“There is a large and growing wealth disparity and I think it is unhealthy. The lower levels of the pyramid do not have enough money to buy things and keep the economy growing.” That was Steve Morton, director in a major broking firm, speaking at Davos. Translated into plain English, what he is saying is that the incomes accruing to the 99 percent are insufficient to sustain consumption at a level that ensures modest growth in GDP. We have to rebalance income distribution or sacrifice growth. It is not just a question of egalitarianism. Income inequality has hit a fundamental economic constraint. To sustain consumption at a level that permits growth, the 99 percent in the pyramid must have a certain minimum share in income or growth halts.

An analogy might help explain this constraint. Imagine a tribe that depends on hunting to eat in a hunter-gatherer setting. It has a star archer who takes the final shot at the deer. The others hunters help locate the herd, shoo it into place for a kill and help in many other ways. When it comes to meat distribution, the star archer takes most of the meat, leaving little for the others who helped. In such a case, either the archer will be replaced or cooperative hunting will end. What two-thirds of the captains of capitalism gathered at Davos are telling us is that such a situation now prevails in most of the developed world. They have not rediscovered equality. Income distribution has become too skewed in favour of capital, as opposed to labour, and must be corrected to restore GDP growth.

Around 70 percent of the 2,600 delegates gathered at Davos not only agreed that capitalism was in trouble but felt government intervention was imperative to restore a healthy balance to income distribution. The average income of the richest tenth of the population in the Organisation for Economic Co-operation and Development (OECD) countries is now about nine times that of the poorest tenth according to an OECD survey. There is wide support for Obama’s call for all making a million or more per annum to pay as much tax as the median middle class US household, an idea first mooted by Warren Buffett. That such a tax may help pay government debt is a bonus. The primary purpose is to put more purchasing power in the hands of the 99 percent. Capitalism without democracy cannot work. If the lower levels of the pyramid do not have sufficient incomes to sustain a growing economy, then enlightened self-interest, rather than a desire for equality, dictates that their share in incomes be increased. What the Occupy Wall Street movement is telling us is that democracy is simply underlining an economic truth.

Few people at Davos have kind words to say for banks, although most agree that well capitalised banks with strong earnings are a must for an economy. The Davos crowd is not going to tell us that the merger of deposit-based banking with investment banking was basically a device to enable bankers to use depositors’ money to bet on markets, something that caused the 1939 depression and was duly repeated this time. It is a measure of the bankers lobbying power that a plan to segregate the two was defeated in the Congress. Without such segregation by law, the banking crisis of 1939 and 2007 will only increase in frequency, causing chaos. Bankers will use short duration deposits to lend long or make bets relying on implied government guarantees. There is simply no case for allowing banks to speculate with depositors’ money.

Davos has not touched upon a major theme that necessitates a fresh look at capitalism as an economic model. In the late 19th century, agricultural productivity increased so dramatically that it could no longer absorb the available labour gainfully. This surplus labour just fell out of the system causing misery, poverty, migration and so forth, before innovations like the steam engine, etc, gave rise to new products. Industry was then able to absorb surplus labour from agriculture into manufacturing. The entire 20th century has been one great story of productivity growth in manufacturing that has enabled unimagined prosperity for billions compared to what came before it. We now face a similar crisis in manufacturing as that faced by agriculture at the end of the 19th century. Manufacturing cannot absorb even a fraction of the people joining our labour force. Apple for instance has sales comparable to India’s GDP but employs only 68,000 workers. We need another revolution in what we now call ‘services’, but we really have no idea where the required innovations and scientific breakthrough(s) will be coming from. Clearly, capitalism must keep an open mind on required changes to the system. Some thinkers in the past like Marx et al, tried to fashion an economic model based on a static agrarian society just as society itself was transitioning to industry with an entirely different dynamic. Capitalism must not fall into a similar ideological trap. It needs to reinvent itself for a post-manufacturing economy, whatever that might be.
Capitalism may well be sitting atop a deeper transition in the underlying economic structure as non-tradable service industry products replace manufacturing as the main engine of growth and employment. But it has by no means failed. In fact, if one combines the US economy with that of China, then over the past 20 years or so, both economies together have lifted tens of millions of workers from subsistence wages to the burgeoning middle class. Yes, there has been a shift of wealth from the US to China but that only speaks of the efficacy of capitalism rather than its failure. Free competitive markets in labour and capital, and free trade remain our best bets in terms of staying open to new ideas and carrying on the existing businesses smoothly. Free and open competition between players, whether capital or labour, firms or workers, will remain central to ensuring against stasis.

Nevertheless, every tenet and assumption in our model of economic development needs to be thoroughly re-examined and validated. For too long we have not really asked the economists to explain where aggregate profits of firms in a modern economy come from. There is no adequate, widely tested and accepted theory of aggregate profits in Economics. That alone should make capitalism shy away from making a case for completeness. In many other areas of economic theory, such as assumption of efficient financial markets, free competition at the firm level and attitude to risk taking when private losses can be externalised to society or government, there are distortions that have gone unexamined even as technology has wrought humongous change, invalidating some traditional concepts. Unfortunate that Davos will not be the place where one looks for answers to such questions.

The crisis of 1939 brought far-reaching changes in the intellectual tools that policy makers used to manage economies. We have lived with those tools for well over 60 years. With another unsettling once-in-hundred-years transition from manufacturing to services underway, we can ill afford to defend existing concepts in a doctrinaire fashion. It is essential to reach deeper into the basic concepts and re-examine their relevance and applicability to the evolving reality of our world. The band aid being applied through stimuli and winding down of debt are unlikely to suffice for the problems that lie ahead. It is time for everybody to put on his or her thinking cap.