New York Times writer Louise Story recaps a bold thesis put forward by David Moss of Harvard Business School, namely, that high levels of income inequality stoke financial crises:
The possible connection between economic inequality and financial crises came to Mr. Moss about a year ago… A colleague suggested that he overlay two different graphs — one plotting financial regulation and bank failures, and the other charting trends in income inequality.
Mr. Moss says he was surprised by what he saw….
“I could hardly believe how tight the fit was — it was a stunning correlation,” he said. “And it began to raise the question of whether there are causal links between financial deregulation, economic inequality and instability in the financial sector. Are all of these things connected?”
Professor Moss is among a small group of economists, sociologists and legal scholars who are now trying to discover if income inequality contributes to financial crises. They have a new data point, of course, in the recent banking crisis, but there is only one parallel in the United States — the 1929 market crash…
Even scholars who support the inquiry say they aren’t sure that researchers will be able to prove the connection. Richard B. Freeman, an economist at Harvard, is comparing about 125 financial crises around the globe that occurred over the last 30 years. He said inequality soared before many of these crises. But, Mr. Freeman added, the data from different nations is difficult to compare. And Professor Freeman says he has found some places, like the Scandinavian countries, where there were crises without much inequality, suggesting that other factors, like deregulation, may be the best explanations…
Margaret M. Blair, who teaches at Vanderbilt University Law School and is active with the Tobin Project, the nonprofit organization Mr. Moss founded a few years ago to study issues like economic inequality….is researching whether financial workers promote bubbles and highly leveraged systems, even unconsciously. Ms. Blair said that because financial bubbles often lead to higher returns, financial workers have the potential to make more, and this pattern can influence their trading strategies and the policies they promote. Those decisions, in turn, drive even greater income inequality, she said.
Yves here. This is intriguing, but I am inclined to believe that income inequality is either a symptom of conditions that can produce bank crises (like excessive financailization of an economy) or a secondary contributor. If you simply look to Minsky’s theory of financial instability, a rise in what he calls speculative units and Ponzi units would benefit leveraged speculators, and shift incomes and wealth away from ordinary workers to those who can attach themselves to capital. Carmen Reinhart and Kenneth Rogoff similarly found a strong correlation between a high level of international capital flows and more frequent financial crises. It isn’t hard to imagine that large scale international capital flows would be associated with the prominence of large international ventures which again could distribute a lot of winnings to a comparatively small (in societal terms) number of beneficiaries. The article also mentions deregulation as a possible prime cause. The neoclassical experiments with radical deregulation, such as Chile and Russia, witnessed plutocratic land grabs, rising inequality, and economic upheaval.
I’m curious to get reader views on where income inequality fits among the factors that generate financial meltdowns.
Things are coming full circle. There was a belief during the Thirties that income inequality in the Twenties led to the economic collapse of that era.
Is it the prime cause? No. But it’s a contributing factor often enough that you can question what should be done about it.
Unequal wealth concentrations are invariably used as weapons against those who are economically weaker and against the public interest as a whole (so they’re never “neutral” or “innocent”, the way the textbooks fraudulently claim).
In the question at hand, this concentrated wealth is deployed to buy deregulation to free itself up even more. Yet at the same time, in the classical contradiction of capitalism, the more wealth concentrates the fewer productive investment outlets it can find, and the more it’s forced into ever more destructive speculation, including the global capital flows described above.
I don’t know which of dereg or global financialization is a greater proximate factor correlated with financial crises. The deeper cause is always the mismatch between production (including the false “production” of bubbles) and consumptive capacity.
Wealth concentration’s role here is dialectical. The original accumulation empowers it to aggressively seek to further concentrate itself by making ever more destructive “investments”, which in turn concentrate it further and further empower it.
Everybody knows crisis is hardwired into this vicious circle, so as the speculator willfully helps generate the crisis conditions and hastens the crisis itself, we can say he intentionally causes it. And since the 50s neoclassical economics has been ideologically clear that crises should be intentionally triggered and exploited as just another tactic of concentration, disaster capitalism.
We’ve just seen the textbook play – the looting process was getting bottlenecked, the bubble had to burst, so the elites intentionally triggered the crisis (by which I mean, they knew it was coming as a result of their continued course of action, they acted to hasten it, and were fully prepared to exploit it) with the full intent of using it as the pretext for the Bailout, the next stage of looting since looting-via-bubble had run out of room.
“Austerity” is then the next stage of robbery as the Bailout and its own bubble reflations (like stocks) become insufficient to keep up the requisite looting level.
In all of this, the overwhelming imperative for the elites is to keep concentrating wealth and power. They will not and cannot stop until they’re forcibly stopped.
“the more wealth concentrates the fewer productive investment outlets it can find, and the more it’s forced into ever more destructive speculation, including the global capital flows described above.”
Theory of OVERACCUMULATION [Marxism-101] coupled with the falling rate of profit in the productive forces of production makes for a “crisis” attributable to speculation. [Monthly Review has harped this theme for years.]
More importantly it attests to the “postscarcity” [excess capacity] threshhold that we have crossed. Without the massive infusion of credit witnessed by the growth of the shadow banking system since 1980 to facilitate the consumption of this “overproduction”, we would have likely experienced this crisis much sooner. Now capital is engaged in a scorched earth policy to eliminate excess capacity in “saturated” markets – the WEST – to return to a “natural equilibrium” more consistent with an artificially-induced scarcity to maintain profit margins.
A distinction must be drawn between voluntary behavior by individuals to reduce mindless consumption – a good thing – and that orchestrated by capital to impose this reduction in the consumption of public goods – full employment, quality PUBLIC education, affordable health care, fully-funded pensions, and a much-needed upgrade of PUBLIC infrastructure – via AUSTERITY – a bad thing. Many a “willing penitent” fails to make this distinction, failing to see how ecology and environmentalism can be manipulated to facilitate AUSTERITY.
To the extent that CAPITAL maintains the upper hand this crisis of overaccumulation will persist as avenues for productive investment [enhancement of public goods] continue to diminish, making the confiscatory appropriation of the aforementioned PUBLIC goods the only source of additional capital accumulation. In such a scenario [worked out initially in the “periphery” via IMF, World Bank,], the democratic institutions taken for granted by many of us have no place as the STATE is merely the authoritarian hammer of the capitalist anvil.
Capitalism has contradictions. It is a system which promotes micro efficiency and macro waste.
“Unmitigated” capitalism brings about each of:
– financialization, with the potential of financial crisis and depression
– arrogant New Yorkers
I think inequality , excess financialization , and gov’t policy promoting both , are self-reinforcing. Positive feedbacks occur : increased financialization increases the polical clout of financiers as they come to represent a growing portion of the economy ; this clout also results in tax policy more and more in favor of the rich , contributing to growing inequality ; inequality means workers have to work more hours to maintain some semblance of progress in their standard of living , and more workers and worker hours reduces their ability to command a fair share of wages ; unions are busted to further favor capital over labor , making wage gains even more unlikely ; concentration of capital at the top contributes to hot money flows as productive areas of investment are reduced due to sagging demand from the increasingly stressed working class ; workers readily take on debt as a way to compensate for their difficulty in maintaining a decent lifestyle , and the piles of hot money in search of yield , combined with finance innovations enabled by captured legislators and regulators , provide an endless supply of that debt ; much of the debt flows to consumption rather than to productive enterprise , so no basis for sustained growth or higher wages is established , and soon , it’s Ponzi Time.
These are some graphs that show the identical patterns in inequality , top marginal tax rates , savings rates , financial deregulation , and relative pay in the financial sector , going back to the early 1900s :
Relative financial wage , deregulation , and top 1% income shares :
Savings rates and top 1% shares :
Top marginal rates : ( imagine this one on an inverted scale , to line up with the others )
or here you can see top rates and top income shares together :
I don’t see the question of what came first as too important. Once the philosophy of laissez-faire and trickle-down was widely adopted , the outcome was a foregone conclusion. We went through this process prior to the Depression , learned from it , and created a stable , just economy that worked just fine for about 40 years , even without the help of financiers and all their crises.
The fact that we’re even debating the issue today shows how completely we’ve unlearned that lesson.
I think there are a couple of things to add here but I agree with most of the above. First it is quite odd to just speak of inequality as a concentration of capital, it is also a concentration of power both in the softer social, control over or framing of dialogue, as well as in the control over the monopoly of force and regulatory body (eg the government). In addition, how can we not consider advantages including the ability to obtain extreme amounts of leverage and extremely low interest rates a type of inequality itself. All manner of advantages in the a playing field are parts of inequality and they provide positive feedback in the process of accumulation.
So here comes the argument that relatively equal countries (based on GINI coefficient) like Germany, Japan, Iceland or the Nordic States had financial crisis therefore inequality’s link to instability is suspect. While there wasn’t a real concentration in capital, there was certainly a concentration in power, and access to leverage. The notion is not that capital simply accumulates amongst a specific concentrated good, but rather that power (as mentioned above) accumulating in a few hands is equally instrumental in creating instability. Furthermore, many of those banks in the more equal countries were in the process of replicating the style of banking from less equal countries in order to survive in an increasingly international banking system. They were subject to the softer form of concentrated power, a control over dialogue.
Now in the case of external capital flows as being a forcing mechanism for speculative behavior. What portion of these capital flows are the result of inequality in China, Russia, and Arab states? I think there is a case to make that accumulation and concentration of wealth in developing/emerging countries as well as resource curse states lead to many of these external capital flows.
Inequality and a certain level of power concentration probably isn’t bad in itself, but within a system with positive feedback these phenomena are self-reinforcing.
To add apologetically,
How does GINI coefficient or any other measure of inequality capture the levels of corporate concentration in the banking, agriculture, mining, telecommunications, media, or any other sectors for that matter. That can also be characteristic of inequality as we have massive market control by a few corporations.
Those corporations have certainly affected the regulatory sphere and instability as well, by purchasing significant amounts of derivates as hedges against changes in commodity prices, as well as paying inflated wages to their upper echelons, adding to the deregulatory fervor in the halls of government, controling massive amounts of market share, supporting the deregulation meme through PR effors, or opening their own trading operations (eg Cargill).
None of this is encountered if we speak of inequality from a strict sense of wages or wealth.
Both Sweden and Finland suffered serious financial crises in the early nineties and these are the two most egalitarian advanced societies on earth. I think since there is so much income inequality in other societies and there are so many financial crises that the two elements just become linked in some peoples minds. But if Sweden’s GINI score in the low 20’s was no defence against a crisis then the answer lies elsewhere.
But there are obviously other reasons why lessening income inequality is a good thing.
Collapse of the USSR definitly affected Finland in early 90th. So case for the crisis was to a certain extent external.
But that does not explain the simultaneous crises in Sweden and Norway.
While the collapse of the USSR may have had an impact, bad loans and deregulation of the lending industries probably played a bigger role.
Moss is way late to the game. Just now “discovering” that income inequality can lead to a substantial decline in aggregate demand during financial crises is akin to Barro and Fama “discovering” the thoroughly discredited Treasury View. Yeah, they did it, but it was because they never learned their economic history.
Just today I ran across several people who made Moss’s “discovery,” but did so years (if not decades) before.
Moss should chat with Michael Hudson.
