Instability Implications of Increasing Inequality: What can be learned from North America?

Lars OsbergEconomics DepartmentDalhousie University

ECONOMIC AND SOCIAL INEQUALITIES: CAUSES, IMPLICATIONS AND REMEDIES, Milan, October 27-28, 2011

Road Map

• Review of Empirical Trends • U.S. & Canada

• Increasing Inequality Unbalanced Growth by Income class• Increasing inequality cannot be a steady state

• MexicoStructural Changes of Development can grow low incomesPolitical Economy of Social Policy – if Elites threatened

• Economic Implications• Interacting Instabilities of Imbalance

• Political Economy – can it produce an Equilibrium ? What kind ?• “Conclusion”

Illustrative Statistics - 2009

CANADA MEXICO U.S.

Population - (millions) 33.7 107.4 307.0

GDP (Billion current U.S.$) 1,336 883 14,044

GDP per capita (PPP 2005 $) 34,600 12,500 41,700

Life expectancy at birth, total (years) 81.2 75.3 78.7Agriculture (% of total employment) 2.5 13.5 1.4

Crude Birth Rate Change (1980 to 2009) -3.9 -15.8 -2.1

Different trends in Inequality?

Mid-1970s Mid-1980s Mid-1990s 2000 Mid-2000s

CANADA

0.294789333658064

0.286903864559859

0.28276145 0.300866821

0.316927232

MEXICO

NaN 0.4523027325181

0.518606009379482

0.506568634094894

0.473640416056482

USA

0.3164682097

0.337509244

0.3613888376

0.3566542176

0.3814068351

0.050

0.150

0.250

0.350

0.450

0.550

Gini: Equivalent After-Tax Money Income

• Mexico• ↑ then ↓

• Canada• ↓ then ↑

• USA• ↑ then ↑

Unbalanced Growth Increasing Inequality

• U.S. & CANADA – similar market Income growth 1987-2007: Top 1 % @ 4%;Bottom 80% @ 0.5%Canada – 1995 = shift in redistribution by government

• Mexico since mid 1990s – declining inequality• Structural changes + Social transfers (Progresa)

• Similar to U.S. & Canada post 1940 ?

• Steady State Equilibrium = Special Case of Balanced Growth• Unbalanced Growth => Linked Instabilities

• 1930s: U.S. New Deal stabilized system – can it be renewed ?

Canada – nil real growth for most

19761977

19781979

19801981

19821983

19841985

19861987

19881989

19901991

19921993

19941995

19961997

19981999

20002001

20022003

20042005

20062007

20082009

0

20000

40000

60000

80000

100000

120000

Total Income of Canadian Family Units:1976-2009

20th percentile 40th percentile median 60th percentile 80th percentile

2009

Dol

lars

U.S. – real growth only at top

Long Swing in Top 1% Share

19131916

19191922

19251928

19311934

19371940

19431946

19491952

19551958

19611964

19671970

19731976

19791982

19851988

19911994

19972000

20032006

0

5

10

15

20

25

TOP 1% INCOME SHARE: U.S. & CANADA

US CANADA

Top1% incomes did not fall – just grew more slowly– Relative Growth => Changed Share

19131916

19191922

19251928

19311934

19371940

19431946

19491952

19551958

19611964

19671970

19731976

19791982

19851988

19911994

19972000

20032006

0

200000

400000

600000

800000

1000000

1200000

Average Real Income of Top 1% U.S. and Canada

Top 1% average income USA Top 1% average income Canada

2008

$

Much Higher Real Income Growth @ Top

P20 P40 P50 P60 P80 P90 P95 P99 P99.5 P99.9 P99.99

Canada 0.004 0.0031 0.0035 0.004 0.0071 0.0071 0.01 0.0195 0.0244 0.0379 0.052

USA 0.003665586409012

05

0.004418900258594

27

0.0049 0.005203945328514

64

0.008455777587552

4

0.0085 0.0134 0.025 0.0281 0.0397 0.0549

0.50%

1.50%

2.50%

3.50%

4.50%

5.50%

Real Income: Compound Annual Growth Rate 1987 - 2007

Percentile Points of Income Distribution

Balanced Growth Same Rate Income Increase @ Top & @ Bottom

• U.S.: Annual Income growth 1987-2007: Top 1 % = 4% ; Bottom 80% = 0.5%

• What chances for bottom quintiles to grow @ 4% cumulatively?• U.S. – Unemployment > 9%; Poverty @peak; Return of Recession?• Canada & US: Unions weak; Low-wage competition strong; small marginal returns

to HK investment & structural change

• Why would Income Growth @ Top slow?• High Incomes => Wealth => Capital Income• “Winner Take All” Positional Rents = f(global market size)• Control over CEO compensation process undiminished

