Tue, Dec 01, 2015, Safar 18, 1437 A.H | Last updated 2 hours ago
Hot Topics
You are here: Home > Today's Paper > Opinion
- Saturday, February 02, 2013 - From Print Edition

US President Barack Obama, in his inaugural speech on January 21, pledged to focus more on economic recovery at home. He said “A decade of war is now ending. An economic recovery has begun”.

Will the US be able to pick up economic growth in the coming years? This remains to be seen. But some distinguished economists like Joseph Stigilitz of Columbia University and Robert Gordon of Northwestern University seriously doubt that the US will lead the world in terms of economic growth and that its economic recovery will be recouping unless basic factors like rising inequality in the US are seriously tackled.

They have made a convincing case to support their viewpoint. Joseph Stigilitz, in his book, The price of inequality, holds wide income inequality as the biggest impediment to growth and economic recovery, as concentration of income and wealth in the top one percent has severe negative implications for recovery. According to Professor Stigilitz, inequality holds back the economic recovery and growth through three channels.

First, if income is not widely distributed in the society, the aggregate demand will be low, as the rich have a limit to consumption no matter how spendthrift they are. Besides ‘how much you spend’ – the quantum – and ‘where you spend’ – the composition – also has implications for aggregate demand.

For example, the middle class will spend most of their income on food, schooling, health, and purchase of household effects and such expenditures will create sufficient demand.

Consequently, factories and businesses will flourish and jobs will be created. Thus a positive cycle of more spending, more demand, more employment generation, more income and resultantly more spending is established. The rich generally spend on palatial buildings, expensive gems and jewellery and other luxuries, which in a sense are static assets. Such capital generally remains dead for a long time and does not trigger a stream of consumption and investment.

Second, squeezing the income of the middle class means that they are unable to invest in the future, in the education of their children; in improving their existing businesses or initiating new projects. Third, inequality, according to Professor Stigilitz, is also associated with boom-bust cycles, as economic inequality and economic instability are closely intertwined.

This raises the question that since inequality has remained one of the characterising features of the US capitalistic economy for decades, why is it being perceived as a big macroeconomic policy problem now? And if inequality is the reason for low economic growth, then why has the US kept growing spectacularly for decades, despite deep-rooted economic inequalities and that too of structural nature.

Economists have given two reasons for this. First, the increase in the share of the top one percent in income has been rapid in the last couple of years. According to some estimates, the income share of the top one percent has increased from eight percent of annual GDP to 20 percent since the 1970s.

Second, huge income concentration in the top one percent encouraged policies of unsustainable borrowing by the lower and middle class income groups. For example, interest rates were kept low and ingenious banking instruments were invented. Thus, through liberal provision of loans against easy conditions of collateral demand was kept high. But the bubble busted with the collapse of Lehman Brothers, triggering the worst financial crisis that has hit the globe after the Great Depression of the 1930s.

Further, in order to save the big banks and financial institutions, huge sums of money were injected to save them. According to Professor Stigilitz if the money had been given to those who were hard pressed due to their debts, it would have been more useful for increasing demand and growth. But saving the too-big-to-fail institutions worsened the situation and held back economic recovery. Professor Stigilitz is not the only voice (though the most forceful) that holds inequality as a big stumbling block to the economic recovery and growth in the US.

Recently, Professor Robert Gordon of Northwestern University has also concluded, based on his work on long-term growth in the US, that the time of American economic growth seems to be over – due to faltering innovation arising from six headwinds which include rising inequality.

His paper titled ‘Is US economic growth over? Faltering innovation confronts the six headwinds’, is an interesting read at least on three counts. First, it challenges the long established version of growth theories, that growth is a persistent phenomenon. Second, the current slow growth in the US is not a transitory phenomenon; rather it is likely to persist for a long time.

Third, growth was the result of three different industrial revolutions that took place in history but the impact of the third revolution that ensued with the advent of the web and Internet had a short-lived impact on growth contrary to popular perception.

The point these economists are emphasising on is that inequality should no more be taken as a social or ethical issue. Rather, it is a macroeconomic issue and should be approached as such. High income inequalities depress demand and as a result economic growth slows down. Rising inequality limits the scope of various macroeconomic policy tools used to encourage demand and growth.

Kemal Dervis, a former minister of economics in Turkey (who also taught at Columbia) rightly points out in his article titled ‘The inequality trap’ that: “Macroeconomic policy can try to compensate the excess of planned savings over investment through deficit spending and very low interest rates. Or an undervalued exchange rate can help to export the lack of domestic demand. But if the share of the highest income groups keeps rising, the problem will remain chronic. And, at some point, when public debt has become too large to allow continued deficit spending, or when interest rates are close to zero bound, the system runs out of solutions”.

The discussion of inequality as a macroeconomic problem generally focuses on US economy. But inequality is rising globally and people are airing their concerns about the ever-deepening inequality traps. We are not an exception to this trend. The phenomenon of jobless growth that we witnessed in the last one decade has certainly deepened income inequalities.

The purchasing power of the people has diminished due to the erosion of their earnings. In this context, we also need to tackle the problem of inequality as an economic problem by bringing in fundamental changes in our economic structures aimed at wide dispersion of economic power in the society.

The writer is a graduate from Columbia University with a degree in Economic Policy Management. Email: [email protected]