By the way, I just recalled that many believe that Lord Keynes himself made Moss’s discovery. In 1936. That’s the whole point of giving money to people who have a propensity to consume (as opposed to hoard).
I’m relying on Story’s account, so she may have misrepresented Moss, but I don’t think you are addressing his point.
The Great Depression, the Japanese post bubble period, and potentially our current crisis (with a much greater lag if this does take place), saw the initial financial shock, a period of stabilization which many observers took as a sign that the worst was over, then a real economy leg down as the demand effects took hold.
So I don’t see financial crises as a result of deficiency in ag demand, unless you are suggesting that leverage is used to remedy that and leads to the blow up. That is arguably the case in the crisis just past, but Moss is looking over a much larger data set. You could argue that for Japan too, but for the US pre Great Depression and other crises? I’d need to see the fact sets.
I can’t give you a set of facts. I do make the following assertions: The inequality of income and wealth distriibution is a profoundly instructive resultant condition. The question is: How did the inequality come about?
In the case at hand, we can look to political actions taken in the name of furthering the general welfare of the public. It generally begins with the Full Employment Act of 1946. That act has been followed by a series of deregulation and income redistribution taxes that have required an inflation of the money supply. A notable mile stone was going off the Bretton Woods agreement which ratified the accelerating debasement of the currency.
The resulting loss of purchasing power has led to the reduction of the numbers and wealth of the middle class. The persistent erosion of purchasing power has operated as the incentive to seek yield. Yield seeking has led to financial innovation, most of which is sufficiently opaque in character that rent extraction that might otherwise be seen as theft is seen to be ‘good’ business and best left unregulated.
The march to ‘free’ markets is a symptom of this yield seeking endeavor which, if the participants were thoughtful might, give them pause. What they really wanted was a fair market and not some canard of a free market. Or perhaps maliciously, they want the opacity that enables their theft mechanisms. The free market rationale is founded in the canard that markets are virtuously efficient, self regulating and that markets will internally punish those who commit fraud.
I am confounded by the fact that as markets are the construct of people, is it not reasonable to expect that markets will reflect all the foibles, folly and fraud the people can conceive? Speculations as to Gausian or Bayesian probabilites are pointless. In the arena of human endeavors, normal distributions do not exist and when you find one please show it to me. I don’t know about black swans, but floods do occur more frequently than once every 100 years in areas that are designated as lying in 100 year flodd plains.
What I worry about is the fact that the middle class is being destroyed and that we are moving toward a have and have not social structure. I worry that there continues to be this enormous global standard of living arbitrage that is operating to extract wealth and globally reduce the middle classes. The balancing of the global standards of living are central to solving the economic problem that we are living in.
There are certain limitations to growth. Water, arable land, and sustainable energy. Fair prices tend to be very effective in allocating resources. Tending to effective and achieving an equitable distribution are two very different propositions. A fair price system demands that the money medium have a stable purchasing power and that does seem to support a middle class and therein a partial solution.
A further requirement would be that there be class mobility. The US has been a country to go to very much because that while we did that a social class structure we did have the rule of law and class mobility. Today, mobility is becoming more difficult in than the determinants of class are generally accepted to be income, education and family standing. Get an education get a well paying job and family standing tends to only impede movement to the upper, upper class. Getting and keeping a well paying job has become problematic. While staring wages are often fair, keeping up with the persistent loss of purchasing power has operated to outstrip what was once the enabler of class mobility.
The European Economic Union is an interesting experiment and yet even it is confronted with the disparities of living standards as evidenced by Greece, Spain, Portugal and Ireland.
The fact that there is much written to point that Greece is disadvantaged by the fact that it can’t unilaterally debase the currency is telling. Debasement is not a solution it’s a form of theft. Similarly, quantitative easing is an admission that the problem is that the purchasing power of credit money is too small. The purchasing power of credit is too small precisely because there is too much of it. Or easy credit leads to its own destruction.
The fact of ZIRP whose purpose is to create an artifical interest rate arbitrage for the banks is telling in its meaning and intention. The banks are using it as intended to extract rents where none might otherwise be available. Investment firms are not rebuilding retained earnings they are paying artificial profits out as bonuses. The write off of worthless assets is far from complete and businesses are loath to rehire because they simply don’t see the demand for product and/or service.
The great fiat currency and reserve banking experiment is a monumental failure. Someone should have listened to DeGaulle, while he wasn’t entirely right he did have a very important point.
What we are experiencing is a currency and balance sheet collapse. The inequality of income and wealth distribution are resultants of the failure of our fiat currency, fractional reserve banking system, a central bank that inflates at any and all opportunities and a government that continually seeks to increase its command of the economy and the polity.
I think lack of aggregate demand has an indirect and therefore not so visible effect by working through investment. It seemed to me (no numbers here, just impression) that a lot of the run into financial instruments in the 00s was due to lack of adequate investment opportunities elsewhere.
If aggregate demand is down (because of wage stagnation) but investment for meeting that demand is also down, we won’t see the oversupply. (Although one could make the case that the oversupply shows up in China and holds down/drives down prices for importable goods).
I don’t know how one could measure this though.
Then again, the worst problem with economics as a body of thought and our economy is a “look under the lamp post because that is where the light is even though I dropped my keys on the other side of the street” tendency to emphasize what can be measured in numbers and devalue what can’t.
Aggregate demand was the problem in this economic crisis. Americans went into debt too much. Savings rate at 0.03% Manufacturing jobs were being lost during the bubble because the credit was being sucked in by housing. In the 1980’s commercial lending was king. Low interest rates, and government assistance created a mania in housing which resulted in overbuilding of housing with artificial demand. Securitization is the result of low savings rate in fractional reserve banking system plus the consumer is going after housing. This is why foreign money flooded the market instead of American money. For an american would have to save for another american to get a mortgage. Savings were being squandered, and home equity was being squandered as well to buy things. Aggregate demand is meaningless, and is infact responsible for the the economic demise. Of course with the economy is busy consuming, squandering wealth, it is at the same time destroying wealth, because much of the money is not involved in wealth generating production.
Slight correction savings rate was at -0.03 according to official government statistic.
Yves, do you have a link to the Story piece?
Your points are fair ones. My initial reaction to the excerpt was that Moss is really on to nothing new there, at least with respect to correlation between income inequality and financial crises. I cannot recall if others have went farther and asserted causation. I do think that the financial deregulation is something of a red herring because there may have been no regulation in the first place. I’ll keep an eye out for what you’re looking for, though.
Robert Vienneau had a post about income inequality last month with a link to a paper that has a lot of interesting data:
And Michael Hudson’s latest missive is a very interesting look at the current FIRE sector in historical context (with a bit of Marx thrown in):
Money quote from the conclusion:
“Finance capitalism has become a network of exponentially growing interest-bearing claims wrapped around the production economy. The internal contradiction is that its dynamic leads to debt deflation and asset stripping. The economy is turned into a Ponzi scheme by recycling debt service to make new loans to inflate property prices by enough to justify yet new lending. But a limit is imposed by the shrinking ability of surplus income to cover the debt service falling due. That is what the mathematics of compound interest are all about.”
His papers on the Mathematical Economics of Compound Interest have some good insights, as well.
My intuition is that whether income inequality causes financial crises depends entirely how that income inequality came about. If it came about because of a predatory financial sector, income inequality will be a proximate cause.
If you treat the same set of people as both a commodity (labor) and the golden goose (consumer), a financial crisis is inevitable. You cannot expect to drive down real wages while driving up debt burden forever. At some point, everything blows up.
Here’s the link, also put it in the post, I neglect to put in links too often, apologies:
No worries. Thanks!
“..with Michael Hudson.” (which should be obvious to EVERYONE!)…
And Pickett and Wilkenson’s The Spirit Level,
This is such an obvious no-brainer: unearned wealth is the major cause of poverty — monopolies on land, capital and knowledge, and today with BankofAmerica’s Monsanto, the ultimate monopoly, the monopoly on life itself — are the drivers.
The more (artificially, as always) concentrated wealth, the slowing down, or lack of, true progress.
There can also be a loop with income inequality causing financialization:
Income inequality -> Inadequate effective demand in non-financial economy -> Inadequate investment opportunities in non-financial economy -> Investment flowing into financial “creativity”
You and me Jessica. You and me all the way. I think that you put your finger on the connection between instability and inequality.
Inequality opens the door to debt transfer from the fortunate to the unfortunate, but interest of debt service transfer to the fortunate. Inequality feeds debt feeds debt service feeds inequality. This recursion continues in Ponzi Sprint to the point of the Big Bang of deLeverage with a large scoop of bankruptcy and a side dish of deflation. Collapsing price structure, unconcealed by token attempts of monetary and fiscal inflation adds fuel to the profits of the short seller thus feeding more inequality.
Please don’t tell me you are one of those mindless cretins who believe that 4% home mortgage default rate brought down the global economy?
Less brain, less pain. No brain no pain.
Mortgage default is a three way zero sum. The debtor losses equity. The creditor looses profit. The court system brings home the bacon.
Did the bailouts prevent the court system from bringing justice to the failed fraudsters. Were the bailouts unconstitutional? Was the bailout a rather obvious cover for the fraud intertwined throughout or government-banking-oligarchy? Does that fraud retain the noose-hold on the necks of each tax payer and inflation payer in this country, plus expatriates, plus our overseas investors, customers, and suppliers? Was the bailout type of cover for the banking fraud the culprit which brought down the confidence which otherwise underpins our market system, desperately seeking free-market-status, desperately seeking justice?
U B Judge!
U B Thurgood
No way does income inequality cause financialization.
Read your economic history and socioeconomic history.
Read Prof Hudson’s latest talk,
(Beyond brilliant, BTW!)
Financialization is about the creation of debt-financed billionaires and the “socialization of risk” and “regulatory capture” — stuff, in the olden days, we labelled high crimes worthy of the noose.
I think it hard to separate sentient, cooperative group behaviors from coincidence, science does not like coincidence. IMHO patterns can be found in everything if you look hard enough.
Wilkinson and Pickett have looked into income inequality in their book The Spirit Level and have made many startling correlations between what ails society and the income gap. They highlight the Scandinavian countries and Japan where incomes of the top 20% only double those of the bottom 20%, whereas in the US, the UK and Portugal that difference is up to 9 times greater. There work has been politicized of course, with the left nailing their observations to the flag pole (the former Labour foreign secretary Jack Straw took it on holiday and Michael Gove, the education secretary, said it was “a fantastic analysis”) while the right have lambasted the book. Christopher Snowdon from the Taxpayers Alliance does not believe that The Spirit Level’s claim that the psychological effects on society of income inequality are so great to cause widespread social ills. “I don’t think people outside the intelligensia worry about inequality,” Snowdon said. “The working class don’t worry about how much Wayne Rooney is earning.”
If you decide to challenge long established and entrenched ideas that threaten the status quo be prepared for the backlash. I get flustered and defensive when my belief system is challenged and so I tend to hang out with people with similar ideals, to my detriment. I am trying to step outside of my box.
Here is the full article.
Galbraith argued something like this, in The Great Crash. From memory, the argument was that the working population was unable to afford the goods they as a whole were making, and this led to lack of demand. If I recall correctly, he mentions this in connexion with ‘profitless prosperity’. He talks about a phenomenon in 28-9 of high economic activity but no profits.
