Quotes of the Day

The front window of the grocery store off Lisson Grove lets in very little light, covered as it is with receipts taped to the glass. Each slip documents a bit of credit extended by the shop — a few dollars to one customer for a half-kilo of meat, a few more to another for bread and eggs. The dozens of receipts add up to nearly $500 — testimony to how dire the economy is in this North London neighborhood. "It's very bad now," says owner Ali Farhat, who says that he turns away job seekers several times a day and that business has fallen 30% in the past two years.

The squeeze on low-income neighborhoods like Lisson Grove has set off a torrent of debate in Britain about who is to blame for the worsening condition of the lower and middle classes in the wake of the Great Recession. Partisan wrangling has only intensified since last year, when Archbishop of Canterbury Rowan Williams attacked the country's coalition government for drastic cutbacks that treated the lower classes like the "undeserving poor," a phrase made famous by Eliza Doolittle's father, a resident of Lisson Grove in the 1912 play Pygmalion.

The dustman's daughter taught to speak like a duchess was George Bernard Shaw's fantasy figure of Edwardian class divides — divides that are making a comeback. With 95% of the neighborhood's children living in poverty, the area ranks among England's poorest. Half a kilometer away is St. John's Wood, home to bankers, football managers and former Beatle Paul McCartney. Up there, you wouldn't know Britain was facing the biggest squeeze on living standards since the 1920s: the local deli sells apricots for $80 a kilo, a flat can run you $9,600 a week, and the credit crunch doesn't seem to have deterred shoppers for the area's "midrange" houses, which cost $10 million to $16 million.

There's nothing new about wealth and poverty occupying the same square kilometer of London. What's changed in recent decades — and what's been growing more acute since the 2008 global financial crisis — is the scale of that inequality. London's Gini score — which ranks an area's wealth inequality on a scale of 0 to 100 — rose from about 34 in 2002 to over 36 in 2010 — significantly above the Organisation for Economic Co-operation and Development average of about 32. With the top 10% of the population worth 273 times the bottom 10%, London ranks as one of the most unequal cities in the developed world, trumping even New York City, notes Danny Dorling, an expert in urban inequality at the University of Sheffield. The rise in income inequality in Britain — the fastest growing in the OECD over the past three decades — is largely due to the dramatic growth of the City, London's financial district, since the industry was deregulated in 1986 to compete with Wall Street. That's partly because Britain's economy is more dependent on London's financial district than the U.S.'s is on Wall Street. The U.S. economy is "five to six times the size of Britain's, and the City of London is five to six times more important to Britain than Wall Street is to the U.S.," says London School of Economics professor Brian Bell. It's also because of geography. London, a prime destination for Asian, Russian and Middle Eastern riches, has a higher concentration of foreign and domestic wealth than New York, especially now that rich refugees from the euro crisis and the Arab Spring have poured money into central London.

That makes the capital city its own ecosystem within the British economy: its citizens pay nearly 7% more for goods and services than Britons elsewhere and 80% more to rent property. But everything that happens in London doesn't stay in London. The prime drivers of Britain's rise in overall inequality since the mid-1990s are twofold: inequality in London and the inequalities in the financial sector, according to research by Mark Stewart, an economist at the University of Warwick. London also has a bigger monopoly on Britain's wealth than New York has on the U.S.'s, since more wealthy Americans are spread across the country and across industries outside finance. Though inequality in British earnings had been rising since the late 1970s, the process of widening stopped by the mid-'90s — with the exception of the top end, which was driven primarily by the financial sector. "There's been a decoupling of the financial sector from the rest of the economy," explains Stewart. "It's also been decoupled from changes in productivity, or GDP per head. Most of the financial benefits have accrued to the top of the income distribution."

It doesn't help that British taxes have become less progressive. In the early '70s, the top income-tax rate was 83%; it's now 50%, having been 40% for two decades. Unequal, too, is the distribution of the spoils of Britain's prosperity boom over the past decade, which has benefited the better heeled. Across England and Wales, properties valued at over $800,000 account for just 4.5% of all housing but nearly 18% of the market's value, according to the real estate company Savills. Except in St. John's Wood and a handful of similarly posh London neighborhoods — where top-end property prices rose 38% from 2009 to 2011, according to research from the real estate firm Knight Frank — property prices have fallen by about 5%. Despite this, tightened credit and frozen wages mean that younger Britons in particular are increasingly priced out of the real estate market. In depressed areas like Lisson Grove, it is the double blow of high unemployment and public-spending cuts that wounds the most. "The austerity program has been a significant drag on growth in recent quarters," observed a report from the respected Institute for Fiscal Studies earlier this year.

As Britain's rich have become richer, flush bankers with bonuses have practically struck gold. The London School of Economics' Bell and John Van Reenen have charted how the growing gap in British wages over the past decade has come from the top few percentiles of earners. All the gains for the top 5% of British workers from 1998 to 2008, they found, were a result of hikes in bonus pay for people in finance. "About 60% of the increase in [Britain's] extreme wage inequality," they observed, "is due to the financial sector."

Britons in the low- to middle-income bracket, whose earnings were flat even during the boom years, now have the recession to blame for an 8% fall in incomes, according to a recent report from the London-based think tank Resolution Foundation. Two-thirds of Britain's low and middle earners say they're struggling to keep up with daily bills; nearly half say they can't afford an annual holiday. Martin Cable, an unemployed floorer from Lisson Grove, certainly can't, not on the $103 Jobseekers' Allowance that must last a week for his family of five. "That only gets you past the first three days," says the 26-year-old. "Ten pounds [16 dollars] on gas, £10 on electricity and the rest on filling the cupboards." He's never claimed benefits before, but in just three weeks on the dole, he's already had to stretch his welfare check with a $93 payday loan. Over the past two years, Britain's Citizens Advice Bureau says it's seen a fourfold rise in these sorts of few-questions-asked payday loans, whose APRs can reach 3,000%.

