Inequality and mainstream economics
from David Ruccio
Consider the following irony: it takes the International Monetary Fund to show mainstream economists that inequality actually matters.
Most mainstream economists don’t even mention the problem of inequality. And when they do, they explain it away as the natural consequence of changing technology, education, and globalization. And even if they consider it to be important, they can’t figure out how it helps to explain the current crises in capitalism (except, perhaps, through politics).
Apparently, though, the IMF does understand there’s a problem, and it’s linked to the current mess we’re in. Thus, the latest issue of Finance and Development is devoted to the issue of inequality, with seven different articles.
Michael Kumhof and Romain Rancière (whose work I’ve cited before) develop a model in which rising inequality leads to an increase in financialization, indebtedness, and current account deficits, which in turn exacerbate the already-high levels of inequality, in countries like theUnited States.*
In reality, increases in income inequality are often followed by political interventions to prop up the living standards of the bottom group, whose real income is stagnating. This is generally done not by directly confronting the sources of inequality, such as declines in the collective bargaining power of the bottom group or shifts in the tax burden from the top group to the bottom group, but rather by promoting policies that cut the cost of borrowing for both individuals and financial institutions. . .These policies include domestic and international financial liberalization, and they put additional downward pressure on current accounts.
Andrew G. Berg and Jonathan D. Ostry, for their part, challenge the presumed tradeoff between inequality and efficiency.
In recent work. . ., we discovered that when growth is looked at over the long term, the trade-off between efficiency and equality may not exist. In fact equality appears to be an important ingredient in promoting and sustaining growth. The difference between countries that can sustain rapid growth for many years or even decades and the many others that see growth spurts fade quickly may be the level of inequality. Countries may find that improving equality may also improve efficiency, understood as more sustainable long-run growth. . .
The recent global economic crisis, with its roots in U.S. financial markets, may have resulted, in part at least, from the increase in inequality. With inequality growing in the United States and other important economies, the relationship between inequality and growth takes on more significance.
Facundo Alvaredo arrrives at much the same conclusion:
The new data call into question the standard relationship between economic development and income distribution—that growth and inequality reduction go hand in hand. But that relationship, postulated by economist Simon Kuznets, appears to be less certain—especially in English-speaking countries, which had a period of falling inequality during the first half of the 20th century followed by a reversal of the trend since the 1970s.
Now, the particular way all these authors think about the conditions and consequences of economic inequality is different from the way I understand and approach the problem. But, still, the fact that they find an important relationship between inequality and important macroeconomic issues such as financial instability, external imbalance, and slower growth demonstrates for all concerned that the majority of mainstream economists have simply chosen not to investigate the problem.
And the rest of us are suffering as a consequence.
* In other countries, such as China, with less developed financial systems, increasing inequality can generate large trade surpluses.
Inequality and the current crises
from David Ruccio
Mainstream economists (like Brad DeLong) can’t seem to find any connections between growing inequality and the current crises. But it’s not a problem for Federal Reserve Board Governor Sarah Bloom Raskin.
Yes, this is the same Raskin who recently decided to look beyond capitalism for a solution to the current crises. In an extension of those remarks, she set out to examine how “economic marginalization and financial vulnerability, associated with stagnant wages and rising inequality, contributed to the run-up to the financial crisis and how such marginalization and vulnerability could be relevant in the current recovery.”
Here’s her argument in a nutshell:
at the start of this recession, an unusually large number of low- and middle-income households were vulnerable to exactly the types of shocks that sparked the financial crisis. These households, which had endured 30 years of very sluggish real-wage growth, held an unusually large share of their wealth in housing, much of it financed with debt. As a result, over time, their exposure to house prices had increased dramatically. Thus, as in past recessions, suffering in the Great Recession–though widespread–was most painful and most perilous for low- and middle-income households, which were also more likely to be affected by job loss and had little wealth to fall back on.
Moreover, I am persuaded that because of how hard these lower- and middle-income households were hit, the recession was worse and the recovery has been weaker. The recovery has also been hampered by a continuation of longer-term trends that have reduced employment prospects for those at the lower end of the income distribution and produced weak wage growth.
This is a remarkable thesis, better than 99 percent of what we have heard from mainstream economists throughout this sorry spectacle (although Raskin does stumble a bit in repeating the mainstream penchant to invoke “technological change that favors those with a college education and globalization” as the causes of inequality).
And Raskin is well aware of how novel her thesis is, at least in mainstream circles:
To be clear, my approach of starting with inequality and differences across households is not a feature of most analyses of the macroeconomy, and the channels I have emphasized generally do not play key roles in most macro models. The typicalmacroeconomic analysis focuses on the general equilibrium behavior of “representative” households and firms, thereby abstracting from the consequences of inequality and other heterogeneity across households and instead focusing on the aggregate measures of spending determinants, including current income, wealth, interest rates, credit supply, and confidence or pessimism. In certain circumstances, this abstraction might be a reasonable simplification. For example, if the changes in the distribution of income or wealth, and the implications of those changes for the overall economy, are regular features of business cycles, then even an aggregate model without an explicit focus on distributional issues would capture those historical regularities.