His implication seems to be that if only there had been some means of increasing salaries, the crash would never have occurred. So the argument is for strong unions and labor market regulation. It is of a piece with the rest of the argument, which seems to have as a subtext that the bubble occurred because of an excess of greed.
The counter argument, which you find argued in Rothbard, is that falling or static real wages in the middle of apparent prosperity is what always characterizes a credit bubble. It is the credit bubble that causes the static wages, and it is the inevitable bursting of the credit bubble that leads to the crash.
If you accept that, you look for the cause of income inequality in the credit bubble, and find it readily enough, since a credit bubble delivers enormously raised levels of financial transactions, and therefore delivers rewards and employment to those engaged in them. This is a form of malinvestment. There is too much credit around, and the finance sector gets to be far bigger than either the manufacturing or service sector requires for purposes of investment and day to day cash management.
You then get to the next step, which is the argument about what caused the crash to be followed by a depression…
Say’s Law (Jean-Baptiste Say) and the Law of Supply (productivity) and Demand (wages).
Rather obvious…..only the crooks would foist “supply-side ECONNEDnomics” on anyone.
Rothbard’s sayings couldn’t be more prophetic. During the housing bubble, wages did fall. Manufacturing declined consistently. It was a credit expansion pure, and simple. Bernanke actually misinformed people during the couple of years before the bubble bursting that housing bubble was a result of higher wages, etc. Coincidently he even mentioned low interest rates. It was a consumption binge on debt. Pure, and simple.
I thought it was the exporting of jobs (finally, something we have been better at than the rest of the world) that led to both the income inequality AND (using debt to hide the head in the sand) the financial crisis.
That’s just an opinion.
That’s an excellent point and part of the equation:
(1) Export jobs and bring in foreign scab workers, plus,
(2) Leveraged buyouts by private equity firms to rape and pillage companies, destroying them and their jobs, plus,
(3) Massive peddling of securitized debt.
The three jackasses of the apocalypse,
Please send all contributions to:
American Friends of Bilderberg, Inc.
c/o James Johnson, Perseus, LLC
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Any chance the flooding of the USA with tens of millions of uneducated peasants has also contributed to “income inequality”?
i think income inequality is a secondary effect of the boom process (lending picking up and resulting in higher leveraging and increased income share to capital). the inequality is a symptom, not a cause. for those who think it is a cause i ask you this, do you think transfer payments to the poorest proportionately from the richest in an attempt to make everyone’s income as close to the mean as possible would eliminate financial crisis? i am certainly very to the left on most things but i’m having trouble finding a causal link that doesn’t first go through other processes (like rentier and interest income)
Clearly the causality here is
deregulation -> financialization -> income inequality
another branch is
deregulation -> financialization -> minsky bubble crash
the two leaves of the tree are not causally connected
If those on the low end of the income inequality problem attempt to gain ground through the use of speculation, there would indeed be a causal relationship not found in your two branches.
Something like this:
income inequality -> speculation by low end -> more bubble
The difficulty with the deregulation argument is logical: mostly what is actually meant by ‘deregulation’ is not the abolition of regulation, but the substitution of a different set of regulations. In the case of the twenties, Galbraith argues basically that we had a boom caused by greed, this greed operating to the disadvantage of ordinary working people outside the finance sector.
The problem with this account is Rothbard’s demonstration, which seems ironclad, that the underlying cause was the increase in lending power caused by the changes which accompanied the formation of the Federal Reserve. This was not deregulation in any sense, it was simply a change in the applicable regulations, one made by the Federal Government, and the result of which was to lay the basis of the subsequent credit bubble.
It is true that there is a relationship between what we wrongly call ‘deregulation’ and the growth of income inequality. But the reason for this is that what we call deregulation is no such thing, it is the positive intervention of some government to create a credit bubble. This then leads to growing inequalities of income not because of some exploitation of workers by capitalists. Rather because some sectors of the economy, both working people, asset owners, managers, all profit differentially during credit bubbles. Those sectors which handle credit and move financial instruments around do very well, whatever their social class. Those who work in manufacturing or service industries do not do well.
A second problem is the Austrian question. The Austrians ask why it is that managers (including finance sector managers) make sensible and prudent decisions for year after year, and then suddenly appear to go mad. Why? It is the twenties we are talking about, so Prozac is not a candidate. Their answer is: the madness is actually a rational response to the conditions they see, under the very important condition that the conditions they see are the result of normal economic cycles.
What kills them, and makes them behave with what in retrospect is total insanity, is that the conditions are not the result of the business cycle, but of the government inflating a credit bubble.
Not only do hitherto sober managers go mad, but they all seem to go mad at once and they go mad in the same way. “It’s a party, and it’s free!”
I am not even sure managers had a choice but to “go mad.”
If, say, Dick Fuld, loathsome as he is, had announced in early 2007 that Lehman would reduce its net leverage, get out of the business of securitizing dubious assets and sell out of any position that smelled of subprime or CRE, Lehman shareholders would have demanded his head, if the Board did not beat them to it.
For added irony: doubling down turns out to have been a rational decision so far: those firms that survived have managed to keep their profits and socialize their losses through numerous front- and back-door bailouts. No criminal charges have been filed so far.
Happy days are here again (for arrogant New Yorkers).
The financial crises derives directly from the debt-financed billionaires peddling securitized debt (ultraleveraging based upon debt, and ultraleveraged speculation based upon debt).
Which was a colossal, historically epic, transfer of wealth from everyone below the super-rich, to the super-rich.
What’s so difficult to comprehend?
I just posted a comment at the bottom of
the main list that might be
relevant to your last remark.
I think a) the economic goal of most sane people in society is financial stability. b) The restrictions placed on the economy in the name of stability close off some opportunities for a tiny minority to get their hands on the product of the majority’s work. c) To re-open those opportunities, the criminal minority work to dismantle the restrictions, hence d) increasing inequality, but followed by e) financial instability.
So e) is a side-effect of the sequence of events b)-d). Not even the criminals really want it to happen, it’s just that criminals aren’t very good at thinking through the consequences of their actions.
it is a good argument, that deregulation leads to instability. It is captured in a generalized minsky argument. Namely since reagan, the ethos has been to deregulate. Some good things have come out of it (most derivatives use) some bad things have come out of it (some derivatives use). Clearly the minsky cycle of debt bubble was left to run wild because macro monetary theory was considered a defunct academic pursuit. It has come back to haunt us. Again, income inequality is a facet of it at least in US and UK (as noted deregulation does not lead to inequality in other countries).
Somebody should look at the income distribution of mortgagors, comparing the beginning and the end of the volume boom. That should provide key data.
Galbreath noted this in the Great Crash. It’s not a new theory.
Also, puffed up asset values become essential to ‘rising prosperity’ during periods of extreme inequality. This is why the #1 objective of Bernanke and Co is to prop up the stock market and housing.
It seems to me that income inequality is the *intended* result of the behaviour that leads to the crisis.
if professor Black is correct, then the whole reason for making (and allowing to be made) lots of really bad loans is to create short term profit and take home a LOT of money in bonuses. That creates income inequality, because you got a giant chunk of income. That was the whole point.
It also causes a crisis, because the loans are not going to get paid back, but only later, and the agents who behave like this are personally indifferent to that.
I think there is potentially a link in the way the money system works.
We all know that most of our money is ‘credit money’ that comes into existence when a loan is made, typically secured against assets.
You can end up with extreme concentrations of wealth like we have right now. Being a mirror image of debts, such an extreme inequality would signal overindebtedness of a large part of the population – the mirror image of wealth.
The ‘inequality’ of incomes and assets reflects an imbalance in trade between people (think Germany and Greece or China and America – the principle is no different). How do you restore balance – there are options: inflation, default, taxes or re-balancing ‘trade’ through earnings.
Unfortunately, with the very wealthy doing their utmost to avoid the re-balancing acts of either paying taxes or sending more than they earn, we are left with inflation or default. Choose your poison.
I don’t know what the effect of income inequality is on the larger economy, but it seems no one is bothering to examine the period AFTER the crash for evidence of equality. If the disparity was so great in the 20’s that is caused the Crash and Depression, was there a period afterward when things returned to a level of equilibrium? You could argue that the 50’s and 60’s were a boom time for the middle class, but was that really at the expense of the the upper income levels? Or was the growth in the American middle class due to an unsustainable increase in American exports while Europe and Asia were rebuilding post-WW2?
Economic charts are useless, they describe events that have already happened not their cause. A map of Greenland describes Greenland, that is all, the origin of the island, its evolution, lie well outside cartography.
Income inequality is based on the impossibility of Universal Profit. Private Profit is seen as being the same as the universal one but what we call profit, that is private profit, consists in the transfer of wealth from one group to another. Then there is a group that accumulates and another that is deprived. The deprivation must be continuous in a stable society, therefore the deprived society would eventually disappear together with the accumulating one since both are in a mutual relation. Let’s remember that property is liberty itself it is concrete freedom and freedom then is the same as life. According to Spinoza the aim of all beings is to continue existing and their mode of surviving is their essence. The “crisis”, the mode of capitalist survival, consists in the realization of the fact of deprivation and accumulation. Both sides fear their respective destruction and the process of surviving is the “crisis” There is no need to invoke morality in this problem. The nature of the relation between deprivation and accumulation sustains the historical society and transforms it. The vicissitudes of history are all in there.
I am trying to follow your logic and I don’t understand. Can you rephrase it?
My point is that accumulation and deprivation are mutual. The disappearance of the deprived part of population would mean the disappearance of the accumulating part. Both parts realize their danger. For the deprived it is an imminent danger, for the accumulators it is a danger once removed. They don’t die because they are momentarily sufficient but their sufficiency is based on the existence of the deprived, therefore both aspects of society perceive the near danger of extinction and they try to extricate themselves from it. This is what is called a crisis. As one may see the crises are the very essence of the system. The system advances and persists thanks to the steps taken to resolve the crisis. What is normal for capitalism is the crisis. The interludes are simply the slowly gathering elements of the crisis. Sorry if I am obscure but my fundamental view is that every thing that happens is rational and independent from morality.
I recollect income inequality being proposed by Raveendra Batra in “The Great Depression of 1990” as a reason for the 30’s depression and the new one to come in 1990. He was off by 10 years. I put the start of the current depression when the dot com boom crashed in 2000, and the remedies of the bush administration postponned and exaserbated the current crisis for which this is part. And if you think about it, we were in a very deep recession in 1990 that was also solved by greenscams remedies of juicing up the economy with low interest rates and debt. We also were in the midst of our first banking crisis in 1990. It seems to me we are at this inauspicious economic moment because of fiscal remedies persued since the downturn in 1990 and only amplified over time to continue the economic miracle.
The only thing surprising about this conclusion regarding wealth concentration it that it’s taken economists this long to figure it out.
It “came to Mr. Moss about a year ago…”
Forgive me, I come from the world of the arts and grunt labor and have been getting more involved with this stuff because of my background in cultural anthropology and the project I’m working to advance.
The relationship between de-regulation, wealth distribution and stability is a very old one.
In fact, it can best be viewed when its understood that the roots of civilization lie in individual and group decisions. Quite literally… down to the most insignificant decision of which side of the bed to get out of.
And like, the weather… its impossible to predict too far in the future though you can certainly see large things developing.
