Echoes of the Gilded Age. Part 2: Politics

In my last post, I described the parallels between the current era of globalization and the globalization during the Gilded Age. There, I described the investment trends that could emerge in a deglobalizing world. However, much will depend on politics and the policies taken by future governments in reaction to the current globalization wave. As we approach a fork in the road, let us take it and see what the political developments of the Gilded Age can teach us about the political trends of the next couple of years.

Globalization is intrinsically unequal. The benefits of globalization are reaped disproportionately by the owners of capital because globalization leads to increased competition for cheap labour and cheap production techniques around the world. Hence, it is no surprise that today just like in the Gilded Age, increased globalization leads to increased income inequality (see our chart below for the US). 

As inequality increases it becomes increasingly a political question, especially if globalization hits its limits and economic growth slows down. In the Gilded Age these limits to globalization were eventually hit when the British Empire stopped expanding and across the Atlantic when the US entered the Great Depression that then took hold of the global economy. If the economic pie doesn’t grow fast enough anymore to lift all boats, there are two possible political reactions:

  1. Continue to focus on globalization by trying to change the economic output towards high-tech and high-margin products that can be sold globally. This change in the make-up of the local economy will inevitably produce winners and losers. Inequality in this scenario needs to be addressed with domestic redistribution, e.g. a more generous safety net, retraining for lower-skilled workers etc. This is essentially the path that the UK and Germany followed in the Gilded Age and countries like Germany and South Korea followed during the current era of globalization.

    To finance these measures, politicians need to raise revenues. This can be done in many ways. In the US, income taxes were raised in reaction to the Gilded Age for the first time, but only for the super-rich. The Revenue Act of 1913 specified a 1% income tax for net personal income above $3,000 and an additional 6% for income above $500,000. Similarly, the emphasis on free trade in the British Empire meant that Prime Minister Robert Peel had to reintroduce the income tax in 1842 to substitute lost income from lowering tariffs. With the introduction of the welfare state in the UK in the People’s Budget in 1909, the then Chancellor David Lloyd George and his young ally Winston Churchill needed to find £7 million in additional revenues. The government proposed the introduction of a 5% income tax on incomes greater than £2,000 and an additional supertax of 2.5% on incomes above £5,000 (c. £570,000 today). Additionally, the government proposed a land tax (which was never adopted) and an increase in the death tax.

    Today, it is mostly politicians on the left and centre-left that advocate for increases in taxes to finance redistributive government spending. The introduction of a public healthcare option by expanding Medicare in the US as proposed by many Democratic candidates for President would likely need to be financed with higher taxes. In the UK, the Labour Party Manifesto of 2017 calls for an end of the current freeze on welfare benefits and the introduction of free child care places for two-year olds as well as an extension of maternity leave payments to 12 months. In order to finance this spending, the Labour Party wants to increase the top corporate tax rate from 21% to 26%, lower the threshold for the top 45% income tax bracket to people earning more than £80,000 per year, and introduce a 50% income tax on people earning more than £123,000 per year.

  2. The second path taken both during the Gilded Age as well as today is the path of populist politicians who exploit inequality to stoke nationalist and isolationist sentiment. At the peak of the Gilded Age, anti-immigrant sentiment in the US ran high. It was mostly aimed at Chinese immigrants as well as catholic and Jewish immigrants from central and southern Europe. The most infamous example of this anti-immigration trend in the US was the Chinese Exclusion Act of 1882, which effectively banned immigration from China with few exceptions (notably, one of the exceptions led to the rise of Chinese restaurants in the US but that is a different story). And the 1917 Immigration Act introduced a literacy requirement for immigrants, thus effectively barring many foreigners from poor countries and lower social status from entering the US. Of course, the most consequential and devastating nationalist policies that were enacted to fight inequality were those by the Nazis in Germany and the fascists in Italy. 

