Inequality and mainstream economics

from David Ruccio

Consider the following irony: it takes the International Monetary Fund to show mainstream economists that inequality actually matters.

Most mainstream economists don’t even mention the problem of inequality. And when they do, they explain it away as the natural consequence of changing technology, education, and globalization. And even if they consider it to be important, they can’t figure out how it helps to explain the current crises in capitalism (except, perhaps, through politics).

Apparently, though, the IMF does understand there’s a problem, and it’s linked to the current mess we’re in. Thus, the latest issue of Finance and Development is devoted to the issue of inequality, with seven different articles.

Michael Kumhof and Romain Rancière (whose work I’ve cited before) develop a model in which rising inequality leads to an increase in financialization, indebtedness, and current account deficits, which in turn exacerbate the already-high levels of inequality, in countries like the United States.*

In reality, increases in income inequality are often followed by political interventions to prop up the living standards of the bottom group, whose real income is stagnating. This is generally done not by directly confronting the sources of inequality, such as declines in the collective bargaining power of the bottom group or shifts in the tax burden from the top group to the bottom group, but rather by promoting policies that cut the cost of borrowing for both individuals and financial institutions. . .These policies include domestic and international financial liberalization, and they put additional downward pressure on current accounts.

Andrew G. Berg and Jonathan D. Ostry, for their part, challenge the presumed tradeoff between inequality and efficiency.

In recent work. . ., we discovered that when growth is looked at over the long term, the trade-off between efficiency and equality may not exist. In fact equality appears to be an important ingredient in promoting and sustaining growth. The difference between countries that can sustain rapid growth for many years or even decades and the many others that see growth spurts fade quickly may be the level of inequality. Countries may find that improving equality may also improve efficiency, understood as more sustainable long-run growth. . .

The recent global economic crisis, with its roots in U.S. financial markets, may have resulted, in part at least, from the increase in inequality. With inequality growing in the United States and other important economies, the relationship between inequality and growth takes on more significance.

Facundo Alvaredo arrrives at much the same conclusion:

The new data call into question the standard relationship between economic development and income distribution—that growth and inequality reduction go hand in hand. But that relationship, postulated by economist Simon Kuznets, appears to be less certain—especially in English-speaking countries, which had a period of falling inequality during the first half of the 20th century followed by a reversal of the trend since the 1970s.

Now, the particular way all these authors think about the conditions and consequences of economic inequality is different from the way I understand and approach the problem. But, still, the fact that they find an important relationship between inequality and important macroeconomic issues such as financial instability, external imbalance, and slower growth demonstrates for all concerned that the majority of mainstream economists have simply chosen not to investigate the problem.

And the rest of us are suffering as a consequence.

* In other countries, such as China, with less developed financial systems, increasing inequality can generate large trade surpluses.