The rich are no longer getting any richer

Maybe the fat cats will soon slim down. One of the marked features of most developed countries during the past 25 years has been the widening of income differentials. The widening has been particularly marked in the UK, though this was partly a reaction to the sharp narrowing of differentials that took place in the 1960s and 1970s. But now there are signs that differentials are being compressed again, and the key issue is whether this is just a cyclical end-of-boom phenomenon, or whether there is something bigger afoot.

Maybe the fat cats will soon slim down. One of the marked features of most developed countries during the past 25 years has been the widening of income differentials. The widening has been particularly marked in the UK, though this was partly a reaction to the sharp narrowing of differentials that took place in the 1960s and 1970s. But now there are signs that differentials are being compressed again, and the key issue is whether this is just a cyclical end-of-boom phenomenon, or whether there is something bigger afoot.

You didn't notice that differentials were being compressed? Well, the headlines still reflect large increases in the pay of top executives, but these may be a lagging indicator reflecting what happened 18 months ago rather than what is happening now. If you look instead at tax revenues, it is clear that something has changed.

One of the reasons why the Chancellor's revenues are running below forecast is a shortfall in the income tax paid by top earners. Overall wages have carried on rising – they are up nearly 4 per cent year on year – and employment is at an all-time high. However, a disproportionate amount of income tax comes from the highest paid. Indeed, 1 per cent of earners pay nearly a quarter of total income tax, while the top 10 per cent pay more than half of it. So any decline at the top makes a big dent in the total. We will know more about the size of the dent when the Chancellor reveals how serious the shortfall is in his pre-Budget report next month.

But that change is probably mostly cyclical; the fall in City bonuses alone will have had a big effect on tax revenues this year. The big question is whether the millennium marked a high point in the widening of differentials and whether we will now see, if not a downward trend, at least no further rise. My own hunch is that we will not see any further widening and maybe even some compression.

Why so? Well, you have to look, at the reasons why differentials widened in the first place. The US economist Paul Krugman lists three main theories: globalisation, the need for skills and the rising attractions of celebrities. He believes that none of these fully explains the phenomenon, and I think he is right, but it is useful shorthand.

Globalisation means both that top earners can command the highest rates available in the world and will move to get them, and that at the other end of the scale, lower-paid people in developed countries find themselves competing with even cheaper labour in the developing world. A good example of the latter is the closure of some call-centres in the UK, with the jobs being shipped to India.

The need for skills is pretty self-evident: production-line factory jobs are going and the growth is in white-collar jobs, which at least need interpersonal skills and may need complex technical ones, too.

As for celebrities, half of that factor is pretty self-evident: Ulrika is being paid so much for her autobiography because she and Sven are alpha celebs. The other, probably more important, half is less evident: there has been a cult of celebrity in business, too, for companies have sought to hire top managers with star reputations.

But now all these drivers of inequality have gone, to some extent at least, into reverse. Globalisation may or may not be reaching a high point, but we are becoming more aware of the extent to which global skills may not be transferable, at least at the top end of the scale. At the bottom end there may still be some mileage, but I suspect we will see more resistance to the transfer of jobs abroad in the future.

As differentials have widened so the thrust for finding ways to use lower-skilled people (and to economise on the highly skilled) has increased. Companies hunting for cost cuts find that getting rid of the low-skilled does not save enough money. Squeeze down the ranks higher up and you get the savings you need.

And the celebs? I'm sure that there will always be a market for people like Ulrika and Sven, and they will continue, rightly, to be very well-paid for entertaining us. But the notion of the celebrity chief executive officer or investment banker has taken a knock. Several of the supposed stars of the business world have actually driven companies into the ground. So there will be some retreat: investors are saying: "Don't waste money on stars, just hire someone who can do the job."

Besides, differentials are not just about money; they are about status, too. Our ideas about the worth of people may well be starting to change, with money becoming no longer the sole arbiter of merit.

If you look at the United States, there has been a huge revulsion about the amount of money paid to executives whose companies have failed. In some cases there has been fraud, and the revulsion is all the greater, but in many the crime has been a combination of bad luck and greed. Bad luck is excusable, for many ventures got caught in the downturn. But greed on the scale of some American executives is hard to defend. Most Americans want the respect of their communities, and you no longer get it by flaunting the executive jet. Look how America's most fêted manager, Jack Welsh of General Electric, has given up part of his lavish pension package in the face of public disapproval.

Over here the excess has been less marked. Not only are the numbers much smaller, but top business people tend use their money to obtain preferment by giving donations to the Labour Party, rather than flashing it on conspicuous consumption. I happen to think it is more corrupting to have a society where business people buy peerages rather than buying Gulfstream V jets, but there you go.

At any rate, society on both sides of the Atlantic is starting to lean against excessive pay packages. If someone has built up a business or earned it as a talented professional, then few people are going to fret about their wealth. I think, too, that society recognises that the shelf life of entertainers of all sorts is limited and that the rewards need to compensate for that.

Nevertheless, expect the value-for-money test to be applied more and more. You can even see this in the area where the star system has up to now ruled unchallenged. Much cheaper to use unknowns, as in Big Brother, and entice them to work for a brief flash of stardom than to have to hire expensive trained actors.

What people are paid is a market, and ultimately the market is self-correcting – though that may take a long time. Pay differentials in the 1970s were unsustainably low. Many people in responsible jobs went on doing so out of a sense of duty, resenting their relatively low pay and getting out when they decently could. Others went abroad.

Now differentials may be unsustainably high – or at least unnecessarily high to attract people into jobs. If you have a large excess of people wanting to do a job at a particular rate, and able to do it, then the rate is too high. There are probably quite a lot of people in well-paid jobs whose replacement will earn less than they do. For one of the harsh lessons of the downturn is that there are people who are simply not worth their salaries.

A great sea change just beginning to become evident? I'm not sure. But I am sure that there are lessons about pay that have been learnt in the past two years that will linger long after growth picks up – as it will.