Inequality in wealth in the USA is approaching record levels. Research by Emmanuel Saez of the University of California, Berkeley, and Gabriel Zucman of the London School of Economics examined the share of total wealth held by the bottom 90% of families relative to those at the very top – 0.1%. Their research in wealth distribution reveals three trends:
1. Wealth inequality appears to have followed a U-shape evolution since 1913, with a marked increase since the 1980s. By their estimates, virtually all the increase in the top 10% and top 1% shares over the last three decades is due to the rise in the top 0.1% share, from 7% in the late 1970s to 22% in 2012.
2. The wealth share of the bottom 90% has followed an inverted-U evolution: from a low point of 15% in the late 1920s and at the beginning of the Great Depression, it steadily rose to 35% in the mid-1980s—thanks to rising pension and housing wealth—but then dropped to 23% in 2012 because of an increase in mortgage and other debts.
3. The increased concentration of wealth at the top seems driven by surging top incomes. The combination of increasing income inequality with increasing saving rate inequality is fueling wealth inequality
The Economist produced a very good interactive graphic on this entitled – Some are more equal than others – see the screenshot below. Useful for Unit 5 of the A2 course that looks at the Lorenz Curve.
Here is another clip from Mr Clifford. Good for teaching scarcity, choices, self-interest, incentives, cost/benefit analysis, voluntary exchange, and economics systems. I particularly like the supply and demand graph at the start.
A hat tip to colleague David Parr for this interesting item. With Russia being in the news over the Ukraine situation and President Putin coming under a lot of pressure at the G20 Conference in Brisbane (in fact he left early), the Russian stock market – number 20 in the world – was surpassed in value by the iPhone maker last week. According to Bloomberg’s Mark Barton Apple could use the change to buy every Russian a 16GB iPhone Plus.
The value of Russian equities = $531 billion
The value of Apple = $667.2 billion
Singapore and Italy are now worth less than Apple as well. And with Christmas approaching who will be next?
Paul Krugman in the ‘New York Review of Books’ wrote a very informative review of Tim Geithner’s book “Stress Test: Reflections on Financial Crises”. Although I have not read the book Krugman does put across a strong view that the stimulus to end the US economy’s free fall was too small and too short-lived given the depth of the slump.
We can think of the economy as a patient who was rushed to the emergency room with a life-threatening condition. Thanks to the urgent efforts of the doctors present, the patient’s life was saved. But while the doctors kept him alive, they failed to cure his underlying illness, so he emerged from the procedure partly crippled, and never fully recovered.
Something went very wrong with the US economy in 2008. But what?
Quite early on, two somewhat different stories emerged about the economic crisis.
1. A classic bank run of enormous proportions. And there certainly was a very frightening panic in 2008–2009.
2. The large overhang of private debt, in particular household debt.
What’s the difference? A financial panic is above all about confidence, or rather the lack thereof, and the overriding task of policy is to restore confidence. However confidence will not overcome the problem of debt overhang. It needs policies like sustained fiscal stimulus and debt relief for families.
Financial panics arise institutions promise their creditors ready access to their funds but are unable to pay them. This is because they invest in assets that are relatively illiquid, and this works only when a small fraction of a bank’s depositors try to pull their money out on any given day. When this does happen the bank is forced to sell assets – usually at fire sale prices – in order to raise cash – and this can break the bank. And this in turn means that when investors fear that a bank may fail, their actions can produce the very failure they fear: depositors will rush to pull their money out if they believe that other depositors will do the same, and the bank collapses.
The point is that a financial panic is very much a case of self-fulfilling prophecy. And it needs a “lender of last resort,” providing banks facing a run with cash, so that they don’t need to engage in desperate fire sales.
So why was it so hard to organise an effective response to the 2008–2009 panic? One answer is that the Fed was set up to deal with conventional banks, and had neither a clear legal mandate for nor much experience in bailing out shadow banks. Fear of bank losses led to 3 ideas that needed to be debated.
1. Some who warned of “moral hazard”—that bailing out banks would reward bad actors, and encourage future irresponsibility.
