Inequality as a critical cause of the financial crisis?
by Linda Beale
crossposted with Ataxingmatter
Inequality as a critical cause of the financial crisis?
As readers know, Ataxingmatter is premised on a concept that I have called “democratic egalitarianism.” that This is the idea that sustainable democracy requires forces that push economic and other resources towards a more equal distribution rather than permitting resources to accrue more and more to the already powerful and well-resourced amongst us. Redistribution, that is, occurs all the time in every economy. Much of redistribution is redistribution upwards–power accrues power; wealth accrues wealth; and accordingly opportunity accrues opportunity. Taxation is one of the mechanisms that society can use to counter the natural tendency towards redistribution upwards. In a democracy, that mechanism is necessarily and appropriately limited, but it can be servicable on a small scale. Thus, mechanisms such as income rather than consumption taxation, progressive tax rates, taxation of large estates passed to beneficiaires, exemptions and refundable credits sufficient to ensure a sustainable livelihood for those who have (and earn) least, and similar provisions can serve to switch the default direction of redistribution from ‘redistribution to the have-mores’ to ‘redistribution to the have-nots’ at least to some degree.
So how does that view of democracy and the need for “democratic egalitarianism” impact upon one’s understanding of the causes and appropriate cures for the financial crisis that expanded into a deep recession bordering on depression?
In my own analysis of the financial crisis (to be published by the IMF, and currently available through SSRN here), I focused primarily on the deregulation/privatization/and tax cutting at the core of the reaganomics trickle-down ideology and the way that led to a predatory casino banking mentality that in turn was fed by the ease of speculation made possible by financial product innovations like naked credit default swaps. Similarly, the risk inherent in this type of banking was increased as institutions consolidated, increasing in resources and in interconnections with other financial institutions (including through the use of new-fangled derivatives).
I didn’t focus, though, on a singular fact about our society that relates to our deepest economic woes during the Great Depression as well as our current Great Recession–the rapid growth of inequality, and the attitudinal changes that likely accompany that (e.g., rampant expansion of greed as a primary motivating factor for human behavior, acceptance of incredible differences in access to resources and influence over governmental decisions without an acknowledgement of corresponding obligations, predatory behavior by lenders and other businesses). But surely it is noteworthy that of all the remedies that could have been taken to address the economic crisis that developed out of the financial institution crisis, the only one that would have kept more people in their homes and protected entire neighborhoods and cities from the blight of foreclosed properties–permitting bankruptcy adjustments of home mortgage loan principal amounts–was never a real option. Banks ended up being more important than millions of homeowners (and the communities that were impacted by their homelessness and joblessness).
Raymond H. Brescia, at Albany Law School, has filled that gap, with an article titled The Cost of Inequality: Social Distance, Predatory Conduct, and the Financial Crisis (draft Aug. 17, 2010) (available on SSRN). He starts with a pair of quotes that are noteworthy in themselves.
An imbalance between rich and poor is the oldest and most fatal ailments [sic] of all republics. Plutarch
The injunction of Jesus to love others as ourselves is a recognition of self-interest . . . We have to tolerate the inequality as a way to achieving greater prosperity and opportunity for all. Lord Brian Griffiths, Vice Chairman, Goldman Sachs International
In the abstract, Brescia explains that the “stunning increase in income inequality…was reminiscent of … the years leading up to the Great Depression.” In the paper, this is illustrated with the following graph: Table Three: Share of Total Income Going to Top 10%, id. at 14.
Brescia notes “several possible explanations for the potential connection between rising income inequality and the great strains on the economy it causes. Did rising income for certain sectors lead to an ability to use that income to influence po,icymaking in such a way that favored those sectors? Did such income inequality pressure politicians to promote policies that favored easy access to credit as a way to mollify lower income constituents who might otherwise grow frustrated with their own stagnating wages in the face of such inequality?” He offers a third explanation–“that both income inequality and racial inequality created greater social distance and this social distance, in turn, led to greater predatory conduct… that turned a mortgage market into an economic killing field.” The abstract further notes critical insights from looking at the crisis from the perspective of inequality data.
1) the greater the income inequality in a state, on average, the greater the delinquency rate in that state.
2) the greater the generalized trust in a state, the lower that state’s delinquency rate
3) the higher the social capital in a state, and the higher the level of volunteerism in a state, the lower its delinquency rate
4) the higher the median income in a state, the higher the delinquencyrate in that state
5) an index of indicators–income inequality within a state, the size of the African-American population in a state and the median income of the African-American population in that state–reveals a strong correlation between these indicators and delinquency rates…[suggesting that] middle-class Afircan-Americans were targeted for, and steered towards, loans on unfair terms, precipitating the foreclosures that are now concentrated disproportionately in communities of color.
“1) the greater the income inequality in a state, on average, the greater the delinquency rate in that state.”
“4) the higher the median income in a state, the higher the delinquency rate in that state.”
Census data just released for 2009 suggests that high median incomes are associated with wide spreads in income distribution. (Though that may be a feature particular to anglo-american sorts of economic arrangements.) If so, then 1) and 4) may be essentially redundant.
