October 2011, Week 2


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Thu, 13 Oct 2011 20:17:35 -0400
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The Instability of Inequality

Nouriel Roubini

NEW YORK - This year has witnessed a global wave of social
and political turmoil and instability, with masses of people
pouring into the real and virtual streets: the Arab Spring;
riots in London; Israel's middle-class protests against high
housing prices and an inflationary squeeze on living
standards; protesting Chilean students; the destruction in
Germany of the expensive cars of "fat cats"; India's
movement against corruption; mounting unhappiness with
corruption and inequality in China; and now the "Occupy Wall
Street" movement in New York and across the United States.

While these protests have no unified theme, they express in
different ways the serious concerns of the world's working
and middle classes about their prospects in the face of the
growing concentration of power among economic, financial,
and political elites. The causes of their concern are clear
enough: high unemployment and underemployment in advanced
and emerging economies; inadequate skills and education for
young people and workers to compete in a globalized world;
resentment against corruption, including legalized forms
like lobbying; and a sharp rise in income and wealth
inequality in advanced and fast-growing emerging-market

Of course, the malaise that so many people feel cannot be
reduced to one factor. For example, the rise in inequality
has many causes: the addition of 2.3 billion Chinese and
Indians to the global labor force, which is reducing the
jobs and wages of unskilled blue-collar and off-shorable
white-collar workers in advanced economies; skill-biased
technological change; winner-take-all effects; early
emergence of income and wealth disparities in rapidly
growing, previously low-income economies; and less
progressive taxation.

The increase in private- and public-sector leverage and the
related asset and credit bubbles are partly the result of
inequality. Mediocre income growth for everyone but the rich
in the last few decades opened a gap between incomes and
spending aspirations. In Anglo- Saxon countries, the
response was to democratize credit - via financial
liberalization - thereby fueling a rise in private debt as
households borrowed to make up the difference. In Europe,
the gap was filled by public services - free education,
health care, etc. - that were not fully financed by taxes,
fueling public deficits and debt. In both cases, debt levels
eventually became unsustainable.

Firms in advanced economies are now cutting jobs, owing to
inadequate final demand, which has led to excess capacity,
and to uncertainty about future demand. But cutting jobs
weakens final demand further, because it reduces labor
income and increases inequality. Because a firm's labor
costs are someone else's labor income and demand, what is
individually rational for one firm is destructive in the

The result is that free markets don't generate enough final
demand. In the US, for example, slashing labor costs has
sharply reduced the share of labor income in GDP. With
credit exhausted, the effects on aggregate demand of decades
of redistribution of income and wealth - from labor to
capital, from wages to profits, from poor to rich, and from
households to corporate firms - have become severe, owing to
the lower marginal propensity of firms/capital owners/rich
households to spend.

The problem is not new. Karl Marx oversold socialism, but he
was right in claiming that globalization, unfettered
financial capitalism, and redistribution of income and
wealth from labor to capital could lead capitalism to self-
destruct. As he argued, unregulated capitalism can lead to
regular bouts of over-capacity, under-consumption, and the
recurrence of destructive financial crises, fueled by credit
bubbles and asset- price booms and busts.

Even before the Great Depression, Europe's enlightened
"bourgeois" classes recognized that, to avoid revolution,
workers' rights needed to be protected, wage and labor
conditions improved, and a welfare state created to
redistribute wealth and finance public goods - education,
health care, and a social safety net. The push towards a
modern welfare state accelerated after the Great Depression,
when the state took on the responsibility for macroeconomic
stabilization - a role that required the maintenance of a
large middle class by widening the provision of public goods
through progressive taxation of incomes and wealth and
fostering economic opportunity for all.

Thus, the rise of the social-welfare state was a response
(often of market-oriented liberal democracies) to the threat
of popular revolutions, socialism, and communism as the
frequency and severity of economic and financial crises
increased. Three decades of relative social and economic
stability then ensued, from the late 1940's until the
mid-1970's, a period when inequality fell sharply and median
incomes grew rapidly.

Some of the lessons about the need for prudential regulation
of the financial system were lost in the Reagan-Thatcher
era, when the appetite for massive deregulation was created
in part by the flaws in Europe's social-welfare model. Those
flaws were reflected in yawning fiscal deficits, regulatory
overkill, and a lack of economic dynamism that led to
sclerotic growth then and the eurozone's sovereign-debt
crisis now.

But the laissez-faire Anglo-Saxon model has also now failed
miserably. To stabilize market-oriented economies requires a
return to the right balance between markets and provision of
public goods. That means moving away from both the Anglo-
Saxon model of unregulated markets and the continental
European model of deficit-driven welfare states. Even an
alternative "Asian" growth model - if there really is one -
has not prevented a rise in inequality in China, India, and

Any economic model that does not properly address inequality
will eventually face a crisis of legitimacy. Unless the
relative economic roles of the market and the state are
rebalanced, the protests of 2011 will become more severe,
with social and political instability eventually harming
long-term economic growth and welfare.

[Nouriel Roubini is Chairman of Roubini Global Economics,
Professor of Economics at the Stern School of Business, New
York University, and co-author of the book Crisis


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