Growing inequality of income and wealth is a common pattern throughout the world. In the boom years up to 2008, the rich got a lot richer, but at least those on low incomes generally saw modest rises in their incomes. Since 2008, however, the continually widening gap between rich and poor has seen the poor and many on middle incomes getting absolutely poorer.
The problem is particularly acute in the USA. Indeed, in his 2012 State of the Union address, President Obama said that it was the ‘defining issue of our time.’
No challenge is more urgent. No debate is more important. We can either settle for a country where a shrinking number of people do really well, while a growing number of Americans barely get by. Or we can restore an economy where everyone gets a fair shot, everyone does their fair share, and everyone plays by the same set of rules.
The good news for the poor in the USA is that at last their incomes have stopped falling, thanks to stronger economic growth. But their share of the growth in GDP is tiny.
As The Economist article states:
The main message is a grim one. Most of the growth is going to an extraordinarily small share of the population: 95% of the gains from the recovery have gone to the richest 1% of people, whose share of overall income is once again close to its highest level in a century. The most unequal country in the rich world is thus becoming even more so.
Apart from the ethical question of whether it is desirable for a society, already highly unequal, to become even more so, there is the question of whether this growth in inequality threatens economic recovery. Joseph Stiglitz argues that the rich have a low marginal propensity to consume and that this is threatening recovery.
Then there is the question of investment. Because most Americans have not seen any significant rise in incomes, it is easy for them to believe that the country cannot afford to invest more. And certainly it is difficult to persuade people that higher taxes are warranted to fund education, infrastructure or research.
The following articles consider the problem and its implications and look at various policy alternatives.
Articles and videos
Inequality: Growing apart The Economist (21/9/13)
What is income inequality, anyway? CNN, John D. Sutter (29/10/13)
Inequality is literally killing America Press TV (22/11/13)
It’s Economic Inequality Stupid – What to Do About the Biggest Crisis Facing America Huffington Post, Robert Creamer (14/11/13)
US Inequality Now Literally Off the Chart Truthout, Salvatore Babones (8/6/13)
Inequality moves to the front line of US politics Financial Times, Richard McGregor (20/11/13)
Is wealth inequality slowing growth? BBC News, Linda Yueh (21/11/13)
American Inequality in Six Charts The New Yorker, John Cassidy (18/11/13)
Income Inequality ‘Profoundly Corrosive’ Wall Street Journal, Larry Summers (19/11/13)
21 Charts On US Inequality That Everyone Should See Business Insider, Gus Lubin (12/11/13)
Data, information and reports
Income inequality in the United States Wikipedia
Inequality Data & Statistics Inequality.org
Income Main United States Census Bureau
World of Work Report 2013: Snapshot of the United States ILO
World of Work Report 2013 ILO
StatExtracts OECD (Search for Gini)
Questions
- How may income inequality be measured?
- Comment on the Gini coefficients in the above link to the StatExtracts site.
- Why has inequality grown in the USA?
- The Swiss have just voted in a referendum to reject a proposal to limit executive pay to 12 times that of the lowest paid worker in the same company. What are the arguments for and against the proposal?
- What features of an unequal society tend to perpetuate or even deepen that inequality over time?
- What features of a well functioning market economy would help to reduce income inequality?
- Are higher marginal tax rates and higher welfare payments the best way of reducing inequality? What other policy options are there?
- Compare the views of Paul Krugman and Joseph Stiglitz on the effects of growing inequality on economic growth. How significant is the difference in the marginal propensity to consume of the rich and the poor in explaining the relatively low rate of US economic growth?
In an apparent U-turn, the Chancellor, George Osborne, has decided to cap the interest rates and other charges on payday loans and other short-term credit. As we have seen in previous news items, the sky-high interest rates which some of the poorest people in the UK are being forced to pay on these loans have caused outrage in many quarters: see A payday enquiry and Kostas Economides and the Archbishop of Canterbury. Indeed, the payday loan industry has been referred by the OFT to the Competition Commission (CC). The CC is required to report by 26 June 2015, although it will aim to complete the investigation in a shorter period.
