Last week I reached the conclusion that creating an economy that provides enough for everyone requires ending the extreme wealth inequality that characterises the modern world. I do not mean that we tax the super-rich and redistribute the wealth such that everyone has a basic income. Rather, I mean the development of economic and financial systems, through state intervention, such that the economy itself distributes income more evenly. But part of that would be a coordinated international approach to ending tax evasion and tax avoidance.
But how could this ever happen, with all the vested interests stacked against it? After all, the major political parties in most countries are, most of the time, funded by the wealthiest in society. The most powerful media outlets, shaping the thoughts of most of the world’s population, are similarly funded. It seems unlikely we could ever see the emergence of the popular or political will to bring this about.
What may help is mastering a dispassionate, scientific understanding of how economies work. The conclusion of such analysis (developed in this blog in 75 posts so far and around 95,000 words) is that a more even distribution of wealth will lead to a stronger economy for everyone, including the super-rich. I am literally saying that the richest individuals and companies should willingly paying their taxes, rather than looking to hide their wealth, and welcome measures that ensure they pay the full amount required to maintain a healthy economic system. Aside from any moral, social or spiritual considerations, doing this will make the rich materially better off.
No industry can make any money unless there is a market for their goods. And such markets don’t just require the goods in question to be more popular than competing goods – they require consumers to have the money in their pockets to purchase the goods. If the mass of the population does not have sufficient income, demand for goods will collapse.
I’ve already described this dynamic as it plays out in a specific region that loses a major industry, in this post on coal mining in South Wales. The same dynamics can play out in national economies. As this post describes, when an economy is in recession, creating new money won’t cause inflation, it will stimulate demand to stop firms cutting wages, laying off staff or going out of business altogether. Demand is the key issue. (To misquote Milton Friedman, and in so-doing correct his monumental errors of economic thinking: recessions are always and everywhere a monetary phenomenon.)
But the basis of modern free market capitalism is always competition. Competition between industries, and then between individual firms within industries for market share, and then competition between business owners, managers and workers over their respective shares of the profits. Companies are always seeking to reduce costs – and this always means workers somewhere earning less, whether that’s in the company itself or in its supply chain. But in this constant drive to reduce costs, they depress worker incomes, and this depresses consumer demand. Even if this doesn’t reduce demand for their own products, the effect will be felt somewhere in the economy. Reducing demand will always slow down the economy.
The standard response of mainstream economics is that distribution doesn’t matter, because someone, somewhere is spending the money. The savings achieved by laying off staff are passed on to consumers in lower prices (enabling them to purchase more and so increase demand), and to the shareholders, who then have more to spend. In aggregate, across the whole economy, the dynamic I’ve just described shouldn’t happen. Distribution shouldn’t matter.
But it does, and the reason mainstream economics is wrong is because people with different levels of income spend that income very differently. If you squeeze the incomes of a particular region, you squeeze all businesses in that region and cause a regional downturn. If you squeeze the incomes of a particular income bracket, you squeeze all the businesses that serve that population demographic. By spreading the income more evenly throughout the economy, you ensure that demand exists for the greatest number of goods and services. This stimulates production, and the wealth of the nation increases.
Rich people spend less on consumption. If you allow incomes to flow to the wealthiest in society, they will seek to save some of that money by purchasing financial assets. Asset markets cannot respond rapidly to increasing supply, so this increase in demand causes asset price inflation. Asset prices inflate away from their fundamental value, causing bubbles. Thus, increasing the income share of the wealthy leads to the paradox of thrift, as their wealth is soaked up into financial assets, whose prices then inflate into bubbles. This is a repeated theme of this blog, with the theoretical framework described in the “Productivity” section and the empirical evidence in “Financial Markets“. Both sections have summaries at the end (here and here), or this post also outlines the theoretical framework and this one the empirical evidence. The paradox of thrift is explained in this post.
Mainstream economics has a massive black hole when it comes to this dynamic. What you here relentlessly is talk of “supply-side” economics. The answer to economic problems is to focus on the efficiency of businesses supplying goods, not the demand for such goods – and that means lower wages, less protection for employees, less regulation, and lower taxes. Why economics keeps reaching such ludicrous conclusions will be explored in in the final section of the blog. But you might notice that this theory will always be attractive to the rich business owners, who seemingly benefit from being able to make more profits and pay lower taxes. This goes a long way to explaining why it is so prevalent!
“Demand-side” economics is generally associated with Keynes, who recognised the need for the government to increase expenditure during a recession to maintain aggregate demand and stimulate the economy. While there is far more than this to his theory (which is widely misunderstood), this does not go nearly far enough in explaining the critical role of enabling demand by distributing income. And at this point, my writing on the blog has overtaken my own research. While many economists have touched on this point, I have not yet found a systematic, empirical study of this aspect of the economy that satisfies my thirst for knowledge. I’m sure it exists, and that as I continue my studies I will find it.
So instead, here is Yanis Varoufakis describing exactly, and very succinctly, what I just described. (I have great respect for Varoufakis, but his books are still some way down my reading list, which is very long!)
The relevant parts of the video are very short. Between 21:38-22:52 he describes how competition in capitalist economies forces down wages, leading to a fall in demand and choking the economy. Between 24:08-24:32 he sums up up how the failure of businesses to invest leads to the paradox of thrift and slows the economy. And as a bonus, between 18:00-18:32 he gives one explanation of why deflation is disastrous (a point often made on the blog).
A more even distribution of wealth and income makes the whole economy stronger. In the section on “Productivity” I deduce logically from the saving-investment identity that if individual acts of saving are not channelled to investment in productivity, the whole economy will shrink through the paradox of thrift. Those with savings will have a bigger share of the pie, but that pie will be smaller overall. However, this doesn’t mean that the rich are worse off – a bigger slice of a smaller pie can, after all, be larger than a smaller slice of a bigger pie.
However, at present we are more than 10 years into an economic downturn that shows little sign of turning around. The economy is clearly in a perilous state. This situation is not in anyone’s interest, no matter how big their slice of pie! I’ve previously described in the blog Pozsar’s empirical work demonstrating that unregulated financial markets are providing “grossly inefficient” responses and rendering these markets highly unstable. Keen has shown that we are on the brink of another financial crisis when we have not yet recovered from the last – in effect, we think we are still in a downturn, but the economy has become so anaemic that this is in fact a boom – we’re trapped in a bubble so big we can’t even see it.
Pozsar’s conclusion is that we have to redistribute wealth to make the economy more stable. I’m arguing (and Varoufakis is arguing, and Keen would also argue) that we have to redistribute wealth to enable the economy to grow. Regardless of any arguments about social justice in respect of wealth inequality or redistributive taxation, a less extreme distribution of income will produce a stronger, more stable economy. It is an essential prerequisite to building an economy that provides enough for everyone.
However, well-being is not just about our level of wealth – it is also dependent on the wider society in which we live. And the empirical evidence is overwhelming and irrefutable that on every indicator – health, happiness, safety – wealth inequality produces a negative outcome even for the richest in society.
This evidence has all been described in one of the most important books of this century, which I will cover next week.