We Interrupt your Regularly Scheduled Programming for a Bit of DeprogrammingPosted: April 12, 2011
It’s time for my regular rant on how bad income inequality is for an economy. I know that John Boenher wants to transfer all the resources in the country to so-called job creators and that CEO Hacks are trying to turn the public school system into a drone production unit, but as usual, I’m going to interrupt the messaging with empirical evidence. I’m just one of those people that doesn’t believe any one unless they back it up with honest numbers. This time, I’m going to direct you to a study by the International Monetary Fund (IMF). Just in case you don’t already know, the IMF is not exactly a bastion of comrades-in-arms. They’ve been soundly criticized by developing nations for exporting American-style capitalism wherever they go to provide help to struggling nations. So, with that in mind, here’s a briefing on the study titled “Warning! Inequality May be Hazardous to your Health”.
Their introduction is so meaty that I’m going to leave it nearly wholesale for you before I return to editing more things for a development journal. Finding ways to raise every one’s boat is my thing, just in case you never noticed.
Many of us have been struck by the huge increase in income inequality in the United States in the past thirty years. The rich have gotten much richer, while just about everyone else has had very modest income growth.
Some dismiss inequality and focus instead on overall growth—arguing, in effect, that a rising tide lifts all boats. But assume we have a thousand boats representing all the households in the United States, with boat length proportional to family income. In the late 1970s, the average boat was a 12 foot canoe and the biggest yacht was 250 feet long. Thirty years later, the average boat is a slightly roomier 15 footer, while the biggest yacht, at over 1100 feet, would dwarf the Titanic! When a handful of yachts become ocean liners while the rest remain lowly canoes, something is seriously amiss.
In fact, inequality matters. And it matters in all corners of the globe. You need look no further than the role it might have played in the historic transformation underway in the Middle East.
The increase in U.S. income inequality in recent decades is strikingly similar to the increase in the 1920s. In both cases there was a boom in the financial sector, poor people borrowed a lot, and it all ended in huge financial crises. Did the recent financial crisis result somehow from the increase in inequality?
Some time ago, we became interested in long periods of high growth (“growth spells”) and what keeps them going. The initial thought was that sometimes crises happen when a “growth spell” comes to an end, as perhaps occurred with Japan in the 1990s.
We approached the problem as a medical researcher might think of life expectancy, looking at age, weight, gender, smoking habits, etc. We do something similar, looking for what might bring long “growth spells” to an end by focusing on factors like political institutions, health and education, macroeconomic instability, debt, trade openness, and so on.
Somewhat to our surprise, income inequality stood out in our analysis as a key driver of the duration of “growth spells”.
We found that high “growth spells” were much more likely to end in countries with less equal income distributions. The effect is large. For example, we estimate that closing, say, half the inequality gap between Latin America and emerging Asia would more than double the expected duration of a “growth spell”. Inequality seemed to make a big difference almost no matter what other variables were in the model or exactly how we defined a “growth spell”. Inequality is of course not the only thing that matters but, from our analysis, it clearly belongs in the “pantheon” of well-established growth factors such as the quality of political institutions or trade openness.
While income distribution within a given country is pretty stable most of the time, it sometimes moves a lot. In addition to the United States in recent decades, we’ve also seen changes in China and many other countries. Brazil reduced inequality significantly from the early 1990s through a focused set of transfer programs that have become a model for many around the world. A reduction of the magnitude achieved by Brazil could—albeit with uncertainty about the precise effect—increase the expected length of a typical “growth spell” by about 50 percent.
The upshot? It is a big mistake to separate analyses of growth and income distribution. A rising tide is still critical to lifting all boats. The implication of our analysis is that helping to raise the lowest boats may actually help to keep the tide rising!
