Links on inequality and the macroeconomy
I am one of those people who thinks that extreme inequality is inconsistent with a healthy economy. I am not here claiming that extreme inequality is morally wrong or unjust (although it may be). I think that inequality is harmful under conventional macroeconomic criteria of sustainable GDP growth with moderate business cycles. Nick Rowe (whom I generally adore) is dead wrong when he writes, “Sure, there might be distribution effects, but distribution effects are the last refuge of a …. person who can’t think up a better argument.” Distributional questions are central to macroeconomics, and underemphasized for reasons that I think are ideological. A good economy must accommodate three coequal but contradictory concerns: incentives, distribution, and dynamism. Pick any two and what you end up with is crap.
Ceci n’est pas an actual blog post. I don’t mean to flesh out an argument here; I am just madly claiming things. But since it will come up, I do want to preempt the “what about China?” complaint. Inequality and strong growth are definitely consistent in open, export-oriented economies, which rely upon discriminating consumers elsewhere to augment domestic demand. But, except for very small economies, this strategy fails the sustainability test. As China is in the process of discovering, large economies can’t rely upon export-oriented growth indefinitely. Eventually they engender hostility and protection among the nations for which they produce and see the claims in which they are paid devalued. (Germany is discovering this as well, in ways that seem more subtle only because they are less widely discussed.)
Perhaps a more nuanced and defensible way to frame the question is this: Can growth and inequality coexist over time without positing continuous capital flows that never reverse (between countries, or between groups within a single country)? Can a “balanced” economy, in which gross credit/debt rises no faster than GDP, be unequal and grow? (Perhaps it is fair to ask whether a “balanced” economy can ever support growth?)
Anyway, that’s too much already. This not-post is intended just as a placeholder for links. I’ve read a bunch of good pieces on inequality and growth recently, but my brain is like a sieve, so I’ll use the “related” box below to maintain a list of bookmarks. Please let me know in the comments what I’ve missed (and accept an apology for the endless omissions). I’ll try to keep updating this for a while.
[Note: My choices regarding what links to include here are likely to be quirky and seem one-sided. Usually when I append links to a post, I try to be fair about including perspectives I disagree with. But the broad inequality debate is more than I want to cover here. I’m interested in the question of how inequality effects macroeconomic stability and growth. Most defenses of economic inequality that I know address different issues, or simply presume that a tension between equality and growth-enhancing incentives outweighs any other effect. So my collection is unbalanced. I want links on the question of whether inequality is destabilizing, or whether inequality suppresses demand, consumption, and market information in ways that impair growth. I am glad to post links on all sides of those questions. I’m aware, by the way, of the (inconclusive) academic literature that tries to relate growth to inequality measures, but I’ve not seen anything that examines 1) the possibility that effects reverse sign — i.e. moderate inequality might be growth supportive while extreme inequality growth destructive; 2) the role of capital flows and/or credit expansion; or 3) long-ish term stability and low frequency crises.]
Steve,
With respect, I don’t think you’re framing this properly. The issue is not relative wealth but the surplus accruing to the lower end of the scale. There are absolute values that affect your calculation.
January 13th, 2010 at 4:44 am PST
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January 13th, 2010 at 5:23 am PST
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Charles — No respect necessary; I’m unworthy of it. But can you explain a bit more what you mean? Are you claiming that inequality is OK (for sustainable growth) as long as the absolute levels at the lower end of the scale are sufficiently high?
I might turn that around and suggest that inequality is OK for sustainable growth as long as the absolute values at the top are sufficiently low. The argument (which I haven’t made here, this really was a linkfest that evolved into a post via indiscipline) is that when the wealthy earn more than they consume or can invest for their own consumption, growth depends upon increasing the consumption of the less wealthy, which implies either more income to the less wealthy, or capital flows — loans — from rich to poor. If income growth, well, that’s less inequality. If loans, then it’s unsustainable.
If absolute values at the top are sufficiently low, then the wealthy can employ their income can by consuming or investing in their own (growing) future consumption, and there is no problem.
But if the rich are very rich, and their wants are in practice not unlimited (a nonstandard but realistic assumption), then there is a problem. [Even if their wants are unlimited and they spend their last dollar for some tiny marginal benefit in terms of personal consumption, technical questions arise as to whether the esoteric ways one might pamper oneself with a billion dollars are technically susceptible to reproduction and growth into the future via investment. Also, one might argue that the very rich value the consumption of others more than some marginal increment of personal consumption, but prefer to retain an option on their wealth by lending rather than giving to support their consumption. In either case, growth becomes unsustainable.]
