A New Bubble?

What are the signs of a bubble? After a 30% rise in the S&P last year, without any huge surge of economic growth in the US or Europe and slowdowns in China, Brazil, and other major economies, one might expect a breather. But the continued upward rise of the global markets seems to say that animal spirits are still very much alive.

How much is too much? After all, stock prices generally do NOT move together with GDP numbers. They instead respond to corporate profits, which often benefit from a downturn that allows corporations to cut costs drastically, then a modest recovery that allows them to hold or raise prices. So the pattern is often one of profits being squeezed by rising costs and competition when the economy is going strong, and profits doing very well on the back of weak recoveries following recessions.

Still, one has to ask whether there are any signs that the party is getting carried away. One sign is the wave of M&A activity; another is the huge price paid for acquisitions such as WhatsApp? When a tiny firm with no assets or profits, except its user base, can change hands for nearly 20 billion dollars, one has to ask if things are getting out of hand.

But for me, one of the simplest signs of a market that is in an inflationary bubble is the response to news. In January, after losing steam, the market responded to news that the US Economy had grown in Q4 by over 3% was taken as great news – the recovery is underway! And stocks resumed their upward trajectory. Of course, those who looked closely noted that much of that growth was in inventories, and that the employment numbers looked weak. No matter, GDP numbers are over 3%, let’s bid higher and higher.

This week, the revised GDP numbers for the US in Q4 were released. As expected, the revision was downward — but it was a bigger downward revision than expected, to 2.4%. No matter — a silver lining can always be found. The decline was due to government shutdown, and bad weather, and other things that are all in the past. So let’s expect 3%+ growth going forward anyway! And bid the marker higher and higher!

Now of course the optimists may be right — more growth may follow. But none of this growth is making much of a dent in employment or wages, so purchasing power is stagnating. At some point, cost-cutting will reach its limits, and corporate profit growth will then be less impressive than it has been. Besides, as long as the party is going strong, who wants to be the first to leave the room?

But a word to the cautious — when the market goes up because growth is strong, AND because growth is weak, it is going up on faith, not facts. That is a sign of a bubble, and the higher it goes, the deeper it will eventually fall.

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Angry protests of the Middle Classes

Bosnia, Thailand, Ukraine, Venezuala: Troubled Transitions of the Angry Middle Class

“He’s run away himself, his guards have run away, his personnel have scattered. A sad end for a president.” – Tweet by Alexei Pushkov, head of the Russian Duma’s foreign relations committee, on former President Viktor Yanukovich of Ukraine.

Victor Yanukovich has joined such infamous fugitives as Ferdinand Marcos of the Philippines, Zine el Abadine ben Ali of Tunisia, Mohammad Reza Pahlavi of Iran, and Anastasio Somoza; all once-powerful rulers who abandoned their capital cities to escape the anger and tumultuous protests of their own people.

Yet the Revolution in Ukraine is just one among recent episodes of violent urban protest that have spread around the world. After confrontations between crowds and governments in late 2013 in Brazil and Turkey, 2014 has opened with eruptions of urban violence in four additional countries – in Bosnia, Thailand, Ukraine, and Venezuela.

What in the world is happening? Is this a global spread of the Arab Spring? Will we see further civil wars, like that in Syria? Or will we see transitions to democracy similar to those of the eastern European revolutions of 1989-1991? Or perhaps inconclusive struggles that do not quite end dictatorship nor produce democracy, like the 2004 Orange Revolution that unfolded in Ukraine a decade ago?

In fact from Sao Paulo to Caracas, from Sarajevo to Kiev, and from Istanbul to Bangkok, we are seeing a similar phenomenon. These are movements of the angry emerging middle class in countries at a crossroads. They are movements of people desperate for change, and where clumsily and rigidly opposed by their leaders, they can lead to true revolutions. But they are not revolutions of the kind afflicting most of North Africa and the Middle East. These middle class movements will likely lead to confrontations and political change but not civil wars. They will lead to some democratic breakthroughs, but in other cases to stalemates or initiate a process of change that may take years or decades to be fully realized.

It is worth looking at the background to recent events in Bosnia, Thailand, Ukraine and Venezuela. Despite the geographic distances that separate them, these countries are remarkably similar in many ways.

All four are “middle-income” countries, neither among the richest nor poorest societies. According to the International Monetary Fund, they range from 73rd in per capita GDP (PPP adjusted), Venezuela’s global ranking, to 106th (the Ukraine), with Thailand at 92nd and Bosnia 99th. In other words, of the 187 countries in the world ranked by the IMF, they are almost exactly in the middle. They have just arrived at the point where the vast majority of the population is literate, expects a government to provide a sound economy, jobs, and decent public services. Yet they are not yet economically comfortable and secure. That security, and a better future for themselves and their children, depends very heavily on whether government leaders will work to provide greater opportunities and progress for the nation as a whole, or only to enrich and protect themselves and their cronies. They are at a point where limiting corruption and increasing accountability are crucial to whether their country will continue to catch up to the living standards of richer countries, or fall back to the standards of poorer ones.

