Stakeholder Capitalism

Low-Interest Rates and Low Inflation

There was one life buoy for low growth and debt until now: low interest rates. Having a low interest on your loan, as many homeowners or student borrowers know, is a blessing. It allows you to pay back your debt without having to worry about the debt load getting larger.

Since the financial crisis, central banks have ushered in an era of low lending rates, giving governments, companies, and consumers low interest rates as a form of relief. The goal is to, ultimately, restore higher growth as people consume more, companies invest more, and governments spend more.

In the United States, the Federal Reserve kept interest rates near zero from 2009 until 2016. It then gradually raised them again to 2.5 percent, half the historical normal rate. But in 2019, the Fed once again cut interest rates55 several times, and when COVID hit, it crashed back down to 0.25 percent.56 Given the challenging macroeconomic environment, a return to the era of high interest rates is very unlikely anytime soon. In other advanced economies, rates are even lower. The European Central Bank has kept its key borrowing rate for the eurozone at under 1 percent since 2012, and at zero since 2016. Most other European countries have similar low rates; Japan and Switzerland even charge depositors for buying bonds, in fact meaning they have a negative interest rate.

As indicated, this is a blessing for governments, companies, and individuals alike who are willing and able to take up new loans or for governments who want to refinance their historical debt. Some observers may even go as far as to suggest the historical debt-to-GDP burden is not as big a problem as it seems, as it can be perpetually refinanced.

But this view fails to consider that repayment problems can quickly get out of hand as government funding gaps for other liabilities increase. Costs related to pensions, health care, and infrastructure are becoming an ever-growing burden on governments, not to speak of consumption subsidies, such as governments paying a part of oil and gas prices for consumers.57 They produce low-quality debt and are hard to roll back, given their popularity with voters.

Public health care spending, notably, already rose by 66 percent from 2000 to 2016—long before the COVID-19 crisis hit—according to the World Health Organization.58 During the same period, GDP growth in OECD countries was only 19 percent. In aggregate, public health care spending in OECD countries now represents close to 7 percent of GDP, with peaks in the United States and Switzerland at double that rate, and that percentage can be expected to rise further as populations age and more viruses or even non-communicable diseases threaten the population. Unless governments can unload these costs to their citizens, many will increasingly struggle to balance their books.

There are more growing government liabilities. The Global Infrastructure Hub calculated the world faces a $15 trillion infrastructure funding gap from 2016 to 2040.59 But infrastructure represents an investment, on which a return could be earned. The problem posed by pensions and retirement savings is an order of magnitude larger, and returns are much lower: unless policies are changed, the World Economic Forum estimates60 the pension savings gap will balloon to $400 trillion in the eight countries with the world's largest pension systems by 2050, with unsecured public pension promises making up the lion's share of that shortfall.

On top of this debt burden is low inflation. Historically, interest rates and inflation tended to be inversely correlated, and central banks used their power to set interest rates as a tool to either curb inflation or stimulate it. By setting high interest rates, central banks gave people, companies, and governments an incentive to save money rather than spend it, easing upward pressure on prices. By setting low interest rates, they gave people the reverse incentive, namely to spend money and push up prices, since saving it wouldn't yield interest anyway.

Since about a decade, however, this inverse correlation has all but ceased to exist in the West, with the situation particularly dire in Europe and Japan. Despite years of near-zero interest rates, inflation often remained close to zero as well. While this is no problem in the short run, it does take away a long-term lever to ease the debt load. With rising prices, nominal debt tends to become relatively less of a burden. With flat prices, however, historical debt remains as heavy as a burden tomorrow as today.

But the nexus between low growth, low interests, low inflation, and increasing debt has one more ingredient, and it could be the most lethal of them all: slowing productivity growth.

Declining Productivity Growth

Compounding many of the structural issues outlined in this chapter is the fact that productivity gains have been low in recent years. Indeed, it was because of rising productivity, more so perhaps than demographic growth, that the middle class in the West saw their incomes rise quickly during the first decades after the war.

