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6 March 2023

Why recessions make the rich richer

The boss of Harrods has admitted his department store prospers during a recession. This is a clear failure of fiscal policy.

By Will Dunn

The UK economy is in a grim state: the International Monetary Fund predicts that Britain will be the only G7 country to enter recession this year, while the Bank of England forecasts that output will not return to pre-Covid levels until 2026. Real wages are falling sharply against double-digit inflation and 99 per cent of mortgages face being repriced at a higher level.

The bad news doesn’t seem to have reached the country’s high-end car dealerships, however. Last week, shares in Aston Martin Lagonda jumped 24 per cent as the company published its annual results, which forecast growth from “the strongest order book in years”. Burberry was similarly cheery in its most recent financial update, which recorded the company’s highest profit for nine years.

The optimism in the luxury sector was explained with remarkable frankness by the managing director of Harrods, Michael Ward, who told the Financial Times on Friday that his luxury department store was licking its lips at the prospect of an economic downturn, because “the rich get richer in a recession”.

[See also: The age of hyper-globalisation is ending]

He’s broadly right. Since economists began studying the distributional effects of the Great Depression in the 1940s, it’s been thought that inequality and economic growth could be “countercyclical”, meaning that earnings inequality rises during recessions and contracts during periods of economic growth. Since the 2008 crisis we’ve also seen a huge increase in wealth inequality, while real wages have stagnated.

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The widening of earnings inequality is thought to be caused by the fact that in a recession, the poor get poorer, as lower earners are more exposed to job insecurity, and are more likely to remain unemployed for longer, which reduces the earnings of the lower-income parts of the economy.

People with less money are also more exposed to inflation, especially if (as is currently the case) price rises are highest among essentials such as energy and food ­– on which lower earners spend a much higher proportion of their income.

At the same time, the classic response to inflation – higher interest rates – makes borrowing more expensive for anyone with debt. The more debt, the higher the cost of paying it off, which means higher earners may take a hit on their larger mortgages, but for the wealthiest people – those with no debt to service – higher interest rates are a benefit, because they offer a higher return on savings. In fact, the benefits of higher savings income and investment returns thanks to higher interest rates are so significant that the Resolution Foundation expects the top 5 per cent of earners to be the only group in the UK whose income will rise between now and 2024.

Higher rates do tend to have a negative impact on asset prices, which could affect rich people’s wealth, but this also creates the opportunity to pick up bargains in a distressed market. This is already true in the UK’s housing market, where the average house is more than £29,000 cheaper if bought with cash rather than a mortgage. The same is true for business owners who can – if they have the liquidity – pick up companies more cheaply; after the 2001 dotcom crash and the 2008 crisis, private equity firms specialising in buyouts were better placed to weather the recession than the S&P 500 index of large US companies.

Higher interest rates may benefit the top slice in a recession, but the attempt not to have a recession at all – by central banks “printing money” and buying government bonds, known as quantitative easing (QE) – also creates a bonanza for the rich by swelling the value of their assets. In 2012 the Bank of England’s own economists concluded that over just three years QE could have benefited the richest 10 per cent by up to £322,000 per household. So, central bankers can make money more or less expensive, but whichever way they pull the lever, it tends to favour the rich.

The diamond-encrusted cherry on this deeply unpalatable cake is that not only do the rich get richer in recessions: in doing so, they actually make recessions worse for everyone else. A 2021 study by researchers at the Bank for International Settlements found that around the world, “economic downturns in countries where income is more concentrated at the top are followed by significantly larger declines in real per capita consumption”. Without policy to address the inequality caused by recessions, they become self-reinforcing, each downturn more unequal – and therefore deeper – than the last.

The only answer to this is for fiscal policy – benefits, taxation and spending – to recognise how recessions redistribute money and act to balance it. Because at some point, even the wealthy notice that we all pay the price of an economy that tilts inexorably in their direction.

Read more:

The Bank of Japan’s new governor has the hardest job in economics

Britain’s GDP figures are a fudge that hides the true state of our economy

Who sets our interest rates – the Bank of England or the US Federal Reserve?

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