A boyishly handsome spectre is haunting economics, the spectre of Thomas Piketty. Inequality has suddenly assumed centre stage in economic discussion. The International Monetary Fund (IMF) and the Organisation for Economic Co-operation and Development (OECD), a club of mostly rich nations, have been talking about it.
Even the Pope has chimed in. He recently set the cat among the Catholic Church’s conservative pigeons by tweeting, “Inequality is the root of social evil." But the main reason for the newfound concern for inequality is a tome by French economist Piketty, evocatively titled Capital in the Twenty-First Century, that has amazingly topped the charts at Amazon.com.
What’s so special about Piketty’s book? Baldly stated, it debunks our fond belief that a rising tide in the economy will necessarily lift all boats. Piketty writes, “If we consider the total growth of the US economy in the 30 years prior to the crisis, that is, from 1977 to 2007, we find that the richest 10% appropriated three-quarters of the growth. The richest 1% alone absorbed nearly 60% of the total increase of US national income in this period. Hence, for the bottom 90%, the rate of income growth was less than 0.5% per year."
The Kuznets curve, which said that a period of rising inequality as growth took off would ultimately be followed by lower inequality, is a fairy tale. Piketty’s computations lead him to believe that rising inequality would result in capital’s share of global income rising to the level it was at in the eighteenth and nineteenth centuries. Labour’s share, of course, would go down correspondingly.
All right, so inequality is increasing. But that story is hardly new. The International Labour Organization (ILO) has been complaining about the declining share of wages in national income for years. The United Nations Development Programme (UNDP) has been saying the same thing and numerous academic studies have come to the same conclusion. The Asian Development Bank (ADB) has chronicled the increase in inequality in Asia. We know globalization has resulted in pockets of the First World in the Third and of the Third World in the First.
The bigger question is: won’t higher growth offset some of the concerns stemming from rising inequality?
Yes, rapid growth can buy off disaffection with increasing inequality or even with lack of freedom, a point well understood by the Chinese ruling class. But Piketty points out that the rate of growth of global output has been slowing, from 4% between 1950 and 1990 to below 3.5% between 1990 and 2012. He forecasts world growth to taper to 3% between 2030 and 2050, and then to 1.5% in the second half of the century. He assumes that the emerging markets will continue the convergence process with developed countries and there would also be significant technical progress improving productivity. He bases his gloomy prognostications on two factors: 1) slower population growth and 2) slower income growth in developing countries as they increasingly catch up with the developed ones.
Piketty marshals an impressive amount of data, over several centuries, to arrive at his conclusions. What consequences flow from his predictions?
First, it’s likely that high levels of inequality lead to lower growth. In a recent IMF staff discussion note titled Redistribution, Inequality and Growth, the authors say it would “be a mistake to focus on growth and let inequality take care of itself, not only because inequality may be ethically undesirable but also because the resulting growth may be low and unsustainable".
Marriner Eccles, chairman of the US Federal Reserve under Franklin D. Roosevelt, expressed succinctly what happened when purchasing power became too lopsided in the run-up to the Great Depression: “By taking purchasing power out of the hands of mass consumers, the savers denied to themselves the kind of effective demand for their products that would justify a reinvestment of their capital accumulations in new plants. In consequence, as in a poker game where the chips were concentrated in fewer and fewer hands, the other fellows could stay in the game only by borrowing. When their credit ran out, the game stopped." That bit of history sounds familiar, having repeated itself in the latest financial crisis.
High inequality, therefore, erodes effective demand, slowing growth. But while inequality may go back to the levels seen during the nineteenth century, society and social attitudes will not. Globalization, automation and the decimation of the trade unions may have won the class war in favour of capital in the West, but the countries are still democratic and, unlike in the nineteenth century, the masses have to be kept in good humour. Circuses sometimes do the trick, but often bread and other goodies are also needed.
The purchasing power of the masses has, therefore, at different periods, been propped up by fiscal transfers on the one hand and lending binges on the other. Sub-prime mortgages are a prime example of the latter. Governments caught between the pincers of footloose capital and democracy have opted to go in for borrowing, either public or private, to support effective demand and growth. At the same time, inequality has resulted in more financial savings by the rich, which has been deployed around the world in a search for yield. The much-talked about financialization of the world economy is the result. What is quantitative easing but a gambit by central banks to aim for higher asset prices to stoke the wealth effect, which, in turn, will lead to more demand?
The upshot of all this is a global casino economy, where capital accumulation is firmly tied to credit bubbles and waves of speculation, leading to spectacular and frequent booms and busts.
Manas Chakravarty looks at trends and issues in the financial markets. Your comments are welcome at email@example.com