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Larry Summers on Income Inequality

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Larry Summers has a remarkable piece in the Financial Times today, “Harness market forces to share prosperity.” It’s noteworthy not so much for the information, arguments, and recommendations Summers makes regarding rising income inequality, but for the line Summers takes. After so many years in the wilderness, it appears that liberals are finally regaining their equilibrium and reacquainting themselves with how to frame economic issues without sounding doctrinaire or anti-commerce.

Summers presents what most American business press readers would see as a pretty leftist position on inequality:

It can no longer plausibly be asserted that the income distribution is relatively static or that average wage growth tracks productivity growth. Indeed, in a recent paper on tax policy prepared for the Hamilton project, my collaborators and I concluded from Congressional Budget Office data that, since 1979, changes in income distribution had raised the pre-tax incomes of the top 1 per cent of the population by $664bn or $600,000 per family – an increase of 43 per cent.

By definition what one group gains from changes in the distribution of income another group must lose. The lower 80 per cent of families are $664bn poorer than they would be with a static income distribution, which works out to $7,000 less in income per family or a 14 per cent loss. To put this in some perspective, the total gain in median family incomes adjusted for inflation between 1979 and 2004 was only 14 per cent. If middle income families had shared fully in the economy’s income growth over the past generation their incomes would have risen twice as rapidly!

While the most recent data available for performing these calculations come from 2004, it appears that the trend towards increased inequality is continuing and may even be accelerating, and will continue even in years when the price of stocks and other assets does not rise abnormally. It also appears that these trends reflect far more than increases in the financial return from education, as the top 1 per cent of the population has pulled away from the rest of the top 10 per cent and the top 0.1 per cent has pulled away from the rest of the top 1 per cent.

Read what Summers wrote closely. The subtext is clear: class matters. He adroitly steers away from using value-laden words like “fairness,” but the picture of the middle classes left behind while an elite group reaps most of the gains (and by implication, an elite group that isn’t necessarily deserving) is one that anyone outside that top 1% finds unacceptable. And the more this story is told, the more support there will be for intervention (or more accurately, undoing the practices that have helped create this situation).

Now get a load of this:

What should be done? As is often the case in economic policy the answers are not entirely clear but probably lie between the extreme positions on offer. In the face of the experience of the past generation it is no longer credible, if it ever was, to argue that the goal of economic policy should be only to increase the size of the economy and that addressing questions of its distribution is populist or divisive. Given what has not happened to the pay cheques of average workers over the period of the information technology-induced acceleration in productivity and cyclical expansion, it is not plausible to suppose that policies that focus only on aggregate economic growth are sufficient to meet current challenges.

Equally, arguments that suggest the only way to raise the incomes of middle-class families is through measures to regulate business practices more heavily or to restrict increases in international trade are very dangerous. As much justified concern as we have about increased inequality, we need to recognise that it could be much worse if the economy had not been able to achieve the combination of under 5 per cent unemployment and sub-3 per cent inflation that we have enjoyed for much of the past decade. This surely would not have happened without the US economy benefiting from greater global integration. As western Europe’s long experience with unemployment rates that in some cases are more than double American rates illustrates, we would be taking great risks if, in the name of benefiting workers, we took steps that made production in the US less competitive in the global marketplace.

The right approach is activist but it embraces activism that goes with – rather than against – the grain of the market system. This is not a new idea. The enduring legacy of the New Deal is not the many measures taken to regulate prices or increase public employment. It is the measures such as securities regulation and Social Security that do not seek to oppose but channel market forces and mitigate their consequences.

This is brilliant. The status quo is unacceptable Heavy handed intervention is a bad concept. So what we need is a middle of the road approach like the enduring elements of the New Deal.

Let’s hope this piece is a sign that the Democrats are finding their voice again. It has taken a long time.

Below is Summer’s article in its entirety:

When I studied economics in graduate school a generation ago we were taught that it was a “stylised fact” that the US income distribution was very stable. We were shown that the fraction of the population in poverty tracked almost perfectly the performance of median family income over time and that productivity growth and average real wage growth moved together, with both declining sharply after the oil shocks of the 1970s. These observations led naturally to the conclusion that the main way of reducing poverty or increasing the incomes of middle income families was raising the rate of economic growth.

Today, we have another generation’s worth of data including the experience of the information technology-driven re-acceleration of productivity growth in the 1990s. This experience forces a reassessment of the earlier economic orthodoxy. It can no longer plausibly be asserted that the income distribution is relatively static or that average wage growth tracks productivity growth. Indeed, in a recent paper on tax policy prepared for the Hamilton project, my collaborators and I concluded from Congressional Budget Office data that, since 1979, changes in income distribution had raised the pre-tax incomes of the top 1 per cent of the population by $664bn or $600,000 per family – an increase of 43 per cent.

By definition what one group gains from changes in the distribution of income another group must lose. The lower 80 per cent of families are $664bn poorer than they would be with a static income distribution, which works out to $7,000 less in income per family or a 14 per cent loss. To put this in some perspective, the total gain in median family incomes adjusted for inflation between 1979 and 2004 was only 14 per cent. If middle income families had shared fully in the economy’s income growth over the past generation their incomes would have risen twice as rapidly!

While the most recent data available for performing these calculations come from 2004, it appears that the trend towards increased inequality is continuing and may even be accelerating, and will continue even in years when the price of stocks and other assets does not rise abnormally. It also appears that these trends reflect far more than increases in the financial return from education, as the top 1 per cent of the population has pulled away from the rest of the top 10 per cent and the top 0.1 per cent has pulled away from the rest of the top 1 per cent.

