Inequality, Debt Servicing and the Sustainability of Steady State Growth

† Earlier versions of this paper were presented at the meetings of the Eastern Economic Association, Boston, March 2014, the Review of Political Economy Malvern Conference, Great Malvern, July 2014, and the VII Encontro Internacional da Associa¸cão Keynesiana Brasileira (AKB), São Paulo, August 2014.

ABSTRACT

We investigate the claim that the way in which debtor households service their debts matters for macroeconomic performance. A Kaleckian growth model is modified to incorporate working households who borrow to finance consumption that is determined, in part, by the desire to emulate the consumption patterns of more affluent households. The impact of this behavior on the sustainability of the growth process is then studied by means of a numerical analysis that captures various dimensions of income inequality. When compared with previous contributions to the literature, our results show that the way in which debtor households service their debt has both quantitative and qualitative effects on the economy's macrodynamics.

KEYWORDS:

• Consumer debt
• emulation
• income distribution
• Golden Age regime
• Neoliberal regime
• expenditure cascades
• growth

JEL Codes:

• E12
• E44
• O41

Acknowledgements

The authors would like to thank conference participants and two anonymous referees for their helpful comments. Any remaining errors are our own.

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

† Earlier versions of this paper were presented at the meetings of the Eastern Economic Association, Boston, March 2014, the Review of Political Economy Malvern Conference, Great Malvern, July 2014, and the VII Encontro Internacional da Associa¸cão Keynesiana Brasileira (AKB), São Paulo, August 2014.

¹ See also Kim et al. (2014), who discuss the implications of different debt servicing behaviors for consumption in a static (non-growth) context.

² For simplicity, the price of equity is fixed and normalized to one.

³ Production and non-supervisory workers account for 80 per cent of all employees in the US economy.

⁴ The ‘working rich' refers to upper-level salaried employees who have, in increasing numbers, joined capitalist households at the very top of the income distribution over the last 30 years. See Piketty and Saez (2003), Wolff and Zacharias (2009) and Atkinson et al. (2011) on the evolution of ‘top incomes' in the US. See also Mohun (2006) on the correct accounting treatment of the ‘wage' income earned by the ‘working rich', and Wolff and Zacharias (2013) on the relationship between social class and the size distribution of income.

⁵ Notice that, following Skott (1989, 2014), working households accumulate wealth only in the form of interest-earning bank deposits: all corporate equity is owned by rentiers. This differs from the approach taken by Pasinetti (1962) and Palley (2012), in which physical capital is the only asset that households can own, so that workers who save own equity (and therefore receive some share of profit income). Clearly, the two approaches are not mutually exclusive, and the consequences of equity ownership by working households are worthy of further investigation in future research.

⁶ See also Palley (2013a).

⁷ The investment function in Equation 8 does not include a separate accelerator term through which can influence independently of , but it nevertheless generates an ‘orthodox' Kaleckian stagnationist result under conventional neo-Kaleckian conditions, as demonstrated in Equation 23 below. However, as discussed in Section Two, this stagnationist result does not necessarily carry over to the model as specified in this paper.

⁸ For empirical evidence supporting these claims, see Wolff (2010) and Onaran et al. (2011).

⁹ Equation 13 can be thought of as a simplification of the more general expression: where denotes a ‘normal' level of consumption established in the past and is the incomplete information set that provides the basis for expectations formation in an environment of uncertainty. This expression is consistent with the claim of Kahneman et al. (1986), that aspirations (such as ) are based largely on objective observations of past outcomes and outcomes experienced by others. Note that increases in may involve distinctly defensive or restorative behaviors by households. For example, as an expression of private consumption norms, may increase because the erosion of public services such as health care requires private provision of these services if household welfare is to remain unchanged, or because acquisition of market goods (such as alarm systems) is required to redress the erosion of social capital such as trust (Barbosa-Filho et al. 2008; Bartolini et al. 2014). Increases in and the household borrowing and indebtedness to which they give rise may, therefore, reflect efforts by households to merely maintain (rather than increase) overall consumption and/or welfare. The simplification in Equation 13, however, focuses attention exclusively on outcomes experienced by others as a ‘driver' of , and hence on the process of emulation in consumption behavior that is central to this paper.