2. Some who were in favour of nationalization argued that the banks needed to be bailed out. The idea was that the government, in return for taking on big risks, should temporarily acquire ownership of the most troubled banks, so that taxpayers would profit if things went well.
3. Some thought that the financial crisis should be treated more or less as an ordinary lender-of-last-resort problem—that temporary nationalization would hurt confidence and was unnecessary, that once the panic subsided banks would be OK.
Whatever the reasons, however, the stress test pretty much marked the end of the panic. The graph below shows several key measures of financial disruption—the TED spread, an indicator of perceived risks in lending to banks, the commercial paper spread, a similar indicator for businesses, and the Baa spread, indicating perceptions of corporate risk. All fell sharply over the first half of 2009, returning to more or less normal levels. By the end of 2009 one could reasonably declare the financial crisis over.
But a funny thing happened next: banks and markets recovered, but the real economy, and the job market in particular, didn’t. It’s still very hard to find a full-time job—both the number of long-term unemployed workers and the number of people unable to find full-time jobs remain far above pre-crisis levels.
Balance Sheet Recession
The best working hypothesis seems to be that the financial crisis was only one manifestation of a broader problem of excessive debt—that it was a so-called “balance sheet recession.” This is where households have taken on high levels of debt and at some point face pressure from creditors to ‘deleverage’, reducing their spending in an effort to pay down debt. But by doing this they reduce consumer spending in the economy and this can turn into a self-reinforcing spiral, as falling incomes make debt repayment even harder.
However a balance sheet recession cannot be cured by restoring confidence. Fiscal stimulus and debt relief are required by the government to reduce private debts and allow debtors to spend again. The private sector is not in a position to do so.
With the A2 essay paper tomorrow here is a quick revision note on monopolistic competition. This is a market structure in which there are a large number of firms selling commodities which are very close substitutes. There are weak barriers to entry and firms may enter the industry with ease. Notice on the diagram that the firm initially makes supernormal profit at Q0 – at MC=MR Price = P0 and Cost = AC0. However with weak barriers to entry these profits are competed away and they now produce at Q1 where at MC=MR and the Price and Cost = AC1
Modern capitalism is characterised by a large number of ‘limited’ monopolies. They are sole suppliers of branded goods, but other firms compete with them by selling similar goods with different brand names. This is the market structure described as monopolistic competition. Thus the commodities produced by any one industry are not homogeneous; the goods are differentiated by branding and the use of trade marks. The individual firm has a monopoly position, but it faces keen competition from firms supplying very similar goods. It has, therefore, only a limited degree of monopoly power – how much depends upon the extent to which firms are free to enter the industry. Product differentiation is emphasised (some would say, created) by the practice of competitive advertising which is, perhaps, the most striking feature of monopolistic competition.
Advertising is employed to heighten in the consumer’s mind the differences between Brand X and Brand Y. It is important to realise that we are concerned with the differentiation of goods in the economic sense and not in the technical sense. Two branded products may be almost identical in their technical features or chemical composition, but if advertising and other selling practices have created different images in the consumer’s mind, then these products are different from our point of view because the consumer will be prepared to pay different prices for them.
The main competing views of macroeconomics (Keynesian vs Monetarist) is part of Unit 5 in the A2 syllabus and is a popular topic in the essay and multiple-choice papers. Begg covers this area very well in his textbook. In looking at different schools of thought it is important to remember the following:
Aggregate Demand - the demand for domestic output. The sum of consumer spending, investment spending, government purchases, and net exports
Demand Management – Using monetary and fiscal policy to try to stabilise aggregate demand near potential output.
Potential Output – The output firms wish to supply at full employment after all markets clear
Full Employment – The level of employment when all markets, particularly the labour market, are in equilibrium. All unemployment is then voluntary.
Supply-side policies – Policies to raise potential output. These include investment and work incentives, union reform and retraining grants to raise effective labour supply at any real wage; and some deregulation to stimulate effort and enterprise. Lower inflation is also a kind of supply-side policy if high inflation has real economic costs.
Hysteresis – The view that temporary shocks have permanent effects on long-run equilibrium.