Public policy has been successful in cushioning the impact of these trends but in some cases, such as President George W. Bush’s tax cuts, has actually exacerbated them. Of even greater concern is the growing suspicion that gaps in educational access for children and in life expectancy across the population may well be increasing. The observation that trends of the type observed in the US are also observed in other industrialised countries – in particular the English-speaking countries – suggests that something quite fundamental is at work.

What should be done? As is often the case in economic policy the answers are not entirely clear but probably lie between the extreme positions on offer. In the face of the experience of the past generation it is no longer credible, if it ever was, to argue that the goal of economic policy should be only to increase the size of the economy and that addressing questions of its distribution is populist or divisive. Given what has not happened to the pay cheques of average workers over the period of the information technology-induced acceleration in productivity and cyclical expansion, it is not plausible to suppose that policies that focus only on aggregate economic growth are sufficient to meet current challenges.

Equally, arguments that suggest the only way to raise the incomes of middle-class families is through measures to regulate business practices more heavily or to restrict increases in international trade are very dangerous. As much justified concern as we have about increased inequality, we need to recognise that it could be much worse if the economy had not been able to achieve the combination of under 5 per cent unemployment and sub-3 per cent inflation that we have enjoyed for much of the past decade. This surely would not have happened without the US economy benefiting from greater global integration. As western Europe’s long experience with unemployment rates that in some cases are more than double American rates illustrates, we would be taking great risks if, in the name of benefiting workers, we took steps that made production in the US less competitive in the global marketplace.

The right approach is activist but it embraces activism that goes with – rather than against – the grain of the market system. This is not a new idea. The enduring legacy of the New Deal is not the many measures taken to regulate prices or increase public employment. It is the measures such as securities regulation and Social Security that do not seek to oppose but channel market forces and mitigate their consequences.

The challenge for those running for president of the US in 2008 – a challenge very different from that faced by presidential candidates until very recently – will be to develop a mandate for policy approaches that can ensure prosperity is more fully shared without threatening its fundamental basis.

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2 comments

  1. Tom Geraghty

    The notion that “liberals are finally . . . reacquainting themselves with how to frame economic issues without sounding doctrinaire or anti-commerce” strikes me as more right-wing propaganda than anything else.

    I mean, when objectively have US liberals evoked truly or anti-commercial ideas (at least since World War II or so)? Maybe in our heavily right-skewed political economy Democrats milquetoast critiques of the economic status quo can be labeled as “anti-business” or whatever, but come on.

    Oh, and have you taken a gander at any of FDR’s speeches from the 1930s? Some of them sound pretty “anti-commerce,” but it was pretty effective politics. I think some version of it still would be.

    You may be right that Summers’ light touch may be just the tonic to convince our economic betters that something needs to be done about inequality, but I doubt it. I suspect they are going to have to be dragged kicking and screaming, FDR style, into it.

  2. unlawflcombatnt

    Summers is only partly right.

    Here’s where he’s wrong.

    1) From a supply-side point of view, Americans need to produce something tangible of wealth, in order to have wealth to spend. Producing some type of tangible wealth is absolutely essential to sustain our economy.

    2) American workers/consumers must not only produce some tangible wealth, they must be paid for that production of wealth, in order to create the DEMAND necessary to maintain production.

    3) Current globalist/free trade policies work against both 1 and 2. Production is being shifted to low-wage foreign countries– reducing the wealth and wages Americans have to purchase production. The result is that American workers aren’t paid enough to maintain spending and the demand for production necessary to keep our economy afloat.

    4) The problem with Summers (still) pro-Globalist thinking is that he ignores the basic concept that replacing high-paid American workers with low-paid foreign workers reduces spendable American consumer wealth, and reduces the production demand that spending would have created. (Clearly credit expansion and easy borrowing have obscured this effect.)

    Replacing a $130/day American worker with a $2/day Chinese worker reduces American consumer spending power by $130/day, and reduces global consumer spending power by $128/day. In order for cost reductions to balance out the American wage loss, American prices would have to decline to the equivalent of that $130/day wage loss, or $128/day to balance out the Global wage loss. Clearly this is NOT happening. If prices were reduced to that extent, there’d be no motivation for outsourcing. By deduction, much of the American wage loss is going into the profits of American multinational Corporations.

    Loss of Aggregate Demand, especially the consumer demand component, is exactly what ultimately happened during the Great Depression. As unemployment increased, aggregate worker income declined, causing consumer spending to decline and production demand to decline. Substituting low-wage foreign workers for higher-wage American workers causes exactly the same problem. By decreasing American labor demand, it reduces both American employment AND average wages, decreasing the money available to fuel consumer spending & production demand, as well as aggregate demand.

    A more equal distribution of wealth is not just a social justice issue, a “fairness” issue, or an “equalitarian” issue. It’s an economic “growth” issue as well. If consumer spending is insufficient, it REDUCES economic growth. It REDUCES economic expansion. If consumer spending and production demand are insufficient, production declines as well. Production growth will not continue without production DEMAND growth.

    Excessive income inequality limits total economic growth as well. Without production demand, no production occurs. Without production, there is no increase in wealth. Maintaining worker/consumer income is absolutely essential for maximum economic growth and wealth production. Without the current increase in credit growth and consumer expenditure of borrowed money, our economy would have ground to a halt. And this debt-financed consumer spending is NOT sustainable. When this credit-fueled spending growth finally runs out, our economy will sink like a rock.

    Summers is wrong if he’s implying we only need minor changes. We need major changes in American trade policy for our economy to survive. Hopefully those in power will realize this before it’s too late. Only time will tell.

    Economic Populist Forum

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