¹⁰ Bartolini et al. (2014, pp. 1030–1031) argue that ‘powerful industries (advertising, media culture, etc.) present in contemporary market economies have successfully pushed people into substituting short-term materialistic wants, which can be satisfied on the marketplace, for long-term happiness, which can be pursued by investing time and effort to develop deep interpersonal relations.' This suggests that the locus of responsibility for the propensity to emulate (and any increases therein) is contestable: it may reside with the individual or society (or both).

¹¹ The term in Equation 17 is workers’ net debt (i.e., debt owed to rentiers) to capital stock ratio. This bears a straightforward relationship to the more intuitive debt to income ratio, which is given by .

¹² The capacity utilization rate is an adjusting variable in our model in both the short run and the long run. We acknowledge, however, that there has been an active debate about the validity of variable capacity utilization in the long run. See for example, Hein, Lavoie, and van Treeck (2011, 2012) and Skott (2012).

¹³ The results reported in Table 3 assume and that the Keynesian stability condition holds (i.e. the denominator in Equations 18–20 is positive).

¹⁴ See, for example, Dutt (2005, 2006) and Hein (2012, ch.5).

¹⁵ It should be noted that the result is, however, made more likely by this behavior, since what Setterfield and Kim (2013) show is that increased debt servicing obligations always provide a stimulus to the economy. The intuition for this result is straightforward: with the ‘pecking order' behavior hypothesized by Setterfield and Kim (2013), workers sacrifice only savings to meet increased debt servicing obligations, while rentiers spend some part of the additional income they receive as a result of the transfer payments created by debt servicing. In this way, a leakage from the circular flow of income (workers’ saving) is partially transformed into an injection (rentier spending), boosting aggregate demand formation.

¹⁶ See Dutt (2005, p. 167, Equations 14 and 15) and Dutt (2006, p. 347, Equations 6 and 7), respectively.

¹⁷ See Kim (2012, p. 8, Equations 13–15).

¹⁸ See Dutt (2008, p. 543, Equation 11).

¹⁹ Note that the result described above is not constrained by the Keynesian stability condition, which in Dutt (2008) requires that

or

where is the profit share of income. The term on the right-hand side of this last expression is unambiguously negative, so the term on the right-hand side can be either positive or (within bounds) negative.

²⁰ Under these conditions, we have and , where the Keynesian stability condition ensures that .

²¹ In Setterfield and Kim (2013), and hence (profit-led growth) is also unambiguously more likely than in the two-class model with no borrowing by workers from the capitalist class.

²² In this context a ‘crisis' refers only to a breakdown in the dynamics of the model as specified. Exactly how the economy reacts to these circumstances is beyond the scope of the current paper.

²³ The exception is if initially. In this case, workers will eventually cease to be net debtors.

²⁴ The exact values of the Golden Age distributional parameters used in the calculations reported in the second row of Table 5 are , , , and . These values are derived from the sources used to evaluate , , , and during the Neoliberal era, as previously reported in Table 4.

²⁵ In Setterfield and Kim (2013), the feasibility coefficient is given by . Comparing this expression with the feasibility coefficient in Equation 26, it is immediately clear why the modification of workers’ debt servicing behavior considered in this paper can make even the Neoliberal growth regime sustainable. In short, debtor households’ treatment of debt service payments as a deduction from saving (as in Setterfield and Kim 2013) generates a tighter budget constraint for debt service payments, ceteris paribus.

²⁶ Ours is, of course, a closed-economy model that assumes no public sector. Both the public and external sectors may be relevant for the dynamics of household debt accumulation, so that extending our model to include these sectors would be a useful avenue for future research.

Additional information

Funding

Mark Setterfield would like to thank the Institute for New Economic Thinking and the Dana Foundation for generous financial support that facilitated his work on this paper.