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(Illustration found at “‘Fiscal Cliff’ = Economic Blackmail?” by Bombshell Betty, Palomino Road, here)
The outstanding faults of the economic society in which we live are its failure to provide for full employment and its arbitrary and inequitable distribution of wealth and incomes. – John Maynard Keynes
I’ll start 2013 with the first of two posts dealing with my understanding of the economics of inequality based on what I have learned over the last two years. On April 10, 2011 I posted in this blog a summary of the extreme extent of income inequality in the United States that has developed over the last thirty years: The Thirty-Year Growth of Income Inequality. Over the following twenty months, that extreme situation has worsened, as inequality growth and economic decline in the United States have continued. Indeed, the growth of income inequality is apparently accelerating.
The above cartoon is not my favorite inequality graphic, but it is possibly the most apt. Technically, with four years of falling median incomes and high unemployment, we’re now in a depression. (See Paul Krugman, End this Depression Now!, 2012; The Return of Depression Economics and the Crash of 2008, 2009.) Krugman retreated during the presidential election campaign to the official position that the U.S. has recovered from but is close to sliding back into a recession.
Although private sector unemployment edged below 8% late in 2012, however, poverty levels continue to rise and median real income continues to fall. The sad news is that for some time the U.S. has been headed gradually toward the “inequality cliff,” toward the next Great Depression, and there has been no significant course correction.
Over the past two years, this blog has endeavored to identify and explain the causes and effects of economic inequality. The comprehensive databases now available of income data over the last century, and gradually accumulating analyses, reveal that income inequality and the concentration of wealth are far more important macroeconomic factors than has generally been perceived, leading to some remarkable conclusions:
(1) Market economies are unstable, and without government intervention inequality tends to continue growing, through an upward redistribution of wealth and incomes, until depression sets in;
(2) Inequality growth reduces the potential level of overall growth and prosperity, and the macroeconomic consequences of high levels of inequality are more severe than previously imagined. Stopping inequality growth and controlling the levels of income and wealth distribution should be considered government’s most important economic responsibility;
(3) Sufficiently progressive taxation moderates the concentration of incomes and wealth at the top, enabling higher levels of growth and prosperity. As we are only just discovering, however, insufficiently progressive taxation aggravates inequality and reduces growth, perhaps to an even greater degree. The huge reduction of effective taxes on top incomes and corporations over the last thirty years is the engine that has generated the huge surge in inequality.
Such conclusions are of course rejected by conservative economists, and they have yet to be accepted by “mainstream” economics. There is a deep American aversion to suggestions that “free market” capitalism does not efficiently provide for the general welfare. Deeply ingrained economic ideology argues that: (a) market economies are stable and tend to return automatically to full employment equilibrium; and (b) when the wealthiest people are doing well, their success will trickle down, stimulating growth and improving the opportunities and fortunes of everyone else. Although these ideologies have been proven wrong, indeed the opposite of the truth, they have inhibited appreciation of the full macroeconomic implications of economic inequality.
The lead-in quotation from Keynes is the statement that opens the last chapter of his groundbreaking book, The General Theory of Employment, Interest, and Money (1935), in which he suggested potential policy implications of his General Theory. Keynes developed a macroeconomic model, the “general theory of employment,” that predicted (explained) the level of employment. However, although he identified the unequal distribution of wealth and incomes as the second major fault of a market economy, Keynes did not develop a “general theory of distribution.” Because he had not reasoned out an extension of his model to include the income and wealth distribution variables, he merely described the development of inequality as “arbitrary.” The data now show, however, that although several potent institutional, technological, and geographic factors cause greater inequality, its growth is not entirely arbitrary. The distribution of wealth and incomes is causally interrelated with overall economic growth and taxation, and is therefore a major component of macroeconomic reality. Helping to better understand that reality has been a major focus of this blog.
Towards a new perspective
Here’s the point: If the consequences of inequality growth are as draconian and inexorable as we are discovering them to be, it is crucial for the field of economics not only to discard the false “conservative” ideologies mentioned above and return to a Keynesian understanding of how the economy works, but also to develop the “general theory of distribution” that Keynes fell short of providing. The data are in, and economists can do it, but they are divided in their thinking. This division in thinking has significant consequences.
