration
* Yakult, the Japanese maker of probiotic drinks, said net income for the nine months to December was up 30%, with overseas revenues up 37% per cent
* Blue Bottle, a coffee chain with a devout following amongst San Francisco's startup community, received a $25.75m of venture capital investment
* The growth in worldwide tablet shipments slowed in 2013, with the International Data Corporation (IDC) warning that "markets such as the US are reaching high levels of consumer saturation"
* Treasury Wine Estates, maker of wines including Lindeman's and Penfolds, lowered its earnings estimates, saying that government austerity measures in China were impacting consumer demand for premium wine
* The Chinese Year of the Horse, which began on 31st January, may bring strong gains in stocks linked to wood, one of the year's dominant elements, according to Hong Kong's practitioners of the ancient art of feng shui – horse trading

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