Wealth concentration must be understood within the context of money’s vital but also critically flawed role as a measure, store, and allocation mechanism for ‘social energy’.
In a healthy, ideal, “Adam Smith”-type economy… someone does something productive for the whole… he ends up with extra ‘social energy’ coupons. The idea being that he gets rewarded and everyone benefits… and then he move on to the next good idea for the town.
However, scale has interesting effects on group decision. This is largely related to issues of proximity… (social, physical, phychological, etc.) and Dunbar’s Number (natural human community size).
These two factors… (proximity and natural human community size) relate to biological altruism.
This affects decision mechanisms (an impossible to overcome ‘decision bias’ which will not even by recognized by those so biased.)
It can actually get to the point that they think an “investment” is lending someone money to go to the town casino and buy cocktails… and that so long as they’re getting a ‘usury fee’… they think they’re investors and that the town is somehow richer!
You gotta be pretty disconnected from your own town to think that way…
Here’s an example of how it affects decision (in my opinion)…
Let’s take the “Globalization bias” of the political/financial elite.
It’s not without good rationales and at root is a natural evolution towards a more integrated world… (however their image of national ‘specialization’ is flawed… the need for resiliency suggests a different model… but that’s a different, though related discussion about things like the de-ruralization of Haiti and the role of International capital in that sort of stupidity.)
But here’s two biases that I believe shaped the ‘elite’ mindset of how this process should proceed…
They had very good, solid reasons to “know” that the process would be very profitable for those already at the top…
But as for an existing American middle class (and poor) belonging to the same ‘social organism’? How this was to play out somehow not so clear to the elites… there were arguments that we’d end up with “better jobs”…
They couldn’t be sure… which leaves room for bias without any need for conspiracy… (though I have no doubt at all that there were quite a few A-bites who knew exactly what was going on… the front-men may just be extra stupid and/or gullible)
Frankly I think it took a good deal of mutually-supported cognitive dissonance (around the golf course) to not see where it would go… but they managed to pull it off… and even convince the American public… (accidental control fraud?)… who relied on their thoughtful, well-dressed leadership.
In other words, it took NO conspiracy… but it DID rely on an increasingly isolated ‘decision sector’… You still see establishment bozos trying to tell us how great their globalization model is.
And this has to do with how the boundaries of biological altruism affect decision is scaled social organisms without mechanisms to ‘interrupt’ or prevent that isolation of decision.
These mechanisms need to be designed… and frankly continuously monitored… (see David Brin’s work on Transparency… and ideas regarding regulation from the bottom-up).
My development, I believe, is also one such vital tool.
Political Fundraising: Act Blue, Facebook and the Missing Network Imperative
And a brief thought on the tragic role of Objectivism on national policy:
Ayn Rand & Alan Greenspan: The Altruism Fly in the Objectivist Ointment
(got 60 hits yesterday on this one from zerohedge alone! I hate being a self-promoter but no one else is gonna do it and I think its important stuff with practical implications which are uncomfortable for the status-quo… at this point what can I lose… my house?)
Tell Mr. Moss he sounds very bright and I agree with his conclusions. However also let him know that we can’t be waiting for economists to catch up to reality.
Charts and graphs are great. But you don’t actually need one to see this relationship.
A scaled social organism… all by itself… profoundly distorts group decision… (especially one with an idiotic Ayn Rand bias running through it)
BTW, I could use a job… this would be a good one for me!
Put me on some corporate compensation committees for a whole different perspective (call me the Paycut Czar for the elite with sound scientific reasoning):
Compensation and the Social Network
I promise… I can fake it with the best of ’em.
“Does Income Inequality Help Cause Financial Crises?”
Does a cat have an ass?
Is a pig’s pussy pork?
Does ice cream melt on a hot side walk?
Income inequality is a product of deception.
Accumulated asset wealth and income stream is always a product of the success of past deceptions — the aggregate generational deceptions that have created the tilted playing field — coupled with the creation of the present day deceptions.
It is always a contributing cause of financial crises.
Brainwashed Horatio Alger type scamericans, content with their deceptively gained excessive crumb share, have a very hard time getting their heads around this concept, and so, lost in the deflective details of denial set out for them, they prattle on about; ‘free markets’, ‘private property’, ‘capitalism’, etc., all of their Orwellian gangster terms created and co-opted to rationalize and justify their share of the stolen goods.
A better question might be; has the global wealthy ruling elite’s corrupt creation of and hijacking of the global central banks, nation state governments, and global media intentionally caused this particular global financial crisis?
Deception is the strongest political force on the planet.
I have clean my coffee off my keyboard from the resulting belly laugh caused by reading your post!!!
Bravo comments, i on the ball patriot, bravo comments!
Is the pope catholic?
Is a dead Eskimo stiff?
Has President Obama appointed the most anti-worker, anti-small business, anti-union clowns possible?
Are Richard Perle, Henry Kissinger and David Rockefeller American Frieds of Bilderberg?
It’s not so much the inequality/distributional effects per se, but the affluent have ways of creating their own weather.
The CEO compensation ratchet, political contributions, regulatory capture, etc., are all avenues for the well-disposed to secure their positions and extend their influence over the lesser classes.
That they were capable of driving up prices for financial assets commonly associated with the well-to-do was no surprise, but in this last go round they had accumulated enough resources (capital, leverage, regulatory acquiescence) to finance inflated prices for the only asset the middle class has ever really cared about: housing.
In effect they got bored bidding up prices for financial instruments and commercial/statement real estate and decided to come down to the middle class neighborhoods and piss in the public pool.
I see a very simple relationship.
Those that make less still live surrounded by wealth – either physically or via TV/movies.
And some of them want those things and that lifestyle of the wealthy.
Yet, their $30k job (and decreasing), even if they work 50% more hours, is simply not going to get them there.
So they do what any rational person would do.
They purchase lottery tickets.
And if ever offered the chance to lever up in order to purchase a taste of that wealthy lifestyle, they take it.
They are in a situation where taking financial risks makes a lot of sense. So they do.
Collectively, all this risk taking adds up and contributes to a bubble.
Geez, it must be so blissful to be so simple-minded?
Thinking is sooooo hard!
Math is sooo difficult!
And so is a-r-i-t-h-m-e-t-i-c…..
Was that a reply to my comment or did your cat walk on your keyboard?
If a mistake on your part, I understand.
Exactly right, Yves.
The Dirty Fed and Wall Street capture of Congress and Treasury create asset bubbles.
Asset bubbles create both income inequality and financial instability.
Doug Henwood sees inequality as destabilizing at least in the specific context of the US. To summarize, as workers’ bargaining power was weakened in the ’80s and ’90s, workers’ income stagnated. In order to keep consumption up, personal debt was encouraged.
From http://www.leftbusinessobserver.com/LearningNothing.html (which would make a good guest post IMO):
First, in 1979, Jimmy Carter, blindly following the recommendation of David Rockefeller, appointed Paul Volcker chair of the Federal Reserve. On taking office, Volcker announced that the U.S. standard of living must decline, and then made it happen. He drove interest rates towards 20%, provoking the deepest recession since the 1930s. That terrified the U.S. working class…
Just over a year after Volcker’s ascendancy, voters put Reagan into the White House. Reagan’s major contributions to the class war were firing the striking air traffic controllers, signalling open season on the unions; cutting taxes on the rich, signalling that all social constraints on wealth accumulation were suspended; and rebuilding U.S. military power, signalling that the era of imperial reticence following Vietnam was over.
It all worked splendidly. Unions were broken, wages stagnated… Corporate profitability bottomed out in 1982 and began a fifteen-year surge. But—and this is a very big but—an economy that was dependent on high levels of mass consumption and a political system that depended on the same thing for its legitimacy had to figure out how to keep spending up while wages were heading south. The answer, as we all know, was debt: household liabilities more than doubled relative to income between 1982 and 2008. The ratio has since come down a bit, but not by much.
So here’s the structural crisis: profitability was restored, but at the cost of fostering unsustainable levels of personal debt. The profit boom and the upward redistribution also gave rise to a gusher of cash that flowed into the financial markets, prompting a proliferation of incomprehensible instruments of mind-boggling vastness. The ratio of financial assets of all kinds to GDP more than doubled between 1982 and 2007. That too has come down a bit, but not by much. The financial sector’s share of corporate profits nearly tripled over the same interval.
Despite having the recession as a result of skyrocketing interest rates to “fight inflation.” You had record home, and car sales. In the era of cheap credit, and consumption monetary policy, and tax cuts, you have record low home sales, and car sales. Home sales worst since the Great Depression. Interest rates have been on the downward trend since the 1980’s to the point they are practically zero “today.” Not that I am defending 20% interest rate, because I doubt it if that would be the real market interest rate, but certainly they couldn’t be too low either. Of course hiking interest rates would destabilize the economy, much how Alan Greenspan keep rates too low for too long, and then raised it temporarily to about 5%, still no as high as before, just enough to blow up the bubble.
Barry Lynn, author of “End of the Line” has a new book out called “Cornered” that treats the questions of income inequality and market instability as integral through the vector of industry concentration. It is a logical extension of the thesis from the earlier book that over concentration of industry was creating fragility.
He gets a little folksy, as best as I can tell in an attempt to circumvent the cognitive bias against systems and statistics, but if you get into the meat of his arguments they are very persuasive.
Hah, I think concentration is a big part of the problem, both concentration and mere increasing scale (due to underlying growth plus conquest of markets). Many activities feature increasing returns to scale operations, and information businesses similarly have strong network effects.
So in many fields, bigger businesses are more profitable if adequately run. But then w/ greater concentration, you get oligopoly pricing on top of it….
So that means you need government to ride herd (this is why libertarian fantasies drive me nuts, they are irrelevant to a world of large scale enterprise). But such big businesses require bigger government to act as an effective check (and now, global coordination, which given our policy trilemma, you can’t have national sovereignity, deep international economic integration, and democracy at the same time), created a big mess and gives big business the upper hand even when government tries to scale up to contend with bigger private sector counterparts.
Here is an example of a financial class conflict of interest that could be argued is a contributing factor to the issues raised in the main article. It is posted on Zerohedge this AM and the video is worth 2-3 minutes of your time.
Intuitively, I’d say income inequality is a symptom of an “unregulated” or corrupted economy, one which allows for the abuse, of systems that have been established to ensure the optimum allocation and use of resources to achieve the common good. This abuse then becomes part of a vicious cycle, wherein money and influence thus obtained and concentrated, work to further undermine these systems, creating the bubbles that burst when it all gets too top heavy..
The question is formulated correctly, IMHO, and Yves identifies some of the key factors at work. That said, I’d question whether we can generalize about the different crises, or at least the way that income inequality contributes to each crisis. For example, it seems to me that a key component of the current crisis is the role cheap imports has on both consumers and retailers. Cheap imported goods, mass-produced in China or Indonesia, for example, allow lower-income consumers the chance to purchase products they otherwise could not. If only a percentage of consumption was invested in imports, that’s not a problem. However, when folks start spending most of their money on imported products, made at much lower costs, we see a rise in corporate profits for companies importing or manufacturing outside the US, for example, reduced demand for domestic products selling at higher prices, and strong pressure to cut wages or benefits while demanding increased productivity. Access to cheap goods offers the illusion of wealth/spending power, but the result is that consuming another countries products doesn’t usually help improve the profitability of local businesses who provide the income for consumption.
