The Economics of Inequality

April 18, 2018


This speech was given by Per Capita Senior Economist Warwick Smith at an event held by the Victorian Fabians on 18 April 2018. Warwick tweets @RecoEco.


I’d like to begin by acknowledging the tradition custodians of this land, the Wurrundjuri people of the Kulin nation and pay my respects to their elders; past, present, and future.

There can be no meaningful talk of inequality in this country without acknowledging and discussing the profound inequality between indigenous Australians and most of the rest of the population. I’m not only talking about economic inequality. Indigenous child mortality is still double that of the non-indigenous population and there are too many other damning statistics to rehearse them all here today.

Despite being an economist myself, I think it’s fair to say that pretty much every important economic question has a political answer. There are, however, a lot of economists out there who would deny this. They believe that economics is a hard science, like physics or chemistry; with laws and immutable facts. This couldn’t be further from the truth.

The economy is a social construct and economics is, therefore, a social science. This means that economics is inherently political.

As a social science, economics is not something you can really understand simply by studying the present. Just as it’s inherently political, it is also inherently historical. I have always found the most informative voices in economics to be economic historians because they understand why we do things the way we do them today.

It’s become very unfashionable to talk about class and power but, ultimately, the story of inequality is a story of class and power. As US billionaire Warren Buffet said; “there is a class war, and my side is winning”.

The capitalist class has won the class war so decisively that they’ve made discussing it seem like wild conspiracy theory and those who bring it up are accused of the politics of envy.

Let’s have a quick look at some historical trends in Australia before returning to the topic of class and power <shows slides>.

This same trend occurred across much of the developed world during the 1970s and 80s.

So, what happened in the 70s and 80s that changed everything so dramatically? I’m not going to bore you with a story of neoliberalism and the rise of Thatcher, Reagan and… dare I say it here… Keating. We’ve all heard those stories before and I think perhaps they were symptoms, not causes. The more interesting story is why this transition occurred at around the same time across the globe.

This period of relative prosperity and progress, often referred to as the post-war boom, didn’t happen by accident. It was the result of a bipartisan commitment to avoid repeating the conditions that led to the Great Depression.

One of the clearest documented indications of this is the Curtin government’s 1945 White Paper on full employment — an extremely impressive political document (at least by today’s standards) that’s recommended reading for anyone interested in Australian politics.

The authors and instigators of the 1945 White Paper witnessed the Great Depression first hand. With unemployment averaging nearly 20%, and much higher in certain parts of the country, and among young school leavers, the depression left an indelible mark on those who lived through it. These policy makers — perhaps foremost among them in Australia, H.C. Coombs, then lived through World War Two. During the War, the economy was fully employed; indeed, there was such a shortage of labour that even married women were encouraged to work.

Towards the end of the War, Coombs and others, trained in the new economics of John Maynard Keynes, wondered, if the government, by stimulating demand, could bring about full employment during wartime then why not during peace? Thus, the White Paper was born and along with it came 25 years of low unemployment, shrinking inequality, rising material standard of living, and strong economic growth known as the post-war boom.

The core of the White Paper and related policy was that unemployment resulted from a lack of private demand for labour and that government could, and should, use its spending power to maintain full employment during economic downturns.

Unemployment was seen as an inherent part of a capitalist market based system and, if we wanted the positive elements of this system then we needed to take responsibility for the costs. In other words, unemployment was seen as a collective problem, not an individual failing.

By the 1970s most of the politicians, policy makers and intellectuals who had lived through both the great depression and the Second World War as adults were either retired or dead. Power had shifted to a new cohort of economists trained in a new brand of economics — neoclassical economics. The politicised version of neoclassical economics atomised society into individual workers, consumers and companies and reduced the role of government to the correction of “market failures”. Government run enterprises and services were privatised in the name of efficiency — which, for the most part, was code for cutting services and paying the workers less to make room for profit for business owners.

Neoclassical economics did not rise to dominance due to progress within the discipline or due to a better understanding of the economy but as an intentional response to the reduction in inequality. Here’s the important thing: inequality had been falling for more than 25 years. That is, the share of the economy’s output going to the wealthy had been falling for more than 25 years. Well, the wealthy fought back. They created entire economics departments at prestigious universities, primarily in the US but not only there. They built a complete and well championed alternative to the Keynesian economics that had dominated since WW2. Then they waited for an opportunity to undermine the bipartisan commitment to heavy government intervention in the economy.

Finally, in the 1970s, the OPEC induced oil shocks provided the opening they needed to claim that Keynesian economics had failed. Skyrocketing oil prices resulted in high inflation, high unemployment and floundering economic growth — stagflation. Traditional Keynesian economics had no response and was successfully painted as a failure. That this crisis had little to do with domestic economic management and was driven by external shocks was lost on most. This con, and it was a con, could only succeed because, by the 1970s, most of the policy makers who had lived through the great depression had either retired or died. Had Coombs and his colleagues of 1945 still been dominant, neoliberalism (the political sibling to neoclassical economics) would have been dismissed out of hand as the pro-business propaganda that it was. They’d seen this kind of policy making before and they’d seen it end with the Great Depression.

When it came to the unemployed, government policy shifted dramatically from viewing unemployment as an inevitable consequence of capitalism and, as such, a collective responsibility; to viewing unemployment as an individual failure. A new economic term was coined, a term that only an economist could come up with; the Non-Accelerating Inflation Rate of Unemployment or NAIRU. This was the level of unemployment, below which, labour would have too much power and would be able to demand wage increases above productivity increases. This in turn would cause inflation. It’s an entirely theoretical construct by the way, nobody really knows what the NAIRU is or how to calculate it — but that doesn’t stop them assuming a number and acting on it.

