at the IMF or central banks have also been notoriously wrong regarding their projections of economic variables like gross domestic product, inflation and unemployment. Political economy as an academic discipline might be equally bad at making predictions about the future, but tends to be much better in explaining post hoc why economic events occurred in the way they did. The reason is that political economists do not base their theories on unrealistic assumptions and that they take into account non-economic factors that all too often ignored by neoclassical economists.
One of these factors is power and politics: political economists are critical of the neoclassical presumption that economic phenomena can be separated from relations of power and politics. Neoclassical economists believe that someone’s wage or income is a reflection of the marginal productivity of his or her labour – that is, the additional revenue a firm gets from hiring that particular individual (see chapter 1). As a typical example from neoclassical reasoning, consider the following statement by Greg Mankiw – author of one of the most famous introductory handbooks in neoclassical economics, Principles of Economics:
Most of the very wealthy get that way by making substantial economic contributions, not by gaming the system or taking advantage of some market failure or the political process … Take the example of pay for chief executive officers (CEOs). Without doubt, CEOs are paid handsomely, and their pay has grown over time relative to that of the average worker … [However], the most natural explanation of high CEO pay is that the value of a good CEO is extraordinarily high.11
Yet this neoclassical conception of CEO compensation ignores the role of the government, the legal system and all other institutions and norms that underpin the political power of CEOs and might have played a role in helping them receive high incomes. For instance, the highest federal marginal tax rate in the United States fell from 91 per cent for all personal income in the 1960s to less than 40 per cent in the 2000s. Such changes in the US tax system were vital in boosting top incomes of CEOs. In their book Winner-Take-All Politics: How Washington Made the Rich Richer – and Turned Its Back on the Middle Class, political scientists Jacob Hacker and Paul Pierson argue that the dramatic increase in income inequality in the United States since 1978 has been the result of political forces, rather than the natural and inevitable result of technological innovation and increased competition associated with globalization. They note that the balance of political power shifted sharply in favour of those at the very top of the economic ladder. Financial and economic elites have used their political clout to dramatically cut taxes, dismantle social welfare and liberalize labour markets, reduce the power of labour unions and deregulate the financial industry.12
In the following chapters of this book, we will provide a comprehensive overview of the many policy and institutional changes that have shifted political power from workers to the top managers of firms and their shareholders and have contributed to the rise in inequality in income and in wealth. These changes fall under the rubric of neoliberalism – a set of policies grounded in neoclassical economic theory and aimed at maximizing the role of markets in the allocation of economic resources and reducing the role of the state to the principal enforcer of ‘market efficiency’ in the economy.13 Neoliberalism tried to undo the Keynesian compromises of the post-war era of egalitarian capitalism through a process of marketization – such as lifting restrictions on international economic transactions and subjecting governments and workers to the discipline of global market forces (see chapter 2). The compromises of the Keynesian era arose from the Great Depression of the 1930s, which had created a new consensus among economists and policymakers that activist state intervention in the economy and a more equitable distribution of income and wealth were the most effective ways to sustained prosperity:
The key to full employment and economic growth, many at the time believed, was high levels of aggregate demand. But high demand required mass consumption, which in turn required an equitable distribution of purchasing power. By ensuring sufficient income for less well-off consumers, the government could continually expand the markets for businesses and boost profits as well as wages.14
This Keynesian consensus unravelled during the economic crisis of the 1970s, giving rise to a neoliberal turn in economic thinking and policymaking that heightened income and wealth inequality and ultimately contributed to the global financial crisis of 2008. In this book we will trace neoliberal transformations in four policy domains that have played a pivotal role in fuelling economic inequality and financial instability over the past four decades:
1 macroeconomic policy, which refers to the tools of the government to manage the business cycle, fight unemployment during economic recessions and maintain price stability;
2 social policy and industrial relations, which is about the organization of the welfare state and labour market;
3 corporate governance, which consists of formal and informal rules and norms shaping firms’ business strategies and the distribution of profits between their main stakeholders (i.e. shareholders, managers and workers); and
4 financial policy, which is about the regulation of the banking and credit system.
This book is the first to give a comprehensive and systematic overview of neoliberal transformations within these four policy domains since the 1980s and show how these transformations have made advanced capitalist societies in Europe and the United States both more unequal and unstable.
The book will examine these changes from a ‘growth model’ perspective. It will provide a synthesis of a nascent comparative and international political economy literature that has linked the global financial crisis to the formation of two mutually dependent but unsustainable growth models: the Anglo-Saxon liberal market economies (LMEs) as well as several Southern European mixed market economies (MMEs) pursued debt-led growth models, whereas the Northern and Western European coordinated market economies (CMEs) adopted export-led growth models. The development of these growth models was deeply connected to distinctive patterns of income and wealth inequality in these advanced capitalist countries – patterns that have been shaped by divergent institutions that both reflect and shape the bargaining position of various classes and groups in these countries. From the growth model perspective elaborated in this book, these institutions reflect temporary and fragile attempts to resolve structural tensions and conflicts between different classes and groups, making the capitalist system intrinsically unstable and prone to crisis.
The book is structured in eight chapters. In chapter 1 we introduce various economic concepts and measures needed for a systematic study of these challenges. The most important objective of the chapter is to give a comprehensive and empirically grounded overview of the cyclical patterns and interlinked nature of economic instability and inequality since the birth of democratic capitalism in the beginning of the twentieth century. We will discuss different measures of income inequality, highlighting the important distinction between personal income distribution and functional income distribution and their connection to wealth inequality. Empirically, we will show that dynamics of inequality are deeply connected to varieties of capitalism: the Anglo-Saxon LMEs have more unequal personal income distribution and experienced a much sharper increase in the national income share of the top 1 per cent than the Northern and Western European CMEs, which witnessed a starker decline in the share of national income going to labour (which is the main measure of functional income distribution). Moreover, we discuss the neoclassical interpretation of rising inequality in the advanced capitalist world since the 1980s and criticize its neglect of power relations, the role of institutions and the structural instabilities that permeate capitalist economies. As such, the chapter explains why (comparative and international) political economy is needed for a deeper understanding of rising inequality, and of how it is connected to the global financial crisis of 2008 through the development of two unsustainable growth models.
In chapter 2 we give an overview of the rise and fall of egalitarian capitalism, which is linked to the