But you wish to make the opposite case, no? That if the absolute income of the poor is sufficient things are okay? That might (or might not) be true in terms of welfare or justice, but how do the high-income rich, who dominate GDP measures, grow real output and match it with consumption in order to generate measured growth? [Perhaps artificially, I’m trying to restrict this conversation to the effect of inequality on conventional measures of growth rather than questions of whether inequality is morally tolerable.]
January 13th, 2010 at 5:33 am PST
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i guess it is important to keep in mind the distinction between wealth inequality and income inequality. presumably the former is more directly important for political outcomes (the lobbying power of vested interests), the latter more for economic outcomes (the ability of low-income borrowers to realise their share of productivity gains and thereby ultimately repay their debts).
January 13th, 2010 at 7:57 am PST
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“when the wealthy earn more than they consume or can invest for their own consumption, growth depends upon increasing the consumption of the less wealthy, which implies either more income to the less wealthy, or capital flows — loans — from rich to poor. If income growth, well, that’s less inequality. If loans, then it’s unsustainable.”
I don’t understand this sentiment. After wealthy people have spent what they spend (which recycles via trickle down economics, to use a false perjorative) they invest the rest, creating capital used for growth elsewhere by those with more energy for its pursuit. I don’t see that as “unsustainable” by its nature unless risk and return are permanently out of whack (due to overregulation or overtaxation, for example).
As to inequality, there’s one thing working for it and one against. For it is the growing value of intellectual vs. physical capital; there are greater natural disparities in the former and that gets reflected in income/wealth distribution. Against it is human nature (and time). Wealth does not tend to last for generations because heirs lack incentives, and within a generation there’s only so much time to buy stuff vs. invest. Arbitrarily correcting income inequalities by political fiat almost certainly will have negative consequences for growth at both ends of the spectrum. That said, long-term wealth inequalities are likely bad, period, for a stable and productive society.
January 13th, 2010 at 8:41 am PST
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Oh boy! This gets complicated really quickly. That’s why I restricted myself to three sentences.
I’m mostly saying that if you want the growth model to keep functioning that you’re going to get more bang for your buck from increasing median incomes in Nigeria than from diminishing differentials in the U.S. – this completely irrespective of what the rich-poor gap is in the latter country. Conversely, it is possible to imagine a place in which everybody is wealthy beyond their ability to spend and the gap remains unchanged. Absolute levels do matter.
You are quite correct about the transfer of buying power via loans. In the U.S. it was done as such. In Europe it was via the guarantees of the welfare state and the curious practice of sprouting, and rearing, kids at less than the replacement rate. Both cases are debts to be repaid.
That the continued functioning of the growth model in the industrialized countries seems to have depended on this debt to the future makes me think that there is something more fundamentally awry than income distribution.
Don’t be so self-effacing. Almost everybody else who blogged with your rigour has thrown the toys out of the pram and gone home.
January 13th, 2010 at 9:08 am PST
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Steve,
John Ruskin’s four essays entitled Unto this last ( http://historyofideas.org/toc/modeng/public/RusLast.html )remain as relevant today, for me, 150 years after he wrote it. More contemporary, Prof. Roland Benabou of Princeton pursues research in “Inequality, Social Mobility, and Redistribution” ( http://www.princeton.edu/~rbenabou/papers.html ). Also, we now have Inequality.org ( http://www.demos.org/inequality/index.cfm ).
For a “non-post”, you have my attention.
Best,
Miguel
January 13th, 2010 at 10:54 am PST
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January 13th, 2010 at 11:42 am PST
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As already pointed out in point 5, debt is a problem but equity is not if you want a sustainable economy. The rich can provide venture capital and the poor can improve their prospects that way.
You could go quasi-islamic and limit the amount that any single person can receive via debt and achieve your objective of sustainability. Beyond a point, money that flows into the rich inheritor’s fund has to come from a risk-sharing instrument like equity than an isolated hands-off one like debt.
Also, a deviation, but Charles’s point about taking an international perspective. Can’t be said enough. You guys are arguing over differences as trivial as the cheese on a cheesburger when the world outside your sovereign walls can’t afford bread.
Anyway, if we are setting morality aside, I think that the rich generally should be at the cutting edge of doing fun and cool stuff, consumption wise(which is the basic reason for production). Today, commisioning a movie for satisfying a personal preference may seem like an eccentric indulgence of a billionaire. After a 40 years of economic growth, its cost could have come down to the extent that the average joe would be doing it. Who knows that some megalomaniac wanting to live forever might actually commission some project that ends up curing cancer or aging? There was this billionaire lady who died and wanted her fortune to be used to improve the welfare of dogs. The sci-fi author David Brin suggested that they could undertake a project to uplift (his term) dogs to sentience. That would be a huge boost to research into human consciousness due to an old lady’s quirks.
