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Income inequality and a crumbling model for capitalism

Economic rationalism – that is, a belief in free markets, deregulation, and globalisation – has been a hallmark of progressive governments in the West since the demise of socialism. While these policies have sustained productivity and growth, the spoils have not been evenly shared as living standards in low and middle income households have stagnated in many developed countries. The median income for an American male is unchanged in real teams over four decades. The promise of open markets and capitalism has sadly failed the middle class and their dissident voice is becoming louder.

You can see a clear divergence emerging in the share of incremental growth going to labour versus capital by way of profit share in the graph below.

US labour income and profit share

Source: Minack Advisors

Owners of capital, aka the wealthy, have benefited tremendously from soaring returns on capital. Real wages on the other hand have lagged well behind productivity improvements. The impact of globalisation on low-skilled jobs has been an important contributor here. As capital has shifted to lower labour-cost destinations, the owners of capital have benefited from the immediate uplift in productivity, while the workers that have been displaced have seen living standards fall. The graph below illustrates the 10-fold increase in real wages in China versus stagnation in the US and Japan.

Manufacturing hourly pay in real US$ terms

Source: Minack Advisors

Migration and open borders, another feature of globalisation and political union, has intensified this threat to job security. In the graph below, you can see how immigration has put downward pressure on the real wages of unskilled workers in the US. Austerity policies in the aftermath of the financial crisis have further stressed households dependent on social services. To them it seems unfair that the banks get bailed out yet they pay the cost through austerity.

US weekly median pay by education level

Source: Minack Advisors

Falling interest rates, another feature of the ‘great moderation’ of the past 20 years, have only exacerbated this trend toward inequality. Those who own most of the assets have benefitted as asset values have been bolstered by lower interest rates. The asset poor have missed out, while real wages have fallen.

Financial markets and politicians missing the signals

The disenfranchised are rejecting these liberal beliefs, giving rise to the nationalist and extremist views that are gaining popularity in many western countries. The unexpected Brexit result in the UK, the ascendancy of Donald Trump in the US, and the rebuke to the LNP in the Australian election are all manifestations of this. The political class appear detached from the shift in public opinion. Financial markets, where the true acolytes of the neoliberal church reside, are even further removed. A consequence is the ongoing failure of markets to recognise the importance of this protest vote and the potential impact on favourable policies that have been tremendously beneficial to investors.

The shift in political mood and the prospect of a reversal in these market-friendly policies are a negative for the market outlook. The political establishment also seems a long way from recognising the problem. Consider the retribution to Brexit voters the European Commission is calling for, clearly far from a workable solution.

Make no mistake; this is a very loud voice, a voice that will become louder until we see a reversal in the divergent trends in the above graph. In the meantime, the political risks will grow, unsettling financial markets.

Shifting demographics, weak productivity and deleveraging are all features of slowing global growth. The precipitous fall in bond yields in recent weeks reflects this outlook, with many bonds now trading below the zero bound. Australia’s 10-year government bond rate has slipped to 1.8%, fractionally above the cash rate. With the yield structure so flat and no carry or compensation for duration, it is hard to see any scenario where bonds can deliver anything but horrible returns in the medium term. Investors have been left with few choices, explaining the resilience of shares in the face of disturbing developments both politically and economically.

We feel more confident than ever in the merits of hedging strategies like those employed by Watermark. Bond yields are telling us the outlook for growth is as weak as it has been in a generation. There is no carry; a passive, buy and hold strategy will deliver low returns at best. Only an active strategy that can deliver enhanced returns through security selection stands a chance of delivering acceptable returns in this climate.


Justin Braitling is Chief Investment Officer at Watermark Funds Management. This article is for educational purposes only and does not consider the circumstances of any investor.


Jonathan Hoyle
August 13, 2016


Deregulation and the freedom of movement of people and goods (economic liberalism or 'rationalism' to use a pejorative term) has lifted some 500 million people out of poverty over the past three decades. Living standards have risen exponentially for middle and upper class Westerners, and for all people, especially the poor, in the developing world. The (relative) losers have been unskilled Westerners. We shouldn't lose sight of this fact. Let's not forget the economic horrors of government ownership, fixed markets and closed borders.

Gary Judd
August 13, 2016

"Those who own most of the assets have benefitted as asset values have been bolstered by lower interest rates."

It can be added that benefits also go to those who are able to be the first ones to access the new money whether the new money has been created through the banking system and at an added pace because of low interest rates or through QE.

Central banks' actions are the cause of interest rates being forced down and additional money being put into the system through QE. The reason is the belief that this interference with the market is in some way beneficial to economies. It hasn't been so central banks having dug the expanding money hole now dig it deeper by forcing interest rates down even further and, in some cases engaging an even more QE.

Is it rational to pursue these failed policies? A rational response is surely to note that the policies are failing to do what they are intended to do and to stop them, not to continue with them in the vain hope that what failed in the past may somehow succeed in the future.

In the meantime great damage is being done to the economic interests of those who are unable to benefit, to those who have ceased to be able to earn and increase wealth because the returns on their assets are being forced down and, socially, people are seeing the effects described in this article which may lead to all sorts of social consequences which in turn will exacerbate the cause of the problems by forcing governments to introduce even more regulation and control as well as engaging in the irrational policies of trying to get more money into the system.

Jamie Forster
August 12, 2016

This study by the IMF ( provides an interesting counterpoint to the theory, developed by Thomas Piketty, that incomes had suffered because returns on capital had outpaced economic growth. The IMF's thesis exposes as flawed Piketty's assumption that correlation equals causation. In the absence of that assumption, the theory crumbles.

Thomas Sowell also provides thoughtful input into the debate

Garry Anderson
August 12, 2016

I live in UK and made analysis of income inequality metrics - after our government stated that inequality improved under them.

My findings destroyed the myth that inequality improves.

It is a fact that inequality in society - the range of incomes from the poorest family in poverty (with little or no income) to the richest (with great wealth built up because governments squeeze worker's not the rich) - increases massively every year.

Government authorities 'fiddled the figures' with statistical confidence tricks.

Analogy: If the government measured weight problems by ignoring the obese and dangerously underweight - you would say they were corrupt and trying to hide the problems - wouldn't you?

That is how they measure inequality - ignore the richest and poorest groups - those millions of people most affected by what is being measured.

Indeed, our highest authority with official oversight, the UK Statistics Authority (Deputy Head of Regulation) actually admitted to me about the Gini coefficient, “I agree with your observation that it is not ideal if your particular interest is in inequalities at the top or bottom of the spectrum”.

The authorities admitting the fact it is "not ideal" if you care about rich or poor.

The first time they disclosed the fact they know it hides the inequalities of the rich and poor – yet the media will not report it.

This is not just the Gini coefficient but also other metrics including the much praised Palma ratio.

I made a video of my findings on the Gini explaining so that even a school kid could understand:

August 11, 2016

Good article with many strong points but is it a little loose on the definition of productivity – my understanding is that within country productivity gains have been weak but productivity on capital (by switching to offshore manufacturing) has had a good run.


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