It was becoming increasingly clear, however, that the government would not wait until the CC reports. It has been under intense pressure to take action. But the announcement on 25 November 2013 that the government would cap the costs of payday loans took many people by surprise. In fact, the new body, the Financial Conduct Authority, which is due to start regulating the industry in April 2014, only a month ago said that capping was very intrusive, arguing that it could make it harder for many people to borrow and push them into the hands of loan sharks. According to paragraph 6.71 of its consultation paper, Detailed proposals for the FCA regime for consumer credit:
The benefits of a total cost of credit cap has been looked at by the Personal Finance Research Centre at the University of Bristol. This report highlighted that 17 EU member states have some form of price restriction. Their research was ambiguous, on the one hand suggesting possible improved lending criteria and risk assessments. On the other, prices may drift towards a cap, which could lead to prices increasing or lead to a significant reduction in lenders exercising forbearance. Neither of these latter outcomes would be beneficial for consumers. Clearly this is a very intrusive proposition and to ensure we fully understand the implications we have committed to undertake further research once we begin regulating credit firms and therefore have access to regulatory data.
The government announcement has raised questions of how imperfections in markets should be dealt with. Many on the centre right argue that price controls should not be used as they can further distort the market. 
Indeed, the Chancellor has criticised the Labour Party’s proposal to freeze gas and electricity prices for 20 months if it wins the next election, arguing that the energy companies will simply get around the freeze by substantially raising their prices before and after the 20 months.
Instead, those on the centre right argue that intervention should aim to make markets more competitive. In other words, you should attempt not to replace markets, but to make them work better.
So what is the reasoning of the government in capping payday loan charges? Does it feel that, in this case, there is no other way? Or is the reasoning political? Does it feel that this is the most electorally advantageous way of answering the critics of the payday loan industry?
Webcasts and podcasts
Payday Loans To Be Capped By Government Sky News (25/11/13)
New law to cap cost of payday loans BBC News, Robert Hall (25/11/13)
Osborne: ‘Overall cost’ of payday loans to be capped BBC Today Programme (25/11/13)
George Osborne announces cap on payday loan charges amid concerns ITV News (25/11/13)
Articles
UK to cap payday lenders’ interest charges Reuters, Steve Slater, Paul Sandle, Kate Holton and William James (25/11/13)
Capping payday loans: from light touch to strong arm Channel 4 News, Faisal Islam (25/11/13)
Payday loans: New law to cap costs BBC News (25/11/13)
Payday loan ‘risk to mortgage applications’ BBC News (26/11/13)
Q&A: Payday loans BBC News (25/11/13)
George Osborne is playing social democratic catch-up on payday loans The Guardian, Larry Elliott (25/11/13_
Payday loans cap: George Osborne caves in following intervention led by Archbishop of Canterbury Independent, Oliver Wright (25/11/13)
The principle, the practice and the politics of fixing payday loan prices: why? And why now? Conservative Home, Mark Wallace (25/11/13)
George Osborne and the risky politics of chutzpah New Statesman, Rafael Behr (26/11/13)
Chancellor too quick off the mark on payday lending cap The Telegraph, James Quinn (25/11/13)
Crap and courage of convictions: the political problem with Osborne’s payday loan plan Spectator, Isabel Hardman (26/11/13)
Payday loan calculator
Payday loan calculator: how monthly interest can spiral BBC Consumer (7/11/13)
Questions
- What types of market failing exist in the payday loan industry?
- What types of controls of the industry are being proposed by George Osborne?
- What is the experience of Australia in introducing such controls?
- What alternative forms of intervention could be used to tackle the market imperfections in the industry?
- What were the proposals of the FCA? (See paragraph 6.6 in its document, Detailed proposals for the FCA regime for consumer credit.)
