Home Finance Rising Inequality In South Africa and the World: Some Insufficiently Recognised Causes

Rising Inequality In South Africa and the World: Some Insufficiently Recognised Causes

by internationalbanker

Azar-JammineBy Dr Azar Jammine, Director and Chief Economist, Econometrix (Pty) Ltd, Johannesburg, South Africa



Episodes of social unrest seem to have escalated in many parts of the world in recent years. Few would disagree that one of the causes for this has been an increase in levels of inequality. In South Africa specifically there can be little doubt that growing inequality has been at the heart of the escalation in industrial unrest in recent years and most recently has been partially responsible for an outbreak of xenophobia. Such circumstances are nonetheless being driven by the growing awareness amongst such persons of the enormous disparity that has developed between their remuneration and that of their employers in recent years. Typically, throughout the last century, the ratio of remuneration of the top manager to the lowest paid worker was in the region of 30:1. Today it is closer to 300:1. Internationally there are several examples that illustrate similar growth in inequality between the rungs of the lowest-paid workers and of the highest-paid executives. According to the proxy-voting agency Manifest, the pay of FTSE 100 Index chief executives was 120 times the average earnings of their employees in 2013, up from 47 times in 1998. Along similar lines, a study at the University of California, Berkeley, by Emmanuel Saez, found that the top one percent of the American workforce captured 96 percent of the income gains in the US economy in the first three years following the economic recovery in 2009.

Globally, according to the Global Wealth Report 2013 by Credit Suisse, global wealth (defined as the value of financial assets plus real assets, principally housing, owned by households less their debts) reached a new all-time high of $241 trillion in 2013, representing a 68-percent increase over the preceding decade. This is equivalent to an annualised growth of 5.4 percent per annum, well ahead of overall economic growth worldwide of less than 4 percent per annum and significantly lower than the average growth in developed economies over this period of around 2 percent per annum. A mere 32 million US dollar millionaires (or 0.4 percent of the world’s population) own 41 percent of all assets. In South Africa specifically, there are 46,000 US dollar millionaires, with about 600 “high net worth” individuals with net assets exceeding $30 million. These figures contrast with median wealth of a mere $3,050. The extent of the disparity in wealth is manifested in the huge discrepancy between the above-mentioned median level of wealth and the mean level of wealth in the country of $19,600.

Criticism of the rising trend of inequality is usually couched in terms of the “ills of capitalism”. It is as if the capitalist system is inherently faulty and will lead to ever-increasing inequality if allowed to continue on its current path. This in turn has generated large numbers of “anti-capitalist” lobbies and movements, with the concomitant calls on governments to intervene because the so-called market system is not working. What is not fully recognised is that it is not the nature of the capitalist system itself that is responsible for the growing trend of inequality, but rather specific institutional developments that have contributed towards the capitalist system being abused. The first of these is the manner in which the financial sector has come to dominate the world economic system over the past three decades. Driven by gains in information technology and communications, financial innovation has developed derivative instruments aimed at assisting global financial institutions to diversify their risk onto other peers. Together with accommodative monetary policy, this has spawned a huge global industry in which wealth is being accumulated through financial ingenuity rather than productivity and real economic enterprise. The systemic risk that followed massive amounts of new loans being advanced in the last decade led to the global financial crash of 2008-09. However, this has been followed by still more accommodative monetary policy, more recently in the form of quantitative easing. The trouble is that much of the new liquidity generated through purchases of bonds from financial institutions by leading central banks has not found its way into generating a commensurate amount of new economic activity and employment. Instead, much of that liquidity has been used by ingenious financial brains to accumulate wealth through financial assets. What ought to have resulted in increased inflation of goods and services as a result of rising demand exceeding supply has instead been transformed into asset-price inflation. The ordinary working class and the unemployed who have a relative lack of access to financial assets have seen relatively little benefit, while those fortunate enough to own financial assets have seen their wealth appreciating.

As with many other equity markets around the world, the Johannesburg Stock Exchange (JSE) All Share Index has also hit new all-time highs most recently. In South Africa, the resultant rise in inequality has been even more acute than in a country such as the United States, because a much smaller relative percentage of the population owns financial assets either directly or indirectly (through pensions or retirement funds). Conversely, the fact that interest rates have been so low and negative in real terms for so long has jeopardised the financial positions of those poorer sections of society, often the elderly and those with lower incomes, who have simply saved their funds in bank deposits to secure their ability to survive in the future. They have not been in a position to exploit a system that has encouraged risk-taking rather than prudent savings.

