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Making Rich People Richer DoesnT Make The Rest Of Us Richer

The above idea, known as ‘trickle-down economics’, stumbles on its first hurdle.

What they tell you We have to create wealth before we can share it out. Like it or not, it is the rich people who are going to invest and create jobs. The rich are vital to both spotting market opportunities and exploiting them. In many countries, the politics of envy and populist policies of the past have put restrictions on wealth creation by imposing high taxes on the rich. This has to stop. It may sound harsh, but in the long run poor people can become richer only by making the rich even richer. When you give the rich a bigger slice of the pie, the slices of the others may become smaller in the short run, but the poor will enjoy bigger slices in absolute terms in the long run, because the pie will get bigger.

What they don’t tell you The above idea, known as ‘trickle-down economics’, stumbles on its first hurdle. Despite the usual dichotomy of ‘growth-enhancing pro-rich policy’ and ‘growth-reducing pro-poor policy’, pro-rich policies have failed to accelerate growth in the last three decades. So the first step in this argument – that is, the view that giving a bigger slice of pie to the rich will make the pie bigger – does not hold. The second part of the argument – the view that greater wealth created at the top will eventually trickle down to the poor – does not work either. Trickle down does happen, but usually its impact is meagre if we leave it to the market.

The ghost of Stalin – or is it Preobrazhensky? With the devastation of the First World War, the Soviet economy was in dire straits in 1919. Realizing that the new regime had no chance of surviving without reviving food production, Lenin launched the New Economic Policy (NEP), allowing market transactions in agriculture and letting the peasants keep the profits from those transactions.

The Bolshevik party was split. On the left of the party, arguing that the NEP was no more than a regression to capitalism, was Leon Trotsky. He was supported by the brilliant self-taught economist Yevgeni Preobrazhensky. Preobrazhensky argued that if the Soviet economy was to develop it needed to increase investment in industries. However, Preobrazhensky argued, it was very difficult to increase such investment because virtually all the surplus the economy generated (that is, over and above what was absolutely necessary for the physical survival of its population) was controlled by the farmers, as the economy was mostly agricultural. Therefore, he reasoned, private property and the market should be abolished in the countryside, so that all investible surplus could be squeezed out of it by the government suppressing agricultural prices. Such surplus was then to be shifted to the industrial sector, where the planning authority could make sure that all of it was invested. In the short run, this would suppress living standards, especially for the peasantry, but in the long run it would make everyone better off, because it would maximize investment and therefore the growth potential of the economy.

Those on the right of the party, such as Josef Stalin and Nikolai Bukharin, Preobrazhensky’s erstwhile friend and intellectual rival, called for realism.

They argued that, even if it was not very ‘communist’ to allow private property in land and livestock in the countryside, they could not afford to alienate the peasantry, given its predominance. According to Bukharin, there was no other choice than ‘riding into socialism on a peasant nag’. Throughout most of the 1920s, the right had the upper hand. Preobrazhensky was increasingly marginalized and forced into exile in 1927.

However, in 1928, it all changed. Upon becoming the sole dictator, Stalin filched his rivals’ ideas and implemented the strategy advocated by Preobrazhensky. He confiscated land from the kulaks, the rich farmers, and brought the entire countryside under state control through collectivization of agriculture. The lands confiscated from the kulaks were turned into state farms (sovkhoz), while small farmers were forced to join cooperatives or collective farms (kolkhoz), with a nominal share ownership.

Stalin did not follow Preobrazhensky’s recommendation exactly. Actually, he went rather soft on the countryside and did not squeeze the peasants to the maximum. Instead, he imposed lower-than-subsistence wages on industrial workers, which in turn forced urban women to join the industrial workforce in order to enable their families to survive.

Stalin’s strategy had huge costs. Millions of people resisting, or being accused of resisisting, agricultural collectivization ended up in labour camps.

There was a collapse in agricultural output, following the dramatic fall in the number of traction animals, partly due to the slaughtering by their owners in anticipation of confiscation and partly due to the shortage of grains to feed them thanks to forced grain shipments to the cities. This agricultural breakdown resulted in the severe famine of 1932–3 in which millions of people perished.

The irony is that, without Stalin adopting Preobrazhensky’s strategy, the Soviet Union would not have been able to build the industrial base at such a speed that it was able to repel the Nazi invasion on the Eastern Front in the Second World War. Without the Nazi defeat on the Eastern Front, Western Europe would not have been able to beat the Nazis. Thus, ironically, Western Europeans owe their freedom today to an ultra-left-wing Soviet economist called Preobrazhensky.

Why am I nattering on about some forgotten Russian Marxist economist from nearly a century ago? It is because there is a striking parallel between Stalin’s (or rather Preobrazhensky’s) strategy and today’s pro-rich policies advocated by free-market economists.

Capitalists vs. workers From the eighteenth century, the feudal order, whereby people were born into certain ‘stations’ and remained there for the rest of their lives, came under attack from liberals throughout Europe. They argued that people should be rewarded according to their achievements rather than their births (see Thing 20).

