Inequality - Economics 101

In the long term an economy should be in equilibrium. That is: in every part of it as much money should go in as goes out.

The present Western economies obviously aren't in equilibrium: inequality is increasing. As the rich spend less and differently that means falling demand for many products. To repair that we have quantative easing - the cowardly cop-out by politicians afraid to raise the taxes on the rich. The problem is that it is not a real solution: after some time all the extra money will leak away towards the rich and the next stimulus is needed.

The world has faced a similar situation in the 1930s. Roosevelt too faced the problem that he needed to keep stimulating the economy. As soon as he relaxed the depression came back. Things only changed structurally after the war had led to a huge increase in the taxes for the rich.

Of course it is possible to imagine a country that is stable at a larger inequality. Piketty describes it as the 19th centrury's Jane Austen society. And at the moment Latin America still has a very similar society. But such a society as a whole is by definition poorer. Inequality is primarily about driving the poor in a more dependent position. They will get worse education, spend more time unemployed and their economic position will be more unstable. There needs to be a permanent "labor reserve" in order to keep the wages down. As a consequence their contributions to the economy will decrease. The contributions of the rich - on the other hand - will not increase: they will just get a bigger part of the national wealth at the expense of the poor.

Rising nations typically put a lot of effort in providing education, healthcare and other services to the whole of the population. They know that that is the key to economic growth. Even retirement benefits fit in that goal as they liberate the workers to focus on their jobs. But in the rich countries that goal tends to slowly get lost. Those still supporting more equality start to use bland arguments like that it is a sign of civilization. But that is a very subjective argument that can mean different things to different people.

So the road towards a more unequal society is a road with a shrinking economy. And that also means a shrinking tax base. This at a time when the demands on the system will increase due to an increase in the number of poor. That will cause demands for government budget cuts, resulting in more poverty. So there is self reinforcing process going on here.

The corona crisis has a very bad effect. Many people saw their wages suspended. But income from capital went nearly untouched. Hardly anyone saw his rent reduced. So the net effect is a huge transfer towards the wealthy.

Another issue that deserves our attention is how we deal with economic crises. The economy goes up and down and with it the stock prices. That wouldn't be problematic when the same people that owned the shares when they rose sky-high would still own when they sink. But that is often not the case and as a result you will see a lot of bankruptcies when things go down - what can be rather destabilizing for the economy. In reaction we see governments increasingly inclined to avoid such a mayhem. That means bailouts and other ways that allow the rich to avoid the effects of the downside of the economic cycle. This was what made Japan's lost decade(s) so problematic. 

 

Unfortunately we increasingly see similar policies in the US and the EU. The excuses are always the same: pension funds hold some of the shares and bonds too and if one company goes broke others may follow (the Lehman Brothers precedent). But the fact that some companies may go broke shouldn't detract our attention from the fact that the rising share prices in the past increased the share of capital in our economies and that when we support those failing companies we further support that process. It isn't that we never should do it. But we should be aware of the larger process and take compensating measures elsewhere in the economy.