Don’t worry, you don’t need to fully get the economics of that to understand that this means we need a large pool of desperate unemployed people, clamouring for jobs, so that those in employment will be too scared to ask for a pay rise or for better conditions. This wage suppression effect of the unemployed will keep a cap on inflation — so we’re told. It will also, conveniently, create higher profits.

The most powerful bargaining chip that workers have is to walk away. If you are easily replaced and being on the dole is a living hell then your power as a worker is greatly diminished because your willingness to walk away is eroded. This is what the NAIRU is about and it’s built into our economic system and into government and reserve bank economic management.

There are many more unemployed people than there are jobs. That’s not a controversial statement. If every unemployed person was the exemplary job candidate, punctual and immaculately dressed, with the perfect CV, the unemployment rate would be — pretty much exactly what it is today. Unemployment is created by a lack of demand for labour, or a skills mismatch, not by the behaviour of the unemployed.

So, if that’s the case, why make the unemployed perform all these “mutual obligations”? Why do they have to constantly jump through all these hoops or face financial penalties?

They are made to do this so that the prospect of becoming unemployed will be so frightening to those who are in jobs that they won’t push hard for better wages or better conditions. Similarly, the unemployed will be so desperate to get out of the punitive “employment services” system that they will accept poor wages and poor conditions.

In turn, this has been made possible by painting the unemployed as bludgers and parasites on hard working Australians. Workers have effectively been turned against the unemployed as part of a program of wage suppression.

The pattern is the same everywhere, with the modern mantra of gain wealth, forgetting all but self. We’ve even privatised our retirement ambitions in the form of superannuation accounts. This atomising of the social contract is absolutely integral to the neoliberal project. Unions are among the few remaining barriers to the completion of this project, and their decline is another indicator of how the class war is going.

As I said earlier, this is ultimately a story of class and power. Our economic system is a construct and, as such, it can be reconstructed so that it works better for a larger proportion of society. The disconnect that has developed between economic output and wages is just one indication that power has shifted too far in favour of the holders of capital and away from workers. There is nothing inevitable about this shift — it’s not a product of unstoppable technological progress or of globalisation — these are just narratives designed to disempower — it’s a product of the inherent conflict between capital and labour.

Those who are winning the class war have tried to change the narrative to say that there is no inherent conflict, that we can work together toward shared goals. While this may be appealing and may be true within individual workplaces, the incentive structure of unregulated capitalism creates inherent conflict between the interests of workers and the interests of the owners of capital.

If we are interested in reducing inequality then we have to be willing to have these conversations and we have to be ready for the inevitable backlash as we are painted as communists, accused of prosecuting the “politics of envy” and of waging a class war.

Perhaps some of you have noticed that at the beginning of this talk I said that no serious discussion of inequality can be had without paying attention to indigenous inequality and here I am, near the end of my rant, having said no more about indigenous disadvantage.

Of course, we couldn’t do justice to the subject of indigenous disadvantage even if we spent the entire evening on it. However, in the context of this speech, indigenous policy was perhaps hit hardest by the rise of neoclassical economics.

Just as we, as a society, had matured enough to acknowledge indigenous disadvantage, measure it in the census and begin to make some token steps to acknowledging and addressing 200 years of dispossession and persecution, in came the economics of individualism. This provided the convenient excuse to write off indigenous disadvantage as a result of indigenous failure. As with the modern treatment of the unemployed, this is a complete abdication of responsibility from those with the power to do something about the problems.

The profound nature of indigenous disadvantage means that there is no simple fix. However, we can fly to the moon, we can make cars that drive by themselves through incredibly complex environments. Complexity is not an excuse for complacency.

There’s a similar story with respect to gender economics including the gender pay gap and the gender superannuation gap — two things I’ve spent a lot of time working on recently. We know what the problems are but we keep fiddling at the edges expecting “the market” to fix it. So steeped are we in the worship of economics that we dare not tell the truth — the system is broken and only profound political intervention can fix it.

The obvious place to start in addressing inequality is at the bottom. To me, this means giving homeless people homes; it means giving jobless people jobs or at the very least lifting the dole to a level that people can actually live on.

We are one of the richest countries in the world at the richest time in human history. Let that sink in for a minute. We could go to people in remote indigenous communities and ask them what they want for their communities — and then we could provide them with the resources, the training and the jobs to do those things — how’s that for a radical idea?

Today I’ve worn my economist hat, I’ve worn my historian hat and I’ve worn my social theorist hat. Now I’m going to wear my philosopher hat. I cringe a little bit every time I call myself a philosopher because it feels only one step removed from calling myself a wanker. Such is the victory of anti-intellectualism in this country — in fact across the anglosphere — that somebody who calls themselves a lover of wisdom is a wanker. What other discipline though, than philosophy, is really suited to addressing this issue of inequality?

Ultimately the modern inequality question is this: how much of our nation’s economic output should go to the workers, how much should go the owners of capital and how much to those who fall through the cracks? There is no mathematical formula or economic model that can answer that question. It’s a moral question that is in practice answered by the outcome of a contest of power. Those who don’t understand that, at least implicitly, have already lost the contest.

In the end though, if you want an explanation of inequality, look no further than those words of billionaire Warren Buffet; “There is a class war, and my side is winning.”