Close the wage gap or everyone will suffer

Yawning differentials between high and low salaries - unseen since the 1880s - now threaten our social fabric

Last week alone we learnt that the managing director of a cider maker, who must move house from Guildford to Bristol (dear me!), was given a disturbance allowance of pounds 127,000. The chief executive of an advertising agency business was on his way to a bonus of pounds 2.6m. At the same time the chairman of Dixons, who himself earnt pounds 1.6m last year, said he had no intention of following the CBI guidelines on fixed executive pay. There will probably be similar stories this week because we are looking at an inexorable process.

In all advanced economies the rich are getting steadily further ahead. In Britain the gap between the highest and lowest male wage rate is at its widest since the 1880s. In the United States the average boss is earning 120 times what the average worker takes home; 20 years ago the ratio was 35 times. In the world as a whole, says a United Nations report, the share of global wealth owned by the poorest fifth has decreased from 2.3 per cent to 1.4 per cent during the past 15 years while the share held by the richest fifth has increased from 70 per cent to 85 per cent.

In Britain there is a dull resentment at the process which only flares into anger at the high rewards that directors of public utilities give themselves. But the public seems to understand the distinction between capital gains and high salaries.

Entrepreneurs who make millions out of building up their own businesses raise few eyebrows. There is no issue about, say, the hundreds of millions of pounds which Richard Branson's companies are now worth to him. The risks run, the trail-blazing, the creativity applied to business - these are acknowledged and respected, if sometimes grudgingly. Fortunes have been made in this way since the beginning of time.

But in the case of directors of established companies, the situation is completely different and unprecedented. Not many of these people are capable of creating wealth: they are managers, they are industry's bureaucrats who haven't built up the business for which they work - in a sense they have inherited them. Their mandate is to make progress and avoid mistakes. But for some years, their rewards have been rising quickly. This is because they have learnt to work a new system which brings them wealth well beyond any common-sense estimate of their value to society. What is this system?

It is what two American economists, Robert Frank and Philip Cook, describe as a "winner-take-all" market. These are most easily seen in sport and entertainment. The top 10 players in world tennis, for instance, earn 30 to 40 times what players ranked 40 to 50 receive. The same pattern is appearing in football as Alan Shearer's pounds 15m transfer to Newcastle United demonstrates.

Recent developments in information technology have been critical in the development of these markets. In sport, as television has expanded from its terrestrial beginnings to cable and satellite, so the paying audience for events has multiplied. In addition there is open competition for the best talent - the old transfer restrictions in football, for instance, were an inhibition.

Moreover, the focus is on relative rather than absolute performance. While Newcastle United presumably believe that Shearer is, compared with his contemporaries, the best striker that money can buy, the record signing fee does not imply that he is a far more gifted player than British or European football has ever produced before. Indeed, it is a feature of winner-take-all markets that small differences in talent give rise to wide differences in income.

As well as mass winner-take-all markets there are also what might be called "deep pocket" versions, and it is these which are benefiting top business executives. Again developments in information technology have been important - in this case by making business increasingly global. Companies are less protected than they were by national boundaries, and their executives have bigger markets in which to work.

The old reluctance to recruit directors and chief executives from other companies or even rivals have also been substantially weakened. It is significant that in Japan, where executives generally stay with the same company for life, salary differentials are much smaller than in Anglo- Saxon countries, where there is an almost open market for executive talent. Nor are the highly paid chief executives who hit the headlines necessarily exceptional - they are just the best talent available. The deep pockets are provided by companies whose shareholders are persuaded that the financial returns that effective chief executives can bring far outweigh salary costs, even if these do loom large.

To explain the trend is not to be content with it. At some points in the future increasingly wide disparities of wealth and income will cause social unrest. In South America, where that point has been passed, governments are sustained in power only by their armies. In any case, as income disparities continue to grow, it will soon become difficult to maintain cohesion, commitment and loyalty in business enterprises. Institutional investors could restrain executive greed, but they content themselves with ensuring that decisions about directors' pay are properly considered rather than concerning themselves with the amount; after all, people working in the City benefit mightily themselves from winner-take-all-markets.

Left-wing governments could make the tax system more steeply progressive, but they fear rejection by the electorate. There is, therefore, absolutely nothing on the horizon to stop this growing inequality.