In the introduction to his recent book (Occupy the Economy, 2012, pp. 9-10), economist Richard Wolff made a penetrating observation. When the Occupy movement began in the fall of 2011, he argued:
The academic economics profession ought to have been most intimately involved in analyzing and debating a broken capitalist system whose deep crisis had confounded all its confident expectations. It has done nothing of the sort. Instead it proceeds as if – and indeed mostly still insists that – nothing has happened to disturb its fifty-year celebration of capitalism’s efficiency and growth. A few professors of economics (e.g., Paul Krugman) and business (e.g., Nouriel Roubini) have commented on the absurdity of that insistence. But most of them could get no farther than to recycle Keynes’ 1930s critiques of a depressed capitalism and his recommendations for deficit spending and monetary stimuli by the government. And, of course, the few right-wing economists who have taken the crisis seriously, utilized it to push yet again for less government intervention as the panacea. (Emphasis added.)
The emphasized part of the statement accurately describes Paul Krugman’s perspective. In his own book published in May of 2012 (End This Depression Now!, Ch. 5) Krugman expressed alarm over the extent of the income inequality problem, and indicated that his thinking is in flux. However, he at least tentatively held to his long-held mainstream belief that income inequality is a “political” problem, not a macroeconomic one. His recommendations for stimulating the economy are, just as described by Wolff, from the traditional Keynesian playbook of fiscal policy (deficit spending) and monetary policy. He did not even discuss the “tax the rich” option.
It was not until August of 2012 that Joseph Stiglitz became the first well-known economist to sketch out and support a macroeconomic perspective in his book The Price of Inequality. Stiglitz described inequality growth as a process of “rent-seeking” in which income consisting largely of economic rent is increasingly concentrated at the top, at the expense of real production, income and growth elsewhere in the economy. His recommendations include dismantling the mechanisms, constructed over recent decades, through which extreme economic rent extraction has become possible, and also substantially increasing taxation of top incomes and wealth.
The issue of the macroeconomic implications of inequality, ignored for centuries in the development of economic theory, is only now gaining attention. The income distribution data for the last century has only recently been compiled, and economists are only just beginning to analyze it. The topic was off the radar screen from 1935-1970, when Keynes’ revolutionary concept of fiscal policy dominated the economic conversation. Thus, in his new book (Keynes Hayek: The Clash that Defined Modern Economics, 2012), Nicholas Wapshott’s detailed account of the controversies between Freidrich Hayek and John Maynard Keynes contains almost no reference to inequality or distribution issues. Wapshott notes Hayek’s philosophical aversion to attempts to make everyone equal, including this quotation: “The rapid economic advance that we have come to expect seems in a large measure to be the result of inequality and to be impossible without it” (p. 219). This, however, was a point on which Keynes agreed. Neither of them was a “communist” – the argument was (and still is) whether capitalism works best without government interference, or whether it needs help.
With the topic of wealth and income distribution only just now emerging from the hallowed halls of philosophy and entering the scientific field of economic analysis, Krugman and other economists participate today in the “fiscal cliff” debate without a Keynesian general theory of distribution, and lacking even a comprehensive macroeconomic perspective on how income inequality relates to growth, taxation, budgets, and public debt. The implications of the difference between the Stiglitz and Krugman perspectives on inequality are enormous: If Stiglitz is correct that inequality growth is greatly harming the U.S. economy, prescriptions for recovery and growth that do not account for its continuously growing impact will prove to be inadequate.
Confusion on the budget, the debt, and the “fiscal cliff”
As of the beginning of 2013, we now have federal tax changes in place, but the debt limit remains unchanged and the “fiscal cliff” problem persists. Budget battles loom as Congressional Republicans continue to fight for cuts in government programs and lower taxes for the rich.
Amid much confusion, commentators like Paul Krugman and Robert Reich, the author of Aftershock (2010) and Outrage (2012), have over the last few months stressed that our immediate problems are not with the deficit and national debt; they are with stimulating real recovery and growth. But it was Krugman’s New Year’s Eve op-ed article in The New York Times, “Brewing Up Confusion” (here), that prompted this post. In that article Krugman was highly critical of Starbucks CEO and billionaire Howard Schultz for an open letter to employees promoting fiscal bipartisanship: “All he did,” Krugman said, “was make himself part of the problem.”
