Instability Implications of Increasing Inequality: What can be learned from North America?

Lars OsbergEconomics DepartmentDalhousie University

POLICY CHOICES: AUSTERITY, INEQUALITY, OR FULL EMPLOYMENT?March 23-24, 2012Laurentian University, Sudbury Ontario

Why does Increasing Inequality Matter?

• U.S. & Canada• Increasing Inequality Unbalanced Growth by Income class• Increasing inequality cannot be a steady state

• MexicoStructural Changes of Development can grow low incomesPolitical Economy of Social Policy – if Elites feel credible threat

• U.S. & Canada: Economic Implications of Unbalanced Growth• Interacting Instabilities of Imbalances – Debt Fragilities & Hangovers • No Automatic Economic Tendency to Uniform Income Growth

• Can Political Economy produce balanced growth path? What kind?

Illustrative Statistics - 2009

CANADA MEXICO U.S.

Population - (millions) 33.7 107.4 307.0

GDP (Billion current U.S.$) 1,336 883 14,044

GDP per capita (PPP 2005 $) 34,600 12,500 41,700

Life expectancy at birth, total (years) 81.2 75.3 78.7Agriculture (% of total employment) 2.5 13.5 1.4

Crude Birth Rate Change (1980 to 2009) -3.9 -15.8 -2.1

Different trends in Inequality?

Mid-1970s Mid-1980s Mid-1990s 2000 Mid-2000s0.000

0.100

0.200

0.300

0.400

0.500

0.600

Gini: Equivalent After-Tax Money Income • Mexico

• ↑ then ↓

• Canada• ↓ then ↑

• USA• ↑ then ↑

Unbalanced Growth Increasing Inequality

• U.S. & CANADA – similar market Income growth 1987-2007: Top 1 % @ 4%;Bottom 80% @ 0.5%Canada – 1995+ shift to less redistribution by government

• Mexico since mid 1990s – declining inequality• Structural changes + Social transfers (Progresa)

• Similar to U.S. & Canada post 1940 ?

• Steady State Equilibrium = Special Case of Balanced Growth• Unbalanced Growth => Linked Instabilities

• 1930s: U.S. New Deal stabilized system – can it be renewed ?

Canada – nil real growth for most

19761977

19781979

19801981

19821983

19841985

19861987

19881989

19901991

19921993

19941995

19961997

19981999

20002001

20022003

20042005

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20082009

0

20000

40000

60000

80000

100000

120000

Total Income of Canadian Family Units:1976-2009

20th percentile 40th percentile median 60th percentile 80th percentile

2009

Dol

lars

U.S. – real growth only at top

Long Swing in Top 1% Share

19131916

19191922

19251928

19311934

19371940

19431946

19491952

19551958

19611964

19671970

19731976

19791982

19851988

19911994

19972000

20032006

0

5

10

15

20

25

TOP 1% INCOME SHARE: U.S. & CANADA

US CANADA

1940-80: Top1% incomes grew slower than others – Unequal Relative Growth rates => Changed Shares

19131916

19191922

19251928

19311934

19371940

19431946

19491952

19551958

19611964

19671970

19731976

19791982

19851988

19911994

19972000

20032006

0

200000

400000

600000

800000

1000000

1200000

Average Real Income of Top 1% U.S. and Canada

Top 1% average income USA Top 1% average income Canada

2008

$

Much Higher Real Income Growth @ Top

P20 P40 P50 P60 P80 P90 P95 P99 P99.5 P99.9 P99.990.00%

1.00%

2.00%

3.00%

4.00%

5.00%

6.00%

Real Income: Compound Annual Growth Rate 1987 - 2007

Percentile Points of Income Distribution

Balanced Growth Same Rate Income Increase @ Top & @ Bottom

• U.S.: Annual Income growth 1987-2007: Top 1 % = 4% ; Bottom 80% = 0.5%

• What chances now for bottom quintiles incomes to grow @ 4%?• U.S. Continuing High Unemployment; Poverty @peak; Return of Recession?• Canada & US: Unions weak; Low-wage competition strong; small marginal returns to HK

investment & structural change

• Why would Income Growth @ Top slow?• High Incomes => Wealth => Capital Income• “Winner Take All” Positional Rents = f(global market size)• Control over CEO compensation process undiminished

Income & Wealth Accounting • Income = Consumption + Savings

• Income Increases @ top => Savings => Increase Loanable Funds• Real Expenditure Balance iff ↑ Savings of top 1% = ↑ spending rest

