Now we know. We are in the midst of a prolonged economic crisis in which the output of the British economy fell by 7.2 per cent and growth has been close to stagnant for the last nine months. Yet Britain’s leading executives have been behaving as if they have personally pioneered an unprecedented economic renaissance.

According to the pay monitoring group, Income Data Services, FTSE 100 directors – about 800 people – increased their total earnings by 49 per cent in the last financial year. The average remuneration package of a FTSE 100 chief executive (a mix of earnings, bonuses and performance-related benefits) is now in excess of £5 million. Executives took something of a dip in pay at the start of the downturn, but have more than bounced back. The current rise comes on top of a 55 per cent increase a year ago.  Since 2000, executive pay has been rising at six times the rate of the average employee.

While executives have been riding the wave of a two-year pay bonanza, the rest of the workforce is continuing to bear the brunt of a prolonged period of austerity. In the first six months of 2011, 65 per cent of the workforce took a pay freeze or a pay cut. Nearly all pay settlements over the last year have been below the rate of inflation. With real earnings falling for the second successive year and set to do so again next year, the best estimates are that average real living standards are unlikely to recover their 2005 level until 2015. On average, living standards in the UK will have flat-lined for a decade.

While living standards are falling in most rich nations – from the UK and Germany to the US and across southern Europe – the calls for restraint on global pay at the top have been ignored. Initially, the global rich took something of a hit from the crisis they had largely created. Yet the initial slump in the fortunes of the world’s mega-rich turned out to be very short-lived. By the beginning of 2011, most were back from the nadir of 2008.

Despite the continuing turmoil, many bankers, financiers and corporate executives, on both sides of the pond, have returned to their gilded lives as if nothing had happened. As a result, the very richest in the UK have been receiving an ever larger share of a shrinking economic cake, one that is today still close to 5 per cent smaller than in 2007. As a result, the pay gap between executives and their staff has continued to widen, despite the persistence of the economic crisis.

City bonuses have recovered from their slump at the depth of the recession. The average Wall Street bonus in 2009 – at the very height of the crisis – was close to its highest in history. According to the annual Sunday Times Rich List, the combined wealth of the richest 1,000 rose by more than a half between 2009 and 2011, and now stands at £395.8 billion. Forbes counted a record number of 1,210 billionaires in 2011, up by 28 per cent over 2007. Their combined wealth has risen from $3.5 trillion in 2007 to $4.5 trillion in 2010. Little more than a thousand individuals commanded a sum equivalent to a third of the output of the American economy. Big business is enjoying surging profit levels, with many of the nation’s largest conglomerates sitting on near-record levels of cash, most of it standing idle.

It was all very different in the Great Depression of the 1930s. Corporate bosses and financiers paid a heavy price for the crisis of the time. Many lost everything. Few recovered the towering fortunes they had accumulated in the frenzied speculation of the 1920s that preceded the 1929 Crash. Today’s corporate executives, investment bankers, financiers and global monopolists and oligarchs, in contrast, have found myriad ways of firewalling their wealth against external shocks. As a result, while there are individual cases where the rich have lost badly, as a group they have continued to flourish.

The rich, of course, have a long list of justifications for their soaring rewards. None of them stands up. They are rarely justified by performance. As a report by the IDS for the High Pay Commission has shown, in the decade to 2010, average remuneration for FTSE 350 board members rose by 130 per cent while their average share price fell by 71 per cent. In addition, top executives don’t take risks with their own money and rarely pay a price for failure. Running Britain’s largest companies may not be a cake walk, but it guarantees wealth with few if any risks to personal livelihoods.  

In an increasingly global market, it is also argued, rising pay is necessary to prevent talent from being poached. Yet the global market for bosses is largely a myth. Few British and European bosses end up in the United States even though pay is much higher there. As the High Pay Commission has shown only one FTSE 100 chief executive has been poached by a rival in the last five years, and that rival was British.

Typically rising executive pay is defended by the use of pay consultants, a group dubbed ‘ratchet, ratchet and ratchet’ by critics. In their recommendations, comparisons are made not with the ‘average’, but only with the remuneration of a select ‘peer group’ at the top which leads merely to the ratcheting up of benchmarks. One American compensation consultant recalls a CEO asking him with a straight face if everyone in his industry was paid the 75th percentile.[1]

It has long been argued by the prophets of market capitalism that a sharp dose of inequality and big rewards at the top would kick-start enterprise, boost growth and be good for us all. As the influential Austrian-American economist and philosopher Ludwig von Mises, one of the leading post-war pro-market theorists and a founding member of the pro-market pressure group, the Mont Pelerin Society, had written in 1955: ‘Inequality of wealth and incomes is the cause of the masses’ well being, not the cause of anybody’s distress…. Where there is a lower degree of inequality, there is necessarily a lower standard of living of the masses.’ [2]  Although greater reliance on markets would mean the wealth gap might grow, all citizens would still be better off through an expanded economic cake. 

These ideas gelled with the thinking of Mrs Thatcher’s closest advisers. As Sir Keith Joseph, her Education Secretary, put it in a 1976 pamphlet, Stranded in the Middle Ground, published by the right-of-centre thinktank committed to free-market Conservatism, Centre for Policy Studies. ‘Making the rich poorer does not make the poor richer, but it does make the state stronger … The pursuit of income equality will turn this country into a totalitarian slum.’ Similar views were espoused by the New Labour leadership and remain embedded in today’s mainstream economic thinking.

Yet the evidence is clear. The drive to greater inequality of the last 30 years has not delivered on its promises - more successful, more productive, faster-growing and job-creating economies. As one recent study has shown, on only one goal – curbing inflation – can the post-1980 era be judged a clear success.

Inflation rates have fallen, but on all other counts, the economic record of market capitalism has been poorer that that of post-war regulated capitalism.  In the UK, growth and productivity rates have been running at about two-thirds their post-war levels. Unemployment levels have jumped from an average of 1.6 per cent in the immediate post-war era to an average of 7.8 per cent since 1980, a near five-fold rise. This is despite a steady fall in the share of national output accruing to wage-earners, a trend that was designed to unleash a new era of job creation. As shown in the graph below, instability has risen with deeper and more prolonged recessions.

The main outcome of the post-1980 experiment – one based on a return to blind-eye regulation of the City, fewer controls over business and a weakening of collective bargaining – has been an economy that is both more unequal and more fragile and prone to crisis.

So why is this? The reason lies in the relationship between wages, productivity (the increase in productive capacity) and growth. When wages fall increasingly behind growth and productivity – as they have in both the UK and the US in the last 30 years, and at an accelerating rate – the natural mechanisms that bring economic stability stop working. The decoupling of earnings from growth creates three powerful forces that bring first imbalance and then economic failure.

First they suck purchasing power out of the economy. For the last thirty years, an increasing number of rich nations have been running their economies on low levels of wage-generated consumer demand, necessitating an increasing reliance on debt to prevent implosion. In both the UK and the US, the rising levels of politically sanctioned debt enriched financiers and kept economies going for a while. But they were never sustainable.

Secondly, concentrating income at the top, amongst a group more likely to engage in reckless speculation than spend their wealth in ways that benefit the productive economy, eventually leads to asset price bubbles in property, commodities and business values. Thirdly, great levels of inequality bring unequal power. Over recent times, the rise of dominant wealth-diverting finance capitalism has created a powerful new and unaccountable economic elite. Hence the inaction on tax havens, blind-eye regulation on the City and Wall Street and the way the super-rich are treated as a special case for tax. These are all factors that contributed to both the build-up to the Crash of 2008 and to the persistence of the crisis.

Rising executive pay and soaring personal fortunes are important issues of social justice. Levels of personal wealth at the top have risen to levels that are indefensible in terms of economic contribution. But they also have important implications for the way economies function. Until we find ways of breaking up these great concentrations of wealth and power, fragility will remain, and the global economy will struggle to recover.

Stewart Lansley is the author of The Cost of Inequality: Three Decades of the Super-Rich and the Economy, Gibson Square.