I found confusing Krugman’s strained (and dubious) condemnation of Schultz’ campaign in his strenuous effort to explain that, while the “fiscal cliff” should be avoided because it contains recessionary tax increases and budget cuts, attempting to “fix the debt” too quickly in such a manner must also be avoided. Of course it is not Krugman’s fault that the public debate has thus far been dominated by anti-government, trickle-down ideologues. But to the extent that Krugman fails to explain the difference between taxing the rich and taxing everyone else, and fails to point out that higher taxes on top incomes can both “fix the debt” and stimulate the economy, unfortunately he becomes part of the problem.
Krugman read into Schultz’s call for fiscal bipartisanship the inference that he was “blaming both sides equally,” and a suggestion that it is the President who must now compromise and “come together,” after having already made considerable concessions:
The reality is that President Obama has made huge concessions. He has already cut spending sharply, and has now offered additional big spending cuts, including a cut in Social Security benefits, while signaling his willingness to retain many of the Bush tax cuts, even for people with very high incomes. Taken as a whole, the president’s proposals are arguably to the right of those made by Erskine Bowles and Alan Simpson, the co-chairmen of his deficit commission, in 2010.
Krugman is correct on this point: As a proponent of recovery and growth, the president should not make any concessions to the forces of stagnation and decline without a stiff fight, and many feel he’s already made too many.
It was unfair to Schultz, however, to suggest that he had any particular position on the merits of budget issues. I have detected nothing in Schultz’s political statements over the last 17-18 months suggesting any position beyond his frustration with Washington gridlock. In a letter to Starbucks employees (11/8/11, here), for example, he said he was “growing more and more frustrated at the lack of cooperation and irresponsibility among elected officials as they have put partisan agendas before the people’s agenda.” In another letter to fellow business leaders (8/15/11, here; see also, “Starbucks CEO Howard Schultz calls for boycott of political cash,” here), he called upon them to withhold campaign contributions until “incumbents in Washington … strike a bipartisan, balanced long-term debt deal that addresses both entitlements and revenues,” and “to hire and accelerate employment now.” In that letter he argued:
[O]ur long-term business success depends on our national elected leaders doing their jobs, and on tens of millions of unemployed Americans getting jobs. We have it in our power to influence both factors.
This effort is not concerned with helping or hurting one party or another; it’s about applying pressure on all those now in office to compromise for the good of the country. It does not spell out detailed instructions for either a debt deal or a jobs push.”
In the summer of 2012, Peter S. Goodman of the Huffington Post met with Schultz and reported (“Starbucks CEO Issues Open Letter, Calls for Job Creation,” 6/29/12, here):
[W]hen I met with Schultz, he left me convinced that his letter reflects genuine apprehension about the state of the nation. “We all sense one thing in common: something is wrong,” he told me. “The country is drifting and we’re not addressing significant issues. This is not about marketing. This is about conscience. I’m concerned about the state of the country.”
Goodman reported that Schultz said the decline of the U.S. economy, and of opportunity and upward mobility in America, is “personal” to him.
Schultz has demonstrated no more than an intense concern about the need for economic recovery and job growth, which makes him Krugman’s ally. His belief that jobs and recovery are good for both management and labor makes Schultz’s message all the more compelling. (And although I do not know that Schultz has joined Warren Buffett and the Patriotic Millionaires in arguing for higher taxes on top incomes, throughout 2012, ironically, neither has Krugman.) Ignoring all that, Krugman offers only faint praise for Schultz, allowing only that he “has a reputation as a good guy, a man who supports worthy causes.”
I found it extraordinary that Krugman would come down so hard on an ally like Schultz, just to argue that he was “brewing up confusion.” Krugman’s concern with Schultz’s statements is actually a narrow one, traceable to a recent public letter (“Let’s Come Together, America,” 12/26/12, here), in which Schultz merely said this:
As many of you know, our elected officials in Washington D.C. have been unable to come together and compromise to solve the tremendously important, time-sensitive issue to fix the national debt. You can learn more about this impending crisis at www.fixthedebt.org.