Productivity goes up most often because of innovations in the way things are made or done. Well-known examples of productivity gains are the assembly line Ford introduced in the early 1900s, the introduction of digital computers instead of typewriters in the 1970s and 1980s, or the optimizing of a taxi route thanks to apps such as Waze today. All these innovations enable a given worker to produce the same output, or do the same job, in considerably less time. That in turn allowed companies to increase wages.

In the past, the world knew periods of high productivity gains, which translated into high wage growth. During America's golden age of capitalism in the 1950s and 1960s, for example, the annual productivity growth was almost 3 percent per year.61 But productivity gains afterward fell to lower levels, and, problematically, even when productivity did rebound, less of it was translated into take-home pay for American workers. Instead, it remained with the businessowners and executives, a phenomenon known as the “decoupling” of wages from productivity.62

Since the 2007–2009 financial crisis, US productivity growth has fallen to the meager level of 1.3 percent per year. That is a problem, because it means it is not possible to grow the pie for everyone anymore. The distribution of today's economic gains is a quasi-zero-sum game. Other countries, such as Germany, Denmark, and Japan, have kept up productivity gains better and translated them also in higher wages. But the trendline is unmistakable: productivity gains in the West are experiencing a marked decline.

Taken together, the indicators presented in this chapter—growth, interest rates, debt, and productivity—point to a systemic design error in the Western economic development model. Much of its prosperity model was based on perpetual economic growth and productivity gains. Now, that growth is grinding to a halt, and problems that had been festering under the surface are becoming more acute by the day.

Kuznets’ curse is coming back to haunt us. GDP was never a perfect measure for well-being. And now that it is becoming an ever-greater challenge to grow it, we will have to deal with a whole basket of other problems we created while pursuing that higher growth.

The Second Kuznets’ Curse: Inequality

While the original Kuznets’ curse of our recent past is the result of the blind pursuit of GDP growth, there is a second Kuznets’ curse. This one relates more directly to the phenomenon Kuznets became known for in his lifetime: the so-called Kuznets curve.

As Kuznets continued his work as an economist in the 1950s, he started to theorize on an interesting phenomenon. He noticed that US income inequality had started to decline in the post-war period, as the economic boom intensified. That contrasted to the pre-war period, in which America had become a major economic power, but income and wealth were concentrated in the hands of a few. A similar observation, though less extreme, could be made for many other developed countries.

Kuznets theorized about the numbers he found, in a paper for and presidential address to the American Economic Association.63 He derived a potential game-changing insight for development economics, provided the findings held true over time. Indeed, it implied a sort of economic law. Inequality worsens as a nation begins to develop, but as development continues, inequality subsides. In other words, the price of inequality societies pay for development early on is offset by higher development and lower inequality later.

The theory put forth by Kuznets became a worldwide sensation, especially after Kuznets won the 1971 Nobel Prize for Economics, awarded for his contributions to national income accounting (rather than the theory of the Kuznets curve). Throughout the 1980s, economists built on Kuznets’ optimistic theory, plotted graphs that showed how it applied to various countries and periods, and prescribed economic development models because of it.

Figure 2.2 Kuznets waves: How income inequality waxes and wanes over the very long run

Source: Redrawn from Lindert, P. H., & Williamson, J. G. (1985). Growth, equality, and history. Explorations in Economic History, 22(4), 341–377..

There was just one problem: over time, the theory no longer held true. Some of the facts we face today reveal this.

Inequality in fact began rising again in highly developed countries. In a 2016 note, economist Branko Milanovic suggested that the current upswing in inequality could be viewed "as a second Kuznets curve", or indeed, as a "Kuznets wave" (Figure 2.2).

Income Inequality

There is a festering wound in our global economic system, and that wound is rising income inequality.

The story starts with an unexpected twist. Global income inequality, measured by plotting incomes of everyone from all over the world, has actually been steadily declining over the last 30 years64 (see Figure 2.3). This may come as a surprise to many readers, given the perception that the opposite is true in many countries. But the global trend is clear: around the world, people earn more equal incomes, not less.

The decline in inequality happened because of one incredibly powerful force: the huge economic leaps forward in incomes in some of the largest (and previously poorest) countries in the world. China, notably, went from being a low-income country to an upper-middle-income65 one since its Reform and Opening-Up. By its own calculation, it lifted some 740 million people out of poverty.66 India, too, knew various periods of rapid growth, and thereby managed to raise the income of many of its people.