Apologies if I’m simply repeating something elementary and painfully obvious. The reason I’d argue against generalization is that solutions for individual cases require case specific strategies. My own simplistic solution to the initial crisis after Lehman would have been to plough a bunch of money into infrastructure construction directly, through WPA type projects, and to invite international auto makers to partner up with failing US companies. Finally, I would have gone nuclear on a state by state basis, Each state that wanted federal funds would have to build a nuclear plant and waste facility. Funds for high-speed rail, etc would then be made available.
Keeping unemployment under 6 percent would have been my principal priority. I’ve no idea whether these measures would have made problems worse, but I don’t see how we can call what’s taking place now a success.
I believe your analysis is correct. Minsky’s view is the best one. But income inequality does cause social instability which can then lead to financial instability.
In general there must be a certain ROE on investment banks and the financial system that if sustained produces financial instability. To me the long period of high bank profits should have signaled some kind of impending problem. so banks cries about profits usually ring hollow to me.
If you think about the function of the banks they are effectively middle men and there is no reason the profits from this sector aren’t a commodity. This is another reason to break up the big firms. it allows them to price distort for the middle man function. this removal of productive capitial from the system must also hurt long term economic growth.
Income inequality has everything to do with helping to cause financial crises. The system that enables some people to earn more than others can cause a financial crises, or any crises for that matter. It is how our modern society works. There was (and still is!) a huge incentive for certain people in financial services to make personal fortunes to the detriment of the economy. Therefore their incomes rose while others didn’t (e.g., the unemployed), ergo income inequality.
What the researchers miss in looking at the Nordic “income equal” countries for example, is that a very small number of people in these countries made out like bandits while the general populace suffered (i.e., 98% of the populace can have relatively the same incomes, but it doesn’t mean squat if their nominal incomes don’t increase over time: almost everyone is equally worse off!).
Let’s hypothesize: If no one in financial services (capital markets, real estate finance etc) were allowed to have earned more than $55k a year (the U.S. median), would there have been a financial crises? Probably not. If CEO’s and “C” level executives in publically traded companies are not allowed to earn more than, say, 2x the median salary of the employees, would companies show better performance over time (as opposed to CEO “pay to not perform” that exists today?)
I think that inequality is a cause of crisis. Income inequality tend to increase investment and decrease consumption because the rich have a higher marginal propensity to invest.
However an economy cannot work if people don’t consume. In the US, low and middle-income classes had to borrow ever more money against rising asset prices. We wouldn’t have had this debt problem had the middle classes been able to finance their lifestyle through their wages.
Dosent it really come down to how you answer one question: Why did Howard Hughes earn more than Albert Einstein ?
Several points about income imbalance:
1. Money and power concentrated in too few hands induces failures of central planning.
2. Imbalances take the form of market hysterias (too many passengers running to one side of the boat at the same time).
3. Inadequacy of wages leaves earners unable to pay their ordinary bills.
4. Over-reliance on debt and credit postpones an ever-growing day of reckoning, and confuses priorities.
5. Emphasis on financial, insurance, and real estate capitalism (as opposed to industrial capitalism) leads to massive misallocation of resources over the long run.
6. Corporate governance gets corrupted by narrow interests of boards and executives.
7. Skewed executive compensation results in corporate looting, short-term thinking, and fake accounting.
8. Government and tax structure get captured by exclusive interests.
9. Social inequality induces moral hazards at both ends of the socio-economic spectrum: opting out of social compact by both lower classes and upper classes.
10. Middle class disappears, replaced by oligarchy and feudalism.
11. Inequity gradually diminishes the ability to think clearly, in a balanced way, to value the condition of balance as an inherent good.
Economies are about the circulation of goods and services. If fewer people have the cash to buy goods and services, the economy slows down.
One way to look at this:
1) reduced job income (through whatever means > investment moves to low cost areas)
2a) increased proportion of income to wealthy
2b) wealthy have more OPM (which they consider their own) to leverage and speculate
3) asset bubble created to “offset” loss of job income (whether your asset is a tulip or house)
Whether one is cause and other effect, or the end game is the intention/driving force is irrelevant, the history of bubbles, booms and bust is well known – the fact that political leaders are “shocked, just shocked” that this could happen now is either incompetence or outright lying.
I was surprised to read this because to me, it’s very intuitive, although not necessarily “guaranteed” to happen.
When people have just enough money to support their standard of living, they spend it. When people have extra, they invest it. The more “extra” money there is, the more investing, speculating, manipulating, etc.
Eventually, invested money is no longer used to “build” anything (because the builders are at demand capacity), so a bubble forms somewhere. Speculation drives up prices. Speculation can’t happen unless someone has too much candy money.
Nothing would stimulate the economy more than if there was a cap on CEO salaries at 30x the pay of the lowest paid employee in the corporation.
Give the mailroom guy some money. He’ll spend it. Give the CEO more money, he’ll speculate with it.
Yves — try this as an explanation of inequality’s cause and effect on the financial crisis.
How Inequality Created The Other Side of the Debt Problem Leading to the Great Recession
Economists have described the causes of the great recession and the possible ways forward from a number of perspectives. One perspective that deserves more discussion is the concept of a savings glut that created pressures to seek yield. Viewing the great recession as arising from too much debt misses the other side of the coin, pressure to lend from savings seeking returns. Borrowing has to equal savings. Three factors contributed to a large savings pool seeking returns through lending. An (1) increased consumer savings pool partly arose from tax cuts which government had to replace with borrowing. The (2) financial system magnified savings through fractional banking. (3) Trading partner mercantile policies contributed diverted savings from emerging economies to the US. The following provides a simplified macroeconomic model of how wealth and income inequality contributed to this savings phenomenon and increased and contributed to causing the great recession.Macroeconomic analysis starts with four cohorts, consumers (C), businesses (B), government (G), and trading partners (F). To understand the following dynamic, consumers will be divided into two cohorts and businesses will be divided into two cohorts.
The two business cohorts are finance industry (Bf) and non-finance industry (Bn). Understanding the finance industry (Bf) cohort is critical. The finance industry (Bf) cohort is a conduit for matching savings and borrowing and a creator of an increasing level of funds for borrowing. Money is created by the Federal Reserve. Fractional banking magnifies the funds created. If bank reserve requirements are 10%, the fractional system provides an increase of $10 in loans for every $1 created by the Federal Reserve. The finance industry (Bf) cohort magnified Federal Reserve money creation even further by the creation of shadow banking units, some of which had reserves of about 3% creating $30+ dollars for every dollar of reserves.
For the consumer cohorts, assume a correlation between income level and savings. Stated simply assume low income consumers to be net borrowers and high income consumers to be net savers. Assume some percentage of consumers such as the lowest 90% in income borrow on net an amount equal to the net savings of the highest income 10% magnified through the finance industry (Bf). Whether 90% is the right number is not critical to the following discussion. The consumers cohorts are consumer borrowers (C90%) and consumer savers (C10%).
Some observations about the 2000s leading up to the great recession. Government (G) net borrowing and trading partners (F) net savings in the US were about equal. Consumer savings were low and are assumed to be zero for the following discussion. Consumer income and wealth inequality did increase.
Here is a simplified description of what took place.
* Government (G) lowered taxes benefiting primarily the consumer savers (C10%) cohort. This increased the level of savings searching for investment.
* Consumer borrowers (C90%) wanted to buy much of our trading partners (F) products and services.
* For consumer borrowers (C90%) to buy these products and services, savings had to be made available to them.
* As we well know now, the borrowing of consumer borrowers (C90%) greatly exceeded their ability to pay from current and expected income.
* Savings was made available to consumer borrowers (C90%) through the finance industry (Bf) based on expected increases in new and existing home values used as collateral.
* Trading partners (F) on net ran mercantile policies. The US trade deficit (and current account deficit) was financed by trading partners lending to us. In other words our trading partners on net had dollars they wanted to save instead of spend.
* Savings flowed from consumer savers (C10%) and trading partners (F).
* Non-finance businesses (Bn) were not major borrowers or savers.
* Savings flowed to (i.e., borrowing was made) by consumer borrowers (C90%) and government (G).
* The finance industry (Bf) was a conduit magnifying consumer savers (C10%) savings. Since the finance industry (Bf) is primarily owned by consumers savers (C10%), it can best be viewed as an extension of consumer savers (C10%). The growth of the finance industry (Bf) primarily benefited consumer savers (C10%) cohort contributing to wealth and income inequality.
* High finance industry (Bf) wages and bonuses went primarily to people who were in the consumer savers (C10%) cohort further contributing to wealth and income inequality.
* Trading partners (F) savings went primarily to fund government (G) debt.
* Consumer savers (C10%) (including finance industry (Bf) created money) went primarily to consumer borrowers (C90%).
* When home values ceased to provide collateral for consumer borrower (C90%) debt, consumer savers (C10%) and the finance industry (Bf) suffered the losses. The losses for consumer savers (C10%) were increased by the fact that this cohort was the primary owner of finance industry (Bf) equity and bonds.
What was the role of government deficits in this dynamic. If government (G) had not run deficits, consumer savers (C10%) would have had less savings and trading partners (F) would have had to make up the savings difference (or sell less) taking on consumer borrowers (C90%) credit risk. Trading partners (F) might have been less generous with credit terms. Even if the great recession still happened the risk would have been spread more broadly between beneficiaries of the boom, the consumer savers (C10%) and trading partners (F). Interestingly trading partners (F) savings placed in government (G) borrowing avoided the losses that consumer savers (C10%) suffered as result of placing savings through and having ownership interest in the finance industry (Bf).
With the onset of the great recession, a new dynamic arose. Consumer borrowers (C90%) began to de-leverage thus becoming savers. Suddenly all cohorts except government (G) were savers. The contraction in borrowing was magnified through the fractional banking system. Government (G) through stimulus and Federal Reserve quantitative easing bailed out much of the finance industry (Bf). Since all government spending and transfers must come from taxes people pay (businesses simply pass through the cost of taxes to consumers, employees or stockholders) consumer borrowers (C90%) and consumer savers (C10%) were bailing out the subset of consumer savers (C10%) that were finance industry (Bf) bondholders. (Note: When the Federal Reserve buys treasury debt, is is still ultimately a form of taxation.) Consumer savers (C10%) with equity investments in the finance industry (Bf) suffered significant losses. Consumer savers (C10%) with bond investments in the finance industry (Bf) suffered little loss. With all cohorts savers except the government (G) and since borrowing must equal savings, a contraction in borrowing will destroy savings until they equilibrate. government (G) moved to offset this destruction by substantially increasing its borrowing (including creating money). The resulting contraction is the largest since the great depression with substantial wealth destruction, reduced incomes and high unemployment.
Geez, are you a clown!
You really believe all that clownish formulaic BS they tout about financial engineering, dontcha?
You really believe the equations behind those SPEs, SIVs, etc., dontcha?
Yeah…I seen it now.
Debt is an asset.
War is peace.
Slavery is freedom.
And Darrell is a douche.
Correlation is not causation, of course. To establish a causal relationship you have to identify the mechanism(s) through which A causes B, and I just don’t see that here.
I agree with other commenters that income inequality and financial instability are probably both caused effects rather than causal agents.
