Bang Goes The Theory

The demands of the ultra-rich have been dressed up as sophisticated economic theory and applied regardless of the outcome.


How they must bleed for us. In 2012, the world’s 100 richest people became $241 billion richer(1). They are now worth $1.9 trillion: just a little less than the GDP of the United Kingdom.

This is not the result of chance. The rise in the fortunes of the super-rich is the direct result of policies. Here are a few: the reduction of tax rates and tax enforcement; governments’ refusal to recoup a decent share of revenues from minerals and land; the privatisation of public assets and the creation of a toll-booth economy; wage liberalisation and the destruction of collective bargaining.

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The policies which made the global monarchs so rich are the policies squeezing everyone else. This is not what the theory predicted. Friedrich Hayek, Milton Friedman and their disciples – in a thousand business schools, the IMF, the World Bank, the OECD and just about every modern government – have argued that the less governments tax the rich, defend workers and redistribute wealth, the more prosperous everyone will be. Any attempt to reduce inequality would damage the efficiency of the market, impeding the rising tide that lifts all boats(2). The apostles have conducted a 30-year global experiment and the results are now in. Total failure.

Before I go on, I should point out that I don’t believe perpetual economic growth is either sustainable or desirable(3). But if growth is your aim – an aim to which every government claims to subscribe – you couldn’t make a bigger mess of it than by releasing the super-rich from the constraints of democracy.

Last year’s annual report by the UN Conference on Trade and Development should have been an obituary for the neoliberal model developed by Hayek and Friedman and their disciples(4). It shows unequivocally that their policies have created the opposite outcomes to those they predicted. As neoliberal policies (cutting taxes for the rich, privatising state assets, deregulating labour, reducing social security) began to bite from the 1980s onwards, growth rates started to fall and unemployment to rise.

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The remarkable growth in the rich nations during the 1950s, 60s and 70s was made possible by the destruction of the wealth and power of the elite, as a result of the Depression and the second world war. Their embarrassment gave the other 99% an unprecedented chance to demand redistribution, state spending and social security, all of which stimulated demand.

Neoliberalism was an attempt to turn back these reforms. Lavishly funded by millionaires, its advocates were amazingly successful: politically(5). Economically they flopped.

Throughout the OECD countries, taxation has become more regressive: the rich pay less, the poor pay more(6). The result, the neoliberals claimed, would be that economic efficiency and investment would rise, enriching everyone. The opposite occurred. As taxes on the rich and on business diminished, the spending power of both the state and poorer people fell, and demand contracted. The result was that investment rates declined, in step with companies’ expectations of growth(7).

The neoliberals also insisted that unrestrained inequality in incomes and flexible wages would reduce unemployment. But throughout the rich world both inequality and unemployment have soared(8). The recent jump in unemployment in most developed countries – worse than in any previous recession of the past three decades – was preceded by the lowest level of wages as a share of GDP since the second world war(9). Bang goes the theory. It failed for the same obvious reason: low wages suppress demand, which suppresses employment.

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As wages stagnated, people supplemented their incomes with debt. Rising debt fed the deregulated banks, with consequences of which we are all aware. The greater inequality becomes, the UN report finds, the less stable the economy and the lower its rates of growth. The policies with which neoliberal governments seek to reduce their deficits and stimulate their economies are counter-productive.

The impending reduction of the UK’s top rate of income tax (from 50% to 45%) will not boost government revenue or private enterprise(10), but it will enrich the speculators who tanked the economy: Goldman Sachs and other banks are now thinking of delaying their bonus payments to take advantage of it(11). The welfare bill approved by parliament last week will not help to clear the deficit or stimulate employment: it will reduce demand, suppressing economic recovery. The same goes for the capping of public sector pay. “Relearning some old lessons about fairness and participation,” the UN says, “is the only way to eventually overcome the crisis and pursue a path of sustainable economic development.”(12)

As I say, I have no dog in this race, except a belief that no one, in this sea of riches, should have to be poor. But staring dumbfounded at the lessons unlearned in Britain, Europe and the United States, it strikes me that the entire structure of neoliberal thought is a fraud. The demands of the ultra-rich have been dressed up as sophisticated economic theory and applied regardless of the outcome. The complete failure of this world-scale experiment is no impediment to its repetition. This has nothing to do with economics. It has everything to do with power.

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2. Milton Friedman and Rose Friedman,1980. Free to Choose. Secker & Warburg, London.

3. For an alternative vision, see Tim Jackson, 2009, Prosperity Without Growth. Sustainable Development Commission.

4. UNCTAD, 2012. Trade and Development Report: Policies for Inclusive and Balanced Growth.

5. See David Harvey, 2005. A Brief History of Neoliberalism. Oxford University Press.

6. The UN reports: “The overall effect of these changes in the tax structure made taxation more regressive. Indeed, a review of tax reforms in OECD countries did not find a single country where the tax system became more progressive (Steinmo, 2003: 223).” UNCTAD, 2012, as above.

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7.“Redistribution through fiscal measures may therefore be in the interest of society as a whole, especially where inequality is particularly pronounced as in many developing countries. This is supported by the experience in developed countries,as investment rates were not lower – but indeed often higher – in the first three decades of the post-war era, even though taxes on profits and top incomes were higher than after the widespread fiscal reforms implemented subsequently. There are strong reasons to believe that the willingness of entrepreneurs to invest in new productive capacity does not depend primarily on net profits at a given point in time, but on their expectations regarding future demand for the goods and services they can produce with additional capacity. This is of particular importance when considering the overall effect of an increase in corporate taxes. Provided that higher tax revenues are used for additional government expenditures, companies’ expectations of a growth in demand will improve. This demand effect is independent of whether the additional government expenditures take the form of government consumption, public investment or social transfers. When the level of fixed investment is maintained as a result of favourable demand expectations gross profits will rise − and generally so will net profits, notwithstanding the initial tax increase. In the process, additional income and employment will be created for the economy as a whole.” UNCTAD, 2012, as above.

8. “The proposition that greater flexibility of the aggregate wage level and lower average wages are necessary to boost employment, as they lead to a substitution of labour for capital in the economy as a whole, can be directly refuted, given the strong positive correlation between investment in gross fixed capital formation (GFCF) and employment creation that exists in developed countries (chart 6.3). This correlation contradicts the neoclassical model: in the real world, companies invest and disinvest in capital and labour at the same time, and the level of their investment depends on the overall state of the economy, which determines their demand expectations. This implies that, in the macroeconomic context, capital and labour can be considered substitutes only to a very limited extent.” UNCTAD, 2012, as above.

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9. “Just ahead of the new big jump in unemployment in developed countries − from less than 6 per cent in 2007 to close to 9 per cent in 2010-2011− the share of wages in overall GDP had fallen to the lowest level on record since the end of the Second World War (i.e. to 57 per cent, down from more than 61 per cent in 1980). This should be a wake-up call. If unemployment rises more than during any other recession that occurred during the last three decades, even though the share of wages in GDP has fallen, there must be something fundamentally wrong with an economic theory that justifies the rise of inequality mainly in terms of the need to tackle persistent unemployment.” UNCTAD, 2012, as above.

10. Thomas Piketty, Emmanuel Saez and Stefanie Stantcheva calculate that the optimal level for the top rate of income tax (to maximise revenue) is between 57 and 83%. Piketty, Saez and Stantcheva,2011. Optimal taxation of top labor incomes: A tale of three elasticities. National Bureau of Economic Research, Cambridge, MA.

11. Patrick Jenkins, 14th January 2013. Goldman Eyes Tax Delay on UK Bonuses. Financial Times (£).

12. UNCTAD, 2012, as above.

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