So, in the long run, yay for eccentric billionaires!
January 13th, 2010 at 1:54 pm PST
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Steve,
We discussed this back in June 2008 (oh so long ago!) on Interfluidity, and at the time I did a Google search on inequality and productivity and came up with this:
http://www.interfluidity.com/v2/125.html#comment-790
Richard B. Freeman, Alexander M. Gelber
NBER Working Paper No. 12588
Issued in October 2006
NBER Program(s): LS POL
—- Abstract —–
This paper examines performance in a tournament setting with different levels of inequality in rewards and different provision of information about individual’s skill at the task prior to the tournament. We find that that total tournament output depends on inequality according to an inverse U shaped function: We reward subjects based on the number of mazes they can solve, and the number of solved mazes is lowest when payments are independent of the participants’ performance; rises to a maximum at a medium level of inequality; then falls at the highest level of inequality. These results are strongest when participants know the number of mazes they solved relative to others in a pre-tournament round and thus can judge their likely success in the tournament. Finally, we find that cheating/fudging on the experiment responds to the level of inequality and information about relative positions. Our results support a model of optimal allocation of prizes in tournaments that postulate convex cost of effort functions.
This seems plausible to me. The question for Americans going forward is whether we descend into neo-feudalism–which implies long-term economic decline if the above is true–or whether our income and wealth distributions can be returned to something that most Americans find to be fair. Simon Johnson is correct in saying that the country is currently being run like a banana republic (“with nukes”). But the inequality has been long in the making and extends across virtually all occupations.
Most Americans today believe in some way or another that the social contract is broken. The most compelling historical theory of this that I’ve found is Strauss and Howe’s The Fourth Turning, which suggests that we’re heading into a crisis over the next decade or more that will require a rewrite of the American social contract. It’s going to be interesting.
Thanks.
Benign
January 13th, 2010 at 2:47 pm PST
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January 13th, 2010 at 3:02 pm PST
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January 13th, 2010 at 4:09 pm PST
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SRW:
“But since it will come up, I do want to preempt the “what about China?” complaint. Inequality and strong growth are definitely consistent in open, export-oriented economies, which rely upon discriminating consumers elsewhere to augment domestic demand.”
Wow — you’re saying that China is relying on discriminating consumers (in the West?) to augment domestic demand?
You really are just madly claiming things. Must feel good to let it all out ; )
January 13th, 2010 at 4:34 pm PST
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” I’m aware, by the way, of the (inconclusive) academic literature that tries to relate growth to inequality measures, but I’ve not seen anything that examines …2) the role of capital flows and/or credit expansion”
Exactly. I’m convinced that if one corrected for the role of credit expansion on GDP growth , the correlation between lower inequality and higher growth would become evident.
There’s a nice paper waiting to be written on this topic. The way to approach this , IMO , is to do inter-country comparisons on advanced economies only , using some PPP-adjusted per capita GDP output cutoff ( at current levels , maybe $20k/yr) , use a minimum of 30-40 years worth of data , and make some attempt to reasonably correct GDP growth over the period for the extent to which ( public plus private)debt/GDP levels have changed. In other words , normalize GDP growth to a flat baseline of debt/gdp.
Critics would pounce , of course , but so what ? Now , more than ever , there should be a willingness to concede that rapid debt growth , whether public or private , draws future demand forward , distorting GDP growth calculations.
January 13th, 2010 at 6:26 pm PST
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Point #5: Sure the wealthy invest their surplus capital but what is invested in is the concern. Resources are misallocated by the market all of the time. Lets look explore some negatives of resource misallocation, well negatives from my perspective at least: 1) Asset price inflation (Housing, stock market, oil and other commodity speculation), 2) government capture through lobbying for subsidies and artificial monopolies (Healthcare, Pharmaceuticals, Military Industrial Complex, Agribusiness, Telecommunications consolidation) or simple corruption (any third world government by multinational corporations), 3) extension of credit where it is overly risky (CMBS, RMBS, Failing states, Dictators), 4) a glut production capacity that cannot be absorbed by consumer demand (Chinese manufacturing, Finance Industry potentially), 5) manipulation of market or public sentiment (public relations, business news, advertising, propaganda, some think tanks). These all constitute what I consider a majority of problems within our social and economic system and they have been rather recurrent. Now you may have a problem with certain things I suggest are wrong, based upon your place within the ideological spectrum. But, I’m sure everyone will think some of those things are wrong. Some of them may be rational from an individual perspective, short term profit, but may result in severe misallocations of resources by the market, and net disutility for the public. The conservatives will just blame high healthcare costs on lawsuits and the liberals on the healthcare companies.