What DOES make sense to me is the idea that excessive income and wealth inequality leads to a shrunken economy, at least compared to what would be possible with the same resources if they were more broadly distributed.
Possibly our current series of asset bubbles, starting with the S&L crisis, resulted from the elites’ frantic efforts (motivated by a desire to avoid acknowledging that our economy isn’t/wasn’t healthy, and for some also by a desire to keep milking the economy for personal gain) to expand the size of the economy in the face of what would otherwise have been flagging demand.
But I don’t think income inequality per se contributed to any of our recent financial crises.
Another hypothesis is that both income inequality and financial crises have the same cause or causes. An especially likely candidate is the typical compensation structure for individuals working in the financial services industry. If they are rewarded when the assets owned by the entity employing them appreciate but suffer no detriment when these assets depreciate, they have a strong incentive to cause that entity to engage in transactions that could produce substantial gains, even if there is a substantial risk of loss. Stock options, carried interests, bonuses based on current profits all create what the economists refer to as externalities. The rest of us need these individuals to share significantly in the losses of their employers; the Bear and Lehman executives did have a lot at risk but not enough to make them act more prudently. As things now stand, each of these individuals has been given a pump to help blow a bubble until it blows up.
Testing this hypothesis obviously requires learning the composition of the income of the people at the very top of the heap.
Its not only limited to financial aspects but the basic strength of society. I believe Plato, Machiavelli, and Sallust noted how societies with greater connections between the upper and lower classes tended to be stronger and more prosperous per capita than societies where there were gaps. See both New England and the South for examples from American history.
Does Income Inequality Help Cause Financial Crises — everyone is commenting from the inside — the inside of the US. What about the US’s 5% of the population consuming 25% of the world’s resources does this cause financial crisis? Probably!
Even the lowest economic level in this country lives far better than a large percentage of the world. Now ask yourself, why is that. First it was because WW2 destroyed a large percentage of the world’s manufacturing ability.
As the rest of the world started recovering not one politician could come out and tell Americans the truth and that their standard of living was going to decrease. Instead, I do not know if it was an overall plan or it just happened by circumstance but the standard of living of the US was increased or at least stabilized through putting leverage in the system and this was also used in much of the free world. One example of this was Fannie and Freddie have issued more bonds (at least this was true a year ago) than the US govt.
Some people were smarter about leverage than others and some people made money from the leverage.
Now that the bubble is starting to collapse a large sector of the population is running around saying they did not get what they were entitled to. Personally, I would say to most Americans you have gotten more than you are entitled to. Do you think for some reason you are entitled to live better than the rest of the world? Why? Is it because you work harder? Not true! Is it because you are smarter? Not true? Is it because you have a better government? That is a joke! Keep kneeling down to the great Federal Reserve God and pray that he will save you.
Now, I did live and work in Scandinavia. Why was I there you might ask. Well they had a lot of work to get done and the average Scandinavian did not want to work hard enough to get it done. There was no motivation since there was such high taxes the net was not worth the effort. So, they brought in an outsider who got paid on an hourly basis which equaled more than the CEO of some of the largest corporation but did not have to pay the high taxes since he was there less than 6 months. The jobs got done and I left.
Now all the people here who call themselves Liberals, Progressives, Socialists or people who want Social Justice what you keep whining for has failed every where and every time. You can not even point to one place where what you want has worked. This is mental masturbation to the furthest extent. Being involved in Argentina (a country which in the early 30’s had a far higher standard of living than the US) in the 70’s and early 80’s I have seen where what you are wanting leads — capital flight and a death spiral of the economy.
In the 70’s and 80’s Americans were known as can do people who would get the job done. Now we sound like a bunch of whinging poms that make me feel a little ill to my stomach. The following quote was on Clusterf*(& Nation a while back.
“That America has transformed itself from a nation of earnest, muscular, upright citizens to a land of overfed barbarous morons ruled by grifters.”
In my opinion this is the reason we have financial crises in the US. Everyone wants to live rich in the US and not perform any work. Just like Icarus’ reaching for the sun on wings held together by wax, the US’s financial ponzi schemes unwind and the US falls to earth.
Ishmael said: “Everyone wants to live rich in the US and not perform any work.”
A bit of a broad brush there methinks. Many have been manipulated into believing in Manifest Destiny but most humans, including Americans, were not born with a silver spoon in their mouths and expect to work for their keep. America has been hijacked by the rich grifters and their mind controlled followers who did not become such entirely on their own. IMO, very little focus is paid to the power of the media and the marketing prowess and strategies of the corporations owned by the rich. They entirely control the depth and breath of public discussion and you should disabuse yourself of thinking that your textual missives here are anything more than white noise in their system.
psychohistorian, I assume that you have not traveled extensively outside the US, nor much on a number of US tribal reservations.
In some locations outside the US, you will encounter living conditions that are unsanitary, where human excrement flows in the mud-wallows that function as pathways through slums that defy easy description. Rats in these places can grow to the size of my housecat in the U.S.
This is not true everywhere, and is generally symptomatic of corrupt governments (often involving tribal disputes, but for more on that topic you’d need to re-read Tom Crowl’s commentary).
Although many of us have a ‘work ethic’ (and probably anyone who comes to NC on a Sunday has a ‘work ethic’), I encounter people each week who have a very limited view of the world and seem to think that they are being treated ‘unfairly’ if they don’t get what they desire, and kudos along with it.
I would also point out that I know thoughtful people who commit time and resources to work in their local (US) communities as coaches, in food banks, or other activities that strengthen community ties. In addition, I know people who take their talents and ‘volunteer’ in Africa, the South Pacific, and South America because they have medical skills and they believe that their efforts to alleviate suffering and promote health are of enough ‘value’ to them that they pay enormous sums of money to go ‘do good in the world’. Every one of them that I know has come back a bit shellshocked at some of the conditions they’ve seen.
As the globe shrinks, the issues of corrupt governments, resource control, extreme poverty, and disease become more significant.
I believe that Ishmael makes a point worth reading with respect, and I will not mock or disdain it. I believe that I have also seen some of what he mentions, and as a result I can sense that he must find it incredibly frustrating.
However, not all Americans are lazy and ‘entitled’, which is a mercy.
readerOfTeaLeaves — thanks for the support. I have lived and worked a number of places where most Americans would find unacceptable. Getting up in the morning and kicking the lizards out of the shower or going 6 months during the winter with no hot water at all (luckily it never got below 60 but you still had to brace yourself for a quick wash off). At least the requirement to use a squatter is limited. One time a VP in the US was throwing a tantrum with me that I was being unfair when I gave her only 3% of her payroll budget for raises (same as everyone else). As I told her then, you were given the fair end of the stick when you were born in this country.
Americans should go back and look at the homes that people just 2 generations ago lived in the US before they start squealing about inequities. I live in a relatively small place even though I could afford much more and heard about it for quite a while from my partner. Now she sees what happened and says thank god. It is wanting what you can not have and have know way of obtaining which screws with many people’s minds.
reader — by the way I have significant blood from four American indian tribes in me. My grandmother gave birth to her first child working in a field.
But I have pondered this point by Yves:
It’s ideologies that enable plutocrats and oligarchs that worry me. The sense of ‘entitlement’ that I encounter disgusts me, yet I see people in their 20s and 30s working valiantly to ‘get ahead’, but the deck is stacked against them much higher than it was stacked against my Baby Boomer generation.
The concentrations of capital, combined with global flows of information and funds, sets up a new dynamic. In a sense, it seems like a new form of ‘energy’ in a dynamic system that we still don’t fully understand.
It’s my personal view that in an era of global communication, the shocking gaps between utter poverty and your average middle class American (who takes sewers, tap water, and paved streets as a given) will continue to be a problem. However, I would have to reiterate that I tend to associate extreme poverty with government corruption.
The corrupt officials of governments are presumably looking for ‘investments’, generally in the West. But these are not purveyors of Main Street ‘small-c, civil society capitalism’ in which I was raised.
Many of these ‘investors’ assume that corruption and extreme economic disparities are ‘normal’; they have no personal experience of middle class culture, and don’t recognize the stabilizing economic and cultural value it brings to a society.
Not sure whether this comment is on-topic, but your comment — plus Yves’ passage — got me thinking about the fact that we now live in a global economy where many ‘investors’ don’t really care about, understand, nor value the benefits of a stable middle class.
Those within society who feel ‘entitled’ are a side, subordinate topic to the one in this comment. There are still many in America who work hard, yet are living in an era of globalization where financial interests have no incentive (apparently) to consider the destabilizing effects of widely unequal economic distributions.
(One thing the tribes of my experience tend to be good at is at least trying to share resources equitably.)
“The Gini coefficient is a measure of the inequality of a distribution, a value of 0 expressing total equality and a value of 1 maximal inequality…it is commonly used as a measure of inequality of income or wealth. Worldwide, Gini coefficients for income range from approximately 0.23 (Sweden) to 0.70 (Namibia).”
It can not measure negative income, so it has its limits as many households will have found that the sum of their efforts over a period of years is actually negative. It has other negatives as well, it can not measure the “stickiness” of class, nor purchasing advantages [think lower interest rates for the wealthy], but they are fully described in the piece. The one thing can do though is to provide a fairly accurate measurement of trend against economic stability…and there, particularly if we had pre-WWII data, you will see the reason the OSS-CIA had such a strong affinity for this particular coefficient.
Libertarians love to go on and on how they are superior beings and this being a hypothetical question, they would probably lie, but for most of us, we should ask ourselves this question.
If YOU were to be birthed from a randomly selected vagina…where class and position in society were determined by roulette wheel and you were allowed only one input…that of the Gini coefficient.
Would you choose:
1] a high number
2] a low number
3] I’m a Libertarian, it doesn’t matter.
“This is intriguing, but I am inclined to believe that income inequality is either a symptom of conditions that can produce bank crises (like excessive financailization of an economy) or a secondary contributor.”
Income inequality is a phenomenon that is worth examining in greater historical and geographical detail. South America, for instance, is particularly notable for the parabolic nature of its socioeconomic data… the great distances between its rich and poor. Historically, almost any feudal or heavily regimented society has displayed this phenomenon. Economies in which a class of people become entrenched – always through law (or in some cases mere force), be it licenses or grants of monopoly or federalized cartels – tend to exacerbate the advantages of that class. They become “favored”. Someone should examine this… I’ll simply mention it.
If these favors (sometimes flattered as “regulations”) pertain to the wealthier occupations – and they usually do, because governments typically operate from economic rather than benevolent motives – then you will have society’s resources increasingly allocated to these safe, publicly supported sectors.
To give a concrete example: in this country we have effectively placed the risk of the financial sector squarely upon the back of government, through insurance, bailouts, a federal commitment to asset inflation, and a host of other barriers to competition and disruption; this, and the lopsided nature of deregulation – which never addressed the passing-on of risk – can easily explain (at least in part) the alarming growth of the financial sector over the past several decades. The profits were privatized and the risks were socialized — the ideal investment. And where favoritism rules, the Big Bosses always get the Big Payout.
For a while, the working class in this nation was granted similar favors…. The New Deal was as thorough in cartelizing the working classes as it was the business sector. It was not merely “professional” trade groups – like the NASD – that became mandatory during the Depression. Unionization of the labor force was also a mission of the FDR administration.