In addition, 1) and 4) seem to suggest causality, but I would think that when high income and wide income gaps are found together, that combination is caused by some factor or factors not named here, and that they are the same factors which lead to delinquency. Policies which aggrandise wealth will almost of necessity denigrate the lack of wealth, and undervalue those without wealth. If combining good behavior with poverty gets you little more opportunity than just poverty alone (because of a culture focused on wealth, rather than virtue), then let’s not worry about good behavior.
Could you please provide a link to your paper (there is no link where indicated above, nor in your cross-post on your own site)? I’d very much like to read it as I’ve been digging into the inequality issue, too. Thanks.
but the stupid we always have with us. so we need to look for another reason. i am inclined to think that absent the church or the family to look out for us, or, even, the feudal landlord, we need a paternalistic government. and that idea drives people crazy. the rich think it means communist totalitarianism, and the poor are insulted that someone thinks they are, well, stupid.
but in any case, we see that there are predators among us, and always will be. and that will always drive down the standard of living for most people. the only hope “most people” have is to figure out a way to maintain a governmetn that protects them from the predators without becoming a predator itself, or a tool of the predators. it’s an unstable situation. the founders thought they had the answer in checks and balances. but the predators trumped that with checks and cash.
Stupid is as stupid does.
“This is the idea that sustainable democracy requires forces that push economic and other resources towards a more equal distribution rather than permitting resources to accrue more and more to the already powerful and well-resourced amongst us.”
And Democratics wonder why the population turned on them? Amazing!
Who is the population?
trouble is i could agree with you if your expressed your concerns more intelligently. the democrats should not be seen as “redistributionists.” the poor don’t like it any more than the rich. they like the effect, of course, but they don’t like the implications.
there are plenty of ways a country can and should try to make sure that the poorest among them can have a decent life, but taxing the rich for direct income transfers is an ugly way to go about it, and will fail. on the other hand, allowing “the already rich and powerful” to aquire all the “economic resources” as they inevitably will without government intervention… is the path to economic and political suicide.
Dan, let’s try a majority of voters.
Heh. CoRev, the majority of voters embraced Democrats two years ago, and the party stood for the same values then.
But thanks for playing. Try again sometime.
“we need a paternalistic government. and that idea drives people crazy. the rich think it means communist totalitarianism” coberly
My friend, ours is a paternalistic government. Those paternalistic inclinations are, however, reserved for the very few at the expense of the many. Voila!! Increasing inequality in wealth distribution and earnings. We have a one party, two faction political system which ranges from the slightly right of center to extreme right wing reactionary ideology. In effect the two factions which we identify as Democratic and Republican parties have been perpetuating a myth of ideological distinction. All significant legislation in the past forty years that has contributed to the extreme distribution of assets that now exists had been passed by a series of bi-partisan Congressional votes. And we now witness the great Conciliator from Chicago as he supports every Republican demand for influence until there is no likelihood of change. This in spite of his popular mandate and promises of change. Things won’t get better until they get severely worse.
Accounting tells us that way to get rich is to earn more money than you spend. This is true for any economic system that allows savings and profit. Unfortunately, this means that the economy tends towards an equilibrium state in which most of the money is in the hands of people who spend the least. If money is the ability to do work, then this is the economic equivalent of economic heat death. The economy will wind down, unless there is some mechanism to get money into the hands of those who will spend it.
In the 19th century, the US relied on land reform, taking land from its owners, the native Americans, and giving it to ranchers, miners and farmers, effectively putting money into the hands of anyone willing to work for it. Even now Marxists will call for land reform, but land isn’t as important a generator of wealth as it once was.
In the 20th century, the income tax served instead, at least until the tax cutters got serious. I’m not sure of the best mechanism for the 21st century, but without Maxwell’s demon, the best we can hope for is stagnation.
Joel, is Nov 2 soon enough for us to play again? Voters were fooled, lied to, and just tired. They are now, concerned, angry about the above lying, and ready to make a statement with a change.
Are you ready to listen?
alas, i think you may be right. i was just trying to revive a sense of nobless oblige. we seem to have created a society that has gone mad. even the quite well off imagine themselves in need of a tax cut. because they are not as well off as they’d like to be, and the only place they can think of to save money is on their taxes.
i am told people watch movies about organized crime and think the lifestyle is charming.
I think this commentary makes some important points which our larger (conservative), financial media seem to overlook. There has been a dramatic increase in disparity in wealth in the years leading up to the Great Recession just as there was in the years leading up to the Great Depression. Also we saw tax cut, deregulation, pro big business policies in the years leading up to the Great Recession just as there was in the years leading up to the Great Depression. This is why we have seen financial crises occurring on the watch of Republican power. Because Republican power is associated with policies leading to income disparity. So I believe the basic premises made in this commentary are in fact supported by the evidence and facts. And the policies currently advocated by Republicans, namely more tax cuts and deregulation, would only exacerbate the existing problems. At the same time I personally disagree with the Democrat and the author above approach that more government stimulus and even bailouts of the common man is the answer either. The quickest resolution to the current crisis is to allow the deleveraging process to occur just as it did during the Great Depression (and in contrast to the endless malaise of Japan). Government should provide a strong safety net and policies which encourage solutions to the structural problems of budget and trade deficits and a low savings rate. We thus need lower spending and higher taxes, and we need to export more and import less. If that means a trade war with China, so be it.