Home > income redistribution, inequality, The Economics Profession > Inequality, the Second Great Depression, and mainstream economics

Inequality, the Second Great Depression, and mainstream economics

from David Ruccio

This morning, we’re faced with the extraordinary spectacle of two left-of-center, Nobel Prize-winning economists stumbling all over themselves trying to make sense of the role of inequality in creating and sustaining the Second Great Depression.

Really?! Now, they may have missed the trend of growing inequality over the course of the past three decades. Still, with all the talk of obscene levels of inequality in the last five years and mainstream economists, even the best and the brightest, are still having a hard time formulating a theory about the impact of that inequality in producing the conditions for the crash of 2007-08 and sustaining the recovery that never was.

First, Joseph Stiglitz argued that “Inequality stifles, restrains and holds back our growth.” Then, Paul Krugman responded by telling us he’s not convinced “that this particular morality tale is right.” 

It’s true, they agree that current economic conditions are, for that vast majority of people, pretty ugly. And that inequality distorts the political process, by allowing those on top to buy their favorite politicians and policies.

Both Stiglitz and Krugman also mention that growing inequality fosters financial crises, although from all that I’ve read neither has ever offered a theory of how that actually works.

So, their big disagreement is centered on the role of inequality (which, after a brief hiatus in 2009, is growing once again) in sustaining the current non-recovery, which I have come to refer to as the Second Great Depression. Basically, Stiglitz borrows from the radicals’ playbook and makes an underconsumption argument, which Krugman attempts to refute by invoking private savings rates and the idea that there can be full employment “based on purchases of yachts, luxury cars, and the services of personal trainers and celebrity chefs.”

Sure, but there isn’t. Not even close. And, according to all the projections I’ve seen, there won’t be for quite some time.

It is surely an embarrassment for mainstream economics that two of its best can barely even begin a serious discussion of the complex and contradictory effects of inequality on the pace and nature of growth since the financial crash of 2008. But, to give them credit, they’re still way out in front of their mainstream colleagues, who aren’t even attempting to make sense of the role inequality has played and continues to play in creating the Second Great Depression.

  1. January 22, 2013 at 12:54 pm

    The fact is that no matter how many yachts or luxury cars are bought, the consumption of the wealthier class typically constitutes a smaller share of their total income when compared to the case of the poor, who usually need to consume all their income. A super-rich person does not spend all the income, a poor person must. Thus, the marginal propensity to consume is higher amongst the poorest, and inequality reduces consumption, and thus demand. You could say that inequality also increases saving and thus investment, but this is not true, since in a crisis such as the present one the money that is put in the bank, or hoarded in another way, is not subsequently used for investment, because there are no investment opportunities (for example, the money that is injected into banks has not led to further investment in the countries affected by the eurozone crisis). In a crisis, saving leads to hoarding, not investment. It is investment that leads to saving through growth, not the other way around, especially when the present situation of the financial sector. Thus reducing inequality would indeed be essential to get out of the present situation. I am against making self-promotion of your own papers in blogs, but I cannot possibly fully elaborate this here, and indeed I have written a whole paper on the topic, and on its relationship to heterodox economics, so please forgive me, here it is:


    • January 24, 2013 at 10:26 am

      Nuno, I’m with you in spirit but not on this detail:

      “… in a crisis such as the present one the money that is put in the bank, or hoarded in another way, is not subsequently used for investment, BECAUSE THERE ARE NO INVESTMENT OPPORTUNITIES”.

      Of course there investment opportunities. The problem is, expectations have been formed by the mainstream doctrine that the purpose of investment is to make money, not to make everyone’s lives better. In more sensible times wealthy people gave themselves the satisfaction of underwriting the provision of local public facilities like churches and town halls, schools and libraries, parks and railways, which benefitted everyone including themselves: not least via the vicarious pleasure of seeing other people enjoying them. In Britain’s National Trust and preserved railways, the moderately well off still do. The dismal science, however, based itself on physics, where power is dissipated at the point of use, rather than on broadcasting, where the same information, once provided, can be shared for free. Thus its focus is on money power regenerating itself via the “selling on” of products, rather than what does the use (or hoarding) of money say about the acquirer of it? In that context the Keynesian solution is only using government to finance by tax what rich people should be doing by “charitable” giving, and in Britain can be doing by covenanting contributions to causes of their own rather than the Government’s choice. My solution is to recognise and act in accordance with the truth that money is simply information: no more than credit limits on the credit cards of our lives and communal projects, which spending on what we have already produced turns into debt, and working to reproduce goods rather than recyle money is the requirement for sustainability.

  2. sergio
    January 22, 2013 at 1:07 pm

    Bailouting banksters by the government is the only thing which prevents capitalism and neoclassical nonsense from collapse. What would neoclassicals do without government?They should praise it.