However, the narrative I have emphasized places economic inequality and the differential experiences of American families, particularly the highly adverse experiences of those least well positioned to absorb their “realized shocks,” closer to the front and center of the macroeconomic adjustment process. The effects of increasing income and wealth disparities–specifically, the stagnating wages and sharp increase in household debt in the years leading up to the crisis, combined with the rapid decline in house prices and contraction in credit that followed–may have resulted in dynamics that differ from historical experience and which are therefore not well captured by aggregate models. How these factors have interacted and the implications for the aggregate economy are subject to debate, but I have laid out some possible channels through which there could be effects and that I believe represent some particularly fruitful areas for continued research.
I’m certainly not going to hold my breath—and I doubt Raskin is, either—until mainstream economists decide to actually pursue these lines of research.
Inequality, the Second Great Depression, and mainstream economics
from David Ruccio
This morning, we’re faced with the extraordinary spectacle of two left-of-center, Nobel Prize-winning economists stumbling all over themselves trying to make sense of the role of inequality in creating and sustaining the Second Great Depression.
Really?! Now, they may have missed the trend of growing inequality over the course of the past three decades. Still, with all the talk of obscene levels of inequality in the last five yearsand mainstream economists, even the best and the brightest, are still having a hard time formulating a theory about the impact of that inequality in producing the conditions for the crash of 2007-08 and sustaining the recovery that never was.
First, Joseph Stiglitz argued that “Inequality stifles, restrains and holds back our growth.” Then, Paul Krugman responded by telling us he’s not convinced “that this particular morality tale is right.”
It’s true, they agree that current economic conditions are, for that vast majority of people, pretty ugly. And that inequality distorts the political process, by allowing those on top to buy their favorite politicians and policies.
Both Stiglitz and Krugman also mention that growing inequality fosters financial crises, although from all that I’ve read neither has ever offered a theory of how that actually works.
So, their big disagreement is centered on the role of inequality (which, after a brief hiatus in 2009, is growing once again) in sustaining the current non-recovery, which I have come to refer to as the Second Great Depression. Basically, Stiglitz borrows from the radicals’ playbook and makes an underconsumption argument, which Krugman attempts to refute by invoking private savings rates and the idea that there can be full employment “based on purchases of yachts, luxury cars, and the services of personal trainers and celebrity chefs.”
Sure, but there isn’t. Not even close. And, according to all the projections I’ve seen, there won’t be for quite some time.
It is surely an embarrassment for mainstream economics that two of its best can barely even begin a serious discussion of the complex and contradictory effects of inequality on the pace and nature of growth since the financial crash of 2008. But, to give them credit, they’re still way out in front of their mainstream colleagues, who aren’t even attempting to make senseof the role inequality has played and continues to play in creating the Second Great Depression.
Walking and chewing gum at the same time
from David Ruccio
Clearly, liberal economists and columnists are having a difficult time making sense of two key problems at the same time: unemployment and inequality.
Some (like Ezra Klein) think we need to focus on unemployment right now, and leave the issue of inequality until later. Others (like Dean Baker) argue that, since unemployment is a main cause of inequality, economic growth and tighter labor markets will reduce the unequal distribution of gains in the current economy. And then, of course, there are still others (likePaul Krugman) who, while they consider inequality to be a “Big Something Deal,” still think the real issue is how it negatively influences politics and thus prevents policymakers from enacting the obvious unemployment-reducing policies.
I suppose I should be happy that some progress has, in fact, been made: unemployment and inequality are both on the table right now. Finally!
Still, the problem has been staring us in the face for a long time, and liberal thinkers are only now getting around to considering the possibility that perhaps the two problems are related. No, it’s not an iron law: there can be and have been periods in U.S. economic history of growing inequality with low unemployment, and periods of high unemployment with falling inequality. But when inequality has returned with a vengeance and unemployment remains intolerably high—when the levels of inequality are simply grotesque and tens of millions of workers are unemployed, underemployed, and, if they have a job, are paid below-poverty wages—well, then, we have a problem that the liberal models of economics and politics simply can’t handle.
That’s when we have to look at the political economy as a system, one that for the past six years has generated disastrous levels of both inequality and unemployment with no end in sight. It’s not just a matter of looking at how high unemployment leads to more inequality or at rising inequality as a cause of excessive unemployment. What they need are theories, models, and data series that allow them to see how unemployment and inequality are both being caused by an economic system in which the decisions to create (or not) adequate jobs and to capture large portions of national income are concentrated in a few hands.