Perhaps this explains the moderation in income disparity through the middle of the century. In more recent years, the labor market has been deregulated to a much greater extent than the elite professions. For instance the minimum wage has been largely allowed to rot at the hands of inflation, something I consider to be good in principle, but also quite unfair given the fact that there has been only buttressing of the enfranchised guilds you find in the higher-paying careers like medicine, law, accounting, finance, with their preferences for diplomas and licenses and flaming hoops.
Essentially, lower-income unions have been allowed to dissipate while higher-income unions have been continually reinforced.
You must also consider the impact of government spending and regulation. We heavily subsidize medicine in this country through various programs, and the federally mandated reliance upon insurance as it extends to the private sector is, essentially, another subsidy… it ensures far more business for the doctors and the pharmaceuticals than would otherwise take place. It’s a bit ironic that every federal policy ever used to raise commodity prices has been brought to bare on the medical industry – and we turn around and ask ourselves, why are medical prices so high? But I digress.
To the legal profession, every law passed is a subsidy, even if it is not (always) paid through taxes. Accounting is largely a bureaucratic enterprise at this point… the vast majority of accountants either work for, or because of, the government. Generally, inflationary policy – we’ve had just shy of 100 years of it – benefits capital enterprises first and labor last. Trickle-down, at least when applied to monetary policy, is a disturbingly apt description.
Construction, infrastructure – policies that compete for less-skilled workers – have not been politically popular for some time now.
So broadly, income disparity is increasing because those who earn the most are becoming increasingly favored. It has nothing, in my opinion, to do with a market failure. This is purely a result of the rulebook the federal and state governments have laid down.
More restrictive labor laws would address the disparity – and violate every principle of self-determination and personal liberty (nothing new here). The arms race will continue and we will inflate our way out of existence (sorry). This course seems pretty likely to me.
OTOH, less restrictive professional laws would require a change in attitude that is largely off of the radar at the moment. We have been convinced, despite all evidence, and rather conveniently, that guild law makes us safer… that the incompetence produced by these professional organizations is a suitable cause for their continued existence. And it appears as though our government is determined to channel even more of our wealth into our lawyers, doctors and bankers, even as the very foundation of these professions is found to be faulty, even fraudulent.
I doubt we can agree on the solution, but the derivative nature of income disparity and banking crises – perhaps we can agree on that.
As for comparisons with the 20’s, like all correlations there are similarities and great. National demographics then and now – particularly immigration, population growth, and income mobility – are worlds apart. Whereas the political influence of the privileged – the Rockefellers and the Morgans – is a common meme. I doubt we can get much useful information from the comparison.
You lost me here.
Consider a freeway overpass: the people required to design, construct, and enforce it involve civil engineers (a BS at a minimum), accountants (a BA at a minimum), and various skills involving horticulturists (a BS at minimum), etc, etc.
The amount of skill and credentials required to do the most basic public projects that I’ve been aware of are impressive. You don’t just pick up an engineering degree along with your fries at the local fast food window – a tleast, not where I live. Nor do big projects allow someone just out of high school to oversee the budgets involved.
As for the ‘labor’, I’m simply not aware of municipalities that let someone simply ‘walk on’ to a job site that represents millions of taxpayer dollars and pick up a shovel.
As for ‘market failure,’ I can only assume that you do not have a solid grasp of the notion of ‘public goods’, which do not function well in a market environment. Which is why, after a generation of ‘free marketeering’ the US has a great deal of crumbling infrastructure.
reader — agreed totally with you on that point. Don’t know about you, but when I go see an MD I certainly want to know that they graduated from a good and accredited medical program. I am certified in some area and regulated by the states. This is not to keep people out of the area but to set minimum standards.
Moss’ thesis is wrong. The transfer of wealth away from workers to an investment class created a paper economy which privileges destructive short term “make a buck at any cost” profits over all others. Many of us have been saying this for an age. It is a global, as in global financial markets, phenomenon. The idea that Moss feels he has to run out and look at 125 local financial crises to prove his point is just a typical case of an academic missing the point.
Wow! An intelligent, pithy explanation.
Good deal, maestro!
And Moss is a douche!
Income inequality may have little effect on economy because of global trade. It is my understanding that if the economy is in a growth stage, income inequality may in fact facilitate the growth. Right now it looks more like a maintenance for the US. And yes, the risk of looting is high.
Geez, mario, this thinking gig is somewhat knew, and I note that you are still floundering mightily.
It’s global trade, is it? A real supply-side economics dilemma, huh?
The risk of looting is high, is it?
Perhaps you can point out to me those areas which DON’T INVOLVE LOOTING?
Can’t find any, huh?
Yes, thinking is very haaaarrd….
Mario….still a cartoon character in a game.
Glad someone have everything sorted out.
I doubt that old school economists understood all the side effects of globalization.
Reading through comments prompted me to think precisely the same thing.
There are many terrific, insightful comments but I think this one addresses a huge problem: traditional economists seem to focus on the 1920s and 1930s, which was before international phone lines, before high speed trading was even possible — and mostly prior to globalization.
At least beginning in the 1970s, with the OPEC price hikes as well as signs that many basic resources (particularly timber and fisheries) were under too much pressure, the crises have been more severe and the economists have been less able to predict and/or address them. But then, their econmomics still assumes ‘equilibrium’, and supply-demand curves that are relatively stable.
As far back as the 1970s, the oil states were piling up petrodollars, needing ‘investment’. That didn’t synch with the existing economic paradigms, and I fail to see how Alan Greenspan or Ayn Rand-type free marketeering sensibly incorporated the fact that some basic commodities created extremely concentrated wealth, seeking outlets for ‘investment’.
They offer up the equivalent of Euclidean geometry, still stuck in the mindset of the nation state.
Things simply don’t work that way anymore, but we don’t yet have sensible economics to describe our current, globalized era.
simple :20 – 80 ratio
Interesting to read everyone’s take on it.
I offer no opinion myself as they have already been laid out here by everyone else’s posts, but mine mostly fall in line with Yves’.
I will, however, explain to all of you why Dr. Moss said something we already knew, and why Yves characterized it the same way. Dr. Moss is one who looks to create a new theory of regulation, and thus it must be determined that he already knew the inequality aspects that others such as Keynes have written about. The reason he acts surprised is so that general disbelievers would look at his work as an objective rather than a subjective piece of analysis. In other words, he tries to swing the pendulum without using any sort of confrontation. His method is a hopeless one, but understandable.
Yes and no. The surprise might be genuine, as in those awakening from a long, deep dream of trickle-down Utopia. There are those who really believed private good public bad. The Free Market as the god that failed.
On the other hand, it might be the old Upton Sinclair quote, “It is difficult to get a man to understand something, when his salary depends upon his not understanding it!” The money for academic, corporate, and journalistic economists is entirely on the “enrich the wealthy” school. And still does: talking about one’s rich patrons being dangerous just by being rich sounds like a poor career move.
The question now is, who’s got anything left to lose? Answer, few and little.
I went back and looked at some numbers. Since 1947, the top 5% of the population has grown from 7.2 million people to 13.5 million people in 1998 and income for the top 5% has grown in constant 2007 dollars has grown from 65,000 to 184,000.
Now here is a question which I can not answer right now which is what the birthrate and immigration rate is across income percentiles. I did see a statement that women on public assistance had 3 times as many children as women who were not on public assistance. In addition in 1998 there are now 46 million Hispanic members of the population.
I do not believe it is much of a reach to say lower income population have higher birth rates than higher income. Because of higher birth rates among lower income there would be a shift of people who were once in the top 20 percentile group up into the top 5 percentile group. In addition, the number of people who were in the top 40 percentile in 1947 has been totally added to the top 20 percentile group in 1998. Accordingly, part (and I am not making a case that all) of the apparent concentration of wealth really is largely a result of population growth and a higher rate of birth among the lower percentile.
If most of the population growth has occurred in the bottom 20% of the population then it would appear that all of the wealth has shifted into the top 5% of the population which might not be necessarily true. In fact the wealth dispersion in number of people could have remained relatively constant.
One thing for sure, just looking at wealth across percentiles is meaningless unless we look at birth rates and immigration across percentiles. If all the growth of the population was in the bottom 20% due to high birth rates and immigration then no conclusion could be drawn to income or asset distribution. This is just plain mathematics.
If this shift in assets/income is due to high population growth in the bottom 20% of the population then that would mean the original argument would have to be rewritten as “Was the financial crises brought on by disproportionate population growth across income percentiles.” That seems a reach. Accordingly, I do not believe any conclusion can be reached on the originally argument either.
Looking at percentages of population holding assets across an increasing population appears to me to be a case of lies, damn lies and statistics. No conclusion can be reached on this data without much more information.
For a very quick, visual overview try Gapminder’s “The Wealth and Health of Nations” (goes back to 1800s):
There are plenty of links off that page.
Also the US Census has a ton of data (although maybe you already used some of it):http://www.census.gov/
It offers tons of data.
Also, OECD: http://www.oecd.org/home/
Apologies if these are dupes for you ;-)
reader — thanks for the info links. I did look at census data in constructing my table. I am going to perform more work on this.
Ishmael, look at top .1% and top 1% to get anything meaningful. From 2007:
The new data also shows that the top 300,000 Americans collectively enjoyed almost as much income as the bottom 150 million Americans. Per person, the top group received 440 times as much as the average person in the bottom half earned, nearly doubling the gap from 1980.
The top 1 percent received 21.8 percent of all reported income in 2005, up significantly from 19.8 percent the year before and more than double their share of income in 1980. The peak was in 1928, when the top 1 percent reported 23.9 percent of all income.
The top tenth of a percent reported an average income of $5.6 million, up $908,000, while the top one-hundredth of a percent had an average income of $25.7 million, up nearly $4.4 million in one year.
This also does not take share of wealth into consideration which I believe is significantly more skewed than income. These individuals also pay lower effective tax rates because their income is primarily made up of capital gains. Which is effectively taxed at what? around 15%. I really wish that the lower upper and upper middle would stop being shills for the top .1%. You may be rich but you certainly aren’t wealthy.
Doesn’t this link into theses first promulgated by J.A. Hobson about underconsumption being the cause of most modern capitalist crises (with the flip side being overproduction)? This seems to be a major problem of capitalist economies – where previous class systems had extreme wealth inequality they were not predicated on mass consumption of commodities as the main driver of the economy. Greco-Roman slavery, feudalism, the Chinese economy pre-capitalism – the elites didn’t care if the peasantry/lower class were able to buy increasing quantities of goods. Now, they clearly need it/care about it.
If Braudel and the Marxist world-systems theorists like Wallerstein and Arrighi are correct, then the worst of these wealth effects seem to happen at both the very periphery and the very inner core of the world economy. In the former case there’s little domestic consumption of products anyway so nobody minds, in the latter the elite use their hegemonic position after a certain point to consume ever more relative wealth. The elite gamed the rules to allow for risky but large expansion of wealth at the top, and created a twenty-year end run around underconsumption first with credit cards, then with real estate and mortgages. The Wile E. Coyote economy has finally looked down, though, and there’s not enough consumption-power left for most of us to pick up the pieces.
Put me in the “excessive financialization as the root cause” group. For years, I’ve been quoting myself in the form of Cain’s Law: Any situation where it is easier to become wealthy by manipulating financial instruments than by producing the underlying goods and services will end badly.