    • January 24, 2013 at 11:32 am

      Dave, I fully agree that the purpose of investment should be to make everyone’s lives better, and that once one focuses on things such as broadening human capabilities, there are certainly many investment opportunities. I was trying to make an internal critique of a system in which investment is made for other purposes (i.e., profit), leading to a contradictory situation, since without wage-led growth the investment oportunities (from the point of view of profit-making) do not exist. One must of course broaden the framework as you suggest (and I also do, I think the emphasis should be on human capabilities), but it is also important to show the contradictory nature of the system to those who do not accept alternative views, in that case the critique must be made from within the system they accept (as I think you also do in your comment). Thanks for the comment!

      • Mike Meeropol
        January 24, 2013 at 11:51 am

        Nuno, your comment about the need to make a critique “from within the system” is very apt. I have always thought that the great contribution the neo-Keynesians (beginning with Joan Robinson and including Luigi Pasinetti, Geoff Harcourt and many others) was to marry the insights of Marx and Keynes so that certain heterodox ideas would enter into the mainstream. This had a much more significant impact in the UK than in the US (witness the emergence and development of the CJE) but certainly some within the US were similarly influenced. Perhaps, despite the fact that Joan Robinson excoriated him when he was a research student in Cambridge, Joe Stiglitz himself, absorbed some neo-Keynesian analysis — which emerged when he saw the damage done by neo-liberalism up close and personal at the World Bank and in the Clinton Administration.

      • January 26, 2013 at 9:48 am

        Nuno and Mike: somewhat belatedly, thanks; I found the comments about your own approaches very helpful, as I don’t want it to be thought I am criticising critics. Given how in-bred and autistic “the system” has become and the futility of criticising details without prior understanding of what “a system” is, what “the system” is and how it works,
        I’ve been into systems analysis and trying to increase understanding of the evolution of systems and how they work. Experience of autistics shutting out fears leads me not to attack them but to include them as spectators, hoping they will see the point of our arguments in their own good time.

      • January 26, 2013 at 10:04 am

        Nuno: on capabilities, one of my own lines of argument is that the wealth of a nation is primarily its people, and the continuing development of succeeding generations is one of the reasons why work will remain significant even if machines could produce everything and credit cards permit its equitable distribution.

  3. Nell
    January 22, 2013 at 2:18 pm

    Never thought the ‘rich people will spend’ argument held much water. It assumes that the majority of rich people want to spend their money on luxury goods. Maybe some do, but maybe some don’t, they, at least have the luxury of making a choice. I once lived in a city that had the most millionaires per sq mile. There was little sign that they spent their wealth ostentatiously. (Run of the mill clothing, cars, furniture – all chain store stuff).
    Given that spending equals income, it makes more sense to distribute income away from the top towards the lower end of the scale. As Martin points out, distribute to people who have little choice but to spend it. I am also intrigued by Martin’s argument that investment leads to saving, so thanks for the link to your paper. For example, if I was Chancellor of the UK, the last thing I would do is decrease benefits to the unemployed and disabled.

  4. BFWR
    January 22, 2013 at 3:24 pm

    Learned folly. Wisdom, specifically its condensations of Faith as in Confidence, Hope, Love and Grace is what is needed. That and symmetry as in monetary Grace for everyone. Then we can get to where we want to go.

  5. January 22, 2013 at 3:35 pm

    Somewhere in “American Made: the enduring legacy of the new deal” (Nick Taylor) in the first part there is a eye opening description of the attempts, circa 1929 – 32, to generate employment based on yachts, tending golf courses and hiring caddies. Turns out the poor didn’t have a clue — kept giving the golfers the wrong clubs. As Lord Grantham so aptly explained “Downton has an obligation to local employment.”

  6. January 22, 2013 at 6:46 pm

    Both Stiglitz and Krugman fall for the sleight of hand that makes whatever they come up with incoherent. That particular hocus pocus is the substitution of growth for full employment as the objective of fiscal and monetary policy.

    Over at Beat the Press, I commented that the disappearance of full employment from the liberal agenda has been a long term trend — perhaps a strategy. In the General Theory, Keynes used the parable of telling people that green cheese is the same thing as the moon to get around the inconvenient fact that money has paradoxical conditions of supply and demand:

    Unemployment develops, that is to say, because people want the moon;–men cannot be employed when the object of desire (i.e. money) is something which cannot be produced and the demand for which cannot be readily choked off. There is no remedy but to persuade the public that green cheese is practically the same thing and to have a green cheese factory (i.e. a central bank) under public control.