- According to a representative example on Wonga’s website, a loan of £150 for 18 days would result in charges of £33.49 (interest of £27.99 and a fee of £5.50). This would equate to an annual APR of 5853%. Explain how this APR is calculated.
- The proposal is to allow a relatively large upfront fee and to cap interest rates at a relatively low level, such as 4% per month, as is the case in Australia. Explain the following comment about this in the Faisal Islam article above: “The upfront fee, in theory, should change the behavioural finance of consumers around taking the loan in the first place (there are ways around this though). So this is an intervention based not on lack of competition, but asymmetries of information in consumer finance.”
- Comment on the following statement by Mark Wallace in the Conservative Home article above: “If overpriced payday loans should be capped, why not overpriced DVDs, sandwiches or, er, energy bills?”
- Compare the relative advantages and disadvantages of George Osborne’s proposal with that of Justin Welby, the Archbishop of Canterbury (see the news item, Kostas Economides and the Archbishop of Canterbury).
A constant feature of the UK economy (and of many other Western economies) has been record low interest rates. Since March 2009, Bank Rate has stood at 0.5%. Interest rates have traditionally been used to keep inflation on target, but more recently their objective has been to stimulate growth. However, have these low interest rates had a negative effect on the business environment?
Interest rates are a powerful tool of monetary policy and by affecting many of the components of aggregate demand, economic growth can be stimulated. This low-interest rate environment is an effective tool to stimulate consumer spending, as it keeps borrowing costs low and in particular can keep mortgage repayments down. However, this policy has been criticised for the harm it has been doing to savers – after all, money in the bank will not earn an individual any money with interest rates at 0.5%! Furthermore, there is now a concern that such low interest rates have led to ‘zombie companies’ and they are restricting the growth potential and recovery of the economy.
A report by the Adam Smith Institute suggests that these ‘zombie companies’ have emerged in part by the low-interest environment and are continuing to absorb resources, which could otherwise be re-allocated to companies with more potential, productivity and a greater contribution to the economic recovery. During a recession, there will undoubtedly be many business closures, as aggregate demand falls, sales and profits decline until eventually the business becomes unviable and loans cannot be repaid. Given the depth and duration of the recent recessionary period, the number of business closures should have been very large. However, the total number appears to be relatively low – around 2% or 100,000 and the report suggests that the low interest rates have helped to ‘protect’ them.
Low interest rates have enabled businesses to meet their debt repayments more easily and with some banks being unwilling to admit to ‘bad loans’, businesses have benefited from loans being extended or ‘rolled over’. This has enabled them to survive for longer and as the report suggests, may be preventing a full recovery. The report’s author, Tom Papworth said:
Low interest rates and bank forbearance represent a vast and badly targeted attempt to avoid dealing with the recession. Rather than solving our current crisis, they risk dooming the UK to a decade of stagnation … We tend to see zombies as slow-moving and faintly laughable works of fiction. Economically, zombies are quite real and hugely damaging, and governments and entrepreneurs cannot simply walk away.
The problem they create is that resources are invested into these companies – labour, capital, innovation. This creates an opportunity cost – the resources may be more productive if invested into new companies, with greater productive potential. The criticism is that the competitiveness of the economy is being undermined by the continued presence of such companies and that this in turn is holding the UK economy back. Perhaps the interest rate rise that may happen this time next year may be what is needed to encourage the re-allocation of capital. However, a 0.5 percentage point rise in interest rates would hardly be the end of the world for some of these companies. Perhaps a more focused approach looking at restructuring is the key to their survival and the allocation of resources to their most productive use. The following articles and the report itself consider the case of the trading dead.
Report
The Trading Dead The Adam Smith Institute, Tom Papworth November 2013
Articles
Zombie firms threaten UK’s economic recovery, says thinktank The Guardian, Gyyn Topam (18/11/13)
Zombie companies ‘probably have no long term future’ BBC News (18/11/13)
Rate rise set to put stake through heart of zombie companies Financial Times, Brian Groom (14/11/13)
Why we can still save the zombie firms hindering the UK economic rival City A.M., Henry Jackson (18/11/13)
Breathing new life into zombies The Telegraph, Rachel Bridge (9/11/13)
Questions
- Which components of aggregate demand are affected (and how) by low interest rates?
