LOSING CONTROL (17 page)

Second, while the arrival of Ronald Reagan (and, before him, Margaret Thatcher) led to a profound shift in beliefs about free markets, political parties of all colours increasingly felt constrained by global economic realities, whether or not they necessarily sympathized with the views of free-market fundamentalists.
The fear of capital or labour exodus plays a bigger and bigger role in government attempts to make economies ‘business friendly’.
Seen this way, we may not like the consequences of increasingly skewed income distributions, but, with mobile labour and capital, political leaders have been unwilling to stem the tide.
Put another way, the institutions created in the 1930s and applauded by Levy and Temin may no longer be tenable in the modern world and, at the very least, could lead to accusations of protectionism.

Third, I am not at all convinced that Wall Street – or, indeed, any other financial centre – is in some sense disconnected from the rest of the world in a way that makes trade-based comparative advantage arguments irrelevant.
Rather, we fail to measure trade properly.

Take, for example, a typical month in the life of a Wall Street or City analyst.
It might involve some meetings with companies or policymakers.
A couple of research papers might be produced.
There may be some conference calls with pension funds or hedge funds and, perhaps, a trip to Frankfurt or Hong Kong to meet directly with some of these funds.
The cost of the analyst will almost certainly be picked up locally and statisticians will count the analyst’s work as being
locally produced.
The analyst is, apparently, not engaged in the business of exporting his wares to other parts of the world.
Nevertheless, the result of his engagement with the rest of the world is that the Wall Street firm’s outposts elsewhere in the world are able to conduct trades and earn commission on the back of the analyst’s endeavours.

Now imagine the analyst decides to leave the Wall Street firm and set up a consultancy.
He now sells his research on the open market.
Those who want to receive his research reports will have to pay for them directly.
Those who want to have meetings with him will have to pay especially fat consultancy fees (or so the analyst hopes).
And many of his customers, as before, are dotted across the world.
Suddenly, as a result of the shift from Wall Street to consultancy, the analyst is producing business that will be recorded as an export.
This reflected the true position all along, but it wasn’t recorded in that way.
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Support for the influence of international finance on income distribution comes from the UK where, like the US, income inequality has increased dramatically since the 1980s.
The feature common to both countries – and not shared to anything like the same degree by other developed nations – is the role of financial services.
New York and London are the two epicentres of global finance and, in both cases, financial activities have played a significant role in widening income inequality.

According to the Office for National Statistics,
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the biggest shift in the UK’s income distribution occurred between 1977 and 1991, long before the emerging economies mattered for the UK or had any kind of major influence on global economic conditions.
Between 1992 and 2007 there was comparatively little change in income distribution, judged by income quintiles.
At first sight, then, the UK’s experience
seems to be very different from America’s.
But once the top income quintile is prised open, the same results apply.
Income for the top 10 per cent of income earners rose quickly throughout the entire thirty-year period and income for the top 1 per cent, as with the US, rose particularly rapidly.
Meanwhile, incomes at the very lowest end of the distribution have struggled to keep pace.
As in the US, the gains in income at the top end of the distribution appear, once again, to be closely linked to developments in financial services.
And, as in the US, the result has been a gradual rise in the Gini coefficient which, according to the Institute for Fiscal Studies, in 2007–08 ‘increased … to the highest level seen over our consistent time series going back to 1961.
Over the period since 2004–05, the incomes of the poorest fifth of households have fallen by 2.6 per cent, after inflation, while the incomes of the richest fifth rose nearly 3.3 per cent on the same basis.’
All this after a decade of rule by a Labour government that, historically, would happily have burnished its redistributional credentials.

As we have seen, growing income inequality is not confined to parts of the developed world.
China has witnessed a widening gap between a growing middle class and the majority of people who still remain wrapped in poverty.
Other emerging economies have also seen a growing divide between rich and poor.
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These developments are consistent with the thoughts of Simon Kuznets (1901–85), arguably the father of modern national accounts, who described the changes in the distribution of income as economies shifted from agrarian to urban societies.
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The argument is straightforward.
Urban workers are more productive than their inefficient rural counterparts.
As urban development lifts off, so the nation as a whole becomes more productive.
The benefits initially accrue almost entirely to the urban workers.
Thus, income inequality inevitably
increases in the early stages of development because some members of the population become richer while the rest remain as they were.
When the numbers in urban areas exceed roughly half the population, income inequality will slowly decline: the majority will now be on the higher income level and it may be easier for the government to compensate the remaining poor through the tax and benefit system.

Yet there is a major problem with this argument: it’s related to size.
If one small country alone is engaged in this kind of economic development, there may be no significant impact on global economic conditions because global prices of basic commodities such as food and energy are largely unchanged.
Even if the country is large, it may still be possible to develop in this way if the shift from rural to urban living is accompanied by a significant rise in agrarian productivity, so that the remaining rural workers are able to meet the basic needs of a rapidly growing aspirant urban population (India’s green revolution in the 1970s is a case in point).

If, however, many countries are rapidly developing simultaneously, the global impact of their behaviour is likely to be of significant consequence for income distribution.
In Chapters 1 and 5, I referred to the effect on global energy prices of China’s rapid economic development.
Energy, however, is not the only issue.
Food shortages are likely to become increasingly problematic in the years ahead in response to increased affluence within the emerging world.