For those of us who have been working on income inequality for sometime this is not a surprise.
I would like to see how the two graphs combine with the rise and expansion of those stores. Here are some anecdotes from the ground; Two years ago when I visited Mexico Missouri, I took a short tour around the square and found about seven payday lenders just in that space. They had around 20 in the town. When I taught social justice in Missouri in 2001 and 2002 we took on limiting the interest rate for payday lenders as our middle school project. We did work with a state Senator who sponsored our bill but that never passed. Even then predatory lending was fully ensconced as part of the attack on the poor. It seems that the expansion of that lending followed welfare reform too closely, and perhaps a reason for welfare reform was to create another base of indebted consumers.
Another question is what data the “inequality graph” is comprised of. There are still hot debates about how we calculate the net worth of folks who qualify for public beneifts. Was it wage income, net worth etc? Did the deregulation graph include the expansion of payday and other types of predatory lending?
So it seems to me that the income inequality is likely an effect of deregulation and that it is more an indicator of an upcoming crisis than a cause. Today we have the greatest income inequality since the 1920s. That is clearly not a recipe for economic recovery.
As I stated above, Robert Vienneau had an interesting blog post about income inequality with a link to a paper you might find interesting.
The “inequality graph” there is based just on annual income without capital gains, which would mean anything that you pay personal income taxes on. I took a quick spin (literally, with the mouse wheel) through the document and saw no chart reflecting relative debt burden.
By the way, I think your point about looking at the debt burden is very astute and fits in with Steve Keen’s approach in his “Scary Minsky Model.” One of the problems that we seem to have is that the debt dataset is incomplete. For example, Steve has to calculate the year-over-year change in debt to calculate true aggregate demand in a given year (GDP + change in debt), but the debt data appears to reflect write-offs that are subtracted from total new debt. Also, we don’t know how much of an annual increase in debt is due to interest accrual (which is significant for payday loans).
In short, it isn’t clear to me that anybody collects data that gives us a complete picture of debt and its effects on the economy.
I believe that income inequality starts as an effect of predatory finance but ultimately becomes a cause of financial crisis due to predatory finance because (a) in Minsky terms, it moves us into Ponzi finance territory and (b) once in Ponzi finance territory, the existing debt burden ultimately becomes too high to sustain new rounds of financing, and we enter a period of debt deflation.
For sure, high income inequality is a powerful cause of financial crises and the ensuing contractions. But to understand the causal links, you’ll have to give up some false doctrines taught in certain university departments in declining nations: Mr. Friedman’s permanent-income hypothesis has to go, as does the notion that there is no such thing as Keynesian uncertainty, only risk (the econs renamed risk “uncertainty” which was an ingenious way to forget about the real thing). And while we are at it, let’s rid ourselves of neoclassical economics. (Is there anything there worth saving that can’t be taught to fifth graders?) And it would help if we were to understand why Malthus has far more to teach us about our world than Ricardo.
It’s best to begin with the ratio of savings to spending. As the ratio goes up, the return on productive investment tends down, which can and often does precipitate a burst by financial insiders of (1) inept gambling (having convinced themselves they are facing risk when actually they face uncertainty) and (2) adept swindling (because the insiders know more than we do but are no more honorable) and (3) herding (uncertainty again). The symptoms are both credit expansion and asset bubbles, often both at the same time, as in Mr. Greenspan’s episodes.
If you know your Duesenberry–who had the right explanation for the correlation between income and savings rate–you’ll find it obvious why, ceteris paribus, rising income inequality causes a rising savings ratio. Another cause, derived from the same underlying behavioral theory, is widespread income growth. (Which theory? Try Samuel Stouffer, Herbert Simon, Robert K Merton (the father, who had substantive insights, not the son), Robert Frank.)
In a society that has both high inequality and widespread income growth at the same time–such as the contemporary societies blessed by pragmatic and smart neo-mercantilist governments–the savings ratio tends to be very high. Of course, once burned by a crisis, a smart government will try to avoid another one by shipping its excess savings to the Old Fat Man, who has a deserved reputation for taking as much cash as he can get. (Hey, it makes him feel good right now, which is neoclassical nirvana.)
This is not to blame the Asians for the present crisis. High-net-income American companies have a lot of savings. And despite the Labor Dept’s efforts, we really don’t know about the savings of the top 5 or 1 percent of households, but I’ll bet my car it is off the charts. So instead of looking only at the flow of savings into the United States, we also need to look at the flow out of the United States and into Asia, which then sent a whole lot of it right back to the United States. Thus high income inequality in the United States, both among households and among companies, very likely contributed to Greenspans’s crises.
So, yes, rising income inequality in many societies is driving the increasing frequency and severity of financial crises over the last thirty years. Only a neo-classical dreamer is incapable of understanding that the world market system still is reacting, often wildly, to the Malthusian shock a generation ago.
By the way, in his 1951 autobiography Marriner Eccles wrote a succinct and compelling account of how concentrated income caused excess savings and hence the Great Depression. And Eccles was just one guy in a very large crowd. That is to say, we Americans knew about the inequality-crisis link a long time ago. But the anarchist ideologues, aided by careerists who had mastered the calculus, made sure we would forget it.
Thanks Jan…I for one enjoyed that.
Gosh yet another unions were vandalized by management/capitalists in the 1920’s which caused workers to go into installment debt which caused defualts which caused the depression
and hey that’s what happened in the 1980s onward too! fantasy rewrite of history…
Yeah… right I didn’t buy it when this fantasy was FIRST put forth…
how does this “theory” explain all of the financial meltdowns in the 1800s or prior?? you know before our good bro Marx started this worker must be given fair division of spoils non-sense???
Oh, that was a different time… yeah whatever… Bold theory yeah Hugo Chavez would love your “bold” theory
Capitalism is the problem AGAIN – snooze
Granpa, did you forget to take your pills again?
YAWNNNNN!….has been shown historically to be the correct anatomical/ethical position for insertion of pikes to ones cerebral melon, in the MOBS outdoor trophy case.
Skippy…outdoor bird/small critter feeders is my analogy.
“Does Income Inequality Help Cause Financial Crises?”
•• do chickens come home to roost?
•• does entropy ever look back?
•• do the wheels on the bus go round and round?
•• do you know the way to san jose?
•• do financial crises help cause income inequality?
There is possibly a very simple causal link
between Income Inequality and Financial Crises
hidden in the foundations of classical economics:
the usual theoretical justification for market economies is
that they efficiently value economic resources.
This involves some well known and
very theoretical assumptions (eg perfect information)
but most questionable here are assumptions of very free
exchangeability of goods – and in particular
exchange of goods is attributed zero cost
in the usual justifications (foundations of utility theory).
Now Income Inequality may be associated to profit margins
in markets for basic consumer products
being so large (the part that finance, middlemen etc take)
that the cost of exchanging goods undermines the
valuation mechanism, driving valuations
way out of line.
But Financial Crises basically arise when
the valuation mechanism gets too far out of line
and needs to be radically corrected.
I don’t know economic history but I wouldn’t be
surprised if this argument had already been
brought up in the 19th century.
imo, the causality could be found in decision making theory.
Decision making research has shown that those “losing” in games take excessive risks. (I’m not saying those with less income are losers, I’m suggesting they might perceive themselves that way.)
This is evident in the real world by the inordinate amount spent on lottery tickets by “poor” people, as compared to the wealthy or middle class.
So, the mechanism could be thus:
inequality => perception of losing => excessive risks => leverage
As Andrew Lo (MIT) stated: “When you are threatened with extinction, you act like nothing matters”
Or necessity. Is it a risk to put the groceries on the credit card or a bigger risk to go hungry?
How both businesses and individuals make money in an age of deregulation and globalization could easily have something to do with rising inequality.
Leaving aside consideration of the financial services industry of which I know little, it could still happen …
The fact that big corporations can use overseas labor pools costing them dramatically less than domestic labor to whom they sell their goods increases their margin or profit on goods sold. Now ownership of these big corporations is concentrated among the wealthy so the wealthy enjoy increasing returns. They can ignore the fact that their domestic market is being hollowed out for as long as their margins continue to increase.
At the same time stagnant opportunity and income convinces many non-wealthy Americans to take on the debt or over-leveraging to acquire perceived appreciating assets (housing, spec housing to flip). For a few years, this seemed the only way for a non-wealthy American to acquire wealth, but it led to the working class assuming debt while their real employment opportunities continued to narrow. In effect many Americans took up Ponzi finance because it was disguised as home and apple pie, and because real wages and career stunk.
Unfortunately, with one group taking on debt, not increasing their income and another group increasing their profit, inequality would have to increase. Also, this is an emerging terminal situation, with the working class eventually unable to sustain the consumption of goods and debt they owe in event of any sudden systemic shock.
We’ve now reached an impass where Walmart cannot increase sales volume by lowering the price of goods anymore. A significant portion of their shoppers can’t buy anything at all anymore, the well is that dry for them.
I’d be surprised if they weren’t connected — all financial crises tend to center on debt. People don’t actually enjoy being in debt. It stresses them out and I think they’d much rather be able to pay as they go. Which is where the wealth concentrations come into play — so many Americans are working too hard for too little reward. Things that should be affordable — education, health care, housing, aren’t. And most people aren’t willing to work so hard for others and still not have some consumer comforts. Hence the debt, people getting over-extended and the resulting shocks to the system. Wages are simply not meeting the needs and desires of most Americans or even most workers in the western world and you can’t expect people to dial back their desires if you expect them to work this hard.
Yves, there maybe more linkage, based on income and net worth and net financial worth. Here is a link with a lot of data sets.
Wealth, Income, and Power
by G. William Domhoff
September 2005 (updated July 2010)
On the charts including the most egalitarian of societies, Norway, Finland, Sweden, you still a preponderance of the concentration of wealth in the hands of the few.
Table 4: Percentage of wealth held in 2000 by the Top 10% of the adult population in various Western countries:
by top 10%
United States 69.8%
Of course, inequality causes financial crises. With high economic inequality, the monied classes through well-funded lobbyists rule the roost. They have the power to whittle down any government oversight and regulation that already exists. And there is the absence of the countervailing force of a solid middle class and institutions like labor unions (because income inequality erodes these institutions). We saw a clear example of this during the W. Bush years, only so recently. Financial insitutions could go “shopping” for the easiest regulator; officials in regulatory institutions who did their job were penalized; those who merely pretended to be regulating were rewarded with promotions and huge salaries. The lobbying industry grew in leaps and bounds during the W Presidency. Innovation and real productivity suffered; instead, downsizing and layoffs were misinterpreted as increased productivity. Ponzi schemes abounded in one guise or the other–including the housing bubble. Extreme inequality distorted the political structure to such a degree that the rich could do anything–they simply bought influence. Economic rewards were not based on real productivity, innovation and industry. They were based on loopholes in the tax code, and finacial speculation. I write about this connection between inequality and our current economic problems in my book Segregation: The Rising Costs for America (Routledge 2008) in the final chapter.
” . . . but there is only one parallel in the United States — the 1929 market crash. . . ” Not true. The 1870s and 1880s crashes were also examples of gross imbalance of personal assets. Each of our late 20th Century recessions were artificially restrained by moderate redistribution of wealth, which quickly returned to the status quo and kept us on the path which we are currently “enjoying.”