Global New Year’s Resolution Should Be To Decrease Income Inequality Everywhere

6 January 2010. By David Caploe PhD, Chief Political Economist, EconomyWatch.com. The obvious temptation at this time of year is to a) look backwards – especially given the “end” of a decade [depending on how you count it], and b) go with the “Top Ten” theme – especially given tha

6 January 2010. By David Caploe PhD, Chief Political Economist, EconomyWatch.com. The obvious temptation at this time of year is to a) look backwards – especially given the “end” of a decade [depending on how you count it], and b) go with the “Top Ten” theme – especially given tha

6 January 2010. By David Caploe PhD, Chief Political Economist, EconomyWatch.com. The obvious temptation at this time of year is to a) look backwards – especially given the “end” of a decade [depending on how you count it], and b) go with the “Top Ten” theme – especially given that the New Year is 20-“10.”

But we’re going to keep it simple and look forward with only ONE resolution:

the single MOST important aim for the world economy in not just this year, but the whole decade, is to radically decrease the levels of income inequality in practically every country in the world.

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The reasoning is surprisingly simple.

Due to low interest rates nearly everywhere, there is no lack of liquidity – i.e., there’s PLENTY of money sloshing around the globe.

Despite the huge availability of cash, economic growth in the advanced countries – the US / Europe / Japan – is basically stagnant – a fact that should, although it won’t, kill forever the persistent “monetarist illusion”:

that the ONLY thing that matters in economic activity is the money supply, and its “controller,” namely interest rates.

If the monetarists were right, the effective zero interest rates prevailing now, and for the past several years, should mean the world economy would be humming along nicely, instead of the creaking mess – with some happy exceptions, like China and India, for reasons we noted in our Christmas Wishes for the World Economy post – we’ve been and are still experiencing.

So if economic growth doesn’t come from lots of cash floating around, and low / zero interest rates, where does it come from ???

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The SHORT answer was provided by the dominant / then discredited / now returning with a vengeance English economist John Maynard Keynes – and the LONG answer, which we’ll discuss sometime in the future, comes from the Austrian / American “long-wave” theorist Joseph Schumpeter.

In essence, Keynes argued, the key to economic growth is to increase effective demand, and he spent his considerable talents devising both theoretical and practical ways to make that happen, above all during the Depression of the 1930s, when the inadequacy of “classical” economic theories and policies had become manifestly clear, in a fashion similar, albeit not identical, to the situation we are living through today.

[From an intellectual point of view, Keynes’ biggest problem is he was never able to explain the historical fluctuations of effective demand, which is why his extremely powerful policy prescriptions – which we will outline momentarily – need to be supplemented from a theoretical perspective by Schumpeter, whose long-term approach explains the theoretical questions Keynes so adroitly avoided … but more on that in the future.]

So what does it mean to increase effective demand ???

Very simply, it doesn’t mean changing the total amount of money sloshing around the world.

It means putting that money in different hands, basically those of people who will either spend it right away, or, at a slightly higher level, will invest it right away –

especially in projects likely to promote long-term economic growth in the future [the logic of which can be discovered via a Schumpeterian framework, but, again, that is a subject for a different column].

In this context, the lack of global economic growth at the moment stems from not the availability of money – of which there is plenty – but the fact that money is in the wrong hands, both in terms of people and institutions.

Put bluntly, the people who now have most of the money are those who already have plenty of it – financiers from “too big to fail” banks / the top echelons of insurance companies, above all the health “care” business / and others from the higher rungs of the income scale.

While these people do spend some of their money, the vast amounts of it they have mean they’re not going to spend anywhere near all of it. Indeed, their MAIN concern, understandably, is to protect their money – which means finding places to put it, or invest, that are going to be as safe as possible for THEM.

This may be smart for them from a microeconomic [small-scale] point of view, as individuals and families. But it also means, from a macroeconomic [large-scale] point of view, that money isn’t doing very much in terms of promoting the buying and selling that powers the economy – global / regional / national / local – as a whole.

[This also points out, by the way, the utter nonsense of the neo-classical dogma that “every individual, acting in her own self-interest, will unintentionally produce a positive result for society as a whole” – the ultimate example of what the brilliant English historian and theorist E.H. Carr called “the myth of harmony of interests”.]

Why?

