By Alberto Gallo, World Economic Forum From Business Insider

Policymakers have largely ignored the growing gap between the rich and poor.
Capitalism has failed at redistributing wealth.
The American system could soon reach a breaking point.

The American Dream is broken. Paul Ryan, speaker of the House of Representatives, recently stated that “in our country, the condition of your birth does not determine the outcome of your life.”

Yet the idea that every American has an equal opportunity to move up in life is false. Social mobility has declined over the past decades, median wages have stagnated and today’s young generation is the first in modern history expected to be poorer than their parents. The lottery of life – the postcode where you were born – can account for up to two thirds of the wealth an individual generates.

The growing gap between the rich and the poor, the old and the young, has been largely ignored by policymakers and investors until the recent rise of anti-establishment votes, including those for Brexit in the UK and for President Trump in the US. This is a mistake.

Inequality is much more than a side-effect of free market capitalism. It is a symptom of policy negligence, where for decades, credit and monetary stimulus shortcuts too easily substituted for structural reform, investment and economic strategy. Capitalism has been incredibly successful at boosting wealth, but it has failed at redistributing it. Today, without a push to redistribute wealth and opportunity, our model of capitalism and democracy may face self-destruction.

The widening of inequality has deep historical roots. Keynes’ interventionist policies worked well during the post-war recovery, as fiscal stimulus for the reconstruction boosted demand for US goods from Europe and Japan. But soon the stimulus faded. The U.S. found itself with declining growth and rising inflation at a time when it was mired in the Cold War and Vietnam conflicts. The baby boomer generation demanded higher living standards. The response was the Nixon shock in 1971: a set of policies which moved away from the gold standard, initiating the era of fiat money and free credit.

Credit was the answer to declining growth and rising inequality: if you couldn’t afford university, a new house or a new car, Uncle Sam would lend you the key to the American Dream in the form of that extra loan you needed. Over the following decades, state subsidies to private credit became popular, spreading to the U.K. and Europe.

It was the start of debt-based democracies. Private debt outgrew GDP four times in the US and Europe over the following decades up to the 2008 financial crisis, accompanied by the deregulation of financial markets and of banks. The rest is history: nine long years after the crisis, our economies are still healing from excess debt, and regulators are still working on strengthening our financial system. Inequality, however, has deepened even further. Has capitalism failed?

The deus ex-machina of capitalism was competition; a distorted interpretation of Adam Smith’s invisible hand. Competition among individuals and companies created efficient markets, increasing production and GDP. Government intervention became unnecessary: any wealth generated in the economic process would automatically trickle down from the haves to the have-nots. Greed, the unshackled pursuit of individual wealth, turned from vice to virtue.

Today, we know the neoliberal policies initiated by Reagan and Thatcher have been successful at generating growth: the United States and the UK have outpaced others. But we also know that the same neoliberal policies have failed at redistributing resources and opportunity. If individual economic success is deemed the highest possible achievement, poverty becomes justified by someone’s lack of effort or ability. But with rising social and corporate inequality, productivity has stagnated, lowering potential growth rates for the whole economy. The result has been a self-reinforcing cycle of lower productivity, lower interest rates, higher debt levels and even higher inequality.

If trickle-down and neoliberalism have failed the good news is there are some policy fixes. One of them is taxation, combined with investment in productive infrastructure and education. The bad news is policy is going exactly in the opposite direction, especially in the US and the UK.

The Trump Administration’s tax breaks may boost markets, but will likely increase public debt even further, calling for more cuts to education and healthcare.

Defenders of neoliberal policies like Mr Ryan argue that equality of opportunity is fair, while equality of outcome – which Milton Friedman called socialism – is unfair and not meritocratic. The reality is that both wealth and income inequality are closely linked. Richer parents can afford to send their children to better schools: nearly half of the variation in wages of sons in the United States can be explained by looking at the wages of their fathers a generation before. That compares to less than 20% in relatively egalitarian and tuition-free countries like Finland, Norway and Denmark. The story is similar in the UK, where over half of judges, MPs and CEOs of UK companies attended expensive private schools, while around one third of children live below the poverty line – 67% of those from working families. Better education means better opportunities and more wealth later in life: the cycle reinforces itself from generation to generation.

But today this cycle may be now at breaking point. If “let-them-eat-credit”policies allowed the 99% to borrow and increase their well-being over the past decades, interest rates have now reached rock-bottom and private debt levels are at their highest. There are signs that monetary policy may have reached its limits – creating asset bubbles and keeping zombie companies alive – and that it may no longer be able to support this ever-growing debt mountain.

The risk is that rising inequality, lower social mobility and the disenfranchisement of younger generations could result into even more polarised and short-sighted politics, creating a populist trap. The US and the UK could already be stuck: many of the policies on the table in both countries are far from sustainable, and damaging for the people they were to protect. Brexit or an exit from NAFTA are both striking examples.

Continental Europe and Scandinavia – even though far from perfect – have so far escaped from the worst of the populist threat of the Front National, Alternative for Germany, True Finns or the Danish People’s Party, perhaps thanks to their stronger safety net and welfare policies. However, these parties continue to gain ground, as recent elections in Germany and Austria show.

There are two ways we think the world may exit this loop of rising inequality, political polarisation and short-sighted politics. One is to make the poor richer through education and investment. The other is to make the rich poorer.

Last year, the IMF ditched neoliberalism and recommended measures to redistribute wealth and opportunity. This policy mix could reduce inequality, boost political stability and improve long-term growth. In its five-year plan, China’s leadership recently announced a renewed focus on reducing inequality. The US and UK, too, should acknowledge they have a structural, not a cyclical problem, that cannot be solved with one more round of monetary stimulus. Redistribution should be coupled with a reform of the financial system, still too centered on risk-taking and debt incentives; as well as changes to the tax system, which still places too much burden on income and too little on assets.

The alternative to redistribution is instability and crisis. Inequality provides fertile ground for populist parties to harvest support. The US, for instance, has recently been downgraded from full democracy to a flawed democracy. Over time, populist policies can destabilize democracies, turning them towards nationalism, militarism and anti-capitalism. The outcome of populist regimes in history ranges from higher taxes to nationalizations and violations of private property, to commercial and military conflicts.

Neoliberal theory and its policy offshoots have failed. Promoting individual happiness as our utmost ethos is self-defeating, as deeply divided societies turn unstable and unhappy. We need a new American dream based on equality and sustainable growth. The cost of sharing opportunity and wealth may be high for today’s elites, but the alternative is far worse.

Read the original article on World Economic Forum. Copyright 2017.

IMAGE: uncle sam
Broken glass covers an armed forces recruiting poster at the scene of an explosion outside the U.S. Armed Forces Career Center in New York’s Times Square, March 6, 2008.REUTERS/Lucas Jackson

For more on this story go to: http://www.businessinsider.com/how-the-american-dream-turned-into-greed-and-inequality-2017-11