The Price of Inequality

Over the past 30 years, the income gap between rich and poor has widened in most wealthy nations, and especially in the US and the UK. Yet before the present global crisis, the growth of inequality was not a big political or economic issue. The orthodoxy, eventually embraced by the moderate Left along with the Right, was that inequality was necessary for economic dynamism, and that you could have greater equality or a stronger economy, but not both.

Since the 2008 crash and the subsequent recession, this orthodoxy has come under increasing fire as the issue of inequality races up the political agenda. At the 2011 World Economic Forum in Davos, Min Zhu, former deputy governor of the People's Bank of China and deputy managing director of the International Monetary Fund, told his audience: "The increase in inequality is the most serious challenge facing the world." In a speech last December, US President Barack Obama called inequality "the defining issue of our time".

The latest figure to weigh in on what is becoming one of the most hotly contested issues in economics is Joseph Stiglitz. "Of the 1%, for the 1%, by the 1%" is how he memorably describes the current US economic system in The Price of Inequality. Here, the former head of economics at the World Bank and adviser to Bill Clinton, and a long-standing critic of "market fundamentalism", delivers a compelling, passionately argued and comprehensive attack on the economic, political and democratic dangers of an excessive gap. His central thesis is that inequality comes at a high price, creating "an economic system that is less stable and less efficient, with less growth, and a democracy that has been put in peril".

Many of the arguments will be familiar to those who have followed this debate. But while Stiglitz presents little new or original evidence, what he does is marshal, with force, the growing volume of academic research, much of it cited in detailed endnotes and a good deal of it from his own wide-ranging output, on the roots and impact of growing inequality.

"Of all the costs imposed on our society by the top 1 per cent, perhaps the greatest is this: the erosion of our sense of identity in which fair play, equality of opportunity and a sense of community are so important," Stiglitz says. Even before the crisis, he argues, "America had created a marvelous economic machine, but evidently one that worked only for those at the top." While these accusations (and the book in general) focus on the US, Stiglitz's charge sheet applies equally to the UK and other countries with widening income gaps.

Stiglitz attributes today's towering fortunes at the top mainly to "rent-seeking" - the use of economic muscle not to increase the size of the cake but to grab a larger share. Examples include those exercising monopoly power; executives exploiting corporate-governance deficiencies to extract an excessive share of company earnings; and financiers diverting wealth by exploiting the poor through predatory lending and abusive credit card practices.

The central cause of rising inequality, he argues, is not uncontrollable external events such as globalisation, but a captured and compliant political system that has allowed the rich "to shape the rules of the game in their favour". The "American dream" - that all US citizens have an equal opportunity to rise to the top - is at odds with reality. Rather, the US has "less equality of opportunity, less than it was in the past, and less than in other countries".

Stiglitz joins a growing band of economists who argue, controversially, that the roots of the recent crash lie in excessive inequality. "When money is concentrated at the top of society," he writes, "the average American's spending is limited." This contraction of demand would matter much less if the gap had been filled by a boost to investment or exports. But this is not what happened. Instead, the US economy was kept alive by pumping in historic amounts of debt in a way that escalated financial risk and triggered the housing bubble that drove the world off the edge of the cliff in 2008.

Despite growing concern about the impact of inequality, the best evidence is that in the US and the UK, the income gap has continued to grow. This is not for a lack of instruments for reversing the trends of the past three decades. Markets can be reshaped to promote more equal societies, improve job opportunities and narrow the pay gap, as they were on both sides of the Atlantic after the Second World War and as they are today in a number of successful economies. There are plenty of well-developed proposals for capping fortunes at the top: curbing excess in the financial sector, a redistribution of the balance of power between labour and big business, a move to more progressive taxes and tougher controls on global capital flows are some of the options Stiglitz lists here.

Listing is one thing, but implementation is another. One of the greatest barriers to reform is one of the pernicious side-effects of a growing economic divide - an unhealthy and intractable concentration of power. Stiglitz argues that inequality has had a debilitating effect on democracy in the US, eroding public trust in government (a quarter of Americans are not registered to vote) and contributing to a "process of disempowerment, disillusionment, and disenfranchisement" that has enabled "the 1 per cent to shape policies in its own interest".

Any government set on bringing big finance to heel or making the rich pay more tax (as Angel Gurria, secretary general of the Organisation for Economic Cooperation and Development, has called for) is likely to find itself, as in the UK and the US, on the weaker end of a tug of war with a heavyweight team of those who stand to lose the most. In the US, as Obama knows only too well, a coalition of the rich holds the purse strings to power - and the policy veto that goes with it.

Against this, the evidence is mounting that making domestic economies and the global economy more stable and successful requires breaking up the great concentrations of wealth and distributing the fruits of growth more evenly. Even some high-profile, powerful global institutions that once promoted the "equality/efficiency tradeoff" are now adopting this view. Take the IMF: although it has long been an advocate of the virtues of free markets and the necessity of large pay gaps, its recent research shows that more equal economies enjoy greater stability and more sustainable long-term growth. The annual OECD conference in Paris in May was dominated by debates about the threat of inequality and how to tackle it.

Stiglitz hopes that if the 1 per cent - strictly speaking, the 0.1 or 0.01 per cent - were to recognise how their "own fate is ultimately bound up with how the other 99 per cent live", this would provide a new and powerful impetus for change. This is wishful thinking. The global billionaire class shows no signs of acquiescing in an erosion of its muscle, privileges and wealth. Governments continue to dance largely to the tune of Wall Street and City financiers. Nevertheless, the public, political and intellectual mood is hardening. As this book shows, for 30 years the world's "rent-grabbing" plutocrats have had their own way. They now have a tougher battle on their hands to maintain that status quo.

The Author

Born in Gary, Indiana, Joseph Stiglitz took his first degree at Amherst College, where it was said that by his third year, his lecturers felt they had no more to teach him. At the age of 26, he was made a professor at Yale University, and he went on to play a key role in founding the field of the economics of information.

But he was raised by parents, he told The New York Times, who "never let success go to one's head. If I came home with an A, my father would say, 'There must have been a lot of dummies in that class.'" It was, he added, "a joke. With my kids, I'm a little sappier than my father may have been."

A scholar who many feel has moved to the Left, Stiglitz's criticisms of financial deregulation and of austerity plans to combat the economic crisis have won plaudits from the Occupy movement and other activists. Despite his challenges to Chicago School thought, his 2001 Nobel Prize in Economics was widely expected.

Currently university professor of economics at Columbia University with a part-time role at the University of Manchester's Brooks World Poverty Institute, Stiglitz advised US president Bill Clinton, was a lead author on the Nobel prizewinning Report of the Intergovernmental Panel on Climate Change, and chair of the United Nations' Commission of Experts on Reforms of the International Monetary and Financial System.

He is not, however, in Barack Obama's inner circle. Asked by The New York Times if the president had offered him a job, he replied: "No. There was no natural position for me within the usual structure of government." And if Obama were to change his mind? "He knows how to email me."