The impact of these two countries on global inequality has been all-encompassing: economist Zsolt Darvas of the Bruegel Institute showed that without the changes in China and India, global inequality would have remained exactly where it was, or even gone up quite a bit, depending on the calculation method (see Figure 2.3).

This clarifies the real problem posed by inequality today. Global inequality may have declined, but inequality within nations has drastically worsened.

Figure 2.3 The Impact of China and India on Global Income Inequality (Measured in Gini Indices)

Source: Redrawn from Zsolt Darvas, Global income inequality is declining – largely thanks to China and India, April 18, 2018.

In many people's experience, it matters much more how they fare compared to their fellow citizens than to the rest of the world population. In all but a few countries, national inequality has been rising and often rather fast.

The traditional measure of inequality, the Gini coefficient, doesn't do justice to the severity of the problem. The Gini coefficient translates the degree of inequality into a number from 0 (everyone has the same income) to 1 (one person has the entire economy's income). While a higher score over time tells us that inequality has risen, it's difficult to understand what that means in practice. In the US, for example, the Gini coefficient rose from its low point of 0.43 in 1971 to a post-war high of 0.58 today.67 It is an increase, of course, but precisely how good or bad is either number?

Thomas Piketty, a French economist, laid out the problem in a better way. In his 2013 book Capital in the Twenty-First Century,68 he revealed how the share of income that went to the top 10 percent of earners evolved over time. In 1971, his data showed the top 10 percent earners took home one third of national income. In the early 2010s, they took half of income. This leaves the vast majority of workers—the remaining 90 percent—with only half of the national income to divvy up among themselves.

Later numbers from the World Inequality Report, of which Piketty is a co-author, showed how the trend was even more pronounced for the top 1 percent. Over the same period, 1971 to the early 2010s, their income share doubled69 and their incomes more than tripled. This means that in the early 2010s, more than 20 percent of the national income went to the top 1 percent of earners. For those at the bottom of the income pyramid, the situation was much bleaker. Many workers saw their real incomes and purchasing power decline since the early 1980s (Figure 2.4). In the UK a similar shift took place.

The social and economic outcomes of this worsening inequality in the US have been highly problematic. There are again many working poor in America, a painful outcome in the wealthiest country the world has ever known. Guy Standing, a British economist, even coined the term precariat, to point to “an emerging class, comprising the rapidly growing number of people facing lives of insecurity, moving in and out of jobs that give little meaning to their lives.”70

Seen from this perspective, it is no wonder that in 2011, a one-page call for action in an activist magazine led to one of the most supported American protest movements of this century. The page in AdBusters read, “17 September. Wall Street. Bring Tent.” Protestors did in fact show up in lower Manhattan on that day, they brought tents, and with that, Occupy Wall Street was born. Referencing the extreme inequality in America, the movement's rallying cry became “We are the 99 percent,” and the protestors decried the wealth, income, and power accumulated by the 1 percent richest individuals and corporations in America. As you can see from Figure 2.4, this dichotomy between the 1 percent and the rest of income earners was not imaginary.

The same pattern exists in other parts of the world, and in some countries the outrage over these inequalities has erupted with equal force as it has in the English-speaking world. In fact, it was movements in the Mediterranean and Middle East that inspired Occupy Wall Street, Kalle Lasn, one of the founders of Occupy, told one of us in a 2012 interview.71 There, in the early years of this decade, Spanish Indignados took to the streets in protest. A year later, Arab Spring protesters in Tunisia, Egypt, Syria, and other countries took the streets to express their anger over economic inequities within their countries. In Tunisia, they forced a regime change.

Figure 2.4 In the US, Income Inequality Has Risen Sharply

Source: Redrawn from Piketty, Saez and Zucman (2018), World Inequality Report 2018..

“We saw what happened in Tunisia, with the regime change, and started to brainstorm about what that would look like in America,” Lasn said. A “soft regime change” in the US, he said, would be to take away power and money from large corporations, which decided “every part of my life. We felt that we had reached a situation—with unemployment of young people, huge student debt, and no good jobs—where if we didn't fight for our future, we wouldn't have a future. That was the core impulse behind Occupy Wall Street.”

In other countries, particularly in emerging Asia, the social outrage over rising inequality has been less pronounced. In China, India, and many ASEAN nations, national inequality also rose. However, overall economic growth in that region was much higher, so a rising tide did in fact lift most boats. Still, the specter of class tensions looms over some of these countries as well (see Chapter 3).

As author James Crabtree highlighted in his book The Billionaire Raj, India is now one of the most unequal societies in the world, to the point of embodying a new Gilded Age society. Unlike in India, in China, most of the population started on the same footing when the country opened to the world. Despite this, China has seen its inequality surge, too, with the top 10 percent now capturing 41 percent of their nation's income.72 In many other emerging markets, the situation is even worse. Just as in the United States, the top 10 percent are taking home more than half their nation's income in countries across the Middle East, Sub-Saharan Africa, and many Latin American countries, including Brazil.

Inequality in continental Europe is slightly less pronounced, with 37 percent of income captured by the top 10 percent of earners. While inequality has been rising, it has done so at a considerably slower pace than in most other leading economies. This is partially due to Europe's greater system of check and balances to facilitate income distribution and redistribution.

But some uncomfortable realities remain here, too. In much of Southern and Eastern Europe, for example, unemployment remains stuck at high levels, especially for the young. Well-paid jobs there are increasingly hard to get, often to the detriment of both blue-collar workers and university-educated youth. Even Northern European economies, which kept a decent growth pace after the European debt crisis put a strain on Europe-wide growth as of 2010, saw their income inequality levels rise in the past decade. Counterexamples such as Belgium,73 Estonia, Romania, Slovakia, or the Czech Republic,74 which experienced declining inequality, remain the exception.

Wealth, Health, and Social Mobility

The Kuznets curve has been disproved when looking at other inequality metrics too. Wealth inequality, which reflects the savings, investments, and other stocks of capital individuals have, is even more lopsided in many countries. And, in lockstep with this wealth disparity, private education and quality health care, which can require large sums of money, are becoming more of a privilege reserved for the upper-middle and upper classes. This is especially the case in countries without proper public alternatives.

This reality is perhaps most keenly felt in the United States, which in this sense looks more like the emerging markets of India and Mexico than the advanced economy it is. Economists Emmanuel Saez and Gabriel Zucman calculated that the wealth held by the one percent richest Americans rose from less than 15 percent in the 1970s to over 40 percent in the early 2010s.75 As such, wealth inequality is twice as high as income inequality.76

These two inequalities—wealth and income—also build on one another and create a vicious cycle.77 A 2020 Financial Times article summarized that by the end of September 2019, a record 56 percent of all US equities was held by the top one percent wealthiest households, amounting to $21.4 trillion. Read that again: the “one percent” does in fact own more than half of all stocks in America. That percentage had steadily gone up in the past three decades, and the rise had been “driven by stagnant wages for many Americans, which held them back from partaking in the stock market's gains of the past decade.”

The 0.1 percent made even greater strides. They accumulated well over a fifth of America's wealth by the 2010s, a share almost three times higher as in the mid-1970s. Those at the bottom, on the other hand, saw their wealth share and savings plummet, to the point even of often not being able to cover for health emergencies and education,78 as has become painfully clear during the 2020 pandemic.

The consequence of this increasing wealth disparity, Nobel Prize–winning economist Joseph Stiglitz asserts, is that US economic mobility is increasingly a thing of the past; even a long or healthy life is out of reach for many. He decried the situation in his 2019 book People, Power and Profits: Progressive Capitalism for an Age of Discontent, and a prior Scientific American essay. “Families in the bottom 50 percent hardly have the cash reserves to meet an emergency,” he wrote. “Newspapers are replete with stories of those for whom the breakdown of a car or an illness starts a downward spiral from which they never recover. In significant part because of high inequality, US life expectancy, exceptionally low to begin with, is experiencing sustained declines.”79

And indeed, the phenomenon Anne Case and Angus Deaton called “deaths of despair,”80 is on the rise in America (and increasingly, the UK81). People are falling off the economic ladder and wither or die because of opioid overdoses, depression, or other health issues associated with their poor economic status.