The time is ripe for politicians to act

Next month’s US Presidential election has been a very firm check on any significant economic policy action by politicians not just in America but also in Europe and China.  It has been left to those in charge of the Central Banks to make all the policy running this year.  In response to the weakening economic data and political stalemates over the last six months, both Bernanke and Draghi have taken it upon themselves to take significant policy action and encourage their politicians to do the right thing.

This year, being an election year, it proved impossible to get any bipartisan agreement in the US on anything to do with the budget deficit – the Republicans insisted on no tax rises of any kind, and the Democrats were not prepared to contemplate any spending cuts.  Instead, they created an outcome of Mutually Assured Destruction, in which in the absence of any other agreement before the end of this year, substantial tax increases and spending cuts will automatically take effect from the start of next year.  If fully enacted, these policies would undoubtedly push the US economy into recession in 2013. It is only after the election in early November that the politicians will begin to get to grips with this issue.  The world economy needs a compromise to be effected between the two parties, assuming, as currently appears likely, that one party does not hold all three of the Presidency, the Senate and the Congress.

Markets are currently expecting that such a compromise does in fact occur.  The best time for any politician to make a politically difficult decision is immediately after an election, when any future electoral consequences are as far away as they will ever be.  Mr Bernanke has indicated that he holds an insurance policy in the event of no agreement and he will become much more aggressive with his QE programme, further to concentrate the minds of the Republicans.

In the Eurozone, the politicians have clearly adopted stalling tactics with regard to making a decision on whether to give further help to Greece, and have delayed receiving the Troika report from an initial late August date until mid November, just after the US elections.  The much smaller Cyprus bailout has also been delayed to be sorted out at the same time as Greece.  The Spanish bailout has also been delayed, first by the Spanish Prime Minister, who has regional elections on October 21st and who does not want to be seen asking for money before then. Also by Germany and some EU officials who are concerned about the knock-on effects in markets of a Spanish bailout request, most particularly for Italy.  Dealing with all of these together in November appears to be the preferred strategy, and as in the US markets are expecting there will be a satisfactory resolution (at least for now).  The longer term issues of enforced austerity weakening growth prospects and the lack of competitiveness in the Southern European economies will no doubt create further crises in due course.

China too is going through leadership change, with the new Politbureau team being unveiled just two days after the US elections.  Here too there has been evidence of policy drift this year with the slowing Chinese economy met by silence from the politicians, though the Central Bank have been easing policy a little during the year.  It is not known what the economic priorities of the new leadership team will be, but markets would appreciate an idea of the direction of policies that will be followed.

The last two months of the year thus provide the opportunity for politicians around the world to resolve several uncertainties about economic policy that have been allowed to build up ahead of the electoral time frame.  Some clear leadership in the next few weeks should boost market confidence, but political indecisiveness would be very damaging to markets. The time is therefore ripe for politicians to act.

Rising income inequality – why is it happening?

The early 1980s marked major lows in income inequality in both the US and the UK, and has since risen steadily back to the previous peaks seen in the late 1920s – there has been a particular acceleration since in the 21st century. In the US today, the top 10% earn 50% of all income, and the top 1% earn 20% of all income. In the UK the figures are only a little less unequal. The Davos forum’s 2012 report recently cited income inequality as a global risk for the first time.

In economic terms, the reasons for this increasing inequality lie in the differing forces affecting the demand and supply of low or averagely-skilled workers and highly-skilled workers. At the lower-skilled end of the labour market, there has been an explosion of supply, China and India are estimated to have tripled the number of people in the world seeking industrial jobs – the world market price for such labour has thus come under enormous downward pressure. This is not just in low-tech, assembly manufacturing, but, given the strong emphasis put on education in both these societies, increasingly too in higher-skilled manufacturing and with the rise of the internet, in service sector roles where brain matters more than brawn. India produces 3 million graduates a year, most with good English and strong IT skills, for whom $20,000 is a very attractive salary. This factor, more than anything else, explains why the median real wage in the US is unchanged over 40 years – the standard of living in the US has risen only because more members of the household are working. As real wages have stagnated, it follows that company profits have seen most of the benefits of economic growth in recent decades.

These higher profits have enabled company executives at the top end of the labour market to receive very much higher pay – generally determined by board members who are senior executives at other companies. This has been compounded by two further factors. First, globalisation has enabled successful companies in one country to expand much more easily internationally – the complexity of managing such businesses and the skills required by executives have increased substantially. In addition companies with greater revenues and profits generally pay better. The second is technology and the “winner-take-all” nature of many new industries as the virtual world places enormous premia on the benefits of networking effects. For example, people use Facebook and Twitter rather than any competitors because they already have so many users, and so their dominance over competitors mushrooms. In addition the rise of information technology has greatly reduced the need for many “middle-management” functions in companies, jobs which provided a career ladder for many of the “averagely-skilled” in previous times.

Thus this rising trend in income inequality has been led by global economic forces. Does this matter? Well – the answer is income inequality matters if society thinks it matters, and it may now be getting to that stage. The recent phenomenon of the Occupy movement around the world in recent months, claiming to represent the bottom 99% suggests that this trend is reaching socially unacceptable levels. From an economic perspective, the natural human tendency to create the best opportunities for one’s children, when combined with greater inequality of outcome, tends to create much greater inequality of opportunity for future generations. This does damage the economic potential of a nation.

In the same way that global economic forces have led to rising income inequality, those forces may also make it difficult to address by redistribution away from the richest. The richest (both individuals and large companies) have always been able to afford better tax lawyers than governments, and with many of them being internationally mobile, they are able to choose where they earn their money and incur tax liabilities. 2012 looks likely to be the year when the debate over income inequality comes to a head in the US Presidential elections with Obama determined to campaign on the notion of taxing millionaires more to reduce the deficit, and the Republicans determined to reduce the deficit solely through spending cuts. This is likely (absent foreign crises) to be the key issue in the forthcoming campaign.