Income inequalities only add to the size of the hole we are in!

A recent IMF report (in fact one of many) highlights a relationship between income inequality and debt.

While these reports and the research that underpins them also attempt to address their causality and solution, it should be clear that income inequalities and high levels of debt amongst those outside of the wealthy elite is a fundamental aspect of the current financial crisis.

I have addressed the issue of income inequalities, high levels of debt and the distribution of debt amongst different earnings bands, as well as the fact that high levels of productivity growth have advantaged only the top income earners in earlier moneymanagedproperly reports.  The issue is currently garnering much attention in the blogosphere as noted in the following link to “Washington’s Blog” “IMF: Inequality Increases National Debt” which alerted me to the IMF report.

One of the key issues leading up to the crisis was the fact that asset supply (homes and securitised debt) and asset prices were being driven by excessive asset focussed money supply growth. Asset prices were being pushed above levels that could be justified by future growth in real output risking a deflationary downturn or inflation as the financial and market universe adjusted to this imbalance.

That such debt was also being used to a greater extent to fuel consumer demand, enhanced the importance of consumer demand to GDP growth further exposing economic growth to reversals of these dynamics. Economies overarched towards consumer demand also fostered global structural imbalances between production and investment and consumption and saving and helped create a potentially more damaging global dependency on debt dynamics.

While income inequalities were supported by rising debt levels amongst lower earners up till 2007, debt defaults, high unemployment and declining economic growth potential post 2007 meant that inequalities placed further pressure on economic and financial stability, and continue to do so.

With wealth concentrated in fewer hands, asset prices, economic growth and financial stability are much more dependent on high net worth consumer expenditure: if these high net worth/high earners exhibit lower propensities to consme (i.e. have higher savings rates) this equates to lower future potential real gdp growth and lower returns on assets, meaning that asset prices should be lower.

If this is the case, then it is debatable whether further quantitative easing will have the necessary impact on final demand that one would expect is hoped for. If all it is doing is to pump up short run asset prices above and beyond their net present value, while bypassing a significant segment of consumer demand, then it is doomed to failure.

In all we need greater balance between the amount of consumption, saving, investment and consumption there is in the economy. As it is there is too much debt, still too much consumption (as a % of GDP)  and an inequitable distribution of income and wealth which further exacerbates the financial and economic risks.

Without addressing inequalities, quantitative easing and other central bank attempts to stimulate economic growth may well be doomed to failure.

As to inequalities themselves and the risks they pose, it should be clear that they do not represent an efficient market outcome if accompanied by increased consumer debt.  It should also be clear that there is a limit to asset value appreciation and economic growth if higher earners save more out of income than lower earners, and if this disparity accentuates over time.  Such disparity of income and capital has been seen in earlier financial and economic crisis (note the 1920s and early 1930s) and its root cause must to some extent be related to imbalances in knowledge and power/say in demand and supply dynamics. 

IMF references

More or Less

Unequal = Indebted

Leveraging Inequality

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  1. Pingback: Income inequality… | Depth Dynamics

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