• PLUS: Escalating Consumption Norms – set @ top and ripple down • “Expenditure Cascades” => ↑ consumption norms for stagnant middle

• U.S. & Canada : ↑ inequality of consumption < ↑ inequality of income• DEBATE: If true: short run welfare implications of ↑ inequality mitigated

• IGNORED: Implied changing distribution of assets and liabilities

• Financial Assets = Financial Liabilities• Financial Instrument: Asset for Holder = Liability for Issuer• Net Savings @ top imply Increased Debts @ bottom • Financial Fragility => Crises => Recessions => Counter-cyclical stimulus

The Power of Accounting Identities

Dt = (1 + rt)* Dt-1 - PBt

Dt = Debt in period trt = average rate of interest in period tPBt = Primary Balance in period t

= (Taxest – Program Expenditurest)

∆ (D/Y)t = (rt - gt)*(Dt-1/Yt ) - (PBt / Yt) Yt = GDP gt = growth rate of GDP∆ (D/Y)t = change in Debt/GDP ratio

Debt Instability

∆ (D/Y)t = (rt - gt)*(Dt-1/Yt ) - (PBt / Yt)

• The compounding of debt overhang • rt > gt

• Accumulated Deficits => ↑ Debt/GDP => ↑ Deficit => ↑ Debt =>

• Anti-Inflation Monetary Policy increases (rt - gt) at both ends

Mexico: Faster growth @ bottom

Mexico: Structural Change & Growth

• 1995: recession => un(der)employment• PLUS Long-Run Structural Changes with Major Income Impacts

1. High % agriculture => rural out-migration => wage gains1. Mexico: 2 step process: rural poverty → informal urban → formal urban

2. Low % employed women => big impact ↑ female jobs 3. Low % enrolled primary & secondary => high marginal HK returns4. Capital deepening => ↑ MPL

5. Large ↓ birth rate → large (educated) demographic bulge

• Political economy of social policy & ‘Progresa’ (1995)• 1994/5: NAFTA + Recession + ↓ PRI + Chiapas – Zapatista insurrection• Credible local ‘hard left’ political option =>“threat effect” for elites

Canada: 1990s fiscal crisis => ↓ redistributionTendency to greater inequality reinforced

19761977

19781979

19801981

19821983

19841985

19861987

19881989

19901991

19921993

19941995

19961997

19981999

20002001

20022003

20042005

20062007

20082009

-0.16

-0.14

-0.12

-0.1

-0.08

-0.06

-0.04

-0.02

0

Change in Gini Index of Equivalent Individual Income Canada 1976 to 2009

Impact of Transfers Impact of Taxes Impact of Taxes & Transfers

Canada: Prescient Elites or Docile Masses ?

• “Kinder & Gentler?” – a relatively recent national narrative• “Colder & Harder” until early 1970s• History of Hard Left Threat: Essentially Zero

• 200 year civil violence death toll less than Mexico City 1968

• 2012: Electoral Politics: Split on ‘Left’ => Conservative Majority• Zero Concern for Poverty & Inequality• Philosophically opposed to unions/regulation• Obsessed with ‘tax competiveness” with USA

• No near term prospect of a political economy of redistribution and stabilization

USA: What chance for a New “New Deal” ?

• 1930s: FDR & “New Deal”• U.S. Policy Innovation Stabilized Growth & Inequality

• Cyclical: Public Works Stimulus• Structural Reforms saved Capitalism from Itself:

• Bank Regulation + NLRB + Social Security + Progressive Taxation

• U.S.: Systemically stabilized for 50+ years• BUT eroded in stages since early 1980s

USA: Conflicted attitudes + $ politics• Bimodal distribution →

small migration tips majority balance• BUT short terms + division

powers + courts → soon tips back

• “Deeper Pockets” • Increased economic Inequality

=> Increased Inequality of Influence -0

.500

-0.35

0

-0.20

0

-0.05

00.1

000.2

500.4

000.5

500.7

000.8

501.0

001.1

501.3

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501.6

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501.9

000

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1

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Preferences for Leveling in the United States 1987-1999

Rel

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The unsustainable does not last – but what follows?• Unbalanced Income Growth Increasing Inequality

• Cannot be a steady state equilibrium• Produces Interacting Instabilities – with cumulative impacts

• U.S. & Canada: Parallels with 1930s but many structural changes

• No Automatic Economic Tendency to self-correction is obvious• Political Economy of Adaptation to Systemic Instability:

• Europe in 1930s: both disastrous choices and enduring successes• Political choices matter