Thursday, July 21, 2011


The Great Depression and the Great Recession has one thing in common - income inequality. Robert Reich, a professor at UC Berkeley and the author of the book “Supercapitalism”, argues that the fundamental reason of the two financial catastrophes is income inequality in his recent book “Aftershock”.

When we see statistics, income inequality does seem to coincide with the period of financial crises and prosperities.

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The period of two crises saw unusually high income held by the wealthiest people. Top 1% wealthy individuals held more than 20% of total income generated in the country. On the contrary, in the period of prosperity (from 1947 to 1975) top 1% people had just around 10% of total income. In that era, maximum tax rate never went below 50%, people shared the growth of the productivities of the country, and individuals were able to see American dreams more than they are today.

Pendulum swings back and forth. After the period of prosperity, average hourly compensation of American workers did not increased or even slightly decreased despite the increase of their productivities. Accordingly, income of top 1% wealthy individuals began to increase again since 1975.

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Why does inequality lead to the economic crisis? The reasoning is as follows: when you are an average worker, you want your living standards to keep the pace with the growth of the country, but your salary doesn’t increase at the same speed of the economy’s growth. Then to keep the game going, you have to cut your savings or borrow money from banks, and these activities pile up the huge debt. However, the game does not go on forever, and someday it will crash, leaving massive non-performing loans. This time, the final trigger was the burst of mortgage bubble.

Income inequality also leads to less consumption growth. It is logically understandable. If the marginal change of your consumption propensity on income increase is negative (I believe it would be the case for most of us), income inequality leads to lower consumption as a whole. Lower consumption means higher savings. The excess liquidity of the financial institutions is said to be part of the reasons of the latest financial crisis.

Based on the observations, the author suggests several measures to remedy current problems of the country:

1) Tax reform: reverse income tax, carbon tax, and higher marginal tax rates on the wealthy

2) Reemployment system

3) School vouchers based on family income

4) College loans linked to subsequent earnings

5) Medicare for all citizens

6) Increase in public goods

7) Money out of politics (limiting lobbying activities)

Though the author’s emphasis on the importance of income equality is understandable, to achieve it is getting more difficult in these days. Globalization and technology advancement collectively drives inequality between and within countries. Limiting companies’ outsourcing makes no sense at all, as the companies would lose in competition if they don’t conduct cost-cut as others do. New Deal program worked 80 years ago, but now we need 21st century-version of it.

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