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     A double-quick quiz to see if need to read this article or not – Is the following statement true? – Egalitarian societies are in general are more economically, socially and politically sound than those where inequality more pronounced.

If you answered false go here and evaluate the evidence for yourself.   If you answered true, then the following will make sense. :)

“Washington, DC – As evidence mounts that income inequality is increasing in many parts of the world, the problem has received growing attention from academics and policymakers. In the United States, for example, the income share of the top one per cent of the population has more than doubled since the late 1970s, from about eight per cent of annual GDP to more than 20 per cent recently, a level not reached since the 1920s.

While there are ethical and social reasons to worry about inequality, they do not have much to do with macroeconomic policy per se. But such a link was seen in the early part of the twentieth century: Capitalism, some argued, tends to generate chronic weakness in effective demand due to growing concentration of income, leading to a “savings glut”, because the very rich save a lot. This would spur “trade wars”, as countries tried to find more demand abroad.

From the late 1930’s onward, however, this argument faded as the market economies of the West grew rapidly in the post-World War II period and income distributions became more equal. While there was a business cycle, no perceptible tendency toward chronic demand weakness appeared. Short-term interest rates, most macroeconomists would say, could always be set low enough to generate reasonable rates of employment and demand.

Now, however, with inequality on the rise once more, arguments linking income concentration to macroeconomic problems have returned. The University of Chicago’s Raghuram Rajan, a former chief economist at the International Monetary Fund, tells a plausible story in his recent award-winning book Fault Lines about the connection between income inequality and the financial crisis of 2008.”

This is not about “socialism” or “communism” or any of the other words the business press has corrupted.  This is about what has happened and what is happening now.

“Rajan argues that huge income concentration at the top in the US led to policies aimed at encouraging unsustainable borrowing by lower – and middle-income groups, through subsidies and loan guarantees in the housing sector and loose monetary policy. There was also an explosion of credit-card debt. These groups protected the growth in consumption to which they had become accustomed by going more deeply into debt. Indirectly, the very rich, some of them outside the US, lent to the other income groups, with the financial sector intermediating in aggressive ways. This unsustainable process came to a crashing halt in 2008.

Joseph Stiglitz in his book Freefall and Robert Reich in his Aftershock have told similar stories, while economists Michael Kumhof and Romain Ranciere have devised a formal mathematical version of the possible link between income concentration and financial crisis. While the underlying models differ, the Keynesian versions emphasise that if the super-rich save a lot, ever-increasing income concentration can be expected to lead to a chronic excess of planned savings over investment.

Macroeconomic policy can try to compensate through deficit spending and very low interest rates. Or an undervalued exchange rate can help to export the lack of domestic demand. But if the share of the highest income groups keeps rising, the problem will remain chronic. And, at some point, when public debt has become too large to allow continued deficit spending, or when interest rates are close to their zero lower bound, the system runs out of solutions.”

So, consider the implications of a monetary policy that encourages people not to hold onto gratuitous wealth.  The 90% tax rate on 3 million and above seems a little less unseemly if it can spurn economic growth and development.

“This story has a counterintuitive dimension. Is it not the case that the problem in the US has been too little savings, rather than too much? Doesn’t the country’s persistent current-account deficit reflect excessive consumption, rather than weak effective demand?

The recent work by Rajan, Stiglitz, Kumhof, Ranciere and others explains the apparent paradox: Those at the very top financed the demand of everyone else, which enabled both high employment levels and large current-account deficits. When the crash came in 2008, massive fiscal and monetary expansion prevented US consumption from collapsing. But did it cure the underlying problem?

Although the dynamics leading to increased income concentration have not changed, it is no longer easy to borrow and in that sense another boom-and-bust cycle is unlikely. But that raises another difficulty. When asked why they do not invest more, most firms cite insufficient demand. But how can domestic demand be strong if income continues to flow to the top?

Consumption demand for luxury goods is unlikely to solve the problem. Moreover, interest rates cannot become negative in nominal terms and rising public debt may increasingly disable fiscal policy.

So, if the dynamics fuelling income concentration cannot be reversed, the super-rich save a large fraction of their income, luxury goods cannot fuel sufficient demand, lower-income groups can no longer borrow, fiscal and monetary policies have reached their limits, and unemployment cannot be exported, an economy may become stuck.”

Is this a hate the rich tract?  No, it is not.  It is an article merely identifying a probable framework behind what is going on in the US economy.

“The early 2012 upturn in US economic activity still owes a lot to extraordinarily expansionary monetary policy and unsustainable fiscal deficits. If income concentration could be reduced as the budget deficit was reduced, demand could be financed by sustainable, broad-based private incomes. Public debt could be reduced without fear of recession, because private demand would be stronger. Investment would increase as demand prospects improved.

This line of reasoning is particularly relevant to the US, given the extent of income concentration and the fiscal challenges that lie ahead. But the broad trend toward larger income shares at the top is global and the difficulties that it may create for macroeconomic policy should no longer be ignored.”

This article supports the idea that a more egalitarian society is a more healthy economic society.  I just wonder if the US policy makers have enough political will to enact this possible solution to some of the economic problems facing the US.