I’ll make this short: In today’s New York Times Paul Krugman once again revealed how his Keynesian thinking has been corrupted by opposing neoclassical, supply-side ideas. If you are losing patience with my continually “picking on” Paul Krugman, I am only focusing on his perceptions because our future, in many ways, depends upon our leading spokesman for populist economics getting the inequality issue right. After this short post, my plan is to concentrate on writing up and refining my own analysis.
Krugman’s latest Op-ed (“Talking Troubled Turkey,” New York Times, 1/31/14, here) seems to clarify the dividing line between the Keynesian and neoclassical schools, that is between the demand-side and supply-side points of view, and helps explain why income and wealth redistribution has economic significance.
The macroeconomic problem with inequality boils down to this: The wealthy, who now own or control the large corporations, the capital stock (means of production), the associated real property, and most of the inputs of production, are making too much money. They charge too much for what they sell, and because they pay excessively low taxes, they are allowed to keep too much of that. They “save” their excess earnings, taking trillions of dollars out of circulation, shrinking the active economy.
You will of course ask: How do we know that? And how much is too much? My answers to those questions are enabled by an entire career spent determining how much income is enough for large corporations engaged in providing vital products and services, including electricity, natural gas, telecommunications, and water. The rates charged for these services have been determined by government because: (1) They are essential services; (2) they have been provided under conditions of monopolistic or near-monopolistic supply. Excess “profits” are windfalls to such companies, and excess retained earnings only create opportunities for cost escalation, or for excessive distributions to management and wealth concentration.
Much else in the marketplace, including, for example, food, transportation, fuel, clothing, and insurance, is essential to society as well. Only vibrant competition can provide efficiency, and prices based on efficient marginal costs; but that kind of competition is non-existent. In short, market power produces an endless accumulation of excess profits and wealth, and that drives inflation, and income and wealth concentration. Concentration continues until people who are not among those at the very top of the income ladder (the top 0.01%, roughly) are denied the fruits of growth and prosperity. Currently there is no growth below the top 1%. Growing unemployment and growing poverty, reduced education and reduced public health and safety, are all symptoms of this growing inequality. It is not the other way around.
Paul Krugman has seemed on the verge of articulating this reality, but he as yet has not. In today’s Op-ed, he said this:
Before I get to Turkey, a brief history of global financial crises. For a generation after World War II, the world financial system was, by modern standards, remarkably crisis-free — probably because most countries placed restrictions on cross-border capital flows, so that international borrowing and lending were limited. In the late 1970s, however, deregulation and rising banker aggressiveness led to a surge of funds into Latin America, followed by what’s known in the trade as a “sudden stop” in 1982 — and a crisis that led to a decade of economic stagnation.
The “world financial system” was “remarkably crisis free” for a generation after WW II, I submit, because the underlying economic conditions were crisis free. I’ve been over all of the details in previous posts: The basic point, seen most clearly in the case of the United States, is that up until 1980 there was broad prosperity and relatively robust growth. The active economy shrunk thereafter, however, with rising income and wealth concentration. Recessions (in terms of unemployment) were progressively deeper and longer-lasting. Now we’re in a depression.
Paul Krugman focuses on what he calls a “sudden stop,” which is in effect a bursting bubble:
Most recently, yet another version of the story has played out within Europe, with a rush of money into Greece, Spain and Portugal, followed by a sudden stop and immense economic pain.
As I said, although the outline of the story remains the same, the effects keep getting worse. Real output fell 4 percent during Mexico’s crisis of 1981-83; it fell 14 percent in Indonesia from 1997 to 1998; it has fallen more than 23 percent in Greece.
Money keeps flowing in, he notes, and yet output and employment falls. We need to ask: How can that be? How can that possibly happen unless inequality is growing and the demand for output is declining? Here we see Krugman slipping into a supply-side frame of reference, and now we have reached the crux of the matter:
You may or may not have heard that there’s a big debate among economists about whether we face “secular stagnation.” What’s that? Well, one way to describe it is as a situation in which the amount people want to save exceeds the volume of investments worth making.
When that’s true, you have one of two outcomes. If investors are being cautious and prudent, we are collectively, in effect, trying to spend less than our income, and since my spending is your income and your spending is my income, the result is a persistent slump.
Alternatively, flailing investors — frustrated by low returns and desperate for yield — can delude themselves, pouring money into ill-conceived projects, be they subprime lending or capital flows to emerging markets. This can boost the economy for a while, but eventually investors face reality, the money dries up and pain follows.
If this is a good description of our situation, and I believe it is, we now have a world economy destined to seesaw between bubbles and depression. And that’s not an encouraging thought as we watch what looks like an emerging-markets bubble burst.
The statement “we are collectively, in effect, trying to spend less than our income” is conceptually wrong: Investors are spending less than their income. Consumers, especially, in the last decade, students and home purchasers, want to spend more than their income, so they run up enormous debt. This is the direct consequence of growing inequality. 
“Secular” stagnation is an inherently supply-side concept typically used to describe stagnation caused by natural (catastrophic or demographic) phenomena, not Keynesian economic phenomena, as discussed in an earlier post addressing Krugman’s “mutilated economy” (here). To regard stagnation as “secular” allows economists to ignore Keynesian stagnation and imagine that economies can and will rebound to full strength on their own, over time. When redistribution is taking place, as in the United States over the past 30-40 years, to characterize stagnation as secular — as Krugman and Summers did at the IMF conference in the fall — requires denying that redistribution has Keynesian economic effects. This leads to the notion that the world might “seesaw between bubbles and depression,” and ignores the existence of continuous, growing stagnation.
What Krugman describes here, however, is the situation he has typically called the “liquidity trap,” where there is much excess savings piling up and little or no investment. Krugman is clear on the outcomes: When saving exceeds investment, we have a “persistent slump;” and if investors pour money into projects that will not produce returns, “this can boost the economy for a while,” but eventually “the money dries up and pain follows.” There can be only one explanation for such a depressed situation, and demand-side Keynesian economics provides that explanation — effective demand has shrunk.
We need to stop and ask: What gave rise to the excess of saving over investment? I submit that can only be the result of excessive profits, that is, corporations making “too much” money, and making more money than you need to cover current costs is the definition of “too much.” Because that money has been taken from consumers, and redistributed to the top, their ability to purchase other things — output for which more investment would be needed — has been reduced. This impairs the ability (and expectation) of investors to earn enough return on investing in the production of such output, and investment and growth “dries up.”
This, as clearly as I am currently able to explain it, is the basic mechanism of how inequality growth through redistribution causes stagnation. This is why distribution is the underlying factor controlling whether prosperity or stagnation prevails in an economy. Because the process of excess profits accumulation is continuous, the cyclical, non-distributive influences on demand envisioned by Keynes only tell part of the story, a part of the story that pales by comparison.
Decline and decay will always be much more substantial than expected until the macroeconomic impacts of wealth and income concentration are acknowledged and factored into economic analysis. And the problem can never be resolved until the cause of income and wealth concentration — excessive profits — is corrected through price regulation or taxation. Of course, for a market economy, except in the case of a few crucial monopolistic industries where price regulation is feasible, the answer has to be taxation.
JMH – 1/31/14
 Added 2/18: It’s important to remember that no economic understanding of inequality, and its implications for taxation, is possible without differentiating between the “propensity to consume” of those whose income share is growing and that of those whose income share is declining. To say that demand is declining is not the same as saying that everyone is “collectively” trying to increase saving; that ignores the decline in real income at the bottom.