Income & Wealth Accounting • Income = Consumption + Savings

• Income Increases @ top => Savings => Increase Loanable Funds• Real Expenditure Balance iff ↑ Savings of top 1% = ↑ spending rest• Escalating Consumption Norms – set @ top and ripple down

• “Expenditure Cascades” => ↑ consumption norms for stagnant middle

• U.S. ↑ inequality of consumption < ↑ inequality of income• Mitigated short run welfare implications of ↑ inequality• Implied changing distribution of assets and liabilities

• Assets = Liabilities• Financial Instrument: Asset for Holder = Liability for Issuer• Savings @ top → Debts @ bottom • Financial Fragility => Crises => Recessions => Counter-cyclical stimulus

Debt Instability Dt = (1 + rt)* Dt-1 - PBt

∆ (D/Y)t = (rt - gt)*(Dt-1/Yt ) - (PBt / Yt)

• The compounding of debt overhang • rt > gt

• Accumulated Deficits => ↑ Debt/GDP => ↑ Deficit => ↑ Debt =>

• Anti-Inflation Monetary Policy increases (rt - gt) at both ends

Mexico: More growth @ bottom

Mexico: Structural Change & Growth

• 1995: recession => un(der)employment• High % agriculture => rural out-migration => wage gains

• Mexico: 2 step process: rural poverty → informal urban → formal urban

• Low % employed women => big impact ↑ female jobs • % enrolled primary & secondary => high marginal HK returns• Capital deepening => ↑ MPL

• Large ↓ birth rate → (educated) demographic bulge

• Political economy of social policy & ‘Progresa’ (1995)• 1994/5: NAFTA + Recession + ↓ PRI + Chiapas – Zapatista insurrection• Credible local ‘hard left’ political option =>“threat effect” for elites

Canada: 1990s fiscal crisis => ↓ redistributionTendency to ↑ inequality reinforced

19761977

19781979

19801981

19821983

19841985

19861987

19881989

19901991

19921993

19941995

19961997

19981999

20002001

20022003

20042005

20062007

20082009

-0.16

-0.14

-0.12

-0.1

-0.08

-0.06

-0.04

-0.02

0

Change in Gini Index of Equivalent Individual Income Canada 1976 to 2009

Impact of Transfers Impact of Taxes Impact of Taxes & Transfers

USA: What chance for a New “New Deal” ?

• 1930s: FDR & “New Deal”• U.S. Policy Innovation Stabilized Growth & Inequality

• Cyclical: Public Works Stimulus• Structural:

• Bank Regulation + NLRB + Social Security + Progressive Taxation

• U.S.: Systemically stabilized for 50+ years• Eroded in stages since early 1980s

Conflicted attitudes + $ politics• Bimodal distribution →

small migration tips majority balance• BUT short terms +

division powers + courts → soon tips back

• “Deeper Pockets” • ↑ ≠ $ → ↑≠ influence -0

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1000.

2500.

4000.

5500.

7000.

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1501.

3001.

4501.

6001.

7501.

900

0

0.2

0.4

0.6

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1

1.2

1.4

Preferences for Leveling in the United States 1987-1999

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The unsustainable does not last – but what follows?• Unbalanced Income Growth Increasing Inequality • Cannot be a steady state equilibrium

• Produces Interacting Instabilities – cumulative impact • U.S. & Canada: Parallels with 1930s but many structural changes

• No Automatic Economic Tendency to self-correction is obvious• Political Economy of Adaptation to Systemic Instability:

• Both disastrous choices and enduring successes observed in 1930s

Debt Instability – The Power of Accounting Identities

Dt = (1 + rt)* Dt-1 - PBt

Dt = Debt in period t

rt = average rate of interest in period t

PBt = Primary Balance in period t

= (Taxest – Program Expenditurest)

∆ (D/Y)t = (rt - gt)*(Dt-1/Yt ) - (PBt / Yt)

Yt = GDP

gt = growth rate of GDP

∆ (D/Y)t = change in Debt/GDP ratio