There is bungling, short-sightedness, and then there is political incompetence. That is annoying, because ultimately that is reflected in economic policy. But there is also such a thing as political clientelism - completely bizarre economic reasoning that ultimately results in financial collapse. Welcome to the United Kingdom, where in 2022 the government presented a policy proposal that may well have made sense in the 1950s, but in this day and age is utterly absurd. The plan (as well as the Chancellor) lasted no more than three weeks, but the damage done is unrepairable.
We call this type of policy trickle-down economics. The notion that if you make the richest part of the population even richer, this will result in more economic growth, which in the end will benefit everyone and will ultimately reduce inequality. So: the more you water the top, the more the whole plant will flourish.
This was researched empirically in 1955 by Simon Kuznets. He developed the Kuznets curve: initially inequality will increase, but as a country becomes richer that inequality will diminish. But, as he noted in that same article, the basis for this was 5% empirical observation and 95% speculation.
He carried out his research at a time when inequality in rich countries was at a historically low level and labour was taxed at a very high rate. The top income tax rates in the United Kingdom and the US were over 90%. This was the time of the ’Trentes Glorieuses’ in France and the Wirtschaftswunder in Germany. So it was tempting to draw the conclusion that economic equality in the richer countries was increasing. This changed radically after the 1970s: income inequality increased in many rich countries. This was due to lower taxes, deregulation, and changes in the structure of the economy, including the emergence of winner-takes-all companies. What trickle-down? As the trees grew higher and higher, the economy below became increasingly overshadowed and withered. It has since become clear that making the rich richer has no effect on economic growth and that in the United States over the last 40 years USD 50 billion has been redistributed from the 90% lowest earners to the 1% richest.
There is a limit to useful inequality. Fortunately, Liz Truss (or at least the new Chancellor Hunt) realised this just in time, after some gentle pressure from voters and markets. However, part of the damage is unrepairable. For instance, the losses for pensioners who won’t get their indexation. This proves, once again, that economic research and theories are often abused for political ends and can have serious real economic effects.
What about austerity policy during a balance sheet recession as the consensus was inin the euro crisis? What about calling sustainability effects simply ‘external effects’ and that pricing is the only policy option, and if that doesn’t work, just let it go? And what about flexibility and deregulation of markets as a solution for more growth, forgetting about the people that are left into uncertainty and marginal jobs instead of a real living?
The only remedy to avoid abuse is common (economic) sense, understanding the connection between ideology and instrument and a good dose of historical knowledge. Because I am under no illusion: things could always be worse.
This is an translation of Hans Stegeman's column in Het Financieele Dagblad, published 4 October 2022.