Impulse Control and Economic Inequality

Martin WolfMartin Wolf has written an important warning over at The Financial Times, Why Inequality Is Such a Drag on Economies. It is based on studies by Standard & Poor’s and Morgan Stanley that show that rising inequality is actually hurting the economy in the United States. This isn’t news. I’ve written about it before, Individual vs Collective Interests. But it is good to see it getting more coverage.

Let’s be clear: it is obvious that high levels of inequality would be bad for the economy. The idea of Say’s Law is that supply creates its own demand. The problem is that Say has been dead for almost 200 years and the “law” is wrong. If Say’s Law were true, we wouldn’t have recessions. Keynes argued that one of the reasons it isn’t true is that prices don’t automatically adjust to economic changes; if a worker is going to starve with a given wage, he just won’t accept that wage.

But look at what we’ve had in the world for the last six years. There are huge amounts of money cycling all through the economy looking for some place to invest it. And there is no place to invest it. So effectively, the rich (including corporations) are sitting on huge amounts of money. If anyone really believed Say’s Law, companies would just start producing stuff because “supply creates its own demand”! But they don’t, because they aren’t idiots.

It’s interesting that so much conservative economics is found to be completely useless when it comes to practical matters. In general, those who have to predict economic conditions and who have money on the line use New Keynesian kinds of models. I think this tells you all you have to know. There is no doubt that the new classical economists have important lessons for people interested in economics as an academic subject. But in terms of practical matters, why do they stick their noses in? Well, it’s pretty clear: because they have ideological axes to grind.

So no one should be surprised that our ridiculous level of economic inequality should be bad for the economy. The more money accumulated by a smaller and smaller group, the less money there is to buy stuff. Of course, it is so much worse than this because it isn’t just economics. The more money the small group has, the more they can manipulate the political process in their favor.

Martin Wolf discusses all this, but he puts far too big an emphasis on education. This I find mystifying. The young people today with college degrees can’t find jobs to use those degrees. If we had twice as many people with college degrees, we would have even more people who are over-qualified for the poor paying jobs that are available. Our focus should be on creating an economy where one could have a good life with just a high school diploma. Then there might be a market for people with advanced degrees. As it is, talking about college just avoids the issue.

And Wolf understand the issue. He wrote:

Thus, in 2012, says the Organisation for Economic Co-operation and Development, the US ranked highest among the high-income countries in the share of relatively low-paying jobs. Moreover, the bottom quintile of the income distribution received only 36 per cent of federal transfer payments in 2010, down from 54 per cent in 1979.

So you see the problem right there: we don’t provide decent jobs because the rich are taking all the profit in the economy for itself. And then, we don’t even take care of the poor — more and more of government transfer payments go to the top rather than the bottom. There is a feedback loop here where bad economic policy leads to high inequality which leads to more bad economic policy.

The question is: will this change? The truth is that I’m not hopeful. I discussed the basic problem earlier this year, Impulse Control and Global Warming. All the problems that conservatives claim plague the poor — things like poor impulse control — actually affect the rich to a much greater degree. They may see that for the economy as a whole, it is bad for all the rich to stick it to the poor. But it is still in their best interest to stick it to their own employees. And this can easily go on to the point where the whole society breaks down.

As Wolf noted, “Enormous divergences in wealth and power have hollowed out republics before now. They could well do so in our age.” Yes they could.

H/T: Mark Thoma

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About Frank Moraes

Frank Moraes is a freelance writer and editor online and in print. He is educated as a scientist with a PhD in Atmospheric Physics. He has worked in climate science, remote sensing, throughout the computer industry, and as a college physics instructor. Find out more at About Frank Moraes.

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