The Return Of Two Nations

One of the unforeseen consequences of the financial crash in 2007 has been an increase in the levels of inequality across the developed world. This has come about as a consequence of  the policy of quantitative easing. QE is the process by which a monetary expansion is used to stimulate aggregate demand in lieu of a more active fiscal policy. It acts by pumping liquidity into the banking system through the purchase by central banks of liquid assets - usually Treasury bonds. That, in turn, inflates the values of financial assets and quasi-financial assets, such as property. Those with assets have seen their wealth grow considerably, whilst those without assets have had to simply watch it happen.

This process has continued long enough to have more systemic implications. The current levels of inequality, of income and wealth, have affected both the supply side of the economy as well as the demand side. The impact on the demand side is easier to see. Wages and salaries have been stagnant for the best part of a decade in nominal terms. In real terms, their share of GDP has been falling consistently over a long period. This has increased the number of people who are just getting by, and we have seen the expansion of poverty relief initiatives. In 2010, when the Coalition came to office, Food Banks were relatively unheard of. They are currently a feature of contemporary life.

The impact of inequality on the supply side is a little more roundabout, but present nonetheless. Sluggish demand has helped to reduce the amount of productive investment in the economy. This, in turn, has capped productivity growth, which in turn limits the degree to which wages and salaries can rise. There has been a growth in part-time, zero-hours, minimum wage, employment in recent years, partly as a consequence of more restrictive benefit entitlements. This has made employment structures far more precarious than they were prior to 2007.

What investment there has been is directed towards unproductive assets (i.e. assets that are not employment creating), such as buy-to-let residential accommodation. Given the poor returns on cash as a consequence of QE, returns on property have provided some of the best risk-weighted returns on capital over the past ten years. However, this has tended to make property expensive to buy, causing a fall in owner-occupation, and adding demand to the rental sector. This demand closes the loop for buy-to-let property by bidding up rents, which underpins the returns to be had from property as an investment class.

One result of this process is a class of people who are doing very nicely and a class of people who are being left behind. There are different gradations within these two classes, but broadly speaking this is a useful distinction. These social divisions, derived from the underlying economic circumstances, have now found a political manifestation. In the UK, the manifestation was Brexit. By and large, those who supported Brexit are those who felt left behind in an economy where some were doing rather nicely, but they were struggling. The feeling was that there wouldn't be much to lose from leaving the EU. Of course, leaving the EU could well fail to solve the problem because it is much deeper than that.

A few weeks back, I drove past Blenheim Palace in Oxfordshire. It gave me an opportunity to reflect on an historical perspective to inequality. The current levels of inequality are not at all extreme when compared to the inequality of the Ancien Regime, or Imperial Rome, or even Feudal England. When taking a long perspective, we are in a relatively egalitarian age. What is different now is that we aspire to equality - both equality of opportunity and equality of outcome, an impossible task - in a way that is different to previous ages. We aspire to a more equal society, and it is this aspiration that is frustrated by the current state of affairs.

Looking ahead rather than backwards, how might this change? QE, the source of much of the current inequality, is an experiment that has done what it set out to do (i.e. to prevent a Great Depression style economic downturn after 2007). It is not clear how QE should be wound down. This is potentially the part of the experiment that contains the greatest dangers. Loosening too quickly risks an runaway expansion with an acute inflation risk. Loosening too slowly risks keeping on the economic brakes too long and causing damage to the economy in terms of unrealised production. There is evidence that the latter effect has made itself felt more readily than the former. Most Central Banks have stated that they intend to hold the underlying financial instruments until maturity, and then to fold the proceeds back into the money supply. That suggests we shall be in QE for decades to come.

If that's the case, then the underlying pressures that gave rise to growing inequality will also be in place for some time to come. Ultra low interest rates and unconventionally loose money are no longer unusual, they have become the new normal. This is where things become awkward. Rising inequality is a process and not a state. If QE is to continue for years to come then inequality will continue to grow for years to come, in the absence of any factor to prevent it. As this happens, the gulf between those doing nicely and those just managing will continue to grow. The ranks of the former will shrink, whilst the ranks of the latter will expand. Britain will again become the land of Two Nations again.

Perhaps it's time to brush up on our Disraeli?

Stephen Aguilar-Millan

© The European Futures Observatory 2018