    In the post-war period, economists and governments have dutifully substituted “full employment” for “money” and “growth” for “green cheese” in Keynes’s parable, effectively reversing its meaning since what grows is the money that Keynes had originally dismissed as the impractical, unattainable “object of desire.” Policy pursues precisely what Keynes had identified as the ultimate barrier to full employment!

  7. randmcgreal
    January 23, 2013 at 12:53 am

    Is it the role of Economics to solve the inequlaity problem in our communities? I guess by Stiglitz’s statements it is this inequal situation in our communities that is preventing economic growth after the Great Recession. How does that work? Are the rich people not investing in new projects? Yes, that is true. They haven’t invested like they normally do. Why, because they knew they would end up sending their money to the government. The tables have turned. So now, it is the government that can invest in new projects.

    Precisely, what Paul Krugman has been arguing going on six years. So the solution is more “investment” by government. Now, this same investment could have been made by the rich before they sent in their tax money. Clearly, they would not be rich unless they were good at the investment game. If they had made the investment it would have occurred quicker and with less bureaucratic loss, but now it is up to the government to perform.

    The question is how is this going to solve the inequality problem? Clearly, government will seek the rich to advise and partner with them in making their green energy investments. So the rich can make more money, but now without risk! Somehow, I don’t see how this ends up as a good outcome.

    Now, if the intended good outcome is to put money in the hands of the disadvantaged, let’s just give them the money. I would support an experiment where we just give every person on the southside of Chicago $50,000 for three years and then come back in 2016 and evaluate the transformation of the community. According to Stiglitz this should solve the growth problem.

  8. Mike Meeropol
    January 24, 2013 at 11:33 am

    Let’s not forget that that Baran-Sweezy-Foster-Magdoff-Magdoff-Yates analysis from the Monthly Review school argues that the “tendency of surplus to rise” is a long run story of two trends — rising inequality and declining productive investment opportunities.

    According to the original formulation in MONOPOLY CAPITAL this emerged in the period just before WW I in the US (as evidenced by the relatively sluggish recovery after the 1907 Panic). It was temporarily interrupted by World War I and in the 1920s by the first wave of “automobilization” only to founder of the increased inequality and rising importance of oligopolistically organized industries by 1929. (The inequality data from Saez and Piketty is a clear vindication of part of Baran and Sweezy’s analysis.)

    The depression speaks for itself as a period of tremendous stagnation. However, Saez and Piketty’s data indicates that the American version of “social democracy” (aka the New Deal) led to a significant reduction in inequality. When World War II provided the stimulus to revive high profits for private investors, they responded with alacrity. After World War II, the postwar boom coupled with the restrictions on increasing inequality that persisted through the 1960s (I would argue that was caused by the competition with Soviet style socialism) delayed the emergence of stagnation (though the 1950s were hardly years of dramatic growth). The boom of the 1960s can in part be traced to Kennedy;s military build-up and the Americanization of the War in Indochina. By 1970 all of those had petered out leading to the re-emergence of stagnation.

    And then came the beginnings of the financial explosion — followed, beginning in 1980 by the increase in inequality which peaked at about 1929 levels just in time for the 2008 collapse. In the interim we had a relatively sluggish period of growth in both the 1980s and first half of the 1990s to be followed by the dot.com bubble in the late 1990s and the housing bubble in the “naughts” (as the Brits would say).

    Though many fault the Baran Sweezy (et al) analysis for appearing to be “non-refutable” (anytime stagnation doesn’t show up there are counteracting forces), I think their stress on inequality is very significant and it can be an important explanation for the rise of the bubble-driven economy since the 1970s.

    • January 24, 2013 at 5:35 pm

      Mike, for completeness’ sake you might have mentioned the historic connection between the 1907 panic and the establishment of the Federal Reserve Bank, the history of America being founded on rejection of the private/secretly run British reserve banking system and the 1st and 2nd Banks of America which had attempted to reintroduce it. Perhaps the First World War was a device for taking America’s eye off the ball?

      [Don’t take this too seriously! Enjoy the leg-pulling even while reflecting on the profit patterns of fraudulent banking (i.e. creation of deposits out of nothing), speculative international price manipulations, and subsequent boom-bust-stick trading cycles affecting creative work and businesses significantly more that speculative trading in other people’s second hand goods].

    • January 25, 2013 at 3:03 pm

      Mike, I agree with what you say on Stiglitz and Joan Robinson, and I think a similar situation occurs with Sen

  9. Michael Monterey
    January 25, 2013 at 7:22 am

    Thanks David R, DT, et al, for a very good thread. Too bad such good thinking and logic and historical analysis don’t make it to the mainstream press and the into the teeny weeny hearts & retarded brains of the culprits (and their conventional sectarian plutonomists) and academia.