Of course, these were liberals of nineteenth-century vintage, so they had views that today’s liberals (least of all American liberals, who would be called ‘left of centre’, rather than liberal, in Europe) would find objectionable. Above all, they were against democracy. They believed that giving votes to poor men – women were not even considered, as they were believed to lack full mental faculty – would destroy capitalism. Why was that? The nineteenth-century liberals believed that abstinence was the key to wealth accumulation and thus economic development. Having acquired the fruits of their labour, people need to abstain from instant gratification and invest it, if they were to accumulate wealth. In this world view, the poor were poor because they did not have the character to exercise such abstinence. Therefore, if you gave the poor voting rights, they would want to maximize their current consumption, rather than investment, by imposing taxes on the rich and spending them. This might make the poor better off in the short run, but it would make them worse off in the long run by reducing investment and thus growth.

In their anti-poor politics, the liberals were intellectually supported by the Classical economists, with David Ricardo, the nineteenth-century British economist, as the most brilliant of them all. Unlike today’s liberal economists, the Classical economists did not see the capitalist economy as being made up of individuals. They believed that people belonged to different classes – capitalists, workers and landlords – and behaved differently according to their classes. The most important inter-class behavioural difference was considered to be the fact that capitalists invested (virtually) all of their incomes while the other classes – the working class and the landlord class – consumed them. On the landlord class, opinion was split. Some, like Ricardo, saw it as a consuming class that hampered capital accumulation, while others, such as Thomas Malthus, thought that its consumption helped the capitalist class by offering extra demands for their products. However, on the workers, there was a consensus. They spent all of their income, so if the workers got a higher share of the national income, investment and thus economic growth would fall.

This is where ardent free-marketeers like Ricardo meet ultra-left wing communists like Preobrazhensky. Despite their apparent differences, both of them believed that the investible surplus should be concentrated in the hands of the investor, the capitalist class in the case of the former and the planning authority in the case of the latter, in order to maximize economic growth in the long run. This is ultimately what people today have in mind when they say that ‘you first have to create wealth before you can redistribute it’.

The fall and rise of pro-rich policies Between the late nineteenth and early twentieth centuries, the worst fears of liberals were realized, and most countries in Europe and the so-called ‘Western offshoots’ (the US, Canada, Australia and New Zealand) extended suffrage to the poor (naturally only to the males). However, the dreaded overtaxation of the rich and the resulting destruction of capitalism did not happen. In the decades that followed the introduction of universal male suffrage, taxation on the rich and social spending did not increase by much. So, the poor were not that impatient after all.

Moreover, when the dreaded over-taxation of the rich started in earnest, it did not destroy capitalism. In fact, it made it even stronger. Following the Second World War, there was a rapid growth in progressive taxation and social welfare spending in most of the rich capitalist countries. Despite this (or rather partly because of this – see Thing 21), the period between 1950 and 1973 saw the highest-ever growth rates in these countries – known as the ‘Golden Age of Capitalism’. Before the Golden Age, per capita income in the rich capitalist economies used to grow at 1–1.5 per cent per year. During the Golden Age, it grew at 2–3 per cent in the US and Britain, 4–5 per cent in Western Europe, and 8 per cent in Japan. Since then, these countries have never managed to grow faster than that.

When growth slowed down in the rich capitalist economies from the mid 1970s, however, the free-marketeers dusted off their nineteenth-century rhetoric and managed to convince others that the reduction in the share of the income going to the investing class was the reason for the slowdown.

Since the 1980s, in many (although not all) of these countries, governments that espouse upward income redistribution have ruled most of the time.

Even some so-called left-wing parties, such as Britain’s New Labour under Tony Blair and the American Democratic Party under Bill Clinton, openly advocated such a strategy – the high point being Bill Clinton introducing his welfare reform in 1996, declaring that he wanted to ‘end welfare as we know it’.

In the event, trimming the welfare state down proved more difficult than initially thought (see Thing 21). However, its growth has been moderated, despite the structural pressure for greater welfare spending due to the ageing of the population, which increases the need for pensions, disability allowances, healthcare and other spending directed to the elderly.

More importantly, in most countries there were also many policies that ended up redistributing income from the poor to the rich. There have been tax cuts for the rich – top income-tax rates were brought down. Financial deregulation has created huge opportunities for speculative gains as well as astronomical paycheques for top managers and financiers (see Things 2 and 22). Deregulation in other areas has also allowed companies to make bigger profits, not least because they were more able to exploit their monopoly powers, more freely pollute the environment and more readily sack workers. Increased trade liberalization and increased foreign investment – or at least the threat of them – have also put downward pressure on wages.

As a result, income inequality has increased in most rich countries. For example, according to the ILO (International Labour Organization) report The World of Work 2008, of the twenty advanced economies for which data was available, between 1990 and 2000 income inequality rose in sixteen countries, with only Switzerland among the remaining four experiencing a significant fall.1 During this period, income inequality in the US, already by far the highest in the rich world, rose to a level comparable to that of some Latin American countries such as Uruguay and Venezuela. The relative increase in income inequality was also high in countries such as Finland, Sweden and Belgium, but these were countries that previously had very low levels of inequality – perhaps too low in the case of Finland, which had an even more equal income distribution than many of the former socialist countries.