Whereas there has been a growing recognition in some quarters in recent times of the role that global monetary policy may have had in intensifying inequality, the same cannot be said of the role of developments in corporate governance. It is interesting to note that South Africa’s ranking in the World Competitiveness Report, insofar as financial market development is concerned, has improved from 25th a decade ago to 3rd at present. Listed companies on the JSE are now ranked as top in the world insofar as their corporate-governance procedures are concerned, yet inequality has risen rapidly. Much of this can be related to the manner through which executive remuneration is arrived. A typical process is one in which the chief executive of an organisation approaches the Board of Directors (BOD), and in particular the remuneration committee of that board, with recommendations regarding increases in remuneration of his/her executive team. Invariably, some of the demands are well in excess of inflation and are rationalised as being necessary in light of the critical skills that a member of the management team may hold. The threat of a departure of such a member to a competitor organisation or even to another country in an increasingly globalised world of finance is usually dangled before the BOD’s remuneration committee. In its wisdom, before the committee accepts or rejects the recommendation put before it, it employs the services of a remuneration agency to conduct a survey of peer group companies to determine where the management or executive team of its organisation lies in relation to competitors. In order to ensure that certain key managers are not poached by competitors, the remuneration committee is then driven to agree to large remuneration increases requested by the chief executive, at least for certain members of the management team. Because of the custom of maintaining a certain ratio between remuneration of different levels of management, including the chief executive, the outcome is frequently for the chief executive to secure a strong remuneration increase as a result of this process. When another competitor company then executes the same procedure in determining its own executive remuneration, the enhanced remuneration of the first company forms part of the comparator sample employed by the remuneration agency to feed back to the second company. However, because of the big increases in remuneration of the first company, the average comparator remuneration fed through to the second company is elevated. This process continues over time in a way that imbues the entire system with an upward bias in executive remuneration. It is no fault of the individuals themselves who are engaged in this process of determining remuneration. They are not necessarily being dishonest in any way. It is just that the system itself leads to excesses over time.

One of the manners in which the system of corporate governance has tried to temper the pace of executive remuneration has been to enforce the publication of such remuneration in annual reports of public companies. The idea has been to try and embarrass executives who may be seen to be excessively remunerated, and in this way to persuade them to be more circumspect in their demands. Unfortunately, it would appear as if this procedure has had the opposite effect. In a world in which vanity is increasingly perceived as a virtue in certain circles, there has appeared to be almost a race to the top amongst executives to prove that they are more capable and in greater demand than their peers. The higher the published remuneration, the greater are the kudos seemingly derived by the executive concerned in several instances. One needs to be clear that this is a generalisation, and there are several exceptions to this pattern. Many executives return a high proportion of their gains to charitable ventures. However, psychologically this is not commensurately appreciated or recognised by the working class, who simply perceive the chasm between their remuneration and that of their executives to be widening. In South Africa, the result is ever-more pressure amongst trade unions for higher remuneration for their members, even if this comes at the expense of higher employment levels. Pressure on the South African government to introduce significantly elevated minimum wages either in certain industries or nationally have been building up as a consequence.

Some analysts have recommended a capping of executive remuneration across the board as a solution to the widening gap between executive remuneration and that of workers. Promoters of the idea say that even though such a move would not in itself lead to a reduction in inequality, the symbolism involved would be important in defusing tensions between workers and employers. Unfortunately, such a move could have unforeseen negative consequences, including a harmful misallocation of managerial skills across different sectors of the economy. A capping of executive remuneration can indeed be seen to be interfering with the market system, imbuing it with a variety of distortions and inefficiencies. It could also inadvertently lead to a loss of skills to other countries. Instead, there appear to be opportunities in addressing these systemic weaknesses within the manner in which the capitalist system is operating, via instruments that would not be seen to be anathema to the market economy. One of these is through the tax system—not by increasing taxes on the wealthy per se, but by changing the structure of taxation to favour income production rather than wealth generation as the first priority. Theoretically, one could argue for the introduction of a tax on wealth on a continuous basis as a quid pro quo for a reduction in income tax rates. One floats the possibility of levying a tax on financial assets and real estate at a relatively small decimal percentage rate. The asset base upon which such a tax would be levied is so large that one could collect a substantial amount of tax revenue at a minimal tax rate, enabling one to reduce income tax rates by a fairly significant margin. In South Africa, for example, the value of financial assets is in the region of $600 billion and the net (of debt) value of real estate is estimated to be around $400 billion. In other words, the asset base upon which one could draw a wealth tax is probably in excess of $1 trillion. Therefore, a 0.1-percent annual levy on such a tax base would yield $1 billion, which would be enough to reduce the level of personal income tax by around 3 percent. More ambitiously, a 0.5-percent annual levy on wealth would yield an estimated $5 billion, or around 15 percent of current personal income tax. In relation to an annual appreciation of the value of financial assets of 10 percent or more in the longer term, a 0.5-percent annual levy would hardly act as a disincentive to accumulate wealth. However, a 15-percent reduction in personal income tax would indeed provide an enhanced incentive to generate more income.

In the South African political context, the notion of an introduction of a wealth tax of this nature represents a way of preventing a disastrous national socio-political crisis in the longer term in the face of rising levels of inequality combined with high levels of unemployment. On a global scale, the idea is aimed at preventing an implosion of capitalism, which would usher in a far worse economic outcome of increased poverty for all, in the interests of a so-called more equitable dispensation. Unfortunately, the idea does lend itself to abuse. Some will argue, quite rightly, that the introduction of a wealth tax will simply be exploited by government populists, effectively to increase tax on the rich without providing a countervailing relief on personal income tax for the man on the street. The funds raised by a wealth tax would simply be redirected towards malinvestment and less-efficient, supposedly “vital” projects on social upliftment. The other concern that one may have is that as equitably unconstructive as the idea may be, it may well be vehemently opposed by powerful financial interests, who would prefer to see the current status quo continue to their narrowly defined advantage. Nonetheless, the ideas put forward here could be used as a basis for starting a social dialogue that could bring together the ambitions of both the working class and business to their mutual benefit from a longer-term point of view. Globally, also, a wealth tax aimed at redirecting the benefits of capitalism towards more equitable outcomes could help defuse a growing probability that capitalism, in its current form, might implode upon itself in the longer term.

Photo Accreditation – Picture via Government ZA

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