- Why do low interest rates offer ‘protection’ to vulnerable businesses?
- How is the reallocation of resources relevant in the case of zombie companies?
- If interest rates were to increase, how would this affect the debts of vulnerable businesses? Would a small rate irse be sufficient and effective?
- What suggestions does the report give for zombie companies to survive and become more productive?
- Is there evidence of zombie companies in other parts of the world?
The Consumer Prices index (CPI) measures the rate of inflation and in October, this rate fell to 2.2%, bringing inflation to its lowest level since September 2012. For many, this drop in inflation came as a surprise, but it brings the rate much closer to the Bank of England’s target and thus reduces the pressure on changing interest rates.
The CPI is calculated by calculating the weighted average price of a basket of goods and comparing how this price level changes from one month to the next. Between September and October prices across a range of markets fell, thus bringing inflation to its lowest level in many months. Transport prices fell by their largest amount since mid-2009, in part driven by fuel price cuts at the big supermarkets and this was also accompanied by falls in education costs and food. The Mail Online article linked below gives a breakdown of the sectors where the largest price falls have taken place. One thing that has not yet been included in the data is the impact of the price rises by the energy companies. The impact of his will obviously be to raise energy costs and hence we can expect to see an impact on the CPI in the coming months, once the price rises take effect.
With inflation coming back on target, pressures on the Bank of England to raise interest rates have been reduced. When inflation was above the target rate, there were concerns that the Bank of England would need to raise interest rates to cut aggregate demand and thus bring inflation down.
However, the adverse effect of this would be a potential decline in growth. With inflation falling to 2.2%, this pressure has been removed and hence interest rates can continue to remain at the record low, with the objective of stimulating the economy. Chris Williamson from Markit said:
The easing in the rate of inflation and underlying price pressures will provide greater scope for monetary policy to be kept looser for longer and thereby helping ensure a sustainable upturn in the economy … Lower inflation reduces the risk of the Bank of England having to hike rates earlier than it may otherwise prefer to, allowing policy to focus on stimulating growth rather than warding off rising inflationary pressures.
The lower rate of inflation also has good news for consumers and businesses. Wages remain flat and thus the reduction in the CPI is crucial for consumers, as it improves their purchasing power. As for businesses, a low inflation environment creates more certainty, as inflation tends to be more stable. Businesses are more able to invest with confidence, again benefiting the economy. Any further falls in the CPI would bring inflation back to its target level of 2% and then undoubtedly concerns will turn back to the spectre of deflation, though with the recent announcements in energy price rises, perhaps we’re getting a little ahead of ourselves! Though we only need to look to countries such as Spain and Sweden where prices are falling to realise that it is certainly a possibility. The following articles consider the data and the impact.
UK inflation falls in October: what the economists say The Guardian, Katie Allen (12/11/13)
British inflation hits 13-month low, easing pressure on central bank Reuters, David Milliken and William Schomberg (12/11/13)
UK inflation falls to 2.2% in October BBC News (1211/13)
UK inflation falls to 13-month low: reaction The Telegraph (12/11/13)
Fall in inflation to 2.2% welcome by government The Guardian, Katie Allen (12/11/13)
Inflation falls to lowest level for a year as supermarket petrol price war helps ease the squeeze on family finances Mail Online, Matt Chorley (12/11/13)
Inflation falls to its lowest level for more than a year as consumers benefit from petrol pump price war Independent, John-Paul Ford Rojas (12/11/13)
UK inflation slows to 2.2%, lowest level in a year Bloomberg, Scott Hamilton and Jennifer Ryan (12/11/13)
Are we facing deflation? Let’s not get carried away The Telegraph, Jeremy Warner (12/11/13)
Questions
- How is the CPI calculated?
