Inequality and the Global Economic Crisis
posted by Frank Pasquale
Yale Global Online Magazine has been publishing some interesting articles on the global economic crisis. I found Branko Milanovic’s observations on the origins of the crisis a refreshing new take on the matter:
In the United States, the top 1 percent of the population doubled its share in national income from around 8 percent in the mid-1970s to almost 16 percent in the early 2000s.* That eerily replicated the situation that existed just prior to the crash of 1929, when the top 1 percent share reached its previous high watermark. . . . . . But the richest people and the hundreds of thousands somewhat less rich, could not invest the money themselves. They needed intermediaries, the financial sector. Overwhelmed with such an amount of funds, and short of good opportunities to invest the capital (as well as enticed by large fees attending each transaction), the financial sector became more and more reckless, basically throwing money at anyone who would take it. . . . The increased wealth at the top was combined with an absence of real economic growth in the middle. . . . [as] household debt increase[d] from 48 percent of GDP in the early 1980s to 100 percent of GDP before the crisis.
The root cause of the crisis is not to be found in hedge funds and bankers who simply behaved with the greed to which they are accustomed (and for which economists used to praise them). The real cause of the crisis lies in huge inequalities in income distribution which generated much larger investable funds than could be profitably employed. The political problem of insufficient economic growth of the middle class was then “solved” by opening the floodgates of the cheap credit.
In other words, rather than being directed toward concrete projects that would satisfy real human needs, the money went round and round in speculative games, as the notional value of global OTC derivatives doubled three times between 2000 and 2008. As Martin Wolf observes, those able to skim compensation from those games “now sit on fortunes earned in activities that have led to unprecedented rescues and the worst recession since the 1930s.” Why would they invest in, say, renewable energy here, or infrastructure in Africa, or heating equipment for China when they could make a quick buck on the US housing bubble?
Another Yale Global writer, David Dapice, argues that US health care costs are the root cause of a different (but related) form of waste and malinvestment. Dapice argues that “lowering US health care costs may help the world:”
US healthcare costs are nearly double that of other developed nations, and are without any attendant benefits: US life expectancy is no greater. . . . In one sense, the US is starving investment in growth by swallowing up so much of the world’s savings. With a lower budget deficit, capital flows that are directed to funding US debt might now go toward developing nations. . . .
Definitely a valuable addition to the usual debate over the effect of reform on the US economy alone. I think Dapice is overstating the case to say that there are no attendant benefits–our pioneer therapies do occasionally diffuse to other regions. But his larger point is sound: there are many zero-sum aspects to today’s economy. As Raymond Tallis argues, in a more philosophical vein:
Affluent societies whose members are eaten up with ambition, competition, jealousy, unrequited longing for recognition, love, or sexual conquest, may be deaf to the basic hungers of the wretched of the earth, even if they accept their own role in making them wretched. That is why we should be aware of the extent to which deliberately, accidentally, or even unconsciously, we fuel the hungers of others.
If the economic crisis teaches anything, it is that no one is an island, and the type of “spontaneous order” praised by Hayek can be as dangerous as it is tempting.
*Just to give a fuller sense of the inequality discussed by Milanovic, consider these observations from Charles Morris’ great, balanced book, The Trillion Dollar Meltdown:
Between 1980 and 2005, the top tenth of the population’s share of all taxable income went from 34 percent to 46 percent, an increase of about a third. The changing distribution within the top 10 percent, however, is what’s truly remarkable. The unlucky folks in the 90th to the 95th percentiles actually lost a little ground, while those in the 95th to 99th gained a little.
Overall, however, income shares in the 90th to 99th percentile population were basically flat (24 percent in 1980 and 26 percent in 2005). Almost all the top one-tenth’s share gains, in other words, went to the top 1 percent, or the top “centile,” who doubled their share of national cash income from 9 percent to 19 percent.
Even within the top centile, however, the distribution of gains was radically skewed. Nearly 60 percent of it went to the top tenth of 1 percent of the population, and more than a fourth of it to the top one-hundredth of 1 percent of the population. Overall, the top tenth of 1 percent more than tripled their share of cash income to about 9 percent, while the top one-hundredth of 1 percent, or fewer than 15,000 taxpayers, quadrupled their share to 3.6 percent of all taxable income. Among those 15,000, the average tax return reported $26 million of income in 2005, while the take for the entire group was $384 billion.
Morris’s book is exceptional because he simultaneously grasps the technical details of the financial crisis and the money-driven politics that gave us the regime that made it possible. I can’t recommend this book highly enough. These chilling words are as accurate a portrait of our current direction as I’ve read in some time:
A broad pattern of official and unofficial initiatives . . . seem aimed at permanently locking in the advantages of America’s new baronial class. There is no conspiracy against the poor and the middle class. It’s more the inevitable outcome of our current money-driven political system combined with ‘the disposition to admire, and almost to worship, the rich and powerful,’ which Adam Smith fingered as ‘the great and most universal cause of the corruption of our moral sentiments.’”
May 27, 2009 at 7:47 pm
Posted in: Economic Analysis of Law, Uncategorized
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Responses (3)
Mike Zimmer - May 27, 2009 at 9:18 pm
That almost all the economic growth went to the smallest fraction of people on the top means that in real terms there was no growth at all in any practical sense. While the UAW contracts have been attacked with a vengeance, the real need in this country is to rebuild a middle class that has been decimated by the economic developments since the 1970s.
David Bernstein - May 28, 2009 at 7:07 pm
“The real cause of the crisis lies in huge inequalities in income distribution which generated much larger investable funds than could be profitably employed.”
That has to be the dumbest analysis of the cause of the financial crisis that I have yet heard.
Frank - May 28, 2009 at 7:19 pm
Apparently Princeton University Press didn’t consider Milanovic dumb when they published his important study on the measure of global inequality:
http://www.carnegieendowment.org/experts/index.cfm?fa=expert_view&expert_id=208
Here are some excerpts from reviews of that book:
“The history of world inequality is a fascinating subject, and Branko Milanovic’s very readable book uses this as a backdrop to explain the problems of measuring inequality when we look across different countries. . . . [I]t is certainly an interesting read.”–Huw Dixon, Times Higher Education Supplement
“A lead economist at the World Bank, Branko Milanovic has written probably the most comprehensive, thorough and balanced assessment yet of global inequality. . . . Milanovic makes a powerful and distressing argument for the intractability of inequality. His expertise and integrity inform every page.”–Thomas Homer-Dixon,The Globe and Mail
“Branko Milanovic masterfully explores standard and new measures of income inequality among nations and among individuals, extraterritorially. . . . The work should be required reading for anyone involved in social and economic research and policy relating to income inequality worldwide.”–Choice
“Branko Milanovic makes a difficult subject remarkably accessible. His expertise and intellectual integrity inform every page.”–Thomas Homer-Dixon, Toronto Globe and Mail
“Worlds Apart offers a thorough description of relative inequalities in the world, and does so by setting research quality standards to which future studies should be held.”–Camelia Minouiu, Ethics and International Affairs
Endorsements:
“Don’t be fooled by globalization’s noisy naysayers or proponents, who invoke the rise or decline of ‘global inequality’ to make their case. Here, in the first comprehensive look at inequality across the world’s individuals as well as the world’s nations, are laid out the many definitions of global inequality, and comprehensive, evidence-based analysis about the course of global inequality, variously defined, before and during our globalization era.”–Nancy Birdsall, founding President of the Center for Global Development
But hey, why substantively engage the arguments and links above when you can just call someone stupid?
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