All four countries are also rated by Freedom House as “partly free.” That is, they have governments that are elected and are expected to conform to legal procedures and respect human rights; but in fact have governments that harass political opponents and manipulate election outcomes, and are often arbitrary in their enforcement of laws and skew economic rewards to favor their supporters. Such partly free or transitional governments are prone to instability precisely because of the anxiety and uncertainty such conditions provoke. In fully consolidated democracies, state leaders would not dare act with such impunity to harass and undermine their opponents and grab excessive rewards; in full and unrestrained dictatorships, popular groups and opposition leaders would not dare accuse the leadership of failing to provide state services and economic opportunities equally to all, nor challenge the leaders so openly. However, in partly free states we are likely to see state leaders overreach; and at the same time we will see opposition leaders and popular groups more likely to take on the state and demand change in response to such over-reaching.

It should be no surprise that these four countries are also rated as highly corrupt: according to Transparency International’s corruption index Thailand is 102nd, Ukraine is 144th, and Venezuela in 160th in level of perceived corruption. The 2012 TI scale rates Bosnia as somewhat more honest, at only 72nd in corruption; but in the last year perceived corruption has risen sharply, as one of the main complaints of rioters in that country are that the Bosnian government’s privatization of state assets in the last year was a spectacle of gross corruption.

These four countries thus have populations sufficiently well-off to be aspiring to still higher living standards, aiming at life closer to that seen in rich Western countries; yet are saddled with governments that are only partly free and highly corrupt.

Moreover, all of these countries have rulers that are in their ‘second phase’ and thus wearing out their welcome. In Thailand, the leader is Yingluck Shinawatra, who is acting as successor and stand-in for her brother, the former premier Thaksin Shinawatra who was driven out for corruption. In Ukraine, the leader is Viktor Yanukovich, serving his second term after having been ousted in the Orange Revolution of 2004, only to return to power when the Orange revolutionary leaders fell out among themselves and left a government in disarray. In Bosnia, the leadership is still held by European appointees who were long ago expected to have departed and yielded full authority to a locally-elected regime. Finally, in Venezuela the leader, Nicolas Maduro, is the stand-in and chosen successor of the deceased populist leader Hugo Chavez. In short, none of these countries enjoys a leader with fresh and recent popularity in their own right; rather all have leaders whose position is already strained and who were tolerated only as long as they appeared to be moving their country in the direction of greater progress and opportunity.

Each leadership thus got into severe trouble when they acted in a way to betray those expectations. Yingluck promoted an amnesty bill clearly designed mainly to bring her brother back to Bangkok and to power; Yanukovich embraced a financial deal with Russia that turned his country away from a widely desired set of agreements that would have strengthened ties wth Europe. The Bosnian authorities undertook a privatization of public assets that reeked of corruption and lack of accountability; Maduro persisted in policies that are causing ruinous inflation and responded to protests by turning on opposition leaders. In each case, the response from opposition leaders and their urban middle class supporters was to demand that the government change course; and if that was refused their demands escalated to seek the resignation of the leader and new elections.

Not surprisingly, the leaders in these nations refused those demands. Yet the opposition refused to give up. They began campaigns of peaceful protests that occupied public spaces or even government buildings. The governments then responded with force, escalating the confrontations and bringing even more people – now concerned that government actions were veering out of control and becoming more and more dictatorial – into the streets to demand accountability and regime change.

Will these countries now spin out of control, and descend into civil war, as happened in Libya and Syria? Fortunately, that is very unlikely, for two reasons. First, unlike Libya and Syria, who have relatively young populations with median ages 26 and 21 respectively, these countries are much more mature. In Thailand, Bosnia, and Ukraine, the median age is 37-40. In such mature societies, where there may be small groups of rebellious youth who will lead violent protests, it is unlikely that large masses of people will rush into battle and violence. That is characteristic only of countries with much larger numbers of readily mobilized youth. Venezuela is relatively young at median age of 27; it is thus the one country among these where large-scale mobilization of youth for battles against the government is possible.

Second, and more important, none of these countries has a long-standing dictatorial leader who can command the loyalty of hardened military forces to act against their own people. What is most likely therefore is some sort of backing down on both sides, some stalling or movement toward compromise, or the resignation of governments if protests continue to grow. Negotiated compromise is thus the most likely outcome. Any government that seeks to survive by force of arms is likely to find that such repression backfires and inflames greater opposition, which may then indeed become violent and demand more radical change.

That risk now looks greatest in the Ukraine, where the government’s forces have fired upon and killed dozens of protestors and injured hundreds more. Yet these actions, rather than strengthening the government’s position, have produced resignations from the ruling party and condemnations and calls for sanctions from the international community. The final outcome is likely to be further weakening of the Yanukovich regime, and Yanukovich’s eventual departure.