Because the key point about money is it’s not the amount that counts – it’s the speed and number of times that money changes hands, its so-called “velocity” or “multiplier effect.”

Put simply, money just sitting somewhere doesn’t do very much for the economy as a whole, even if it benefits the “owners” by earning them interest / dividends etc.

Money DOES do something for the economy as a whole when it keeps moving – when it goes from one person or business to the next, who then pass it on to their suppliers / creditors, who then use it to buy what they need, etc etc etc.

And what’s true for rich people is also true for institutions as well, albeit in a slightly different way.

Put simply, the current crisis began as a problem for financial institutions like banks and insurance companies that had made bad bets about their investments.

When this happened in the past – which it had, and not infrequently – it created serious problems, but nothing like the financial crisis that exploded in Black September 2008, when the US government failed to intervene to save Lehman Brothers.

Now what makes this crisis different from all other such financial crises ???

In one word, derivatives – the instruments St Warren of Omaha has called “weapons of mass economic destruction” – which turned an eminently containable problem in the sub-prime US housing sector into a world-wide financial and economic disaster, and whose blast effects we haven’t even yet begun to feel, let alone the radioactive fallout likely to follow in years to come.

We have talked about WHY derivatives are so dangerous and HOW they came to play such a destructive role before, and will do so again.

Here, though, our main concern is to explain how an eminently containable problem for the US financial sector so quickly turned into a major global economic crisis – which will help make clear why a significant decrease in income in-equality is so crucial in getting the world economy moving from an institutional point of view as well.

Basically, the major banks and insurance companies convinced the US government that they are – in the now famous phrase – “too big to fail” / or TBTF.

They basically said, “You can let us go down for our financial mistakes, as you did with Lehman Bros. But if you do, we will, like Samson in the Bible, take down the entire financial system of the US and the rest of the world with us – which won’t be in anyone’s interest. Therefore, the smart thing for you, the government, to do is assure us that – no matter what happens – we’ll be safe from the negative consequences of our own mistakes and greed.”

And to make sure the US and other governments – as well as Americans and other peoples around the world – got the message, they instituted an immediate lending freeze:

that is, they basically stopped lending money to ANYONE, individual / new business / established companies / whomever, until they got the reassurance they were demanding that the US government would make good their losses, past and future, existing and potential, using taxpayer monies.

As a result, while there is a lot of money around in the world, almost all of it is concentrated, institutionally, in the hands of the TBTF banks and insurance companies – even as huge numbers of smaller banks and insurance companies go out of business every day of every week.

So while the TBTF banks and insurance companies – just like wealthy individuals and families – have plenty of money, they are basically just sitting on it –

refusing to move it around until they get the assurances they want that they will not be forced to suffer in any way for the bad bets they made,

even as they simultaneously insist on holding on to every bit of profit they make, and handing out huge salaries and bonuses to themselves as well.

Quite apart, then, from any feelings of injustice and resentment this may arouse from both the public at large and smaller banks and insurance companies,

the economic effect of this massively unequal concentration of resources in the hands of wealthy individuals & families / TBTF banks and insurance companies is a disaster for the world economy.

Why?

Because those who “have” are simply sitting on what they have – and by not lending out or spending it, they are depriving the world economy of the significantly positive effect that money COULD have if it were being spent or lent out or invested in innovative new entrepreneurial ventures.

Instead, it’s just lying around, not creating any velocity – aka, multiplier effect – that could help the lives of people all over the globe in an immediate and tangible way.

In this context, the single most important step that can be taken to significantly and quickly improve the health of the world economy is to reduce as soon, and to as great an extent, as possible the income in-equality among both people AND institutions –

inequality that is allowing a very small number to live lives of luxury and excess, while the vast majority of individuals / families / and innovative companies are caught in a web of either daily hunger or the realistic fear that such insecurity will become their own fate, should life hand them the very smallest bad break.

With a real change in the currently unequal distribution of income, the world economy can get back on its feet quickly, and people can, once again, look to the future with a realistic sense of hope / growth / and innovation.

Without a decrease in income inequality, economic stagnation, and the hopelessness it brings, will only continue – a disturbing scenario whose negative human, and societally destabilizing, effects we can contemplate, in the memorable phrase of the Danish philosopher Soren Kierkegaard, with only “fear and trembling.”

David Caploe PhD

Chief Political Economist

EconomyWatch.com