I am writing a paper on inequality and the crisis, for which I used Piketty and Saez ‘s World Top Income Database to try to understand whether the distributional effect changed over time. Unfortunately their data cover 2012 only for a handful of countries, among which are the United States; waiting for new data here is the evolution of income percentiles, including capital gains, from 2007 to 2009 (yellow bars), and from 2009 to 2012 (red bars):
The financial crisis of 2007-2008 mainly hit asset prices, thus having a major impact on the richest layers of the income distribution. In fact, the top 0.1% to 0.01% (a handful of people) lost more than 40% of their income in real terms, while average income of the bottom 90% dropped of around 10%. This was short-lasted, nevertheless, as the prolonged recession, and the jobless recovery that followed, quickly restored, and further deepened the distance between the rich on one side and the middle and lower classes on the other. Since 2009 average income of the bottom 95% stagnated (for the bottom 90% it kept decreasing). Nothing really new, here. The iAGS 2014 report, to which I (marginally) contributed, reaches similar conclusions. But I thought it would be interesting to share it.
And while we are at it, here are the ratios of average income of those at the very top, with respect to income of the bottom 90% (from the same dataset):
The top 0.1%-0.01%, the same handful of people as before, has an average income that is 120 times the average income of the bottom 90%. This is also barely breaking news…
Now, as we all know, the traditional view on income distribution states that factors of production are paid according to their contribution to the production process (their “marginal productivity”). Within this traditional view, the recent steep increase of inequality would be explained by skill-biased technical progress and increased competition in the globalized labor market: the entrance in the global labor market of low-skilled workers from emerging and developing economies lowered the average marginal productivity of labor, thus reducing its share of national income. Increasing inequality would then be an ineluctable process that policy is not supposed to address, if not at the price of reduced efficiency and growth. Is this a caricature? Not so much. in his recent Project Syndicate comment on Piketty, Kenneth Rogoff proposes once again the old tradeoff between inequality and growth that the crisis seemed to have buried once and for all (just look at the widely cited IMF discussion paper by Ostry et al). The traditional view is alive and kicking, and those who oppose it are dangerous liberal extremists! After all, Rogoff tells us, the tide raises all boats…
The bottom line is that if a top executive makes on average 120 times the wage of his or her employee, well, this means that he or she is 120 times more productive. Rent seeking and political capture play no role in explaining the difference in pay. Circulez, il n’y a rien à voir…
Nothing new under the sky, I guess. But it is important, from time to time, to send out reminders.
My (very short) take on this: I do believe that Krugman has a point, a very good one, when claiming that standard textbook analysis is (almost) all you need to understand the current crisis, and to implement the correct policy solutions.
The point is what we define as “textbook analysis”. Krugman refers to IS-LM models. But these, that starting in the 1980s virtually disappeared from graduate curricula because supposedly too simplistic, not grounded on optimization, not intertemporal, and so on and so forth.
I personally was exposed to these ideas in my undergraduate studies in Italy, and I still teach them (besides using them to discuss the crisis with my students). But they were nowhere to be found during my graduate studies at Columbia (certainly not a freshwater school). None of the macro I studied in graduate school (Real Business Cycle models, or their fixed-price variant proposed by New Keynesians) as interesting as it was intellectually, could give me insight on the crisis. I simply do not need to use it.
The IS-LM model with minor amendments (most notably properly accounting for expectations to deal among other things with liquidity traps) remains a powerful tool to understand current phenomena. The problem is that it is not mainstream at all. What bothers me in Krugman’s post is the word “standard”, not “textbook analysis”.
Interesting things happened this morning. I assisted to one of the presentations of the OECD interim assessment. There is nothing very new in the assessment, that concerning the eurozone, can be summarized as follows
- The outlook remains negative (while the rest of the OECD countries are doing better)
- There is still room for monetary accommodation
- This monetary accommodation may not benefit the countries that need it more, because the transmission mechanism of monetary policy is still not fully working
- The Cyprus incident shows that there is a desperate (this I added) need of a fully fledged banking union
- EMU countries need to continue on the path of fiscal stabilization, even if automatic stabilizers should be allowed to fully play their role, even at the price of missing nominal targets Read more
Well, not him, actually (I wish I could); I need to content myself with his latest post on austerity. Krugman argues that austerity is happening (it is trivial, but he needs repeating over and over again), showing that in the US expenditure as a share of potential GDP is back to its pre-crisis level (while unemployment remains too high, and growth stagnates).