    Another strain of nationalist policies enacted during the Gilded Age and increasingly today are tariffs. The Smoot-Hawley Tariff Act in the US has become infamous as has the trade war between the US and China initiated by Donald Trump in this era. But it wasn’t the first of its kind. Tariffs were frequently used during the Gilded Age as a means of protecting domestic industries from perceived unfair competition. The price the economy paid in every instance of protectionist economic measures was even lower growth than before and declining income for the poorest households.

Which of these pathways will we take in the coming years? In my opinion, we will have to face both. The Gilded Age led to the rise of Progressive politicians and radical progressiveness as an acceptable policy stance in the US. Theodore Roosevelt and Franklin D. Roosevelt both enacted highly progressive policies. Today, the Presidency of Donald Trump could usher in a Democratic President with an extremely progressive policy platform, though it is unlikely, that these policies will be as easy to enact as in the early years of the 20th century, because of the polarized political atmosphere and the almost guaranteed Republican control of the US Senate. Nevertheless, if Donald Trump remains a one-term President, he could be seen as a historical aberration that ushered in a new progressive era in US politics. And these progressive policies could bring with them higher taxes but also an improved social safety net for lower income households. Essentially, the US would politically slowly move towards the UK model of a well-established social safety net and high taxes. 

But if Donald Trump gets re-elected, it is going to be impossible to see him as a historical aberration. In this case, the populists have created a new trend and the Republican Party will likely further devolve into a populist party of Trumpists. In this scenario, we should expect a fast deglobalization and intensifying trade wars. Outside the US, populists have already managed to gain a grip on power and solidify their position. The populist governments in Hungary, Poland, the Czech Republic and Slovakia have formed the Visegrad group within the EU and are increasingly pushing a populist agenda within it. Populists like Nigel Farrage in the UK have managed to influence British politics for years now even without gaining formal power. It is the mere attention that is paid to them that shifts the political agenda towards more populist measures.

In the worst case, this nationalist competition between populist leaders all over the world could lead to an accidental war, similar to the First World War. The major European economies were in an intense economic and political competition back then and bound to help each other via a series of international treaties. When the Austrian crown prince was assassinated in Sarajevo in 1914, it was this convoluted series of treaties that led to the outbreak of war. The Austrian Empire declared an ultimatum on Serbia and eventually war. Unfortunately, both England and Russia were bound informally and formally to help Serbia, which meant things spiralled out of control quickly. In effect, the First World War was an accident created by nationalist leaders in Europe who were unable to understand the checks and balances that were put in place by the previous generation of politicians like Bismarck in Germany or Disraeli and Gladstone in the UK. Sounds familiar? I thought so…

Finally, there is another parallel between today and the Gilded Age that has to be mentioned. The Gilded Age was dominated by an economic superpower (the British Empire) being increasingly challenged by an emerging superpower at the other end of the planet (the US). In the late 19th century, the US overtook the UK as the world’s largest economy, but for another few decades the UK remained the leading economy of the world thanks to its Empire. The Sterling was the world’s reserve currency and the British Military was the most powerful in the world, securing what was then known as “Pax Britannica”. It was only through the destruction of the two World Wars that the UK lost its status as pre-eminent economic superpower and was replaced by the US.

Today, we see the emergence of a new economic superpower in China. So far, and in my view for many years to come, the US retains its status as economic superpower. Similarly, the US military remains the most powerful in the world and the “Pax Americana” of the last 70 years is supported by a range of international treaties and organizations like the IMF and the World Bank. None of that is likely to change anytime soon, even if China eventually becomes the world’s largest economy by GDP. But what if the US continues to make international policy mistakes? Just like the British Empire was brought down by its involvement in two ruinous World Wars, so could costly wars lead to a continued decline of the American Empire. And if the current generation of US politicians is inept enough to destroy the foundations of the Pax Americana out of sheer ignorance, the decline of the American Empire could be hastened quite a bit. But those are thoughts for another day…

Globalization and inequality in the US

Source: Fouquin and Hugot (2016), Saez and Zucman (2016).