Ruccio points out that Martin Wolf doesn’t understand the inequality-bubble link:
Here’s a good question for Martin Wolf, the chief economics commentator for the Financial Times:
How could a more equitable distribution of income be instrumental in solving the impact of this crisis? Especially in the UK and the USA the top 20% has close to 50% of the net incomes which is one of the reasons for the bubbles on Wall Street and on the housing market.
The amazing thing is, Wolf can’t come up a good answer:
I am not at all sure about the link between inequality and the bubble. I think that the growth of the financial sector played an important role in increasing inequality in the US and UK. It helped a very small proportion of the population to extract a large amount of rent. But I am not sure about the reverse causal relationship from higher inequality to the bubble.
No? So, Wolf can’t imagine how increasing inequality—rising productivity and stagnating wages—led both to higher profits (which could be soaked up by the financial sector through securitization) and increased borrowing (on the part of wage-and-salary-earners), thus generating a financial bubble. Not such a difficult argument to imagine and make, although seemingly beyond Wolf’s worldview.
And, of course, once you imagine a link between inequality and capitalist crises, then you have to think about solving the inequality problem in order to solve the crises. And that’s a place Wolf clearly doesn’t want to go.
This shouldn’t come as a surprise to naive me, but it does. Months back, I made the unverified claim that even Krugman had drawn the inequality-bubble link. Now, I’m having my doubts. Wolf’s argument led me to look back in Krugman’s archives. This post, in particular, challenges the “underconsumption hypothesis,” which states that highly unequal societies will suffer from underconsumption. The argument seems like something that comes straight from Marx. Krugman writes,
But how, exactly, do you reconcile this assertion with the fact that we have a negative savings rate, and that consumption is at a near-record share of national income?
I mean, by all means let’s worry about inequality. But I don’t get how this particular reason for worrying about inequality can be reconciled with the facts.
Isn’t the collapse of our mortgage/credit-based consumption justification for worry about this particular aspect of inequality? Krugman confuses me here, because people like Dean Baker, whom he often cites approvingly, have been making the inequality-bubble argument. And for someone like Krugman, who likes to go off his economic intuition, it is fairly easy to connect the dots for an unequal society temporarily staving off underconsumption with unholy credit mechanisms before finally going down in flames. As for Wolf, there seems to be little hope for him on this particular topic if he can’t read between these lines.
I would suggest that the most recent economic crisis, and the mortgage/real estate bubble that preceded and caused it had little to do with income inequality. It had more to do with the corrupt alliance between politicians, regulators, and Wall Street speculators.
One might argue that the members of the House Banking Committee and the executives at Fannie Mae were trying to reduce inequality by handing out and guaranteeing mortgages to less than credit worthy applicants. However, the inequality itself was not the culprit–it was the populist attempt to re-distribute wealth while giving favors to developers and financiers that created the inflated home values and delinquent loans.
And as for the wisdom of government staving off under-consumption by giving easy credit, that is representative of the failed Keynsian idea of pump priming. Krugman leans that way and like the present administration will spend trillions to bail out a few institutions. The most important “links” to avoid is the ones that have government actions reward bad behavior while punishing good behavior.
To that extent, Wolfe has a point that a tiny percent of individuals took a lot of money from many and they were aided and abetted by the elites in Washington.
I think you’re looking at it the wrong way. I suppose in some sense inequality might be more of a symptom of the structural causes of the crisis. Nevertheless, stagnant median wages in the face of rising productivity seem sufficient to induce a credit-reliant economy. Many have argued to specific policies (such as weakening trade unions, eroding value of minimum wages, changes in the tax code) that have caused both stagnant wages and high inequality, so I think there is an argument to be made.
Nick, I believe you attribute too much to vague and generalized economic forces, that, as you imply, cannot actually be isolated or identified.
A credit-reliant economy can only exist if real live humans borrow too much. I grew up in the depression of 1933, and being at the bottom of the inequality chart, was subjected to wage stagnation. The only option we had, since we knew the dangers of debt, was to spend less–live within our limited income. That worked fine, we survived for a decade, and after the War we prospered, and had no burdensome debt at any time.
I believe Mises book “Human Action” makes this same point that all economics is simply what individuals do or do not do. If there is an explanation for people today stretching their credit instead of tighteneing their belts, it may be attributed to how our government has for 50 years explained that the Deficit and the National Debt are “No Problem Man!”