The Debt Drag
Until the 2008 crisis, debt helped disguise widening inequalities in British society. The Tories, followed by New Labour, enthusiastically pushed consumer spending as a goal. "We were all encouraged to spend, because status was so defined by what consumer goods we got," notes Owen Jones, author of Chavs: The Demonization of the Working Class. "That was easy for the middle classes, but that pressure on working-class people made them rely on cheap credit." Booming financial markets and easy credit exacerbated inequality, according to a recent paper by International Monetary Fund economist Michael Kumhof. His research found that external debt in Britain and the U.S., measured by the countries' current account balances, rose 1% to 2% for every percentage-point rise in the income share of the top 5% of earners from 1980 to 2007. Government coffers, swollen from a booming economy increasingly based on finance, allowed Labour governments to go on the biggest spending spree in Europe, creating nearly 850,000 public-sector jobs, tripling spending on the National Health Service and awarding tax credits to parents and low-income workers.

At its postcrisis peak, Britain's public deficit nudged 12% of GDP, among the highest in developed countries. Over the next three years, the government will have cut nearly a half-million of the nation's 6 million public-sector jobs, all while raising taxes and scaling back on housing and unemployment benefits. "In the last decade or so, low and middle incomes have been propped up by nonearnings," notes Matthew Whitaker, the Resolution Foundation's chief economist. "Now all these props are being pulled away. This not only has social implications but implications for the British economy, where growth has been built in recent years on consumption. It's not going to be there anymore."

Of course, people in neighborhoods like St. John's Wood are still spending. "If anything, we've found that the recession has only supported and upheld the luxury, high-wealth industry. In times like these, people are more keen than ever to invest in something tangible — be it property, art, jewelry or even wine. They see a value and even a comfort in paying for something of worth," says Emma Johnson, editor of Vantage, a magazine for affluent northwest Londoners. Last year Britain's luxury-goods sector grew by 8%, thanks in part to big spenders from the U.S., Russia and the Middle East flocking to London. Luxury department store Selfridges reported a 40% rise in sales to foreign customers.

Frustration Nation
Recent outrage over growing income disparities hasn't gone unnoticed by the British establishment. In January, sensing the public mood, the government stripped Sir Fred Goodwin — a former head of the Royal Bank of Scotland, whose collapse in 2008 prompted a $74 billion bailout — of his knighthood. In 2009 the chairman of the Financial Services Authority, Adair Turner, asserted that the 2008 crisis showed that parts of the sector had grown "beyond a socially reasonable size." Two years later, he suggested in a public lecture that most innovation in the banking sector has added little to economic growth and that either state intervention or taxes on financial activities were a potential way of curbing banks' attempts to extract "rent."

Prime Minister David Cameron chimed in this fall, telling the Confederation of British Industry (CBI), "Everyone agrees now that in the past, Britain's economy had become lopsided — too dependent on debt, consumption and financial services." Cue his list of investments in ports and electricity markets and details of government wooing of foreign manufacturing giants like Siemens. In late December, CBI director general John Cridland called for a "rebalancing of the British economy," moving away from debt-driven consumer-spending growth toward business investment and net trade. "The emerging middle classes of Latin America and Asia want British-branded consumer goods and services, but to do that, we're going to have to start investing in selling to the markets of the world where currently we're underrepresented — the emerging and developing economies."

Shifting Britain's economy away from finance won't come easily or fast. When Tony Blair's Labour government was elected in 1997, manufacturing was over a fifth of the economy; by 2007, that figure was 12%. While the City's share of the economy has grown since 2005, now standing at about 10%, manufacturing lost over twice the proportion of jobs as finance and business services in the first year of the financial crisis. This only exacerbates what Jones says has become an "hourglass" economy, with many top jobs in hedge funds and law and dead-end jobs at call centers and supermarkets on offer but very little in between. "For decades, we had an economic policy tailored to the interests of the City," notes Jones. "High interest rates, a strong pound — all benefited the financial-services sector, but they were extremely damaging when it came to manufacturing jobs, which were never replaced."

For Britons like Cable, reliant on public-sector health and education services as well as housing and unemployment benefits, far worse is to come, and frustration is rising. The Institute for Fiscal Studies noted earlier this year that just 12% of the planned cuts would have occurred by now. "There's a new awareness of class, not just of the people at the top — the bankers, who are being blamed for all of this — but on the other end of the spectrum, of the divisions between the deserving and the undeserving poor," says Will Atkinson, a sociologist at the University of Bristol.

In March an independent-panel report on the 2011 London riots said youth need jobs and opportunities — "a stake in society" — if Britain is to avoid more unrest. For now, the tensions between the top and bottom ends of society show up in small ways, like a recent altercation over a parking space on St. John's Wood High Street. A carefully streaked blonde in fur emerged from her Range Rover to fend off a hollow-eyed, screaming woman standing beside her battered Toyota to defend her right to the spot. The Toyota driver's anger was loud enough to draw a crowd: "She's calling me pikey," yelled the woman after the two exchanged heated words. "Did you hear that?" she cried about the slang reference to someone of low social class. Nobody answered.

• Carla Power
• How the City of London has widened the gap between Britain's rich and poor