Chancellor: Inequality breeds outbreak of populism

July 22, 2016

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

Concerns about immigration may well have tipped the scales in the UK’s recent Brexit vote. It’s not quite right, however, to decry opponents of unfettered immigration as “bigots”, to use former British Prime Minister Gordon Brown’s phrase. Concerns about immigration should be seen in the context of decades of globalisation whose economic gains have been very unequally distributed. With populism growing across Europe and the United States, where the Republican Party nominated Donald Trump as their presidential candidate on Thursday night, the best way to reverse this worrying political trend would be to address the festering problem of inequality.

History shows that increased flows of trade, ideas and people across borders tend to exacerbate inequality. That was the experience of the United States in the second half of the 19th century. For the young nation, this was the period of the “second industrial revolution”, large-scale capital flows and virtually unrestricted arrivals of migrants. Each of these forces worked to increase the gap between the richest and poorest members of society.

Over the course of the 1800s, the expansion of manufacturing wiped out many skilled trades and “hollowed out” incomes. At the same time, the skills premium paid to white-collar employees climbed. Labour-saving capital goods, imported largely from Great Britain, lowered the bargaining power of industrial workers in the United States.

Free capital flows in this first age of globalisation fuelled the expansion of Wall Street, increasing the relative pay of those who knew how to handle money. As the financial sector expanded more quickly than the wider economy, the titans of Wall Street, most famously John Pierpont Morgan, amassed vast fortunes as well as great political power.

The integration of the financial markets in New York and London helped to reduce the cost of capital. The late Victorian period, like the current age, was characterised by continuously falling interest rates. As money became cheaper it pushed up capital values.

As Peter Lindert and Jeffrey Williamson write in their recently published “Unequal Gains: American Growth and Inequality since 1700”, lower interest rates “contributed to rising inequality because the gains accrued disproportionately to the older, more established locations and those at the top holding financial wealth”.

Luxury flourished in the Gilded Age, as the United States progressed, according to a comment variously attributed to Oscar Wilde and Georges Clemenceau, from “barbarism to decadence without an intervening period of civilization”.

This was also a time of mass immigration into the United States. By 1910, around a quarter of the adult male workforce was foreign-born. This weakened the bargaining power of workers. Lindert and Williamson estimate that without any immigration, the real wage for unskilled workers in the United States at the turn of the 20th century would have been 34 percent higher and the rate of return on capital would have fallen by nearly a quarter.

The weak position of workers fed populist movements in late 19th-century America. In the 1890s, William Jennings Bryan stood as the Democratic candidate in the presidential election, inveighing against the deflationary impact of the gold standard. In 1894, an Ohio businessman named Jacob Coxey led a protest “army” to Washington, demanding that unemployment be reduced by the funding of public works with newly printed paper money.

The second age of globalisation, which commenced in the early 1980s, has much in common with this earlier period. Once again, large-scale capital flows have fostered the growth of the financial sector and pushed up the pay and influence of bankers. Declining interest rates have raised asset prices, benefiting the wealthy disproportionately. The integration of China and India into global trade has forced down manufacturing wages and employment in developed economies, displacing workers into service sectors which are less well remunerated. Immigration has exacerbated these pressures, increasing the pool of low-skilled workers with an inevitable impact on their relative pay levels.

The political pressures created by the relentless rise in inequality in the West over recent decades are coming to a head. That’s the lesson to take from the Brexit vote and the rise of populists such as Donald Trump and Bernie Sanders in the U.S. presidential election.

After the Great Depression, inequality in the United States declined for nearly half a century. This was a period when capital controls were in place and the size of the financial sector in the economy shrunk. Immigration was restricted. Inflation eroded the real value of paper wealth, while increasing the burden of taxes for the better off. Marginal rates of income tax were very high. It wasn’t all bad news, however. As inequality declined and labour’s share of national income increased, the country enjoyed a long period of robust economic growth. The stock market delivered decent returns. The Gilded Age gave way to a golden age of capitalism.

There are numerous examples in history of less pleasant ways in which inequality has been eradicated; for instance, through revolutions, wars and hyperinflation. Unless politicians find more benign policies to reverse the current trend of inequality, those other options will remain firmly on the horizon.

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