Harry Geels: The three real causes of inequality
This column was originally written in Dutch. This is an English translation.
By Harry Geels
Inequality is often attributed to capitalism, but its core lies in economic structures: monopolies, monetary policy, and banking practices. Understanding how these structures work can help us better combat inequality.
Last week I wrote a column titled “Growth and exploitation are not capitalist concepts.” I then received a reader’s question about my claim that underlying structures in our economy (and not necessarily capitalism itself) increase inequality. Although these structures were indirectly mentioned in that column, I will now elaborate on them, supplemented with possible measures to reduce inequality. Wealth (capital gains) taxes do not help to combat inequality.
It is striking how often taxes are put forward as a panacea. In practice, however, they are a form of expropriation (and therefore, in my philosophy, a restriction of freedom). Moreover, they end up with the government, and we can only wait and see how efficiently those funds are used. More importantly: many taxes lead to avoidance or deferral behavior by wealthier people, making markets less efficient and causing potential prosperity for all to be lost. But that aside; let’s return to the three causes.
1. Privileged oligopolies and monopolies
Many sectors are dominated by oligopolies or monopolies. A well-known example is the local banking oligopolies in the EU, which are still protected because we have not dared to move to a European banking and capital union. Other examples include Big Food, Big Pharma, and Big Energy. Monopolies and oligopolies are a political privilege. Governments allow them—with weak antitrust rules—or even enforce them. They often form a revolving-door system with government officials.
The problem with large companies is their market power. They can attract the best employees, secure the cheapest financing, optimize taxes (on a global scale), and, due to lack of competition, charge higher prices. Often, they also wield lobbying power that allows them to shape laws and regulations to their advantage. This market structure creates a “wealth transfer” from smaller companies and consumers to the “best” employees and shareholders of the big corporates.
Measures against oligopolies and monopolies begin with stricter antitrust rules. For instance, we could prohibit a company from generating more than 10% of revenue in a given sector. Another option, proposed by Milton Friedman, is more free international trade: allow foreign companies to compete with domestic ones. Finally, employees and customers of large companies should be able to benefit from (excessive) profits, for example through shares.
2. Monetary policy
As argued many times before, monetary policy reinforces inequality. Because central banks have effectively kept interest rates too low for decades and expand money supply during crises, stock prices are driven up. In particular, people who buy real estate with borrowed money benefit. They pay relatively low interest (sometimes even with mortgage interest deduction), while house prices rise due to monetary policy—a double gain. Savers, pensioners, and tenants foot the bill.
The figure below shows the two-year income effect for different income groups after a one percentage point rate cut by the central bank. It concerns income from labor and production factors. Higher incomes benefit the most, even before considering the effects of “asset inflation.” The solution to inequality driven by monetary policy lies in a “more neutral” policy: a narrower monetary mandate and less support for financial markets and governments.
Figure 1: Two-year income effects after a 1% rate cut (across 20 income groups, from low to high)
Source: Andersen et al., Journal of Finance, July 2023
3. Banking policy
The third cause of inequality lies in banking policy, specifically in who does and does not get access to loans. People with a steady income and more wealth gain easier and cheaper access to financing, as do large companies. These loans, often secured with collateral, can then be used to buy (new) assets that, as noted, have been inflated by monetary policy. This reinforces the Matthew effect: the rich get richer, the poor get poorer.
An additional complication is fractional banking. Banks can lend out, for example, ten euros for every euro of savings, often for housing purchases. This puts extra money into circulation to buy scarce assets. Since the housing stock, for example, cannot easily be increased, fractional banking potentially leads to asset inflation, which benefits the wealthy more than the less wealthy.
Part of this inequality problem lies in regulation. The administrative burden of maintaining records makes it more efficient for a bank to serve larger clients. Banks are often also required to hold higher capital buffers for riskier loans. Banks frequently boast of their inclusive and sustainable policies. In my view of these concepts, smaller clients should be served by banks in the same way as larger ones.
Conclusion
We could distinguish between power structures (which hinder market functioning and fair competition) and natural inequality. The latter is influenced, for example, by background, health, networks, talent, and attractiveness (both physical and intellectual).
Of course, there will always be inequality; people are simply different from one another. Diversity increases the chances of humanity’s survival. What is important, however, is to strive for equal opportunities for everyone—for example, by ensuring equal access to good education, home ownership (for those who want it), and fair banking services.
The greatest challenges of inequality, however, lie in the three underlying structures, which are often overlooked. As argued before, Thomas Piketty—the great advocate of equality—largely leaves these unaddressed. To hold capitalism responsible for inequality, when it actually stems from (government) privileges and regulation, goes too far.
This article contains a personal opinion from Harry Geels