There are 4 most prominent schools of macroeconomics thought today.
New Classical – assumes market clearing is almost instant and there is a close to continuous level of full employment. Also they believe in rational expectations which implies predetermined variables reflect the best guess at the time about their required equilibrium value. With the economy constantly near potential output demand management is pointless. Policy should pursue price stability and supply-side policies to raise potential output.
Gradualist Monetarists – believe that restoring potential output will not happen over night but only after a few years. A big rise in interest rates could induce a deep albeit temporary recession and should be avoided. Demand management is not appropriate if the economy is already recovering by the time a recession is diagnosed. The government should not fine-tune aggregate demand but concentrate on long-run policies to keep inflation down and promote supply-side policies to raise potential output.
Moderate Keynesians - believe full employment can take many years but will happen eventually. Although demand management cannot raise output without limit, active stabilisation policy is worth undertaking to prevent booms and slumps that could last several years and therefore are diagnosed relatively easily. In the long run, supply-side policies are still important, but eliminating big slumps is important if hysteresis has permanent effects on long-run equilibrium. New Keynesians provide microeconomics foundations for Keynesian macroeconomics. Menu costs may explain nominal rigidities in the labour market.
Extreme Keynesians - believe that departures from full employment can be long-lasting. Keynesian unemployment does not make real wage fall, and may not even reduce nominal wages and prices. The first responsibility of government is not supply-side policies to raise potential output that is not attained anyway, but restoration of the economy to potential output by expansionary fiscal and monetary policy, especially the former.
Gabriel Makhlouf, Secretary to the Treasury (New Zealand), gave a very thoughtful presentation at the Government Economics Network Annual Conference in Wellington. The main focus of his talk was the relevance of economics and economics teaching. He recalled his early days studying economics at University when Lipsey was the textbook of the day and stagflation and the ascendency of Friedman over Keynes were the talking points.
He quite rightly criticises the reliance on mathematical models in decision-making and he suggests that problems arise when the straightforward models,designed to think in a structured way about the economic issues, are confused with the reality we are trying to address. That risks confusing a moral science for a natural one.
Although we can build economic models based on rational consumers with perfect knowledge there is a need to accommodate unintended events which are part of the imperfect market. As Paul Krugman put it, “economists, of all people, should have been on guard for the fallacy of misplaced concreteness” and “the economics profession went astray because economists, as a group, mistook beauty, clad in impressive-looking mathematics, for truth”.
He quotes Arthur Marshall
“I have a growing feeling that a mathematical theorem dealing with economic hypothesis is very unlikely to be good economics, and I go more and more on the rules:
1. Use mathematics as a shorthand language rather than as an engine of enquiry.
2. Keep to them until you have done.
3. Translate into English.
4. Then illustrate by examples that are important to real life.
5. Burn the mathematics.
6. If you can’t succeed in 4, burn 3. This last I do often.”
Also of note is his advice to the economics profession.
* Are you covering different schools of economic thought in your teaching? Is your approach intellectually pluralistic enough?
* Are you teaching enough economic history, so that we can learn the lessons from the past?
* Do your students have enough time to absorb and reflect on the material they are learning? In fact, as the discipline expands, are your students taking enough economics?
* Are you encouraging your students to embrace and respect the perspectives that other disciplines bring to thinking about and solving economic problems? What, for example, have we learned about neuro, evolutionary and behavioural economics? And how can that learning be better incorporated into public policy-making?
* How can we better understand the trade-offs between policies that improve incomes and those that improve social inclusion or environmental sustainability or our resilience to economic shocks?
* And, perhaps most importantly, are you challenging yourselves, and your students, to think beyond the comfortable?
Having read ‘This Time is Different’ by Carmen Reinhart and Kenneth Rogoff you often wonder why economists and public officials didn’t pick the common patterns amongst so many previous financial crises
Below is a link to the full article – a good read.
Economics: Teaching, Applying, Learning
I can also recommend the book “What’s the use of Economics”, edited by Diane Coyle, which examines what economists need to bring to their jobs, and the way in which education in universities could be improved to fit graduates better for the real world.