  10. January 26, 2013 at 8:51 pm

    Justaluckyfool asks,Isn’t taxation an appropriation, really just a means for the sovereign government to exercise its method of quality and quantity control?
    Why are we using a taxation that is unfair and inequitable if there is a method that can “appropriate” with equality and fairness. Why not end federal income taxes and FICA by “raising revenues somewhere else”(Obama).
    How about A BALANCED BUDGET that would DEMAND the revenues raised be spent?
    PLEASE,challenge,improve or destroy “justaluckyfool’s opinions of this fools interpretations of statements by Keynes,Minsky,von Mises,and especially Soddy (The Role of Money).
    None of it is mine, find for yourself what you wish to use as your guide.
    The Central Bank must be the ONLY entity that can issue legal tender.
    Taxation would be thru “Genuine Lending” which shall carry an interest charge.
    Perhaps with a belief that Soddy is correct that the wealth of a nation belongs to the social group and the government uses its sovereign currency as a recorded receipt of any of the nations wealth until it is exchanged for another form of wealth.
    Please, Wray,Black,Keen,Mosler,Hudson, where are your comments?
    **Please,please read: http://bit.ly/MlQWNs Read what Steve Keen has to say about “credit expansion, von Mises as to what the result of credit expansion could be, William Black has to say about banks and Michael Hudson about compound interest (excerpts are in the article). An explanation of where we went wrong with a solution to how we can fix it.

  11. January 27, 2013 at 7:20 am

    “Both Stiglitz and Krugman also mention that growing inequality fosters financial crises, although from all that I’ve read neither has ever offered a theory of how that actually works.”

    And here is the theory you are looking for:

  12. Rainer Friedrich
    February 21, 2013 at 4:56 pm

    I have read both Stiglitz’s and Krugman’s article, and I can’t see what is wrong with the former. Krugman’s reply is feeble. How can David Ruccio treat them as equally feeble?

  13. March 13, 2013 at 8:10 pm

    Life is inherently unfair. If government doesn’t work to ameliorate life’s inherent unfairness, then (all it is) is just another way that life manifests its unfairness.

    Create dead stable e-money by converting all debt (which includes all govt money) to credits using an/the EBT system, subtract flat % from every EBT acct as needed to fund all govt and compensate every legal adult resident with $500/wk (indexed for local cost-of-living), replacing all other welfare. This should be done on a world-wide basis, as there is only one actual govt. (govt being defined as “One or more persons who claim natural resources, are willing and able to defend their claim on those resources, and who make and enforce decisions regarding the allocation of those resources.”)

  14. March 14, 2013 at 12:18 am

    ” even the best and the brightest, are still having a hard time formulating a theory about the impact of that inequality in producing the conditions for the crash of 2007-08 and sustaining the recovery that never was.”
    How is this for a theory ?
    The tremendous advantage the Private For Profit Banks (PFPB) have over the total social group known as “We the people” is a most powerful force that can only end when inequality is so great that the 1% would have to employ its use against its own members until only 1% survives and the rest of the social group is in servitude in order to pay its debt.
    The PFPB have been given the legal right to issue ‘temporary money’ in unlimited quantities and use that temporary money to acquire ‘real money’ to use for their own selfish purposes. One such purposes is to eventually gain control of the wealth of the entire society.
    Surely all would agree that $1,000 as a bank loan at 4% for 36 years requires $4,000 in order to be paid in full. And $10 trillion would require $40 trillion. $100 trillion would require $400 trillion. And the dumb people are fighting over “who should pay what taxes”. while the PFPB are raking in all profit via a taxation called “compound interest”.
    But one most asked, How is that not a level playing field, where is their tremendous advantage? Answer: The PFPB are allowed to make $100 trillion in loans while having NO MONEY of their own ! Yet you say ,no, because they must have 10% in capitalization, right? Where this goes wrong is that the PFPB is allowed to make believe it has 10% because it is allowed to “temporally appropriate the use of that money they hold in trust as deposits while they such out of the economy $400 trillion, $100 trillion must be retired to replace the ‘temporary money they printed yet still allowing them to gain real sovereign currency of $300 trillion. Maybe Black should re title his book, People do not rob banks, banks rob people.
    We allow PFPB to not only print money, but to allow them to put a taxation (interest) for us to pay.
    What caused the 2008 meltdown?
    The PFPB greed over came their control. The PFPB thought they had figured a way to gain, maximize those $300 trillion in profits in the present by breaking the RULE OF 72.
    They took real money out of the system as profits because they were able to cash in “future profit” by selling MBS. Why wait to get paid? The amount of credit expansion ?
    Surely it is large if we understand why some banks are TBTF.
    The solution: “QE 4 The People”

  1. February 28, 2014 at 3:44 pm

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