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Analysis: As crisis bites, rising wealth gap becomes key

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By Peter Apps, Political Risk Correspondent

WASHINGTON (Reuters) - The rising gap between rich and poor in nearly every country, rich or poor, went largely ignored during the decades of globalization-fueled boom.

But with large parts of the world in financial crisis, ending the time when a rising global economic tide could lift all boats, there are clear signs of the wealth gap becoming a political hot potato.

The consequences -- for companies, individuals and whole political systems -- could be huge. Few politicians could now afford to be quoted, as senior British politician Peter Mandelson was in 1998 shortly after the Labour Party took power, saying that they and their party were "intensely relaxed about people becoming filthy rich."

While the wealth gap between third world and developed countries narrowed more than ever in the last decade, with a few exceptions -- notably Brazil -- the gulf between the rich and poor within nations has risen almost across the board.

In the 20 years prior to the financial crisis, data from the Organization for Economic Cooperation and Development (OECD) group of rich nations show the wealth gap widening in the vast majority of member states, most strikingly in the English-speaking world, Japan and Israel.

But until the 2008 crash, household disposable income was also rising across the board by some 1.7 percent a year. With the economic crisis, that trend looks to be reversing -- and that leaves the newly squeezed middle classes and poor with a striking sense of injustice.

In the developing world, rising food and fuel inflation has also eroded the buying power of middle classes who -- while their per capita incomes may still be rising -- they too feel they have grievances.

The causes of a recent plethora of protest movements -- from the "Arab Spring" to Europe's anti-austerity marches and other campaigns from India to Israel and China to Chile -- vary hugely. But at their root is almost always a dissatisfaction with elites seen as corrupt, out-of-control and no longer earning their keep through delivering on rising aspirations.

The message of anger and dissatisfaction has spread swiftly through social media, often blindsiding national governments now seen struggling to respond.

"In most states around the world ... the wealth gap is growing, and when you combine that with communications technology you're going to see more social discontent," said Ian Bremmer, president of political risk consultancy Eurasia Group.

The general assumption remains that Western democracies, unlike some of the autocracies of the Middle East that have seen rulers swept from power, will find ways to bring such discontent into the political mainstream.

SHADOW OF THE 1930S

But recent experiences in the United States and Europe, which are struggling to resolve their debt crises, show they too face big problems. Spreading discontent could, some fear, make it harder there to solve debt crises and form coherent policy.

With social media-organized protests on New York's Wall Street this weekend and occasional looting by "flash mobs" in other U.S. cities seen as echoing larger protests in Europe, some fear worse to come.

New York Mayor Michael Bloomberg last week warned that without rapid job creation, the United States could see riots like those that hit London this summer.

The lessons of the last century are alarming to some.

"There is a lot of evidence that when you have a small, growing middle class, that is a major driver of political stability," says William Galston, a former policy adviser to President Bill Clinton and now a senior fellow at the Brookings Institution in Washington.

"But when you have a large middle class that is shrinking and where you have alarm and despondency over the future, that is where politics can become very volatile and even dangerous. That's what we saw in Europe in the 1930s."

The rise of the right-wing Tea Party movement in the United States is widely seen as part of a trend toward extremes and volatility, as perhaps too are calls from the left for greater wealth redistribution and for heavier taxes on the rich.

U.S. President Barack Obama on Monday made higher taxes for the rich a key part of his plan to cut ballooning deficits, echoing calls from billionaire Warren Buffett for a rebalancing of the tax system. Republican opponents described the call as "class warfare", but it may have caught the spirit of the times.

Some believe it is all tied together with the rising tide of protest elsewhere in the globe. U.S. counterinsurgency specialist Patricia DeGennaro sees a wider "global uprising" or "worldwide insurgency."

"People are finding that not only can they be heard en masse, they can make change en masse," says DeGennaro, a senior fellow at the World Policy Institute and professor at New York University, citing the rising wealth gap as key. "That is at the root of the insurgency. In essence, people are tired of how the system is benefiting the few instead of the many ... I don't see it as a threat, but governments certainly do."

INVESTOR WORRIES

It already looks to be stirring worries among investors. Political risk insurers report a rise in demand for protection against both social unrest and expropriation, particularly in developing economies.

"Investors like emerging markets, but they are becoming increasingly worried about the risk," says Ravi Vish, chief economist at the World Bank's political risk insurance arm the Multilateral Investment Guarantee Agency. "You have the wealth gap, you have youth unemployment. It can be a volatile mix."

Some analysts suspect big corporations are holding back on planned investments, sitting on cash partly because of fears over an immediate future that includes far too many unknowns.

These include widespread doubt over global and domestic economic demand, unanswered questions over solving Eurozone and U.S. debt worries, regulatory and policy uncertainties as well as questions of what form any post-crisis social and political backlash might take.

Whatever happens, it is uncertain whether governments can do much to stem the broader wealth gap. In a globalized world, the rich and major corporations can easily move assets from jurisdiction to jurisdiction to avoid attempts at redistribution.

In this environment there are clear divisions in the approach taken by the world's most wealthy.

Some, like Buffett, say the wealthiest should pay more taxes and become more closely involved in society rather than hoping to simply isolate themselves.

Others see instead many of the world's rich following the example of Russian oligarchs in the chaotic 1990s, retreating into secure estates protected by private security and bullet-proof vehicles and secreting wealth in offshore tax havens.

For former Clinton adviser Galston, the short-term priority should be to help struggling middle classes through schemes to support home ownership and other basic aspirations to regain their trust in the wider political and economic system. This approach helped fuel decades of middle class growth in the United States -- until taken to such an extreme that it helped fuel the boom that led to the current global crisis.

"The first challenge for a government is to make the middle class feel that they are on their side and that is the job that a lot of governments in the Western world -- starting but not ending with the United States -- are struggling with," Galston said.

"As to whether that in itself would be enough is another question, of course, but it would at least be a starting point."

(Editing David Storey and Philip Barbara)