Inequality is bad for business

In August Canadian Business magazine published my article on why inequality is bad for business.  It is produced in full below.

Last week the International Monetary Fund, not known for left-leaning views, released a series of articles entitled “Why Inequality Throws Us Off Balance”.

One of the papers is by Andrew Berg and Jonathan Ostry entitled “Equality and Efficiency: Is there a trade-off or do the two go hand in hand? A few months earlier they had written a provocative piece “Inequality and Unsustainable Growth” documenting how lower inequality is linked to more sustained periods of growth….and that higher inequality means more volatility.

Yesterday the Conference Board of Canada released its second report on income inequality, looking at trends in income inequality internationally, between and within nations.  It follows an earlier report on trends in income inequality in Canada.  These authoritative pieces of research are funded by 25 big businesses and one government.

2011 has been a year in which relentless growth in income inequality, in good times and bad, has become synonymous with trouble, not just for those getting left behind but for investors and political decision-makers.  But it’s seemingly inescapable.

Income inequality: it’s the new black.  And it’s causing the blues.

As I said in August:

The business establishment is becoming increasingly concerned about income inequality. That’s because inequality is bad for business.

The cautions are getting more numerous and blunt.

Since January, heavyweights who have spoken out include Joseph Stiglitz, former chief economist of the World Bank, Chrystia Freeland, editor of Thomson Reuters Digital and former managing editor of the Financial Times, and even America’s staunchest defender of laissez-faire economics, the five-term former chair of the Federal Reserve, Alan Greenspan. Here in Canada, the Conference Board of Canada has recently released two studies on inequality, funded by 24 influential corporations. The studies warn, “High inequality can diminish economic growth if it means that the country is not fully using the skills and capabilities of all its citizens or if it undermines social cohesion, leading to increased social tensions. Second, high inequality raises a moral question about fairness and social justice.”

We think of Canada as a kinder, gentler country, but our increase in income inequality has been more rapid of late than at any time in our recorded history. Among 32 OECD nations, Canada fell from 14th most equal to 22nd since the mid-1990s (a more rapid decline than even the U.S.). Meanwhile 15 OECD nations—including peers like Norway, Italy and the U.K.—were reducing inequality. The trends affect business in a number of critical ways.

To begin with, inequality leaves consumers with less purchasing power. Economic growth has traditionally meant that everyone is better off, but in Canada the latest surge of growth simply concentrated income gains in the hands of a few, with the richest 1% taking almost a third of all income growth between 1997 and 2007. Compare that to the strong growth of the 1960s, when the richest 1% saw only 8% of all income gains.

So while incomes have grown rapidly for the most affluent, those for the middle have barely budged. Median earnings of full-time full-year workers only grew from $44,100 to $45,600 between 1976 and 2009, taking inflation into account. That’s $1,500. Over 33 years.

True, many things are cheaper to buy than a generation ago, but the big-ticket items like shelter and post-secondary education are taking a much bigger bite out of household budgets today. Real growth in purchasing power has been restricted to a small fraction of Canadian consumers in what is already a small market. Throttling aggregate demand slows the economy for everyone.

Henry Ford connected the dots almost a century ago. In 1914, he doubled his workers’ wages so they could afford to buy the cars they were making, expanding the market for the Model T. In his 1922 autobiography, he wrote, “We wanted to pay these wages so that the business would be on a lasting foundation.”

Evidence shows this relationship applies at the macroeconomic level, too. Just a few months ago, two IMF economists, Andrew Berg and Jonathan Ostry, showed that the more equitably incomes are distributed, the longer are the spells of economic growth.  They note, “Growth and inequality-reducing policies are likely to reinforce one another and help to establish the foundations for a sustainable expansion.”

Yet the IMF analysis shows the reverse is also true, that higher inequality leads to more volatility. Against a backdrop of low and falling interest rates, wealthy investors hunt for returns with higher yields, which means higher risk and more volatility. As Mark Thoma, professor of economics at University of Oregon, writes, “When we see income inequality rising, we ought to start looking for bubbles.”

All bubbles eventually burst. The boom-bust cycle wipes out even successful businesses, and increases market share for the larger players in the game who can tough it out longer or buy up the competition.  This dynamic has led to the “too big to fail” phenomenon, distorting the game for everyone, leading to bailouts and higher prices.

Lack of real income growth and falling interest rates over a generation have led to more borrowing, which points to a world of trouble tomorrow. Nobody gets hurt if the incomes of the top 10% grow more slowly than the bottom 90%, but current compensation practices make that highly unlikely. If the only change on the horizon is higher interest rates, personal bankruptcies and foreclosures will go up.  That could slow access to credit for everyone, and further raise the costs of borrowing for businesses and households alike.

Economic effects aside, there are social consequences to rising inequality, the two biggest of which are the effects on health outcomes and crime.

The British epidemiologists Richard Wilkinson and Kate Pickett have been tracking global trends that show inequality is linked to the higher incidence of ill-health for everyone, not just for the poorest among us. This increases public and private costs of absenteeism, pharmaceuticals and acute health-care needs. More inequality is also systematically linked to more crime and other ways of gaming the system. That means more spending on policing and security, the justice system and incarceration.

Another side of growing inequality reveals shrinking opportunities and squandered potential, economic inefficiencies and twisted incentives. This year’s World Economic Forum in Davos, a sort of brain spa for the world’s movers and shakers, named rising income inequality as the biggest challenge now facing the world economy. Are businesses prepared to see increased taxes in order to deal with these new demands?

Simply put, rising inequality is bad for business. That’s why Canadian businesses will soon be looking for ways to reduce it.