Understanding the 2008 Financial Crisis 4. Inequality and the Crisis Nicoli Nattrass Centre for Social Science Research University of Cape Town January 2015
Rival economic views • ‘Fresh-water’ neo-classical economists (Chicago, Minnesota) vs the more Keynesian ‘salt-water’ economists (e.g. Harvard, M.I.T, Berkeley) in the USA. • Freshwater economists claim that debt-financed government spending is self-defeating because it absorbs available savings, raising interest rates and depressing private investment. Savings
Investment Government Debt
Rising interest rates and lower private investment
Krugman, P. 2009. How did Economists get it so wrong? New York Times
Debt Tax
Government spending
Savings
Profits Wages
Consumption spending
Keynesian arguments: 1) Debt-financed spending by government pays for itself because of the multiplier effect
Debt Tax
Government spending
Investment
Savings
Profits Wages
Consumption spending
Animal spirits
Keynesian arguments: 1) Debt-financed spending by government pays for itself because of the multiplier effect 2) Investment is negatively affected by interest rates but mostly driven by ‘animal spirits’ (helped by booming demand).
Debt
Interest rates Tax
Government spending
Investment
Profits Wages
Savings
Animal spirits
Consumption spending
Keynesian arguments: 1) Debt-financed spending by government pays for itself because of the multiplier effect 2) Investment is negatively affected by interest rates but mostly driven by ‘animal spirits’ (helped by booming demand). 3) If interest rates are high, there is a role for expansionary monetary policy to lower interest rates to help boost investment
• Eugene Fama (of ‘efficient market theory’ fame): ‘The problem is simple: bailouts and stimulus plans are funded by issuing more government debt... The added debt absorbs savings that would otherwise go to private investment. In the end, despite the existence of idle resources, bailout and stimulus plans do not add to current resources in use. They just move resources from one use to another’. • John Cochrane: ‘Every dollar of increased government spending must correspond to one less dollar of private spending. Jobs created by stimulus spending are offset by jobs lost from the decline of private spending. We can build roads instead of factories, but fiscal stimulus cannot help us to build more of both’. • Krugman: ‘its deeply depressing to find, not that people like Eugene Fama disagree with Keynes’s conclusions...but that they’re obviously completely unaware of the whole argument’.
Inequality and the Crisis • Some economists (including Rajan) argue that inequality was a major cause of the crisis (falling share of wages in national income results in pressure to increase debt) • Growing political concern about the ‘one percent’ gaining the lion’s share of income and wealth. • Concern that financial speculation is fuelled by the wealthy • The Inside Job 1.29.46 – 1.33.34 (focusses on international competition, technological change, rising costs of education as the source of rising inequality…)
Debt Tax
Government spending
Investment
Savings
Profits Wages
Consumption spending
Animal spirits
Keynesian arguments: 1) Debt-financed spending by government pays for itself because of the multiplier effect 2) Investment is negatively affected by interest rates but mostly driven by ‘animal spirits’ (helped by booming demand).
Debt Tax
Government spending
Financial speculation
Investment
Savings
Profits Wages
Consumption spending
Animal spirits
Keynesian arguments including distribution 1) Profits mostly go to investment, savings and financial speculation 2) Wages fuel consumption (demand) and hence are vital for economic growth 3) This implies that rising inequality is bad for growth…..
Rising inequality in the ‘functional distribution’ of income (i.e. between labour and capital). The share of wages in value added has been falling (and the profit share has been rising).
Rising income inequality (the share of the top 1% has been rising and is now about 28% of total income). Globally, the top 1% owns almost half of global wealth…. http://www.theguardian.com/business/2015/jan/19/global-wealth-oxfam-inequality-davoseconomic-summit-switzerland
Capital inflows from a ‘savings glut’ in Asia
From: Stockhammer, E. 2013. ‘Rising Inequality as a cause of the present crisis’, in Cambridge Journal of Economics, doi: 10.1093/cje/bet052.
Because the poor have a higher marginal propensity to consume
Stockhammer, E. 2013. ‘Rising Inequality as a cause of the present crisis’, in Cambridge Journal of Economics, doi: 10.1093/cje/bet052.
e.g. USA, UK
Stockhammer, E. 2013. ‘Rising Inequality as a cause of the present crisis’, in Cambridge Journal of Economics, doi: 10.1093/cje/bet052.
e.g. China, Germany
Stockhammer, E. 2013. ‘Rising Inequality as a cause of the present crisis’, in Cambridge Journal of Economics, doi: 10.1093/cje/bet052.
Because the poor borrow to maintain social status
Stockhammer, E. 2013. ‘Rising Inequality as a cause of the present crisis’, in Cambridge Journal of Economics, doi: 10.1093/cje/bet052.
Stockhammer, E. 2013. ‘Rising Inequality as a cause of the present crisis’, in Cambridge Journal of Economics, doi: 10.1093/cje/bet052.
Because the rich speculate more, hold riskier assets
Stockhammer, E. 2013. ‘Rising Inequality as a cause of the present crisis’, in Cambridge Journal of Economics, doi: 10.1093/cje/bet052.
Stockhammer, E. 2013. ‘Rising Inequality as a cause of the present crisis’, in Cambridge Journal of Economics, doi: 10.1093/cje/bet052.
Raghuram Rajan: Fault Lines • 3 Fault lines: domestic political stresses in the US (arising from weak social assistance and inequality); trade imbalances; and clash of financial systems. (see review: http://www.nytimes.com/2010/08/01/business/01shelf.html?_r=0) • Implications for developing countries: ‘arms-length’ financial systems (USA, UK) when they lend to ‘relationship systems’ (China, Japan, South Korea) rely on short-term funding that is unstable. • Recently arguing that quantitative easing in the advanced capitalist countries has been uncoordinated, resulting in capital inflows to developing countries (over-valuing the exchange rates) and increasing the risk of the entire global economy deflating when interest rates start to rise
