3 Pro-capital versus pro-labour policies

As you have seen, the question of whether income inequality drives or hampers economic growth – and hence whether policy makers should do something to address economic inequality – depends on the underlying economic theory. Which theory has had more traction in influencing policy has changed over time.

An influential economist who contributed to this debate was John Maynard Keynes. Keynes’ economic theory of how the economy operates in the short-run gained importance during the years following the Great Depression of the 1930s. The key principle at the heart of his theory was that a too high saving rate – a too high proportion of income saved and therefore not spent on consumption or investment – is the main culprit for sluggish economic growth (Keynes, 1936). In Keynes’ view, what policymakers need to focus on if they want to create conditions that are favourable for economic stability and the objective of full employment is to boost so-called “aggregate demand” (the total demand for goods and services produced within a country), either by increasing government spending, encouraging households’ and firms’ consumption and investments, or by exporting more goods and services than are imported. Keynes was hence supportive of expansionary fiscal policy measures such as tax cuts for workers and increases in public spending (e.g., to make social services accessible to the workforce for free).

Keynesian economics, and especially the insight it offered into the role of aggregate demand in boosting not only output but also full employment, became more and more significant throughout the 1930s, a decade characterised by high unemployment rates (see Figure 6). From the mid-1940s onwards many European countries adopted Keynesian principles, using government resources to publicly fund a wide range of social services, such as healthcare and education (Lavinas, 2017). The first two decades after the two World Wars are oftentimes referred to as the ‘golden years of capitalism’ in the Global North, as these years were characterised by low unemployment and inflation rates and growing national incomes.

Source: Bank of England

Figure 6: Unemployment rates in the UK, 1920-2016

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The graph shows significant fluctuations in the unemployment rate in the UK over the period 1920-2016. The horizontal x-axis represents the years from 1920 to 2016, with major tick marks every four years. The vertical y-axis represents the unemployment rate in percentage terms, ranging from 0% to 18% with major tick marks every 2%. The unemployment ratse is represented by a single blue line that fluctuates over time. There are periods of high unemployment, particularly in the 1930s, 1970s and early 1980s. The are periods of low unemployment, such as during 1940s, 1950s and 1960s.

Figure 6: Unemployment rates in the UK, 1920-2016

However, when the economy in the UK (as well as in other parts of the world) went into recession in the 1970s following a series of hikes in global oil prices, it didn’t take long for Keynes’ ideas to come under the scrutiny of neoclassical economists, who challenged his focus on economic performance in the short run. They argued that while Keynes may well be right to say that government spending leads to an increase in aggregate demand (and consequently output and employment), this is only a short-lived experience. Pumping money into the economy (e.g., by encouraging household consumption via a tax cut), they said, had a negative effect in the long run: it will lead to inflation.

At the same time, pro-labour distributional policies that sought to continuously increase workers’ consumption levels, fell off the agenda too. In the UK, for example, trade union rights were revoked to make it more difficult for workers to collectively negotiate higher salaries (Disney, Gosling and Machin, 1995). These developments have led to the weakening of workers’ bargaining power, which contributed to the fall in the labour share in national income.

In 2008, however, Keynesian ideas regain prominence when the world economy imploded when US house prices started to stagnate (Demyanyk and Van Hemert, 2011). House prices had been increasing in the US for over a decade and families of lower socio-economic backgrounds were encouraged to take out increasingly unsustainable loans to get on the ‘housing ladder’ (Dymski, 2012). However, when many of these households were no longer able to repay their mortgage rates, the ‘housing market bubble’ burst and plunged the US economy, and then the world economy, into crisis. Shaken by the economic recession which the 2008 Global Financial Crisis (GFC) triggered, economists across the board were asked to present their theories that could explain what had caused the GFC (and how to prevent another one in the future). While some economists argued that government interferences had destabilised financial markets, and others contended that the crisis was an extreme form of market failure caused by information asymmetries, a third view highlighted deeper structural problems, associated with capitalism, that caused the GFC (Lavoie and Stockhammer, 2013a).

Since then, the topic of income distribution, including pro-labour income policies and how they impact economic growth, (temporarily) found its way back to the top of the agenda (Hein, 2014). Prominently, in 2012, the International Labour Organisation called for a new growth paradigm, which it entitled ‘equitable growth’ and which is centred on the premise that an increase in wages will fuel domestic consumption and consequently contribute to sustainable growth (Lavoie and Stockhammer, 2013a).