Inequality's effects

Paul Krugman and Joe Stiglitz have been debating the role inequality has played in contributing to the US's weak recovery. As chance would have it, three new papers suggest that Stiglitz is right to worry about its effects.

First, Roland Benabou and Jean Tirole model how competition for "talent" can damage companies and the economy, by diverting workers' efforts from important but hard-to-measure jobs and over-incentivizing the easily measured aspects of performance:

Highly competitive labor markets make it difficult for employers to strike the proper balance between the bene…fits and costs of high-powered incentives. The result is a  “bonus culture” that takes over the workplace, generating distorted decisions and signi…cant efficiency losses, particularly in the long run.

It takes no imagination to apply this to banks and CEOs' pay generally.

Secondly, some laboratory experiments with asset markets have found that short-term bonuses can contribute to larger and longer price bubbles. This is consistent with the theory that big bonuses (and hence inequality) contributed to the crash by inflating the bubble in mortgage derivatives.

Thirdly, Eckhard Hein suggests that the high-powered incentives that contributed to rising inequality:

[have] imposed short-termism on management. This meant a decrease in management’s “animal spirits” with respect to real investment in capital stock and long-run growth of the firm, and an increase in the preference for financial investment, generating high profits in the short run.

These three mechanisms are very different from the underconsumptionist theory of which Krugman is, I suspect rightly, sceptical. But inequality doesn't just affect economic performance through macroeconomic channels. It does so through microeconomic firm-specific ones, and through "cultural" mechanisms, such as, in Benabou and Tirole's model, eroding non-monitorable work ethics.  

In suggesting this, however, I don't want to suggest that rising inequality matters only for its effects upon economic performance. Even if its effects were benign - which is darned hard to show - leftists would still have social and ethical objections to it.

Comments

[Metatone]

What's interesting to me is that whether you reach for underconsumption or for "dearth of investment opportunities" we come back to the same basic problem - money isn't circulating and we're not sure why...

[aragon]

I am with Joseph Stiglitz on this, I do not think we can have an economy of meeting the need of the rich. Even if I may differ on details.

But the elephant in the room is the missing word 'Finacialisation'

But the Tories and Labour are trying to revive financialisation, which will result in another collapse, as financialisation is a broken model.

https://en.wikipedia.org/wiki/Financialization

"Financialization is a term that describes an economic system or process that attempts to reduce all value that is exchanged (whether tangible, intangible, future or present promises, etc.) either into a financial instrument or a derivative of a financial instrument. The original intent of financialization is to be able to reduce any work-product or service to an exchangeable financial instrument, like currency, and thus make it easier for people to trade these financial instruments."

Financiaization is the looting the real economy.

http://news.bbc.co.uk/1/hi/2817995.stm
"financial weapons of mass destruction"

http://www.wired.com/techbiz/it/magazine/17-03/wp_quant?currentPage=all

""the correlations between financial quantities are notoriously unstable." Wilmott, a quantitative-finance consultant and lecturer, argued that no theory should be built on such unpredictable parameters."

[...]

"Bankers securitizing mortgages knew that their models were highly sensitive to house-price appreciation. If it ever turned negative on a national scale, a lot of bonds that had been rated triple-A, or risk-free, by copula-powered computer models would blow up."

The economic model is broken, politians do not recognise this. I subscribe to a different economic model.

[FromArseToElbow]

As I read it, Stiglitz is arguing that inequality has a negative feedback impact on economic activity and long-term investment. Krugman is merely disputing the efficacy of some of the mechanisms.

The Benabou/Tirole paper, on the other hand, is arguing that both inequality and worse performance are effects of another cause, namely labour market flexibility in an era of skill-biased technical change.

I think it's worth thinking about this not just in terms of the 1%, but in terms of the 10%, i.e. skilled workers generally who can command well-above-average remuneration.

To give an example, the spread of contracting has not only reduced tax receipts (one of Stiglitz's points), but the bias against knowledge-sharing (you maximise your value by monopolising it) more than offsets the productivity gains from "buying in new thinking".

Meanwhile, the spread of precarious temp jobs at the other end of the wage spectrum, and the erosion of apprenticeships and inhouse skill development, has exacerbated skill shortages, so driving up the cost of incentives for skilled/flexible workers, and thus contributing to greater inequality.

[Brad]

Krugman's point is not that inequality does not hamper growth in general, it's that a rise in inequality has not been an important factor in the recovery from the recession.

[Mario]

I'm with Brad here: as far as I can tell, Krugman doesn't question that inequality leads to many negative economic outcomes, but that it doesn't explain the weak recovery during the last four years. That inequality leads to bubble inflation or inferior long-term growth prospects is irrelevant for answering the debated question. (or am I missing the causal links which aren't spelled out here?)

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