Then, and only then, will they be able to walk and chew gum at the same time.
Some links, 28/2/2014. Inequality, trust and money (and bad Troika policies)
There are some interesting new reports, all of them implicitly debunking the atomistic worldview of neoclassical economics.
From the IMF: an economy is like a neural network and more inequal nodes hamper its working:
In sum, then, inequality remains harmful for growth, even when controlling for redistribution. And we find no evidence that redistribution is harmful. The data tend to reject the Okun assumption that there is in general a trade-off between redistribution and growth. On the contrary, on average—because with these regressions we are looking only at what happens on average in the sample—redistribution is overall pro-growth, taking into account its effects on inequality. And these results do not seem to depend on the levels of inequality or redistribution. Moreover, they hold even in the restrictive sample, which makes relatively conservative assumptions about which data to include in the regression, as well as in the full sample, which makes use of all available data.
From the European Parliament: an economy is like a circular system and the people propelling the flow of money in this system show, when they react to the acts and the consequences thereof of others, pro-cyclical behaviour instead of contra-cyclical behaviour. Troika policies were a disaster as they were influenced by the ‘confidence fairy’ ideas implicit in DSGE economics that cutting wages and government expenditure will lead to higher private investment and consumption. The opposite happened. Multipliers turned out to exist (duhhh… we’re living in a monetary world) and to be (much) larger than 1, which means that initial cuts were amplified by private behaviour and lower trust and confidence. Unemployment as well as public debt soared and only when ‘success’ is defined as ‘a lower government deficit (excluding bank aid)’ some successes can be spotted. Addendum: contrary to recent statements of Mario Draghi exports in countries like Greece and Ireland are not doing well, ‘despite’ dramatic declines of Unit Labour Costs (a flawed metric, by the way). Export success depends on decades of private and public investments in technology, sales, global value chains and networks – not on cutting wages of teachers (as usual, the economic statisticiansand not the super-modellers are doing the path breaking work when it comes to conceptualizing this).
To conclude, with the improvement of the economic climate in the euro area and Ireland’s successful programme exit, both market and political sentiment has become more optimistic about the possibility that the other programme countries, and certainly Portugal and Cyprus, will be able to exit assistance when their turn comes. The current mood, which tends to focus on exit as a measure of success, is understandable, but should be partly resisted. It is understandable because politicians in programme countries, in euro-area partners and in European institutions, are naturally rejoicing about the good news
which comes after much bad news and before the European and also some national elections. But it should be resisted because many problems remain, even if countries succeed in exiting their programmes. In particular, unemployment rates and (private and public) debt levels are still very high. Growth prospects are still unsatisfactory and far too weak to address the unemployment challenge. Greece is in the worst situation with unemployment at more than 25 percent and public debt at 175 percent of GDP, but the other three countries, with unemployment at about 15 percent and public debt at about 120 percent of GDP, are also not faring well.High (private and public) debt levels and generally weak growth determinants in programme countries, a
fragile global economy, disinflationary tendencies in the EU and the remaining banking problems, suggest that caution should be exercised when considering future exits. Certainly weak structural conditions in Portugal are concerning and indicate that the country should not opt in favour of a clean exit from its programme in May. At the very least it should request a precautionary credit line as a way of insuring against future risks. In the case of Greece, it is hard to see how the country could exit from its programme at the end of this year without some form of further debt relief and an accompanying framework to improve the structural drivers of growth.
From the NBER An economy is like a game with ever-changing rules and players and confidence increases when people learn and discover that they can trust these rules (which itself changes the rules and the players). In the eighteenth century New Jersey, a British colony, was desperately short of cash. Increasing the amount of paper money (a kind of small denomination interest free government ‘Mossler’ bonds) increased the value of this money in New Jersey between 1709-1775, as people learned to use and trust it.
Inequality is political
from Peter Radford
Let me end the week by tying a few things together. Bear with me.
First, I have spent some time talking about inequality. I see this as our greatest long term issue, but more in terms of politics than economics. Why? Because the extent of inequality in society is something we choose through our political action or inaction. There will always be some degree of inequality. I see that a a fact of life. Asymmetries abound. Inconsistencies, mistakes, and plain dumb luck all conspire to make the distribution of society’s spoils a very lumpy and uneven affair. This we cannot change. But we can, I believe, expand or contract the difference between top and bottom if we so choose. There is no “natural” level of inequality, it is entirely a function of policy.
With that said, I see our current level as both morally unacceptable and socially disruptive.
I will leave the moral commentary as self explanatory: there is no way our CEO’s can justify their disproportionate share of the spoils. It was not long ago that they were satisfied with much less. Only in the past few decades has it become socially acceptable for them to rake in what they do now.
As for the social impact, I see two vectors through which damage is done.