I replicated his figure including some European countries, and with slightly different data. I took OECD series on cyclically adjusted public expenditure, net of interest payment. This is commonly taken as a rough measure of discretionary government expenditure. I also re-based it to 2008, as most stimulus plans were voted and implemented in 2009. Here is what it gives: Read more
Wolfgang Munchau has another interesting editorial on austerity, in yesterday’s Financial Times. He argues that the US may become the next paying member of the austerity club, thus making the perspective of another lost decade certain.
Munchau’s article could be the n-th plea against austerity, as one can by now read everywhere (except in Berlin or in Brussels; but this is another story). What caught my attention are two paragraphs in particular.
Update: An edited version of this piece appeared as a Project Syndicate commentary
A few weeks ago on Project Syndicate Raghuram Rajan offered his view on inequality and growth, thought provoking as usual. His argument can be summarized as follows:
- Inequality increased starting from the 1970s, across the board
- Two different explanations of this increase can be offered: a progressive one, that blames pro-rich policies, and an “alternative” one, that focuses on skill biased technical progress. I do not understand Rajan’s restraint, and as I like symmetry, I will label this alternative view “conservative”.
- Both views agree that inequality led to excessive debt and hence to the crisis.
- According to Rajan, nevertheless, the alternative/conservative view is more apt at explaining what happened to Europe, that remained more egalitarian, but was able to hide the ensuing low growth and competitiveness through the euro and increased debt.
- The exception is Germany where, following the reunification, structural reforms had to be implemented to reduce workers’ protection. This explains why Germany today is so strong in Europe.
- Thus the solution is for Southern Europe to implement structural reforms and accept increased inequality through lower workers’ protection; the alternative is sliding into an “egalitarian decline” like Japan.
The way I see it, there are a number of problems with Rajan’s analysis, and more importantly a fundamental (and unproven) assumption that underlies his argument. Let me start with the problems in his analysis, and then I’ll turn to the core of this piece, i.e. challenging the underlying assumption.
Give a look at Dani Rodrick on Project Syndicate (in a number of languages). The scary thing is that it is not completely implausible…
Larry Summers has a very interesting piece on yesterday’s Financial Times.
He argues that a few countries (the US, Germany, Japan, the UK; I would also add France) enjoy extremely low borrowing rates, both short and long run. In particular, real rates (nominal rate minus inflation) are negative or zero for maturities up to 5 years, and extremely low for longer ones. Summers’ conclusions are then straightforward:
- Focusing on further quantitative easing is not particularly useful; given the already very low rates, further reductions are unlikely to trigger private spending (it has a name: liquidity trap. And Paul Krugman has been insisting a lot on this, for example here)
- More importantly, government should borrow now, like crazy, taking advantage of the favorable conditions to reinforce their long term fiscal sustainability. This is what any reasonable CEO would do, and there is no reason why governments should act differently.
Summers makes a point that is almost obvious: Any project that has positive expected return would improve the country’s fiscal position, if financed with debt at negative real rates: This is the time for example to borrow to buy government buildings that are currently leased. Or to accelerate the rate of replacement of aging capital; or again, to engage in long term infrastructure building/renovation. Makes sense, right? It makes so much sense, that chances are that it will not be done…
I would like to add two considerations. The first is to stress that to get private demand started, it is important that growth perspectives are stronger. Firms today do not invest, not because of borrowing costs, but because even at very low interest rates, expected demand is so low that investment is not profitable. The second is that, for Europe, increased borrowing in Germany, France and the UK would be crucial. Countries enjoying low rates could not only significantly improve their long term prospects, as Summers argues. They could also sustain demand in countries that are consolidating, thus favoring the rebalancing I have repeatedly argued for.
The latest IMF World Economic Outlook came out last week. It has lots of interesting remarks on the European austerity. Remarkably enough, it poses the problem of timing: fiscal consolidation, if too hasty, may end up being counterproductive. I played a little with the data accompanying the report, including the forecasts.
I just published an editorial on the Italian daily il Corriere Della Sera (in Italian), that summarizes my views on the causes of the crisis and of global imbalances. It is a reprise of one of my first posts, written with Jean-Paul Fitoussi. It is useful to summarize and refresh the argument: