pursue policies that are more favourable to capital. Second, the capitalist class is able to exert ideological control by representing private business interests as synonymous with the national interest. Seen from this angle, economic globalization fuelled income inequality not by reducing demand for unskilled labour but by strengthening the structural power of capital: the removal of cross-border restrictions on trade, investment and financial flows enabled the owners of capital to threaten their government with capital flight to countries with more favourable conditions. The owners of capital were supported in this by the neoliberal ideology that served to change ‘expectations about the appropriate role of government, the importance of private enterprise, and the virtues of markets’.20
However, as Jacob Hacker and Paul Pierson have noted, ‘the structural power of business is variable, not constant’.21 A variety of developments in the first half of the twentieth century enabled the working classes to strengthen their bargaining position vis-à-vis capital. On the one hand, workers organized in the form of trade unions to engage in collective bargaining, the key purpose of which is to make sure that the wages of the working classes grew in step with labour productivity. When universal and equal suffrage was introduced in the early years of the twentieth century in most industrialized countries (in most cases initially only for male voters), left-wing political parties striving to defend the interest of the working classes also gained influence and became increasingly successful in shaping public policies (either in government or in national parliaments) – particularly after the Great Depression of the 1930s, which revealed the blatant need for more extensive state intervention to protect citizens against the vagaries of markets.22 From the 1930s to the 1970s these democratic class struggles culminated in the development of national welfare states, ushering in a new era of egalitarian capitalism based on collective bargaining, full employment and expansion of social safety nets. These equality-promoting institutions were supported by restrictions of cross-border capital flows, which weakened the structural power of capital by constraining the ability of firms and capital owners to escape these institutions.
The post-war settlement broke down during the stagflation crisis of the 1970s, when a combination of economic stagnation and rising inflation pushed governments of the industrialized countries to liberalize trade, investment and cross-border capital flows. A central question for the emerging CPE and international political economy (IPE) literature since the end of the 1970s is to what extent economic globalization and the ensuing intensification of competition between firms and between states would undermine the main institutional pillars of egalitarian capitalism. Scholars of the VoC school have rightly noted that there continues to be a significant amount of institutional divergence between the Anglo-Saxon economies and the continental European economies in terms of organization of their labour markets, welfare state and corporate governance.23 These persistent institutional differences go a long way to explain why income inequality rose faster in the former group of countries than in the latter. Nevertheless, economic globalization weakened the power of labour and strengthened the power of capital in ways that spawned varying tendencies towards neoliberalization – even in the more egalitarian European countries.24 In the upcoming chapters we will examine these tendencies in various policy domains that have been most consequential in fuelling economic inequality in the advanced capitalist world.
Rising inequality as a structural cause of the global financial crisis
Not only should the neoclassical interpretation of the causes of rising inequality be disputed; its rather sanguine views of the consequences of inequality can be criticized as well. Remember that the rise in income inequality is believed to boost long-term growth insofar as it creates incentives for individuals to develop scarce skills and human capital, and for firms to invest in more efficient technologies, which will enhance the growth in productivity and living standards. Yet a growing number of studies have shown that, other things being equal, a rise in income inequality hampers long-term economic growth and increases financial instability.25
There are two different interpretations of this observation. A ‘supply-side’ interpretation stresses the negative effects of rising inequality on educational opportunities for children in lower-income households, leading to a decline in human capital development that reduces long-term productivity growth. According to this view, higher income inequality translates into higher educational inequality, with low-income children ending up in low-quality schools and having less access to higher education. This slows the rate of economic growth relative to a counterfactual scenario where all children have equal educational opportunities, given that children of poor households accumulate less human capital and will become less efficient and productive future workers. Econometric analysis by the OECD suggests that income inequality has had a negative and statistically significant impact on economic growth, offering empirical evidence for the hypothesis that inequality hampers human capital formation: increased income disparities depress skills development among individuals with poorer parental education background, both in terms of the quantity of education attained (e.g. years of schooling) and in terms of its quality (e.g. skill proficiency).26
A ‘demand-side’ interpretation, by contrast, points to the negative effects of rising income inequality on aggregate demand in the economy (box 1.3). Because individuals with higher incomes have a lower marginal propensity to consume (MPC) – that is, they consume a smaller part of their income (see also chapter 3) – than individuals with lower incomes, an upward redistribution of income from poor households to rich households reduces the level of aggregate consumption in the economy. The fall in the labour income share has the same effect, as the MPC of workers is higher than that of capital owners. The lower level of aggregate consumption, in turn, pushes firms to curtail their investment expenditures, as weaker consumer demand offers a signal to businesses that there is less need to raise their capital stock (e.g. factories, machines and equipment) to meet demand for their goods and services.27 Conversely, rising income inequality since 1980 has generated a large increase in saving by the top of the income distribution, which Atif Mian and his colleagues refer to as ‘the saving glut of the rich’. Because firms have had less incentive to raise their investment and capital stock in the face of weaker consumer demand associated with rising inequality, these savings of the wealthy have been invested in financial assets that were linked to and hence contributed to the substantial dis-saving and large accumulation of household debt of the bottom 90 per cent: in the United States, the savings of the top of the income distribution increasingly financed borrowing by the rest of the population.28
Box 1.3 Supply-side versus demand-side macroeconomics
What are the main sources of economic growth and economic crisis? This question determines the ultimate dividing line between different schools of (political) economic thought. Classical and neoclassical economists emphasize the role of the supply side of the economy, which refers to those factors that underpin the efficiency of the production process of firms – for example, taxation, product and labour market regulation, and the availability of (human) capital. A key assumption of supply-side economics is that entrepreneurship in the private business sector is the ultimate driver of economic growth and capital accumulation: only when private firms and individuals are willing to take risks and invest capital are jobs created and income (profits and wages) generated. From a supply-side perspective, the key to economic growth is profitability: firms will only invest in new factories, machines and production facilities when it is profitable to do so.
Demand-side economists, on the other hand, emphasize the importance of sufficient aggregate demand in the economy: firms will only invest and produce goods and services when they believe their goods and services will effectively be sold. These economists also recognize the importance of private investment spending, but they add that firms will only undertake new investments and raise output if there is adequate demand. In macroeconomics, the following sources of aggregate demand (and therefore economic growth) are identified:
Y