“Inequality wasn’t the answer”

Posted: 27 May 2012 in Uncategorized
Tags: , , , , , ,

A friend suggested, in an email, that I may have been “on to something” when I presented my “Mind the Gap” paper at the Volcano symposium.

The evidence is a recent column by Heather Stewart, who reports on last week’s OECD forum in Paris.

For a long time, the growing gap between rich and poor caused hand-wringing among lefties, but was dismissed by many economists – and the political consensus – as an unfortunate but inevitable side-effect of the battle to subdue inflation, and, later, of technological change and globalisation.

She cites a recent a recent paper written by the National Institute of Economic and Social Research (NIESR), which “shows that low-income households in the UK only maintained their standard of living through the late 1990s and early 2000s by borrowing heavily.”

Without this borrowing binge, it is likely that consumption would have collapsed, and with it growth. And because many poor families are now hamstrung by unpayable debts, demand may be held back for years. So it seems rising inequality does matter – economically, as well as politically.

And it is this history – of decades in which lavish rewards accrued to the few while everyone else papered over the cracks with debt – that could make austerity impossible to bear.

That’s similar to the argument I’ve been making, the direct link between growing inequality and the financial crisis of 2007-08, which has been ignored or overlooked by most mainstream economists. Here’s how I put it in Oxford:

the problem of inequality has threatened to overrun and to overturn mainstream economic discourse.

And so we have entered a second stage, when instead of ignoring the problem of inequality, the task has been to direct it into “safe” channels. We have the spectacle, then, of limiting the effects of inequality to political decision-making (that’s Paul Krugman, who can’t understand the role inequality might play in causing economic crises except as wealthy individuals are able to exert influence over politicians, and cause them to change existing policies, like bank regulations). Or to the effects of inequality on consumption (I’m referring here to Robert Frank, who argues that those outside the very top have been guided by a “keep-up-the-Joneses” mode of consumption, which led them to purchase homes they could not afford). Or, finally, to “the government did it” (as the University of Chicago’s Raghuram Rajan concludes, in placing the blame on Freddie Mac and Fannie Mae for bowing to populist pressures to respond to growing inequality by extending mortgages to those who had no hope of ever paying them back).

That’s the sad state of affairs within mainstream macroeconomics. Now, I think there’s an interesting discussion to be had about why that’s the case: have they chosen to ignore the problem of inequality because it doesn’t fit in their models (whether neoclassical or Keynesian) or because they’re afraid of the policy implications (since, if you make it central, you then have to suggest doing something about it) or because it doesn’t fit within the partisan debate about the causes and consequences of the current economic crises (and, at least in the United States, the mainstream macroeconomic debate has become quite partisan, as a narrow debate between inflation and unemployment, austerity and expansion, between budget deficits and economic stimulus)?

The fact is, the official discipline of economics—in all areas, teaching, research, and public debate—is right now at a crossroads. And there are few if any signs that it is responding to the current crises in a manner that will help us chart a path away from the exploding volcano of inequality.

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Comments
  1. [...] economists have mostly ignored (or, as I have explained before, directed into “safe” channels) the role of inequality in causing the crash of 2007-08 [...]

  2. Magpie says:

    Prof.

    It is unfortunate that I had not read this post before, for I myself have thought along similar lines for some time.

    Two of the three economists you mentioned deserve special comment.

    Krugman’s case is telling, in my opinion, because he has explicitly denied, apparently off-hand any suggestion that inequality has direct economic implications (I have not read his latest book, so I don’t know if he has changed his mind recently).

    Robert Reich (whom, as you know, cannot be suspected of being a commie in disguise) has made this point, only to be disregarded by Krugman last year, in his NYT blog, if memory serves.

    Why? I myself have wondered. In this case this perhaps could be attributed to some kind of personal rivalry.

    The other interesting case is apparently Robert Frank’s (I say apparently, because I have not read him). That’s the case of the “keeping-up-with-the-Joneses”.

    So I am speaking more of the explanation itself, than of Frank.

    This explanation seems to try to place the blame on those on lower incomes: sure, these guys saw their incomes increase little (maybe even decrease), but they could not control their impulses. For short: they were living beyond their means.

    This might be only me, but to me it seems there is an implicit and to me evident moralizing there.

    However, let’s assume this thesis. What would have happened if those on lower incomes had not gone into debt to acquire GDP? Wouldn’t the recession have come earlier?

    In Australia, where savings as proportion of GDP have increased and become positive, we are currently seeing the consequences: retail isn’t growing, there’s price deflation on foodstuffs, housing is also stumbling. Granted, this probably can’t be explained only as a structural change in consumers’ preferences for savings (the RBA has kept interest rates higher than in pretty much all developed nations, contributing to what we call our two-speed economy), but it is telling, nonetheless.

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