That basically says that no one’s boat will really rise as much as it could unless all boats rise. Intuitively, this makes sense because if you think about it, businesses need customers. Poor customers just don’t buy as much unless you provide them with good incomes. Unless you want make government the primary customer in an economy or you’re deluded into thinking business investment will ever be the major agent in GDP, you realize that household consumers are the true center of any market economy. Denying them incomes denies every one of incomes. Just providing monies to the top 1 or 2 percent who are now likely to take their spending and investment any where on the planet is just delusional. Actually, if you want some really good reading on that, I suggest you pick up the book Tax Havens: How Globalization Really Works (Cornell Studies in Money).
In Tax Havens, Ronen Palan, Richard Murphy, and Christian Chavagneux provide an up-to-date evaluation of the role and function of tax havens in the global financial system-their history, inner workings, impact, extent, and enforcement. They make clear that while, individually, tax havens may appear insignificant, together they have a major impact on the global economy. Holding up to $13 trillion of personal wealth—the equivalent of the annual U.S. Gross National Product—and serving as the legal home of two million corporate entities and half of all international lending banks, tax havens also skew the distribution of globalization’s costs and benefits to the detriment of developing economies.
The first comprehensive account of these entities, this book challenges much of the conventional wisdom about tax havens. The authors reveal that, rather than operating at the margins of the world economy, tax havens are integral to it. More than simple conduits for tax avoidance and evasion, tax havens actually belong to the broad world of finance, to the business of managing the monetary resources of individuals, organizations, and countries. They have become among the most powerful instruments of globalization, one of the principal causes of global financial instability, and one of the large political issues of our times.
There’s not really much difference between the Gadhaffi family and the Koch brothers when it comes to where the money goes from exploiting national resources. It’s also really no surprise that when you observe the countries that have the highest per capita incomes in the world that you find the world’s tax havens in the top tiers. (Norway and the US are the only countries in the top ten that aren’t tax havens.) Giving money to the richest folks in your country–the behavior of so-called banana republics–is detrimental to the economic health of that country in many ways. It’s just another way that financial institutions and financial innovation has gutted the productive capability of many a country.
The original IMF study–released on April 8, 2011–is here. I would like to point to the policy implications and suggestions section which makes going to the original study imperative. Think about this when you listen to US banana republic President Obama speak tomorrow on the marvels of the catfood commission’s report. Notice there are other studies cited in the policy suggestions.
There is nonetheless surely policy scope to improve income distribution without undermining incentives—perhaps even improving them—and thereby contribute to lengthening the duration of growth spells.
- Better targeting of subsidies can be a win-win proposition, as with the reallocation of fiscal resources towards subsidies of goods that are consumed mainly by the poor,which can free up capacity to finance public infrastructure investment while better protecting the poor (Coady et al., 2010).
- Active labor market policies to foster job-richer recoveries (ILO, 2011) may help to make recoveries more sustainable, especially as rising unemployment appears to be associated with deteriorations in the income distribution (Heathcote, Perri, and Violante, 2010).
- Equality of opportunity can make for both more equal and more efficient outcomes (World Bank, 2005). For example, effective investments in health and education—human capital—may be able to square the circle of promoting durable growth and equity while avoiding shorter-run disincentive effects (Gupta et al., 1999). Such investments could strengthen the labor force‘s capacity to cope with new technologies (which may have contributed to more inequality in a number of cases), and thereby not only reduce inequality but also help sustain growth. They could also help countries address possible adverse distributional consequences of globalization and reinforce its growth benefits.
- Some countries have managed through pro-poor policies to markedly reduce income inequality. Brazil, for example, after its market-oriented reforms of 1994 implemented active propoor distributional policies, notably, social assistance spending, that were critical to substantial reductions in poverty (Ravallion, 2009).
- Well-designed progressive taxation and adequate bargaining power for labor can also be important in promoting equity, though with due attention to the need to avoid dual labor markets that perpetuate divisions between insiders and outsiders.
Yes, I bolded the sections that are in absolute contradiction with current US political groupthink. I guess Obama just really isn’t that into development policy or research in economics. Read them and weep for what could be. Meanwhile, turn on the TV and go right back to the villagers promoting the idea that trickle up economics makes all of us better off, if you dare.