Economics: Pay inequality needs redress

Much OF Kenneth Clarke's Mais lecture on the relationship be tween free markets and the welfare state last week, the first draft of his manifesto for the next Conservative leadership contest, could in guarded moments have been uttered by Paddy Ashdown or Gordon Brown.

The Chancellor argued that a strong welfare state complements a market economy by guaranteeing a decent standard of living for people unable to work and by assuaging people's fears about the change and uncertainty that are an inevitable part of life in liberalised capitalist economies.

These views are central to most variants of the 'social market' approach to economics on which the centre-right and centre-left in Britain have been converging since the mid-1980s. In addition to some Liberal Democrats and Labour modernisers, growing numbers of Conservative thinkers, including David Willetts and John Gray, are mining this intellectual seam.

All the Mais lecture lacked were references to 'caring and daring' and 'tough and tender' to summon up the spirit of David Owen, who tried to popularise the social market during his ill-fated leadership of the SDP. But rhyme and alliteration do not necessarily add up to a coherent philosophy. Social market thinkers have had only limited success reconciling the mechanisms of the market with the demands of social justice.

To some extent, the social market is an all-purpose 'big idea', which can be pulled and squeezed to accommodate a wide range of views on the proper roles of markets and the state. The German social market model, for example, encourages the deliberate development of long-term relationships between companies, workers, investors, managers, banks and government that would be anathema to most British social marketeers, especially on the centre-right.

The consensual nature of these relationships is a product of German mentality and history. They also lie in the opposite direction to that in which Britain has been travelling for the last 15 years. Even if we wanted to, it would be almost impossible successfully to recreate the German social market here.

Mr Clarke had little truck in the Mais lecture with promoting social ends in Britain through interference with the market, even though he placed the tackling of unemployment at the top of his political agenda for the 1990s. He said that some unemployment would melt away naturally as the economy grew more strongly, but that the best way to cut the 'structural' joblessness that is impervious to recovery was to continue removing rigidities from the markets for jobs, goods and services.

He dismissed the idea that unemployment was caused by shocks to the economy, competition from low-wage rivals or the replacement of labour with machinery and computers. Instead, he argued, structural unemployment rises when the economy is too inflexible to cope with these sorts of changes by concentrating in new areas.

In the same vein, Mr Clarke reasserted the Government's opposition to minimum-wage legislation. He parroted the received wisdom that it destroys jobs, despite mounting evidence from academic research in both Britain and the US that shows modest minimum wages create extra jobs rather than pricing people out of work, because of the natural frictions in the labour market.

But although Mr Clarke expressed admiration for the way in which the pursuit of flexible markets in the US had created 34 million private-sector jobs in the last 20 years, he deplored the social consequences of leaving the effects of free markets untempered.

'The low level of welfare support and coverage in the American system results in poverty and a miserable standard of life for a significant minority of the population,' he argued. 'The American approach results in unacceptably low levels of social support across the range for those not in work, as well as those employed.'

Mr Clarke directly challenged the Thatcherite/Reaganite idea that the benefits of wealth creation would 'trickle down' naturally to the poor, a view once mocked by John Kenneth Galbraith as the belief that if you feed a horse with enough oats eventually some will pass through and fall to the road to be picked up by the sparrows.

So how does one ensure adequate standards of living for all citizens without removing the incentives to wealth creation? Mr Clarke might well like to combine American job creation with European commitment to the welfare state, but is it really possible? This is the circle that the social marketeers have yet to square and Mr Clarke, unfortunately, has not progressed much further.

The Chancellor fell back on the distinction between absolute and relative definitions of poverty: the first implies a concern with the ability of the poorest people in society to buy the basic necessities of life, while the latter also demands that the gap between the rich and poor not widen too much, even if everyone's standard of living rises.

Mr Clarke accepted that the gap between the incomes of the high and low-paid had widened during the 1980s, as employers had increasingly been willing to pay a premium for high performance and skills. But he said this was a price worth paying. 'This has occurred while the real earnings of the lower paid have continued to rise, but no one knows how far the gap between the highest-paid and the lowest-paid will continue to widen. In my opinion, political attempts to narrow this gap would damage performance and create more unemployment.'

The Chancellor said the Government should move away from using the tax and benefit systems to redistribute income directly. Instead, it should concentrate on improving the standards of general education and focus its support for training on people who were under-achievers at school. This would enable more people to compete for highly paid work. Beyond establishing a safety net for those unable to take jobs, the welfare state would also have some role helping people to cope with the greater volatility of wages and more frequent spells of unemployment that are likely to accompany labour market flexibility.

Better education and training are important objectives - which Conservative chancellors would have done well to promote more actively during their first 15 years in office - but they are a slow and uncertain route to improving life for the less well-off. In the meantime, relative poverty matters more than the Chancellor is prepared to admit, and direct redistribution of income and wealth should still remain on the agenda.

The Government may soon be forced to accept this, having announced last week that it has set up a study to investigate the links between inequality and health. According to Richard Wilkinson, of Sussex University, good health and life expectancy in developed economies are determined by the size of the gap between their rich and poor, rather than the absolute standard of living of the least well- off. Inequality and death rates have increased hand-in-hand in Britain over the past 20 years.

Mr Wilkinson argues in a recent book from the Institute for Public Policy Research * that people's health and well-being has less to do with their physical circumstances than how they feel about them. People living in unequal societies are more prone to feel a lack of social support, depression, low self-esteem, insecurity, stress and a lack of control over their lives. These in turn make them more prone to illness. Health and life expectancy are arguably better indicators of a society's standard of living than economic performance measured by wealth or income. But as the Confederation of British Industry argued as long ago as 1986 that absence through sickness cost companies pounds 5bn a year, it seems reasonable to conclude that egalitarian policies might boost economic performance as well. Similar arguments could be advanced for the link between inequality and crime rates.

There is no evidence that inequality is a precondition for economic success. Mr Clarke is right to look for ways to reform the welfare state to improve work incentives and to cope with the uncertainties thrown up by free markets. But tackling inequality remains a valid and neglected goal which governments should pursue.

* Paying for Inequality, IPPR.