Krugman’s real beef, it turns out, is with Fix the Debt. “The people at Fix the Debt,” Krugman said, “have been doing their best to muddle the issue.” Krugman argued:
First of all, it’s true that we face a time-sensitive issue in the form of the fiscal cliff: unless a deal is reached, we will soon experience a combination of tax increases and spending cuts that might push the nation back into recession. But that prospect doesn’t reflect a failure to “fix the debt” by reducing the budget deficit — on the contrary, the danger is that we’ll cut the deficit too fast. * * *
[I]n a new fund-raising letter Maya MacGuineas, the organization’s public face, writes of the need to “make hard decisions when it comes to averting the ‘fiscal cliff’ and stabilizing our national debt” — even though the problem with the fiscal cliff is precisely that it stabilizes the debt too soon. Clearly, Ms. MacGuineas was trying to confuse readers on that point, and she apparently confused Mr. Schultz too.
Wow! Here again, Krugman unloads on another, at least potential, ally. I am sure that Fix the Debt was incensed about being told they were “trying to confuse readers.”
Krugman seems to be wrong about Fix the Debt: They are not one of those partisan right-wing groups, as he put it, “more concerned with cutting Social Security and Medicare than with fighting deficits in general.” Its founders are Erskine Bowles (D) and Alan Simpson (R), co-chairs of the President’s National Commission on Fiscal Responsibility and Reform (here). Moreover, the current Chairmen of Fix the Debt (Michael Bloomberg, Judd Gregg, and Edward Rendell) are not exactly hard-core tea party members.
The Simpson-Bowles plan (Ezra Klein, The Washington Post, 12/4/12, here), which included proposals for significant tax increases on top incomes and capital gains, was according to Krugman himself (see earlier quotation), arguably to the left of President Obama’s own plan. What’s more, the core principles of Fix the Debt, which Krugman takes to task, agree with his fundamental point that “the plan should be implemented gradually to protect the fragile economic recovery.”
Avoiding deeper depression
It troubles me that Krugman went to such great lengths to denigrate erstwhile allies about views that I really don’t think they actually hold just to emphasize that government, in avoiding going over the “fiscal cliff,” must avoid “a combination of tax increases and spending cuts that might push the nation back into recession.” Another article (“Fix the Economy, Not the Debt”?) might have done that in a more straightforward, less contentious way.
What troubles me more, though, is that he missed a perfect opportunity to emphasize that, in combination with spending cuts, it is only the tax increases required on lower incomes that threatened economic health, if we tumbled over the “fiscal cliff.” Although increasing taxes on lower incomes causes more stagnation by reducing demand, increasing taxes at the top both improves growth and prosperity and “fixes the debt.”
At no time in 2012 that I am aware of, however, has Krugman acknowledged the importance of taxing the rich, and given his stature, he should. One of the concerns he mentioned in his article was that in its list of “core principles” Fix the Debt “actually calls for lower tax rates.” Fix the Debt’s core principles (here) merely call for “comprehensive and pro-growth tax reform, which broadens the base, lowers rates, raises revenues, and reduces the deficit.” It’s not reducing taxes at the top that would achieve such results — that’s the “trickle-down” argument — and Krugman should make that clear. These objectives call for higher taxes at the top and lower taxes on middle class incomes and the poor. This is all fundamental to Keynesian demand-side thinking, as Krugman himself emphasized in a debate with Arthur Laffer on the Bill Maher show on Memorial Day, 2012 (See my post It’s the Marginal Efficiency of Capital, Stupid!, 5/28/12).
Keynesian economists need to clarify the importance to growth and prosperity of taxation of top incomes sufficient to counter the continuous transfers of wealth to the top and the growth of inequality. Failing to make that clear only plays into the hands of the “trickle-down” camp. This isn’t just about the richest Americans paying “a little bit more” or paying a “fair share” of the cost of government. If the Stiglitz perspective on inequality is correct, it’s about taxing back down enough of the excessive amount of wealth that is constantly transferring up to stop the spiral down into Great Depression #2.
Paul Krugman is certainly correct that we must not allow austerity policies designed to fix the debt push us deeper into this recession/depression; but we must not let insufficiently progressive taxation in the face of rapidly growing inequality send us there either. It will take much more to counter stagnation, unemployment, and rising debt than most people now understand. We will need much higher tax revenues from the rich and from corporations.
The dangers posed today by a fall from the “fiscal cliff” are minor compared to the devastation waiting for us, in a few years, in that deep chasm beneath the “inequality cliff.”
JMH – 1/1/13 (rev. 1/10,12/13)
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