Of course, in this recent crisis, the government was even more complicit in the expansion of credit because of the lending practices and government guarantee of Fannie Mae and Freddie Mac mortgages as allowed and encouraged by the House Banking Committee. These government institutions virtually forced the debt on the public.
The best way to avoid such unwise accumulation of debt would be to let all the defaulters go under. When the government bails out bad judgment you will get more bad judgment.
It all comes down to the prudence of the people. Their actions determine the economy. If the government interferes with their good sense by guarantees and bailouts, you can’t blame the people for being led astray.
I don’t think one can dismiss the following as “vague economic forces”: producers are producing more stuff; median person has less money right now to buy this stuff, but wants to; median person reasons that s/he will have more money in the future and seeks out credit to buy stuff; interest rates are low, so banks and consumer lending facilities are happy to lend the money; consumer buys stuff, but wages remain stagnant; house prices fall; consumer defaults; too many consumers default, no one can get credit; stuff goes unsold. I think these processes are real and are aided by active decision-making about how our economy should be structured. Consuming less only works if you want to allow society to produce less, employ fewer, and so on. Inequality will cause ruptures in the economy regardless of the savings rate.
I disagree with the assumptions in this, Nick. Of course I’m a depression baby, but it still comes down to allowing the market to work. For example, you say that:
1- “interest rates are low, so banks and consumer lending facilities are happy to lend the money” Lenders do not make their decision on interest rates alone–or shouldn’t. Their major concern should be that the borrower is credit worthy and has ability to repay. If they give bad loans, they will have worthless paper and will have to write them down– as a CPA, I suggest that is the law of Annual Reporting requirements.
2- “median person reasons that s/he will have more money in the future and seeks out credit to buy stuff” The consumer should not count his chickens . . If s/he overborrows the price is foreclosure–always has been. Thrift and prudence Rule!
3- “producers are producing more stuff” It is up to each producer to meet demand. Harvard Business School cases are filled with examples of inventory control, production scheduling, etc. If they misjudge the market they will have to mark down the unsold goods–basic law of business
and accounting.
4- “median person has less money right now to buy this stuff, but wants to” That’s the story of my life-and everyone else’s! If you can’t afford it you don’t get it! Basic law of self-restraint.
To assume anything different, you have to assume all the businessmen, bankers, and consumers are foolhardy, reckless, stupid, and poor planners. Now many are, but that can’t be helped, except by better schooling. For those who err, they always used to pay the consequences. The more sensible ones survived and did well. We humans are largely motivated by rewards and punishment. If you find a way to guarantee rewards, and eliminate punishments, we will run amok!
The processes as I outline them are “real” also and are the way the economy has always been structured.
Your approach seems to assume that the vast majority of producers will overproduce, lenders will issue risky loans, and borrowers will run up unsustainable debt–kind of like our government. Instead of accepting that such folly is at least to some extent inevitable, you seek to solve it by reducing income inequality. The only way to do that is by some form of government bailout for those who need more money (I’d like some by the way)
If you give out more money, the imprudent will still borrow a lot–in fact they will borrow more than otherwise because they will quite rationally figure there’s more where that came from.
And is that justice to all those businesmen, bankers and consumers who were prudent and did not act so foolishly as to add to the bubble or crash?
Can any economy work well that is not based on justice?
The arguments agianst the linkage between inequality and debt bubbles are rather weak
1. Negative saving rate : This is the OVERALL saving rate , or the average , but if you analyze consuption and saving patterns by quintiles you will find that the prospensity to save in the higher stratus is close to 50% ( so the rest is negative,,, very negative
2. Record consumption fiugres : Another weak argument. The consumption is not “high” or “low” ( it sounds somewhat puritan …) by itself but should be analyzed in the context of investment and capital formation. Lets say, wouldn´t we like to live in an economy that permits a 99% consumption rate while a 1% saving rate is enough to maintain and improve our living standards? My case is that the test for consumption level is the capacity of the society to renew and improve its capital. America invests and grows, isnt´it?
3. In the American case there is another “tiny” component which invalidates the “too much consumption” :the huge current account deficit which enables american to consume without bothering too much about capital formation in the short run
4. Capitalism is global ( and is praised for it ) , so the analysis should be done on global scheme. Chinese save more than 25% of their income…. too much consumption???
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