Inequality & Crises

February 4, 2011

Via Stumbling & Mumbling, we learn of a fascinating column on vox which appears to provide a convincing argument that the origins of the financial crisis lay in rising inequality. I’m betting it’ll be seized on by the Left as this year’s Spirit Level*, so let’s have a look at what Kumhof and and Ranciere are saying.

The argument runs that increasing levels of inequality lead to the accumulation of capital by the top strata of a given society. The more capital possessed by the top strata, the less wealth they use for consumption. Something has to be done with this outstanding wealth, and so it’s reinvested – in physical assets, or in financial products. The rich don’t just leave their wealth under the bed; they want it to be working all the time.

This increased demand for financial products leads to the expansion of the financial services sector, who endeavour to meet this demand with the creation of new investment products. Once the given level of investment opportunities available in the economy is exceeded by the amount of capital seeking returns, products which package up consumer credit become more widespread.

At the same time as this expansion in consumer credit commences, restrictions on worker bargaining power mean that the share of GDP that goes to workers decreases, reducing their social status. To reclaim this social status, they access newly cheap credit, which they use for consumption rather than investment. Since their share of GDP continues to decrease, the ratio of workers’ wages against the amount by which they’re leveraged continues to increase. This is clearly not a sustainable situation, and eventually defaults begin. This suddenly slashes the amount of wealth available to the top 5%, who become suddenly much more frugal with their money via their intermediaries, the financial services. Cue a credit crunch.

This is, of course, broadly what happened: toxic mortagages from the US poisoned much of the credit system. The authors predict that without some way of ensuring that workers are able to pay their debt, the result will be another financial crisis. They advocate increasing the bargaining power of workers to achieve this.

We’ll skip over the colossal irony that debt-fuelled expansion was Labour’s economic policy and appears to remain Labour’s economic policy. Let’s focus on the implications of this study. If the modelling carried by Kumhof and Ranciere is correct, the origins of the economic crisis lay not in Thatcher’s relaxation of regulation of the financial sector, but in her tightening of legislation around union activity. The implication of this is that the current furore around bank regulation is misplaced: Government should instead relax union regulations to avoid another crisis.

I have some sympathies with this view – as a Liberal, I don’t believe the State should be regulating the activities of individuals except inasmuch as they impact on the rest of society. Union activity in the private sector, where excessive demands can cause a business to fold, has typically only private consequences. Union activity in the public sector can have implications for everyone else, as Bob Crow appears determined to prove. There’s a strong case for separate bodies of regulation for unions in industries with multiple providers and industries with a single provider, which would enable proper disputation between workers in the former industries. Unfortunately, no-one’s advocating that at the minute – certainly not the Labour Party, who’d be crucified by their public-sector paymasters, and certainly not the Conservatives, who view any union activity as a constraint on their chums in big business. This is something Liberal Democrats should be unafraid to work for.

*for any outstanding believers, do read Christopher Snowdon on this, he’s very good.

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