INCOME INEQUALITY AND GROWTH

This post is in reaction to two articles I saw recently and will be a bit shorter than usual.

Paul Krugman (http://krugman.blogs.nytimes.com/2013/01/20/inequality-and-recovery/), commenting on a piece written by Joe Stiglitz (http://opinionator.blogs.nytimes.com/2013/01/19/inequality-is-holding-back-the-recovery/) states the following:

"[...] we’re talking about the financial crisis aftermath, not the crisis itself. What role does inequality play?

First, Joe offers a version of the “underconsumption” hypothesis, basically that the rich spend too little of their income. This hypothesis has a long history — but it also has well-known theoretical and empirical problems".

Krugman then spends some time discussing theoretically the idea that the wealthy save too much and showing that the data doesn't really jig with that hypothesis...

But I basically disagree in the sense that this is not how I would interpret the 'underconsumption hypothesis'. There certainly was no lack of consumption in the run up to the crisis (and indeed some have argued that it had all been excessive and 'unsustainable' and wanting to return to the status quo ante was foolish) and people really did want all the things they bought (with the possible exception of some speculative real estate). The real problem is not consumption but how it was financed. Using debt was and is and always will be unsustainable beyond 'a certain point'. See Minsky for more details.

So maybe 'underconsumption' is the wrong term but the way inequality fucks up the economy is by driving the 99% to use excessive leverage to keep their consumption going.

And, to be complete, my bet is that, had we not have seen such an explosion of debt levels, we would have seen either a drop in consumption or a revolution by the middle classes...

[Paul Krugman] "So am I saying that you can have full employment based on purchases of yachts, luxury cars, and the services of personal trainers and celebrity chefs? Well, yes. You don’t have to like it, but economics is not a morality play, and I’ve yet to see a macroeconomic argument about why it isn’t possible".

Yeah, well, yes but full employment, however desirable, isn't actually the main objective of economic growth. The main objective of economic growth is to provide people with material safety and, above and beyond, the material means of enjoying their life. Work or employment is just a tool to get there. Germany (or the US) has maintained a pretty low level of unemployment but has a significant chunk of employed people classified as 'working poor'. I am not sure that working and being poor is massively superior to being poor and unemployed. It probably has some benefits (self-estime, possibility of progression, work ethics...) but it's not a panacea.

I don't care if people are working as personal trainers and yachts sailors - As long as they're paid middle class salaries. As long as the middle class is thriving, economic growth - and the components of consumption - will NOT be a problem.

"Joe also argues that high income inequality depresses tax receipts, fueling fiscal fears. Again, I have trouble with this point: our tax system isn’t as progressive as it should be, but it is at least mildly progressive even when you take state and local taxes into account. So I don’t know where this is coming from".

Mildly progressive might not be enough to maintain tax receipts in line with expenditures. Indeed, given how the US debt keeps on climbing despite Obama's capping per capita public spending, I would say that it's obvious the real issue is that the government, just like people prior to the crisis, is using debt to finance its consumption. Guess what? If it is unsustainable for individuals, it will eventually be unsustainable for the state. Ask Greece.

"I wish I could sign on to this thesis, and I’d be politically very comfortable if I could. But I can’t see how this works".

Mr Krugman, I was happy to help. :) . My own liberal socialist leanings aren't just a matter of genetics or education. My training as an economist and my understanding of the world through the tools of economics were and are fundamental as to why I defend a 'progressive' economic agenda.