According to the Economic Policy Institute (EPI), the centre-left think-tank in Washington, DC, between 1979 and 2006 (the latest year of available data), the top 1 per cent of earners in the US more than doubled their share of national income, from 10 per cent to 22.9 per cent. The top 0.1 per cent did even better, increasing their share by more than three times, from 3.5 per cent in 1979 to 11.6 per cent in 2006.2 This was mainly because of the astronomical increase in executive pay in the country, whose lack of justification is increasingly becoming obvious in the aftermath of the 2008 financial crisis (see Thing 14).

Of the sixty-five developing and former socialist countries covered in the above-mentioned ILO study, income inequality rose in forty-one countries during the same period. While the proportion of countries experiencing rising inequality among them was smaller than for the rich countries, many of these countries already had very high inequality, so the impacts of rising inequality were even worse than in the rich countries.

Water that does not trickle down All this upward redistribution of income might have been justified, had it led to accelerated growth. But the fact is that economic growth has actually slowed down since the start of the neo-liberal pro-rich reform in the 1980s. According to World Bank data, the world economy used to grow in per capita terms at over 3 per cent during the 1960s and 70s, while since the 1980s it has been growing at the rate of 1.4 per cent per year (1980–2009).

In short, since the 1980s, we have given the rich a bigger slice of our pie in the belief that they would create more wealth, making the pie bigger than otherwise possible in the long run. The rich got the bigger slice of the pie all right, but they have actually reduced the pace at which the pie is growing.

The problem is that concentrating income in the hands of the supposed investor, be it the capitalist class or Stalin’s central planning authority, does not lead to higher growth if the investor fails to invest more. When Stalin concentrated income in Gosplan, the planning authority, there was at least a guarantee that the concentrated income would be turned into investment (even though the productivity of the investment may have been adversely affected by factors such as the difficulty of planning and work incentive problems – see Thing 19). Capitalist economies do not have such a mechanism. Indeed, despite rising inequality since the 1980s, investment as a ratio of national output has fallen in all G7 economies (the US, Japan, Germany, the UK, Italy, France and Canada) and in most developing countries (see Things 2 and 6).

Even when upward income redistribution creates more wealth than otherwise possible (which has not happened, I repeat), there is no guarantee that the poor will benefit from those extra incomes. Increasing prosperity at the top might eventually trickle down and benefit the poor, but this is not a foregone conclusion.

Of course, trickle down is not a completely stupid idea. We cannot judge the impact of income redistribution only by its immediate effects, however good or bad they may look. When rich people have more money, they may use it to increase investment and growth, in which case the long-run effect of upward income redistribution may be the growth in the absolute size, although not necessarily the relative share, of income that everyone gets.

However, the trouble is that trickle down usually does not happen very much if left to the market. For example, once again according to the EPI, the top 10 per cent of the US population appropriated 91 per cent of income growth between 1989 and 2006, while the top 1 per cent took 59 per cent. In contrast, in countries with a strong welfare state it is a lot easier to spread the benefits of extra growth that follows upward income redistribution (if it happens) through taxes and transfers. Indeed, before taxes and transfers, income distribution is actually more unequal in Belgium and Germany than in the US, while in Sweden and the Netherlands it is more or less the same as in the US.3 In other words, we need the electric pump of the welfare state to make the water at the top trickle down in any significant quantity.

Last but not least, there are many reasons to believe that downward income redistribution can help growth, if done in the right way at the right time. For example, in an economic downturn like today’s, the best way to boost the economy is to redistribute wealth downward, as poorer people tend to spend a higher proportion of their incomes. The economy-boosting effect of the extra billion dollar given to the lower-income households through increased welfare spending will be bigger than the same amount given to the rich through tax cuts. Moreover, if wages are not stuck at or below subsistence levels, additional income may encourage workers’ investment in education and health, which may raise their productivity and thus economic growth. In addition, greater income equality may promote social peace by reducing industrial strikes and crime, which may in turn encourage investment, as it reduces the danger of disruption to the production process and thus to the process of generating wealth. Many scholars believe that such a mechanism was at work during the Golden Age of Capitalism, when low income inequality coexisted with rapid growth.

Thus seen, there is no reason to presume that upward income redistribution will accelerate investment and growth. This has not happened in general.

Even when there is more growth, the trickle down that occurs through the market mechanism is very limited, as seen in the above comparison of the US with other rich countries with a good welfare state.

Simply making the rich richer does not make the rest of us richer. If giving more to the rich is going to benefit the rest of the society, the rich have to be made to deliver higher investment and thus higher growth through policy measures (e.g., tax cuts for the rich individuals and corporations, conditional on investment), and then share the fruits of such growth through a mechanism such as the welfare state.

Reference book: Things they don't tell you about capitalism

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