One is the slow erosion of demand. The demand created by wage incomes and the demand created by capital incomes is not equal. So even though the total remains the same the distribution plays a role. In other words an economy with a 50/50 split between wages and capital incomes experiences different performance than one with a 30/70 split. This is due to the way in which people with power incomes – which tend to be wage driven – save or spend as opposed to people with higher incomes – which tend to have a higher capital component – save or spend. That’s just the way I see it. Others disagree.
Even if this is not true the second vector of damage is, I believe, supported by a more secure argument. It is politically disruptive, over time, for the majority of the spoils from growth to go to a concentrated few. History is replete with societies whose stability was undone by inequality. More often than not this instability was offset by force – authoritarian or autocratic oppression preserved the unequal society. So I ought restrict myself to making the argument that long term and large movements away from relative equality are destabilizing for democratic societies.
And this is where I see we are today.
There has been a consistent and very large shift in the degree of inequality in the US during the past three to four decades. This shift is potentially destabilizing. It fosters a deterioration of allegiance to social programs as they are viewed, even by their beneficiaries, as burdensome. It degrades the level of collective commitment to redistribution of wealth. And, in my view, redistribution is the key to stolid democracy because it prevents the concentration of wealth that can be used to subvert it. Money buys power, it always has, and is not equal tofree speech no matter what out right wing Supreme Court says. So the prevention of excessive accumulation of wealth is the surest safeguard of democracy we have.
We can make a kind of converse argument too.
The paraphernalia of capitalism is, I think, a better mechanism for generating wealth than any other. Private property, relatively free exchange, and modest government interference in markets have, by and large, produced wealthier societies than other combinations and other principles. But capitalism also breeds greater inequality because those lucky enough to flourish within it are able, absent social constraints, to accumulate more rapidly than those less lucky. Hence the need for the redistributive urge of democracy.
A wise capitalist is, therefore, one who surrenders substantial wealth in order to preserve democracy, and not one who seeks to undermine it by excessive accumulation. Similarly, a wise democrat is one who tolerates some element of inequality as the price paid for the extra wealth generating power of capitalism.
The two systems clash. The two systems enable each other, but only in moderated form. We can understand the combination as having a feedback loop that prevents either system from careening off into a pure form.
Today’s high[er] level of inequality suggests, to me, that the feedback loop is not working well. We have too little redistribution and too much accumulation. If this continues we risk destroying both systems because neither capitalism nor democracy in a pure form can survive the social instability they engender. With democracy being the more likely loser of the two.
However, as I see it, our current leadership is oblivious to such risks and sees its role as protector of an economic system that comprises of, and only protects, those with capital. Redistribution, the heartbeat of democracy, is looked at askance. This we know because of the almost total agreement that “entitlement programs” throughout the western world are regarded as being unaffordable. Which they may be if society’s goal is to enable excessive accumulation.
We can detect this bias in our leadership in all sorts of ways. The latest being the downgrading of French sovereign debt by Standard and Poor’s. This downgrade comes despite the French having made good progress towards debt control and deficit reduction. Better progress than, for instance, the British whose economy S&P still lauds. Why does S&P express a negative attitude towards the French with their superior record? Because the French didn’t make progress by reducing entitlements or by reducing redistribution, they did it by raising taxes – by reducing excessive accumulation. They defended democracy not capitalism. They tried to protect that feedback loop.
Another example, closer to home, is the almost total emphasis in Washington on debt control and deficit reduction even though the evidence is piling up that such emphasis is causing great long term damage to the economy. By some accounts we have reduced our future wealth production capability by 7% because we decided to protect capital and not jobs/wages. This reduction will then be used to justify, further, the argument that we can no longer afford to redistribute as much as before.
This will make inequality worse. It will undermine our politics further.
One last thing: recent research has shown a remarkable consistency of support amongst voters for redistribution, no matter what their expressed political opinions are. Indeed so-called Tea Party supporters are far more likely to support higher taxes and increased government spending when they discus programs is substance rather than in theory. This is a well known paradox in American politics. The longstanding tradition of opposing “big” government is an abstract not a concrete notion. It motivates Tea Party supporters when they are confronted only with the abstraction. But when they are asked to comment in detail on actual programs and to comment at a concrete level they express an attachment to redistribution that is, in political terms, to the left of center.
The implication is clear: our leadership, in political terms, sits well to the right of the majority of voters, even those who vote for right wing politicians. There is a disconnect of epic proportions. Why? Because our governments, and our major financial institutions worldwide, are run, or deeply conditioned by, corporate and plutocratic interests. Those interests scorn redistribution. Thus they scorn democracy. And they are armed, by and large, with economic theories that argue inequality is not a problem, but rather is a natural outcome of free markets at work.
Until the influence of those interests is reduced we can expect inequality to increase, and with it the risk of greater social tension and confrontation.
I know many of you disagree with me, but I hope this is a more clear exposition of my point of view.