EconoMonitor

Nouriel Roubini's Global EconoMonitor

The Instability of Inequality

From Project Syndicate:

This year has witnessed a global wave of social and political turmoil and instability, with masses of people pouring into the real and virtual streets: the Arab Spring; riots in London; Israel’s middle-class protests against high housing prices and an inflationary squeeze on living standards; protesting Chilean students; the destruction in Germany of the expensive cars of “fat cats”; India’s movement against corruption; mounting unhappiness with corruption and inequality in China; and now the “Occupy Wall Street” movement in New York and across the United States.

While these protests have no unified theme, they express in different ways the serious concerns of the world’s working and middle classes about their prospects in the face of the growing concentration of power among economic, financial, and political elites. The causes of their concern are clear enough: high unemployment and underemployment in advanced and emerging economies; inadequate skills and education for young people and workers to compete in a globalized world; resentment against corruption, including legalized forms like lobbying; and a sharp rise in income and wealth inequality in advanced and fast-growing emerging-market economies.

Of course, the malaise that so many people feel cannot be reduced to one factor. For example, the rise in inequality has many causes: the addition of 2.3 billion Chinese and Indians to the global labor force, which is reducing the jobs and wages of unskilled blue-collar and off-shorable white-collar workers in advanced economies; skill-biased technological change; winner-take-all effects; early emergence of income and wealth disparities in rapidly growing, previously low-income economies; and less progressive taxation.

The increase in private- and public-sector leverage and the related asset and credit bubbles are partly the result of inequality. Mediocre income growth for everyone but the rich in the last few decades opened a gap between incomes and spending aspirations. In Anglo-Saxon countries, the response was to democratize credit – via financial liberalization – thereby fueling a rise in private debt as households borrowed to make up the difference. In Europe, the gap was filled by public services – free education, health care, etc. – that were not fully financed by taxes, fueling public deficits and debt. In both cases, debt levels eventually became unsustainable.

Firms in advanced economies are now cutting jobs, owing to inadequate final demand, which has led to excess capacity, and to uncertainty about future demand. But cutting jobs weakens final demand further, because it reduces labor income and increases inequality. Because a firm’s labor costs are someone else’s labor income and demand, what is individually rational for one firm is destructive in the aggregate.

The result is that free markets don’t generate enough final demand. In the US, for example, slashing labor costs has sharply reduced the share of labor income in GDP. With credit exhausted, the effects on aggregate demand of decades of redistribution of income and wealth – from labor to capital, from wages to profits, from poor to rich, and from households to corporate firms – have become severe, owing to the lower marginal propensity of firms/capital owners/rich households to spend.

The problem is not new. Karl Marx oversold socialism, but he was right in claiming that globalization, unfettered financial capitalism, and redistribution of income and wealth from labor to capital could lead capitalism to self-destruct. As he argued, unregulated capitalism can lead to regular bouts of over-capacity, under-consumption, and the recurrence of destructive financial crises, fueled by credit bubbles and asset-price booms and busts.

Even before the Great Depression, Europe’s enlightened “bourgeois” classes recognized that, to avoid revolution, workers’ rights needed to be protected, wage and labor conditions improved, and a welfare state created to redistribute wealth and finance public goods – education, health care, and a social safety net. The push towards a modern welfare state accelerated after the Great Depression, when the state took on the responsibility for macroeconomic stabilization – a role that required the maintenance of a large middle class by widening the provision of public goods through progressive taxation of incomes and wealth and fostering economic opportunity for all.

Thus, the rise of the social-welfare state was a response (often of market-oriented liberal democracies) to the threat of popular revolutions, socialism, and communism as the frequency and severity of economic and financial crises increased. Three decades of relative social and economic stability then ensued, from the late 1940’s until the mid-1970’s, a period when inequality fell sharply and median incomes grew rapidly.

Some of the lessons about the need for prudential regulation of the financial system were lost in the Reagan-Thatcher era, when the appetite for massive deregulation was created in part by the flaws in Europe’s social-welfare model. Those flaws were reflected in yawning fiscal deficits, regulatory overkill, and a lack of economic dynamism that led to sclerotic growth then and the eurozone’s sovereign-debt crisis now.

But the laissez-faire Anglo-Saxon model has also now failed miserably. To stabilize market-oriented economies requires a return to the right balance between markets and provision of public goods. That means moving away from both the Anglo-Saxon model of unregulated markets and the continental European model of deficit-driven welfare states. Even an alternative “Asian” growth model – if there really is one – has not prevented a rise in inequality in China, India, and elsewhere.

