There is so much we don’t know about our economy – and it’s stopping us tackling inequality

The run-up to the crash of 2009 doesn’t flatter those who were running economic policy then, and I am not sure post-crash policies will look too good in a few years’ time. There is so much we are yet to understand

Capitalism is under the cosh. You can see the strains in many places, from the gyrations of the financial markets in recent weeks, to concerns about inequality across the developed world, to the fact that the world economy has to be supported by near-zero interest rates, to the rumbling trade war between the US and China – and so on. The challenge is how to separate the froth from the substance, what people feel (justifiably or otherwise) from what is actually happening.

Faced with this challenge, the Institute for Fiscal Studies (IFS) deserves a pat on the back for getting Sir Angus Deaton to chair its study on inequality, launched today. He is a Scot who made his career in the US and won a Nobel Prize for his work. His fear is that the UK is heading towards US levels of inequality, not just in terms of income but in social indicators too. This is happening despite unemployment in both the US and UK being the lowest since the 1970s.

Inequality is only one aspect of the concern that the economic system is not delivering fair and decent outcomes for all, and he and his colleagues will particularly be looking at the UK rather than the world as a whole, but if the IFS can isolate the drivers of inequality in one developed country that will be hugely useful for the rest of the developed world. And indeed it will be useful for the emerging world, for one of the extraordinary features of the world economy is that while inequality is falling swiftly between rich and poor countries, within the emerging nations, inequality is rising in some places more sharply than in the developed world.

The IFS study is a five-year programme and deserves a following wind. But in challenging our global economic system to deliver its benefits more fairly, it would be wrong to neglect the benefits it is bringing to the emerging world. A Brookings study last autumn calculated that for the first time in the history of humankind, more than half the world’s population was rich or middle class, and less than half poor. So the system is working for billions of people in China, India and elsewhere, notwithstanding concerns of people in the US and Europe that it isn’t doing so for them.

The fact that the Chinese economy has grown so fast and will in all probability pass the US in economic size within a decade is one of the reasons for the incipient trade war between them. It raises the awkward question: is the rise of the middle class in the emerging world the prime reason for the squeeze on the middle class in the developed world?

To know for sure, we will have to wait to see the IFS’s findings. Meanwhile, let’s acknowledge that we don’t know nearly enough about how our economy, or indeed any economy, works. This was the subject of a thoughtful essay by Andy Haldane, chief economist at the Bank of England, last week.

He argues: “Often, our policy intuition about complex systems is simply wrong ... Our economies, like our politics, are local. Like the seashore, the more you magnify an economy, the greater its richness, complexity, self-similarity. Like our bodies, understanding our economic health means taking readings at many resolutions. It means understanding the moving body parts, and their interactions, in microscopic detail. It calls for new data, at a higher frequency and higher resolution, and new ways of stitching it together.”

The message is: if we knew more, we could do better. There are certainly plenty of examples of policy failure in the past. The run-up to the crash of 2009 doesn’t flatter those who were running economic policy then, and I am not sure post-crash policies will look too good in a few years’ time. One of the effects of ultra-low interest rates has been to boost asset prices, and make those that own assets (for example, houses) even richer, while making it harder for everyone else. Clearly more information ought to enable policies to be tailored more appropriately – though I would settle for the more modest objective of using better data to avoid mistakes. First, do no harm.

What worries me is that in the hunt for flaws in the present mixed-economy system – and there are plenty of those – we will overlook its triumphs. Top of my list is reducing the numbers of the global poor. As for the UK, the more detail we can find out about the deep reasons for inequality – and this is not just about money – the better chance we have of tackling it.