Promoting income equality

A political group organised the screening of a documentary called The Flaw, at the London School of Economics recently. The film sought to provide context on the financial crisis and in so doing explain the underlying causes of the crisis in greater depth than any previous documentary. The name of the documentary was taken from Alan Greenspan’s October 2008 admission to the US Congress that he had found a “flaw” in his model of how the world works.

What I liked about this film is the way that it did not seek to simply demonise the few but rather to explain how responsibility for the US financial crisis and by extension the global economic turmoil should be placed at the feet of many. British filmmaker David Sington (who was present after the screening to lead a lively debate) touches on how changes in government economic policy throughout the 20th century created the policy environment that framed this disaster. He also touches on the role of financial institutions as well as that of ordinary consumers whose greed fuelled the cycle of boom and bust. Three points were of particular interest to me. Firstly, the whole concept of an economic bubble. Secondly, the pivotal moment that was the 1970s. And lastly, our notions of income inequality.

Firstly, economic bubbles are truly an interesting manifestation of human behaviour. Normally the higher the price of an item goes, the demand for it tends to decrease. With a bubble, however, the higher the price goes, the more people demand it. Most economists may say that this is limited to financial assets but the property market bubble may demonstrate that other assets can be subject to a bubble. In a bubble, the whole nature of cycles is forgotten as the market literally buys into the delusion that price increases would continue indefinitely. In reality, an economic bubble can be accurately identified only after it bursts.

The second interesting point was the level of profound changes taking place in the 1970s. Yale University housing expert Robert Shiller and Harvard University economic historian Louis Hyman both agree that this decade saw the efficient market hypothesis becoming almost an article of faith.  This hypothesis is the belief that government should step back and allow the market to function—a respect for the “wisdom of the crow.” This thinking saw a policy repositioning that eventually allowed the rise of the Margaret Thatcher-Ronald Reagan tag team in the 1980s. It is, of course,  now very clear that at times, when left unchecked, the crowd can be very wrong. Perhaps the extent to which greed can distort the market is only now being understood.

The third and perhaps the most profound point was that debt could be fundamentally regressive, could lead to greater levels of social inequality and could even stand in the way of economic growth and development. Think about it? In the film, Hyman produced data to demonstrate that income inequality in the US peaked at two times in the 20th century—1929 and 2007. He also showed that overall household debt in the US moves in direct correlation to income inequality. This makes sense of course as rising debt is essentially a mechanism for diverting present and future income streams from debtors (the have-nots) to creditors (the haves) and rising debt makes sense for debtors only in the context of rising incomes. So stagnating incomes plus rising debt levels contributes to greater income inequality. We all know what happened right after each peak (1929 and 2007)–the great depression and the 2008 crash.

Most times, the debate over income inequality is framed within a moral context. That is, it is not “fair” or it is not a “good thing.” Here we have an argument for greater levels of income inequality being bad for the entire society and the entire economy. It may actually contribute to economic instability (we already know that it is contributes to social instability). We all benefit from a vibrant middle class. From a government policy perspective, promoting greater income equality makes good economic sense. The wealthy may not like it but those who realise that it leads to greater social and economic stability will eventually appreciate it. The debate should therefore shift away from attacking/defending social spending/social programmes (sometimes called entitlement spending) to re-engineering these programmes to reduce dependency, reduce abuse, encouraging education/ training and entrepreneurship. Again, the documentary is called  The Flaw and it is available online.

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