Any economic model that does not properly address inequality will eventually face a crisis of legitimacy. Unless the relative economic roles of the market and the state are rebalanced, the protests of 2011 will become more severe, with social and political instability eventually harming long-term economic growth and welfare.

This post originally appeared on Project Syndicate and is reproduced here with permission.

17 Responses to “The Instability of Inequality”

MikeinOttOctober 14th, 2011 at 3:16 pm

Can it be said that with the significant reduction in middle class in North America and Europe that we have lost a significant contributer to the flow of money (volume and frequency) to the overall economy? In the context that those with the high incomes (extreme inequality) do not spend to the extent (percent of income) nor with the capacity (volume and frequency) that the middle class would. ps Great to see proposals for solutions from someone finally !

overpopoverOctober 14th, 2011 at 10:59 pm

Most of humanity is increasingly irrelevant to the production of goods and services, to the creation of ideas, and – most significantly – to the creation, maintenance, and use of military force. Combine that with the ever more evident problems of overpopulation and environmental destruction and one must conclude that massive forced depopulation is much more likely than redistribution of wealth and power.

shelbyMay 8th, 2012 at 1:21 am

Agreed. See Agenda 21 re population reduction. See One Bay Area plan (California) to stack and pack low income from Rodeo down past the freeway turnoff – right on multiple earthquake faults. Note vast areas of green in rest of counties.

Hyip HelpOctober 18th, 2011 at 10:34 am

Usually I don’t read article on blogs, but I would like to say that this write-up very forced me to check out and do it! Your writing style has been surprised me. Thanks, quite nice article.

cause of bloody noseOctober 19th, 2011 at 12:28 pm

Nice post. I was checking constantly this blog and I’m impressed! Very helpful information particularly the last part 🙂 I care for such information much. I was looking for this particular info for a very long time. Thank you and best of luck.

Tokina 11-16mmOctober 20th, 2011 at 5:06 am

I do agree with all the ideas you have presented in your post. They’re really convincing and will certainly work. Still, the posts are too short for novices. Could you please extend them a bit from next time? Thanks for the post.

Diablo 3 modsOctober 21st, 2011 at 6:01 am

I am not sure where you’re getting your information, but great topic. I needs to spend some time learning more or understanding more. Thanks for excellent info I was looking for this info for my mission.

hebrew tattoo quotesOctober 22nd, 2011 at 5:38 am

There are some interesting deadlines on this article but I don’t know if I see all of them middle to heart. There may be some validity however I will take hold opinion until I look into it further. Good article , thanks and we want extra! Added to FeedBurner as properly

Bursitis ElbowOctober 23rd, 2011 at 2:30 pm

Attractive section of content. I just stumbled upon your blog and in accession capital to assert that I get actually enjoyed account your blog posts. Anyway I’ll be subscribing to your augment and even I achievement you access consistently fast.

Lilliam HoOctober 24th, 2011 at 11:15 pm

Thank you for an additional fantastic blog. Where else may one get that sort of information written in such an ideal way? I actually have a presentation that i’m presently performing on, and i are searching for such info instead.

Galen TodmanOctober 26th, 2011 at 7:31 am

Im impressed, I should say. Extremely hardly ever do I come across a weblog thats both informative and entertaining, and let me let you know, youve hit the nail on the head. Your weblog is crucial; the issue is one thing that not sufficient individuals are talking intelligently about. Im genuinely happy that I stumbled across this in my search for one thing relating to this issue.

Sammy BoneyOctober 26th, 2011 at 10:17 am

Im impressed, I must say. Really hardly ever do I come across a blog thats each informative and entertaining, and let me tell you, youve hit the nail on the head. Your weblog is significant; the issue is something that not sufficient people are talking intelligently about. Im really happy that I stumbled across this in my search for something relating to this issue.

traduceri engleza romanaOctober 27th, 2011 at 1:28 am

What is here it is a great article this is the reason why I post a link to you in one of my site your link is here . But first of all I must say all every one. Hello. After this I must say that I m thinking to post http://www.economonitor.com/nouriel/2011/10/14/fr… on my Digg profile. And this because in the end I found what I was looking for. What you share here is really nice information. In the minute I saw this tittle, EconoMonitor : Nouriel Roubini's Global EconoMonitor » The Instability of Inequality, on my google search I was very glad. Maybe I found something with the same ideea here http://www.toplevel-traduceri.ro, I’m not sure but I thing it was the same. Thank you

sousOctober 27th, 2011 at 6:06 pm

Admiring the time and energy you put into your site and in depth information you provide. It’s great to come across a blog every once in a while that isn’t the same out of date rehashed information. Wonderful read! I’ve bookmarked your site and I’m including your RSS feeds to my Google account.