As urbanization has taken hold, the quantity of land used for harvesting cereal crops has steadily declined, notably in China.
Crop yields have, in some cases, risen to offset the reduction in land available for agricultural use.
However, not all these crops are being used for the purposes of food production.
With energy prices driven up
partly in response to growing emerging-market affluence, and with growing concerns about the impact on climate change of the use of fossil fuels, land that had been used for cereal production is now increasingly being used for the production of bio-fuels.
In Brazil, for example, land used for the cultivation of sugar cane (from which ethanol fuel is created) increased by almost 40 per cent between 1995 and 2007.
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Climate change is likely to cause further disruptions.
Water shortages will inevitably reduce crop yields in various parts of the world, adding to the upward pressure on prices.

While supply constraints are, thus, a major concern, demand factors may ultimately prove to be more important.
Members of China’s rural population survive on diets heavily dependent on grains.
The urban population has much less interest in grains, instead preferring a diet focused around vegetables, meat, poultry and, increasingly, dairy produce (in Chapter 1, I called this the ‘Starbucks effect’).
More generally, populations in middle- and high-income countries choose diets heavily dependent on meat, fruit and vegetables, whereas those in low-income countries have to make do with cereals, roots and tubers.
For people in the rich developed world, vegetarianism is generally a lifestyle choice, linked to concerns over animal cruelty or their own health.
For those in low-income countries, vegetarianism is the only option available.
The evidence overwhelmingly shows that, as they move up the income scale, most people succumb to eating animals.
McDonalds, the fast-food chain, has benefited from this high income elasticity of demand for meat products.
In 1987, there were 951 branches of McDonalds in the Asia-Pacific region.
Fifteen years later, that number had increased to 7,135.
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For some, meat is murder but, for the majority, meat is tasty.

This shift to meat-based diets is, ultimately, a costly business.
In the words of the United Nations Environment Programme (UNEP) ‘taking the energy value of … meat produced into consideration, the loss of calories by feeding … cereals to animals instead of using
the cereals directly as human food represents the annual calorie need for more than 3.5 billion people’.
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The cost is most obviously likely to show up in the form of higher prices for food which, in turn, will leave the poorest in societies in all parts of the world worse off.
There is also likely to be a longer-term environmental cost.
Livestock production accounts for a high amount of CO
₂
-equivalent greenhouse-gas emissions, not least because animals tend to suffer from flatulence (in total, livestock production is estimated to produce more greenhouse gases than transportation).
Animals also need a lot of water (directly or virtually through the water content in feed).
And global warming means that the amount of land available to produce either crops or animals is likely to decline over the next fifty years.

This all sounds distinctly Malthusian.
Admittedly, further advances in agricultural technology may, once again, increase crop yields.
Higher prices may well encourage such changes.
Perhaps we’ll find ourselves forgoing meat and dairy products.
Maybe, instead, we’ll choose to live on nut cutlets.
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The mechanism to deliver such changes, though, is likely to be the market and, in particular, increases in world food prices.
Those increases, in turn, will be felt more harshly by the poor.

A good deal of the pain will be felt within the emerging economies themselves, where spending on food is a high proportion of aggregate spending.
Those who are not part of the aspirant urban population and who work on farms rather than own them are likely to prove the most vulnerable.
Within commonly defined consumer price baskets, food as a proportion of total spending is around 10 per cent in the UK and Germany, 14 per cent in the US, 15 per cent in France and 23 per cent in Japan.
People in emerging economies are typically poorer and a much greater proportion of their incomes is spent on food.
The equivalent shares are 21 per cent in Brazil, 33 per cent in China, 40 per cent in Russia and a staggering 60 per cent in India.

The poor within Western societies are not so vulnerable – social safety nets exist and, in some cases, work reasonably effectively – but, nevertheless, a world of rising food and energy prices would leave poor people increasingly exposed to Malthusian constraints.
The UK provides an interesting example.
On the basis of IFS calculations,
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17.3 per cent of total spending by pensioners goes on food, with a further 7.4 per cent spent on fuel and light.
For the non-pensioner population, the figures are 12.4 per cent and 4.3 per cent respectively.
The Office for National Statistics uses an alternative approach which focuses not on age but, instead, on the gap between rich and poor.
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For those in the bottom decile of average household weekly expenditure, around 30 per cent of spending is on food, fuel and light and petrol.
For the top decile, the number is only 15 per cent.

Admittedly, these comparisons cannot be taken too far.
Since the 1970s, differences in inflation rates across income cohorts and across age groups in the UK have tended to average out.
This, in part, reflects the volatility of food and energy prices from year to year without a sustained underlying increase in these prices.
Moreover, as economies have become more ‘flexible’ (or, put another way, the probability of losing your job in any given year has gone up), credit markets have expanded to provide protection against transitory income shocks, in line with the predictions of Milton Friedman’s
Permanent Income Hypothesis
.
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Evidence in the US, for example, suggests that consumption inequality is lower than income inequality (if, in any given year, more people lose their jobs, face temporarily reduced hours or discover their bonuses have been slashed, there will be an increase in income inequality, but if credit markets allow people to carry on spending until a new job is found or the bonus improves, consumption inequality will rise by less).