Mainstream 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 and in creating the conditions for the Second Great Depression.
Others, however, are starting to push back. There are the new books by Jamie Galbraith (Inequality and Instability: A Study of the World Economy Before the Great Crisis) and Joe Stiglitz (The Price of Inequality: How Today’s Divided Society Endangers Our Future). And now there’s a three-part series by Stewart Lansley published on the OECD Insights blog (the first two parts are here and here), based on his new book (The Cost of Inequality: Why Economic Equality is Essential for Recovery).
Lansley does a good job putting the issue of inequality on the table and in explaining the links between growing inequality (especially in the United States and the United Kingdom) and the kind of economic instability that erupted in the crash of 2007-08.
Not only has the rise in inequality failed to deliver on faster growth, history shows a clear association between inequality and instability. The great crashes of 1929 and 2008 and the deep-seated recessions that followed were both preceded by sharp rises in inequality. In contrast, the most prolonged period of economic success and stability in recent history – from 1950 to the early 1970s – was one in which inequality fell across the rich world and especially in the UK and the US.
What is significant about Lansley’s approach is that he analyzes inequality not as mainstream economists usually do—as a matter of divergence within the labor market, cause by the returns to different educational levels—but in terms of the distribution of “factor shares.”
The driving force behind the widening income gap of the last thirty years has been a shift in the distribution of “factor shares” – the way the output of the economy is divided between wages and profits. In the first two decades after the Second World War, a transformed model of capitalism emerged – across the rich world – in which it was accepted that the fruits of growth should be more evenly shared than they had been in the pre-War era. In the US, the share of output allocated to wages rose and stayed high. In the UK the “wage-share” settled at between 58 and 60 per cent of output, a higher rate than achieved in the pre-war era and the Victorian age. It was this elevated wage share that helped drive the “great leveling” of the post-war decades.
From the late 1970s, the capitalist model underwent another transformation, one characterised by a backward shift in the way the proceeds of growth were divided. By 2007, the share of output going to wages had fallen to 53 per cent in the UK. In the US, the fruits of growth became even more unevenly divided, with the workforce ending up with an even smaller share of the economic cake.
He then argues that the change in the shares to capital and labor created economic instability through three mechanisms: the explosion in consumer debt, the growth of a tidal wave of global footloose capital (a mix of corporate surpluses and burgeoning personal wealth), and the increased concentration of power with wealth and economic decision-making heavily concentrated in the hands of a tiny minority.
His conclusion is that the attempt to solve the economic problems of the 1970s created the conditions for the current crises.
The economic thrust of the last thirty years – greater reliance on markets, the weakened bargaining power of labour and hiked fortunes at the top – was aimed at dealing with the crisis of the 1970s, a mix of “stagflation” (stagnation and rising inflation ) and falling productivity. It succeeded in squeezing out inflation but replaced these fault lines with an equally toxic mix – global deflation, rising indebtedness and booming asset prices – that eventually brought economic collapse.
Much more work needs to be done, of course. But that’s not a bad start. And the key, it seems to me, is that Lansley connects the problem of inequality directly to the fundamental change in factor shares that occurred starting in the mid-1970s.
In other words, he focuses on the issue mainstream economists most want to avoid: class.
As if on cue, just after I published this post, I ran across the latest attempt by mainstream economists to challenge the link between inequality and the crash. It’s a piece by Michael Bordo and Christopher Meissner [pdf]. The fundamental mistake they make, at first glance, is to presume they can “test” the link between inequality and the current crises by examining the econometric evidence between inequality and all financial crises. That’s not the point: the argument I and others are currently making is not that all financial crises—in all countries and at all times—are caused by increasing and/or obscene levels of inequality but that there’s a particular link between rising inequality and the two great depressions of the past 100 years in the United States. But I’ll have more to say once I’ve had the time to carefully read through their essay.