Inequality and the Great Recession

Over at Religious Left Law, Steve Shiffrin has blogged on Robert Reich’s recent analysis of the relationship between inequality and the recession. As Shiffrin explains, “when wealth is concentrated at the top, the rest do not have enough purchasing power to support the economy.” I wanted to elaborate on that point; I’ll try to address some challenges to it in future posts.

1) Paul Krugman appears to disagree with Reich’s (and others’) “underconsumption theory.” For Krugman, inequality’s negative impact on macroeconomic stability (if it exists at all) is mediated by the political system. Politics gets more polarized during times of inequality, and that polarization may be preventing constructive, cooperative approaches to developing the infrastructure that a thriving market needs.

2) Robert Brenner predicted a “crisis of overproduction” years ago, and we may well be in it now. We know that “businesses are only producing 3 percent fewer goods and services than when the recession started, but Americans are working 10 percent fewer hours.” Economic theory might predict that more productive employers will hire more workers. But when unemployment is as high as it is now, employers can also choose to force the “survivors” at their firms into working longer hours for the same amount of pay.

From assembly line workers to gossip bloggers, anyone can be scared into a “dance marathon” mode of cutthroat competition. The closer labor costs can be driven to subsistence wages, the higher corporate earnings will go. Many “knowledge workers” found this arrangement acceptable when it drove down the costs of their clothing and food, but now feel what it’s like to be considered surplusage. If there is a stand-off between labor and business, the power of the latter can become self-reinforcing. We can expect more health care costs shifted onto labor, too.

3) Branko Milanovic has theorized that the “real cause of the crisis lies in huge inequalities in income distribution which generated much larger investable funds than could be profitably …. employed.” These funds fueled unproductive investments like subprime mortgages, but now their (concentrated) owners are far more cautious. The middle class finds it much harder to get credit. A paradox of thrift may result as belt-tightening leads to a downward spiral of reduced economic activity. I’ve complained about excess credit before, but timing is everything, and it’s easy to see how this sort of spiral could get out of hand at this point in the economic cycle.

4) Perhaps the only constraint on these trends will be the negative macro-consequences of the shrinking buying power of the un- and under-employed. Someone has to buy what businesses are selling, even in a weightless economy. For example, Michigan is discovering that the winners in the “new economy” are reliant on customers and clients with some buying power:

The sputtering Michigan economy is dragging down the state’s once-strong health-care system, offering a preview of how a lingering recession could corrode Americans’ hospitals, savings and health. . . . Years of auto-industry layoffs and benefit cuts to white-collar retirees have left hundreds of thousands of Michigan workers . . . without employer-provided health coverage. . . .

The seven-hospital St. Joseph system lowered its operating margin and projects it will cut $60 million from next year’s budget, about 7% of its revenue. The William Beaumont Hospital system, which traditionally attracted well-insured patients at its hospitals in the affluent suburbs of Grosse Pointe and Royal Oak, reported its first net loss last year.

Unions have often bargained for fair wages, but they appear to be a fading force in the private sector. Given the failure of the most liberal congress in decades to pass EFCA, there may be little hope other than to appeal to the good will of elites. (Or, as Shiffrin puts it, an “enlightened business community.”) As Pope Leo XIII said in the encyclical Rerum Novarum:

Among the many and grave duties of rulers who would do their best for their people, the first and chief is to act with strict justice–with that justice which is called in the schools distributive–toward each and every class. . . . Justice, therefore, demands that the interests of the poorer population be carefully watched over by the administration, so that they who contribute so largely to the advantage of the community may themselves share in the benefits they create–that being housed, clothed, and enabled to support life, they may find their existence less hard and more endurable.

These recommendations pivot on a distinction alien to most contemporary economic thought—between luxury and necessity, i.e., between discretionary consumption and that which reduces pain and suffering. We would do well to revive such priorities as we debate the merits of “austerity” and a new Keynesianism.

Image Credit: Wikipedia thumbnail of poster for film They Shoot Horses, Don’t They?

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