- Use an AD/AS diagram to illustrate how prices have been brought back down. Is the reduction in inflation due to demand-side or supply-side factors?
- What are the benefits of low inflation?
- The Telegraph article mentions the possibility of deflation. What is deflation and why does it cause such concern?
- Explain why a fall in the rate of inflation eases pressure on the Bank of England.
- How does the rate of inflation affect the cost of living?
- Is a target rate of inflation a good idea?
Nearly two years ago, France lost its triple A credit-rating and the news has only got worse. Unemployment has risen and economic growth in France has remained low and this is one of the reasons why France’s credit rating has been downgraded further from AA+ to AA. A high credit rating doesn’t guarantee market confidence, but it does help to keep the cost of borrowing for the government low. Thus, this downgrading could spell trouble for French borrowing costs.
Standard and Poor’s (S&P), who downgraded the French credit rating, is expecting government debt to rise to 86% of gross domestic product and believes that unemployment will remain above 10% until 2016. While the French government has put various reforms in place to boost the struggling economy, S&P don’t believe they are sufficient and have been very public in criticising the government’s effort. They were quoted as saying:
We believe the French government’s reforms to taxation, as well as to product, services and labour markets, will not substantially raise France’s medium-term growth prospects and that on-going high unemployment is weakening support for further significant fiscal and structural policy measures.
Following the downgrading, the return for those investors purchasing French debt did begin to rise, echoing the theory that the cost of borrowing would rise. 
The yield on French government 10-year bonds increased from 2.158% to 2.389%. The outlook given to France by S&P was ‘stable’, implying that there is a relatively low chance that S&P would change France’s credit-rating again in the next two years.
Many were surprised at the downgrading of France’s credit rating, but this may be the nudge that President Hollande needs to push through extensive labour market reforms with the aim of reducing unemployment and generating growth in the economy. Despite this latest move by S&P, the other credit rating agencies have yet to take similar action. Perhaps they are more convinced by the Finance Minister, Pierre Moscovici who claims that France’s debt is ‘one of the safest and most liquid in the world.’ He commented that:
They are underestimating France’s ability to reform, to pull itself up … During the last 18 months the government has implemented major reforms aimed at improving the French economic situation, restoring its public finances and its competitiveness.
It will take some time for the full impact of this development in France’s economy to become apparent. The cost of borrowing has already risen only time will tell what will happen to market confidence over the coming weeks. However, what is certain is that pressure is already mounting on Francois Hollande. The following articles consider the French economy.
France told to reform labour market after second credit rating downgrade The Guardian, Phillip Inman (8/13/13)
France’s credit rating cut by S&P to AA BBC News (8/11/13)
S&P lowers France rating on reform doubts, markets unfazed Reuters, Nicholas Vinocur (8/11/13)
Hollande approval rating slumps as France downgraded The Telegraph, James Titcomb (8/11/13)
S&P cuts France’s credit rating by one notch to double-A Wall Street Journal, William Horobin (8/11/13)
Five charts that show the state of the French economy The Telegraph (8/11/13)
France rating downgrade heaps pressure on Francois Hollande Financial Times, Michael Stothard (8/11/13)
Questions
- What does a double A rating mean for the French economy?
- Which factors will be considered when a ratings agency decides to change a country’s credit rating?
- France’s unemployment rate is one of the key factors that S&P has considered. Why is France’s unemployment rate so high? Which type(s) of unemployment are increasing?
- Use a diagram to illustrate the unemployment that France is facing.
- If a country does see its credit rating downgraded, what might this mean for government borrowing costs? Explain why this might cause further problems for a country?
- Markets have been ‘unfazed’ by the downgrade. How do you think markets will react to over the coming weeks? Explain your answer.
- What action could the French government take to ensure that S&P is the only ratings agency that downgrades their credit rating?
As The Economist article states:
