Opinion

The Great Debate

The instability of inequality

By Nouriel Roubini
October 13, 2011

By Nouriel Roubini
The opinions expressed are his own.

This year has witnessed a global wave of social and political turmoil and instability, with masses of people pouring into the real and virtual streets: the Arab Spring; riots in London; Israel’s middle-class protests against high housing prices and an inflationary squeeze on living standards; protesting Chilean students; the destruction in Germany of the expensive cars of “fat cats”; India’s movement against corruption; mounting unhappiness with corruption and inequality in China; and now the “Occupy Wall Street” movement in New York and across the United States.

While these protests have no unified theme, they express in different ways the serious concerns of the world’s working and middle classes about their prospects in the face of the growing concentration of power among economic, financial, and political elites. The causes of their concern are clear enough: high unemployment and underemployment in advanced and emerging economies; inadequate skills and education for young people and workers to compete in a globalized world; resentment against corruption, including legalized forms like lobbying; and a sharp rise in income and wealth inequality in advanced and fast-growing emerging-market economies.

Of course, the malaise that so many people feel cannot be reduced to one factor. For example, the rise in inequality has many causes: the addition of 2.3 billion Chinese and Indians to the global labor force, which is reducing the jobs and wages of unskilled blue-collar and off-shorable white-collar workers in advanced economies; skill-biased technological change; winner-take-all effects; early emergence of income and wealth disparities in rapidly growing, previously low-income economies; and less progressive taxation.

The increase in private- and public-sector leverage and the related asset and credit bubbles are partly the result of inequality. Mediocre income growth for everyone but the rich in the last few decades opened a gap between incomes and spending aspirations. In Anglo-Saxon countries, the response was to democratize credit – via financial liberalization – thereby fueling a rise in private debt as households borrowed to make up the difference. In Europe, the gap was filled by public services – free education, health care, etc. – that were not fully financed by taxes, fueling public deficits and debt. In both cases, debt levels eventually became unsustainable.

Firms in advanced economies are now cutting jobs, owing to inadequate final demand, which has led to excess capacity, and to uncertainty about future demand. But cutting jobs weakens final demand further, because it reduces labor income and increases inequality. Because a firm’s labor costs are someone else’s labor income and demand, what is individually rational for one firm is destructive in the aggregate.

The result is that free markets don’t generate enough final demand. In the US, for example, slashing labor costs has sharply reduced the share of labor income in GDP. With credit exhausted, the effects on aggregate demand of decades of redistribution of income and wealth – from labor to capital, from wages to profits, from poor to rich, and from households to corporate firms – have become severe, owing to the lower marginal propensity of firms/capital owners/rich households to spend.

The problem is not new. Karl Marx oversold socialism, but he was right in claiming that globalization, unfettered financial capitalism, and redistribution of income and wealth from labor to capital could lead capitalism to self-destruct. As he argued, unregulated capitalism can lead to regular bouts of over-capacity, under-consumption, and the recurrence of destructive financial crises, fueled by credit bubbles and asset-price booms and busts.

Even before the Great Depression, Europe’s enlightened “bourgeois” classes recognized that, to avoid revolution, workers’ rights needed to be protected, wage and labor conditions improved, and a welfare state created to redistribute wealth and finance public goods – education, health care, and a social safety net. The push towards a modern welfare state accelerated after the Great Depression, when the state took on the responsibility for macroeconomic stabilization – a role that required the maintenance of a large middle class by widening the provision of public goods through progressive taxation of incomes and wealth and fostering economic opportunity for all.

Thus, the rise of the social-welfare state was a response (often of market-oriented liberal democracies) to the threat of popular revolutions, socialism, and communism as the frequency and severity of economic and financial crises increased. Three decades of relative social and economic stability then ensued, from the late 1940’s until the mid-1970’s, a period when inequality fell sharply and median incomes grew rapidly.

Some of the lessons about the need for prudential regulation of the financial system were lost in the Reagan-Thatcher era, when the appetite for massive deregulation was created in part by the flaws in Europe’s social-welfare model. Those flaws were reflected in yawning fiscal deficits, regulatory overkill, and a lack of economic dynamism that led to sclerotic growth then and the eurozone’s sovereign-debt crisis now.

But the laissez-faire Anglo-Saxon model has also now failed miserably. To stabilize market-oriented economies requires a return to the right balance between markets and provision of public goods. That means moving away from both the Anglo-Saxon model of unregulated markets and the continental European model of deficit-driven welfare states. Even an alternative “Asian” growth model – if there really is one – has not prevented a rise in inequality in China, India, and elsewhere.

Any economic model that does not properly address inequality will eventually face a crisis of legitimacy. Unless the relative economic roles of the market and the state are rebalanced, the protests of 2011 will become more severe, with social and political instability eventually harming long-term economic growth and welfare.

This piece comes from Project Syndicate.

Photo: An Occupy Wall Street demonstrator marches with his baby around the Chase banking offices near Wall Street in New York October 12, 2011. The Occupy Wall Street movement protesting U.S. economic inequality will target a JPMorgan Chase skyscraper on Wednesday, as the number of rallies on U.S. college campuses planned for Thursday grew to at least 90 schools. REUTERS/Shannon Stapleton; A demonstrator from the Occupy Wall Street campaign holds aloft a sign as the march enters a courtyard near the New York Police Department headquarters in New York September 30, 2011. REUTERS/Lucas Jackson

Comments
21 comments so far | RSS Comments RSS

Capitalism only works correctly when government regulates properly, and this will never happen without major campaign finance reform. Too many businesses, labor unions and lawyers have too much influence in our governments. Until we laws to limit and make transparent their influence, these problems will never stop.

Posted by actnow | Report as abusive
 

In other words, capitalism and democracy can’t work long term without a dash of socialism in the form of social responsibility.

Posted by SGinOR | Report as abusive
 

Great article – good insight. But in the age of wanton greed and extreme political polarization I say that proper government roles and regulation is a fairy tale under any conditions likely to obtain in our lifetimes. We’ve already gone way too far down the road to financial, economic, political perdition to make any turnaround.

Posted by NukerDoggie | Report as abusive
 

This is the first (recent) recession the US has endured with a President who promulgates socialist policies. I think the author fails to comprehend the effect of those policies on American business. Business leaders are frozen in fear of more regulation and centralized control, which drive up costs. So the businesses sit on their capital instead of investing it in new jobs and assets – they are afraid they will need that money for other things. If the Republicans are granted full governmental power in 2012, then the US economy can expect to recover as soon as the failed policies are reversed. That covers this current crisis.

As to the longer term trends and effects, communism was tried in the 20th century. History has amply demonstrated that whatever faults capitalism has, they cannot be as bad as pure communism. There needs to be some kind of adjustment to capitalism, starting with a political clean up in the United States to end the impact of the lobbies and big money in national elections.

Posted by stevedebi | Report as abusive
 

@stevedebi I disagree with your assertion that the Republicans can fix what they messed up under Bush Jr. But you are right that capitalists are afraid to spend their money. The solution? Tax the buggers if they won’t spend their money then give it to the Government who knows very well how to spend your money. Socialist? Yes. Wrong? No.

Posted by LEEDAP | Report as abusive
 

I love the article, especially Marx’s prognostication that unfettered, the transfer of wealth can cause capitalism to self-destruct.

Posted by Sarasota | Report as abusive
 

@stevedebi
Perhaps you are right and the elites hang on to their enormous amounts of money out of fear.
The French found the cure for that fear with a machine called the guillotine.

Posted by Sinbad1 | Report as abusive
 

@stevedebi – I also disagree with your assessment. The author persuasively argues that policy mistakes of the preceding 3 decades destabilized economies contributing to massive capital dislocations. The 2001 tax cuts were particularly damaging as the theme of US business decapitalization was a prominent feature.

As for business investment today, would you risk a billion dollar capital outlay in the US with a Congress willing to risk the calamitous effects of default while arguing for more destabilization via deregulation? It is not surprising that hiring slowed and reversed shortly after the 2010 election.

Posted by SanPa | Report as abusive
 

I think a question I have left hanging is if there’s enough political power left in the working and middle class to actually pull the socioeconomic policies back toward something more in line with their interests.

As it is, we’re practically disenfranchised in comparison to the political power wielded by the upper class.

For example, you’d think after the near collapse of the financial sector in 2008 that a reform bill with teeth, capable of regulating credit default swaps would have been sensible. But the reform bill was completely neutered. It hasn’t done anything of substance. Nothing has changed. In fact, the mantra of deregulation has been preached with increasing ferocity. “Not enough laissez faire!” has been the response of the elite.

If this movement doesn’t lurch the system to be mutually beneficial to all, then I think Karl Marx was going to be more correct than even Roubini has dared to suggest.

Posted by Parallax | Report as abusive
 

In economy it is hard to tell what is a cause and what is an effect. Is it necessarily the wealthy accumulating more wealth that cause lack of purchasing power? Or could it be government spending, which has grown exponentially and is obviuosly unsustainable? It certainly doesn’t seem that rise in government spending or redistribution of wealth prevented the inequality that the article points out.

The funny thing is that we have two sides, liberals and conservatives but neither side would agree that what we have is socialism or capitalism. Yet we are helping the same politicians continue arranging the society the way they have.

I would say that we are still looking for a solution and the arrangements that have been tried were all a nightmare. They just seem better looking back.

I like freedom of people to buy what they want for the money they earned, and their right to keep it. Can your solution uphold that? How much of it are you willing to give up and how do you want to make the others to give it up too?

Posted by Wondering0 | Report as abusive
 

Stevedeb is a comedian. He is blaming Obama for all economic ills. All the greeds and excesses happened under GW Bush Remember the GFC, not long ago but republicans have very short memories

Posted by paccrab | Report as abusive
 

First, great article. It’s nice to know some people can see past the moment.
Republicans: “They won’t spend their money because of fear…” moral: fear the government, support me.
Democrats: “They won’t spend their money on us, so make them…” moral: Support the government, fear them.

Reality:
If I employ 5 people that can each make one widget a day, and I have orders for five widgets a day, the company does well. If I have orders for 8 widgets a day, I hire three more people. If I loose two orders, I lay-off two people.
Pretty freak’in simple isn’t it!

Obviously Republicans and democrats do not run business. Instead, they just deal in FUD.

Posted by tmc | Report as abusive
 

On the other side of this argument we have government spending which has also grown exponentially. It has completely failed to repair inequality although inequality was the excuse for it all along. Now it is no longer sustainable. The debt that governments have piled up is beyond repayment and governments will not be able to meet their original promises. AND there is no amount of taxes the rich could pay that would get our governments out of that debt.

The answer cannot possibly be Marxism, the welfare state, or corporate capitalism.

I think it’s clear we are still looking for the ideal social arrangement and it had better be something new, not a return to the 70s. The point is that we need a debate with everything on the table and a willingness to hear each other’s arguments. Not two football teams each running a different direction once they get the ball.

Posted by Wondering0 | Report as abusive
 

Blaming Bush for your economic troubles is a grossly exaggerated oversimplification. Clinton was the one who lead the massive drive to increase home ownership by lowering mortgage loan standards, which in turn caused the housing bubble. All Bush did was increase spending while decreasing revenue and ramp up a deficit. Sure he didn’t fix the problems but then neither has Obama.

Posted by SadTruth | Report as abusive
 

Great article, but critical only. Pointing fingers is always easier than offering solutions. Solution anyone, hello?

Equality has never been a part of the human history, sadly, regardless of x’ism, except to a greater degree back in the caves when hunting and gathering were the only social activities.

Being able to stage a sit-in on WStreet is already a proof of equality pronounced loudly, to those of suppressed.

Like this constructive comment:

As to the longer term trends and effects, communism was tried in the 20th century. History has amply demonstrated that whatever faults capitalism has, they cannot be as bad as pure communism. There needs to be some kind of adjustment to capitalism, starting with a political clean up in the United States to end the impact of the lobbies and big money in national elections.

Posted by watchers710 | Report as abusive
 

I agree with stevedebi.

@SanPa…no I would hold onto that billion and wait for a GOP supermajority to effect a more pallatble environment for investment, then i’d invest.

@paccrab…if you can only remember as far back as Bush Jr then you have quite a short memory as well, this ha sbeen building a lot longer than that.

@tmc…Sound analysis for a single country, but the world is flat. If I can hire 5 Chinese workers for half the price, less regulatory costs and pay less taxes, I will mov emy entire business to China. What we should do then is lower taxes, regulation, and uncertainty. Invest in infrastructure and education to make ourselves competitive on a global scale, then jobs and investment will pour back into the US – and we can make widgets here instead of abroad. Pretty freakn simple isn’t it?

Roubini writes a very compelling article and I think he is spot on in that we need to make some adjustments and find the right balance between these two ideologies. Capitalism works when run correctly.

To do so, we need to get money out of politics/government and get government out of business. The reason industry must use money to control government is because government controls industry. If we burden business with tax and regulation they will simply outsource.

Posted by jaham | Report as abusive
 

@jaham:

I think it is not only unrealistic, but foolish to believe that getting government out of business is the answer. It is important to remember that the USA is a Democratic/Republic which utilizes Capitalism as its underlying way of doing business. Right now, we are in a situation where we have swung to far to the Capitalism side of the equation.

It is not regulation that’s the problem, or that business is afraid of what evil socialist plan that Obama may or may not have in his head that is the problem. We have deregulated ourselves into this, and have created “free” trade deals that haven’t worked in our favor. Hopefully, the new deal we passed yesterday is more favorable to us, then the usual deals.

Posted by GlassOnion | Report as abusive
 

Roubini writes a compelling article pointing out that the so-called 1st World, or the dominant capitalist nations, have reached the same crisis point by different means. In the last, say three decades, the US has advanced by privatizing profits and socializing debts. The conservative right now claims that the deficit resulting from this practice should be remedied by cutting expenses–cuts to health, education and pubic welfare of any kind being the targets. Their solution: the privatization of education and/or segregation by way of vouchers; privatization of Social Security and Medicare by way of vouchers, privatization of pensions by way of 401Ks, IRAs, TGIKrefts, etc. Today the “baby-boomers” are facing 20-30% losses in these “retirement savings plans” just as they need them. The generation the conservative right is claiming they will save by cutting the debt will inherit the costs of taking care their “baby-boomer” parents at the very moment college tuition for their children will rise as a result of cuts to aid for ed.. Further, if the current trend continues, the next generation will find themselves out of work the minute they reach a salary level “no longer sustainable,” currently about 58. Given the current possibility of jobs for college graduates, let’s not even talk about High School gads and drop-outs, who exactly is going to take of the next generation in a world privatized (i.e., dependent on the market) on every level human need?
Yes, Europe went overboard in the other direction, but making so-called public health, education and welfare dependent on the market made free public programs just as vulnerable to the manipulations of greed and corruption as the US.
We live in a global capitalist economy, an economic system that lives on crisis. Unfortunately, the US, the EU,the various Asian economies, are NOT to big to fail if capitalism requires it. At this time, the US has the greatest military force and the top hand for creating crisis any where in the world that might meets their needs. For instance, it meets our needs to have chaos in Mexico. It brings cheap, dedicated, illegal labor in and it secures cheap labor and low taxes there. Our we surprised that all those “fury” guns ended up in the hands of the cartels? Not so much.
Roubini’s got it right, there is no difference between global capitalism and “1st World” politics. We’ve received exactly what we bought and paid for. Now, a few of us–mostly younger, are trying to figure out how exactly to say “stop!’ Humanity, the earth itself is at risk.” I applaud these people and support this movement in both it’s local and international forms.

Posted by jfclark | Report as abusive
 

When our global economies power forward, the global environment suffers, that’s Inequality.

Posted by Philipnaxxar | Report as abusive
 

I’m not sure Marx ever talked about “regulation” he was pretty clear that the internal dynamics of capitalism were unstable. Keynes and post-Keynes governmental economic management have mitigated the inevitable boom/bust cycle and — to a limited extent — contained monopolistic practices. However that’s built a whole new set of myths.

We now expect governments to “solve” the contradictions. Everybody awaits with bated breath the G20′s magic wand. The concept of “too big to fail” is entrenched. Neither has any power, even in the short term. Governments are about out of bullets, since they’ve transferred so much toxic debt to themselves (the taxpayers) post-2008 there’s precious little scope left for further bail-outs. Consequently there’s little chance of plugging the dyke of a massive collapse of the froth from deregulation.

Serious leadership would admit this and set about emergency planning for the maintenance of commercial infrastructure — so that wages and bills can be paid and cash machines filled. The prospect is dire for the bulk of us, probably less so for the architects of the tottering pile of up to $700 trillion bogus paper padding out banking balance sheets.

Posted by Barking | Report as abusive
 

I agree with many of the major points here, but I have yet to see even a clear expression of what protesters define as “equality” and what their demands are in this regard (nevermind an actual solution as watchers710 says ). It appears rather to be a general sentiment of disaffection expressed as obtuse slogans and incoherent references to the self-evident symptoms of our economic problems. If it is a more meritocratic society that we are interested in when we speak of “equality”, then this debate must be had in full, addressing not only the inefficiency of elitism but also that of the welfare state which raises the expectations without endowing skills and/or will to fulfil those expectations, resulting in the sense of entitlement that we see in the disaffected protesters.

GB-Shaw “Democracy is a device that insures we shall be governed no better than we deserve”

Posted by whirdym | Report as abusive
 

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