Now could these companies stymie or capture the political process or affect its trajectory readily if they weren’t extracting such a large profit from their goods and services? Would the middle class be a risky group to lend to if they had a larger amount of the profit surplus (since their wages have been stagnating since the 70s)? Is asset price speculation going to be as rampant if there isn’t collaboration amongst concentrated market actors to control specific information flows and pump particular investment themes (due to lack of oversight e.g. capture)? Could production overcapacity be absorbed if the poor or middle class were taking home an increased share of the profits from production? I’m not suggesting some sort of communist notions, but how about I don’t spend 40% on taxes when some hedge fund manager or .01 percenter pays 15% capital gains. In a system which is likely punctuated by disequilibria, our speculative bubbles would likely still exist, but it is likely that they would be smoothed out a bit both at the top and at the bottom.
There is no evidence that the good allocations of resources will outweigh the bad. Nor is there evidence that humans will behave rationally, despite what your economics professor told you, based upon behavioural economics and quite an abundance of modern work in behavioural studies. But that also means that there is no evidence to suggest that a large group of people, if the money was distributed to them are going to be more rational than a small concentrated group (Televangelism, rise of some fascist governments, scapegoating, mob mentality). But with a decent system of checks and balances, less collaboratively constructed information asymmetries, massively concentrated financial flows, and government capture by concentrated interests; the highs may not be as high, but the lows are certainly not going to be as low. And, trust me, we have not hit low yet.
Truth be told, some of the continental European banks did have more leverage and quite a bit of exposure to CMBS/MBS, despite the fact that they are more equal countries than the US or Britain. Many of them were, however, speculating on foreign markets Eastern Europe, the mediteranean, and US mortgages. Maybe it is because they bought the collective delusion hook, line, and sinker. Or potentially it became a race to the bottom in regulatory apparatus by governments. But, maybe it is our own delusion that economies in general, independent of their levels of inequality, aren’t entirely nepotistic oligarchies.
Point #9. The eccentricity of billionaires, can have the effect of supporting certain cultural, social or scientific pet projects. But, it can also pump large amounts of money into morally bankrupt practices to name a few: denigrating women’s rights (Saudi Arabia), terrorism, vices (drugs, prostitution), or denialism (new earth creationists, scientology).
Note: I updated the numbers in this comment after deleting some spam, so that it still responds to the relevant prior commenters. No other changes were made. — SRW
January 13th, 2010 at 6:33 pm PST
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January 14th, 2010 at 10:31 am PST
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Onwee
I’m not sure the “investments” you are referring to are really what builds the economy. Most of the investments within the private sector follow more of a casino model and function as rent seeking/speculation and not new wealth creating. Savings does not really create investment its the other way around, new savings come from true investment.
I’m also not sure that taxation and overregulation are what skew risk and return. Its likely just plain ole inability to predict the future accurately. Most everyone knows what the taxation and regulation environment are when they invest. Its the unknowns which kill your portfolio.
January 14th, 2010 at 5:51 pm PST
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January 16th, 2010 at 8:00 pm PST
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January 17th, 2010 at 2:00 am PST
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January 17th, 2010 at 3:20 pm PST
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“A good economy must accommodate three coequal but contradictory concerns: incentives, distribution, and dynamism.”
Steve, you really should have the word sometimes here. There are so many high return investments that increase distributional equality, and increase dynamism, and increase the total pie tremendously, all at the same time. For some you can even add in incentives.
These high return investments include free, or highly subsidized, public education, public health and safety, infrastructure, basic science and medicine, and much more.
There’s just not a tradeoff over the long run for things like free universal pre-school, free universal undergraduate college, schoolfare, and much more.
Even transfer payments in general, including ones with no strings attached like schoolfare (which is far better), have been shown historically to increase the total pie in a recent major two volume work by Peter Lindert of the University of California, Davis, Growing Public, 1 and 2.
January 18th, 2010 at 5:00 pm PST
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I’ll also refer you to a post of mine:
http://economistsview.typepad.com/economistsview/2008/08/tax-cuts-and-go.html
January 18th, 2010 at 5:02 pm PST
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Oops,please insert “,un” before “like schoolfare” in my second from last comment.
January 18th, 2010 at 5:07 pm PST
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