Income Inequality and Market Fragility: Some Empirics in the Political Economy of Finance, Part I

Abstract

A line of thinking associated with 19th- and early 20th-century political economy suggests that income and wealth concentration are not only unjust in some circumstances but also can operate as significant sources of systemic fragility in market economies. The issue is that losses below the top of the distribution can impede the functioning of consumer goods markets. That in turn deprives the macroeconomy of the consumer demand needed to support employment and investment.

NOTES

Notes

1 A particularly telling look at the role of lobbying by the financial industry is provided in Johnson and Kwak (2013).

2 One should also mention here the pioneering and only recently appreciated work of John Geanakoplos (e.g., Geanakoplos 1997, 2005, 2010).

3 Excellent accounts of the broader political–economic dynamic pursuant to which policymakers came increasingly to look favorably upon consumer debt and financialization as easy short-term fixes to longer-term distributional conflict are Phillips (2009), Krippner (2011), Johnson and Kwak (2013), and Morris (2009).

4 On this characterization of bubbles and its rationale, see Hockett (2010a) and Hockett (2009).

5 The intuition here is that policymakers who recognize that economic circumstances will ultimately be rendered more just and prosperous in the long run only by better health, education, taxation, and other social policies might for a time find it easier, in the face of reactionary opposition within undemocratic legislatures like the U.S. Congress, to rely upon more politically palatable consumer credit policies instead. See Hockett (2010b, 2014, 2015). On the undemocratic character of the U.S. legislature, see Roemer et al. (2007).

6 The allusion to Fisher is prompted by Fisher (1933).

7 On the role of the latter in our recent financial troubles, see Hockett (2013a).

8 Moss (2009) also uses bank failures as a proxy for financial crisis.

9 These trends and their significance are tellingly told in the recent work of Hacker and Pierson (2011).

10 Derived using the formula b = 1/[log(S1%/S0.1%)/log(10)], where S1% indicates the share of aggregate income held by the top 1 percent and S0.1% indicates the share of aggregate income held by the top 0.1 percent.

11 “Symbiotically” due to “feedback” dynamics of the kind mentioned in our Introduction and elaborated more fully in the last section.

12 We use the standard correlation coefficient, or Pearson’s r, as a measure of linear dependence between two variables on a scale from −1 to +1, inclusive. Correlations in this section are calculated using the percentage changes in the respective variables shown.

13 One other fact bears noting here: Our measure of inequality, which tracks changes in the income share held by the top of the distribution, is based on underlying tax return data from the Internal Revenue Service. Hence, it is sensitive to changes in the tax regime. In 1986, the Tax Reform Act reduced rates on top incomes but, by eliminating deductions, effectively required those earning top incomes to report more income. This would have produced an apparent one-off spike in the income share at the top without necessarily implying any substantive change to inequality. That in turn may also explain any disconnect between inequality and employment measures circa the crash of 1987.

14 Ironically, the man credited with capitalizing on this development for the Republican Party, in the guise of the vaunted “Southern Strategy” adopted by Richard Nixon, is one of those insightful authors on the sorrows of “financialization” cited above (see Phillips 2009). A readily accessible narrative account of the pre–“Southern Strategy” era and the broadly shared prosperity that characterized it is Halberstam (1994). A state-of-the-art formal and narrative treatment of the subsequent political reaction and its consequences, with comparative coverage not only of the United States but also of other jurisdictions with advanced economies, is Roemer et al. (2007).

15 See Hockett (2007) for more on those constituents and their ownership patterns. We say “paradoxically” high while putatively safe because it is well established that risk and return correlate in well-functioning financial markets. The promise that a new financial product will yield “safe, high” returns is the promise that buyers can have the proverbial cake and penny too. It is accordingly no surprise that such products—junk bonds in the 1980s, subprime and Alt-A mortgage–backed securities in the 2000s—have turned out to be what their names suggested all along.

16 Supermajority voting rules, voting apportionment along state and district lines, and gerrymandering are among the sources of the American legislature’s attenuatedly democratic character. The results can be seen in the party division of the U.S. House of Representatives, in which Democrats received 1.1 million more votes in aggregate than did Republicans, though Republicans nevertheless took a 33 seat majority.

17 See Alpert, Hockett, and Roubini (2011) for more on this political dynamic. Also see Roemer et al. (2007).

Additional information

Notes on contributors

Robert Hockett

Robert Hockett is Edward Cornell Professor of Law & Finance at Cornell University, Senior Counsel at Westwood Capital, and a Fellow at The Century Foundation. He has previously worked at the Federal Reserve Bank of New York and the International Monetary Fund.

Daniel Dillon

Daniel Dillon is Evaluation Lead at the Texas Health and Human Services Commission, and a former Summer Intern at The Century Foundation.