Events in Ukraine, Thailand, Venezuela, and Bosnia thus form yet another wave of people’s revolutionary movements, like the Rose Revolution in Georgia, the Orange Revolution in Ukraine, and the Bulldozer Revolution in Serbia. These uprisings are demanding greater accountability, and challenging regimes seen as corrupt, out of touch, and obstacles to a better future. They are not likely to collapse into civil war or autarchy as occurred in the Arab Spring. Rather, they are signs of more mature societies demanding greater progress, and—with some restraint and international mediation – should produce compromises and negotiated settlements that move their countries forward.

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So glad for so little

So this is what is has come to: anything other than outright recession is cause for rejoicing!

Here is one triumphant quote: “The eurozone’s recovery has moved up a gear,” said Chris Williamson, chief economist of Markit. “Not only has the pace of growth picked up to the fastest since the second quarter of 2011, but the recovery is also becoming more broad-based, encompassing core and so-called ‘periphery’ countries alike.”

Here are some of the growth figures for the last quarter (Q4 2013) in Europe that just came out on Friday:

For 2013 as a whole, growth was a NEGATIVE 0.4% in the Euro currency zone, and a barely positive 0.1% for the entire European Union (including the UK).

To me, that is a dreadful result five years on from the 2008 market collapse; things should be picking up much faster by now.  Unemployment remains at depression levels in several countries still.

However, the fourth quarter looked relatively better:  The Eurozone had 0.3% positive growth, up from 0.1% in the Q3 2013 (after an 18 month “double-dip” recession).  But that is still growth at an annual rate of only 1.2%

Even the strongest countries in Europe did not look much better.  Germany’s economy grew by 0.4% in the last quarter of 2013, France by 0.3%.  This means annual growth of around 1 to 1.5%. However, the one ray of light in the report is that even formerly weak countries had a positive quarter:  Growth in the Netherlands was a very strong 0.7%, Spain and Portugal 0.3% and 0.4%, and even Italy had positive growth of 0.1% in Q4 after showing negative or zero growth the first three-quarters of the year.

Still, for me the news is that Europe’s recovery remains weak and precarious, and is far from resuming a robust rate of growth.  Given Europe’s demographics, one cannot expect growth to return to 3%, perhaps ever.  Still, in order to reduce unemployment, raise wages, and give people hope for the future, steady growth of 1.5% -2% is necessary, and at present hardly any countries in all or Europe look to be reaching that level.

Yes, growth of any kind is better than further contraction, but that is like saying a patient in critical condition should be glad because she’s not dead.  Europe’s economy is still in danger.

On February 5th, we had the following report, warning on retail sales and deflation:

Retail sales in the eurozone fell sharply over the Christmas period, with their biggest monthly fall in two-and-a-half years. December’s sales fell by 1% compared to the same time a year ago, and by 1.6% compared to November. Both figures were much worse than analysts expected.  … Germany saw the biggest annual fall in sales for December.  The drop in consumer demand followed a surprise fall in eurozone inflation to 0.7% in January.

The U.S. has had several wonderful quarterly reports on GDP, only to have growth falter in succeeding quarters.  Besides, quarterly data is prone to revisions, so differences of one-tenth of a percent over or under expectations may simply be measurement error.

So a very faint hooray from me for the Q4 European growth figures; a bigger cheer will be deserved when we get a full year of growth at 1.5%.  Until then, policy needs to be proactive for growth and to fight off deflation, and no assume that the trajectory from one quarter is ever upwards.

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A magical place


The picture above, of a large village on an otherwise barren sand-spit, is Dubai as it was roughly when I was born, in the early 1950s.  As you can see, there is not much there.  At that point, the United Arab Emirates, of which Dubai and Abu Dhabi are the main economic engines, did not yet exist.  The emirates of the region were British protectorates.  Prior to 1950, Dubai had benefited from its inlet to become the main re-export hub in the Persian Gulf, while Abu Dhabi had just started exploring for oil.  Both had been weakened by the Great Depression and the collapse of their local pearl industry (after the Japanese began large-scale production of cultivated pearls).  In the late 1960s, both Dubai and Abu Dhabi began to produce oil, and after the departure of the British in 1971, the emirates developed a federation which became the UAE.

After the massive increase in oil prices that followed the formation of OPEC, the emirates found themselves with astonishing sums to invest.  The result has been the creation — virtually from nothing and within one lifetime — of modern mini-Manhattans by the sea, as both Dubai and Abu Dhabi are now marked by soaring modernist skyscrapers and developments that stretch for hundreds of kilometers along the shores of the gulf.  Here is what Dubai looks like today:

Dubai today

Dubai is home to the world’s tallest building, the Burj Khalifa, and both Abu Dhabi and Dubai are chock-a-block with modernist glass towers in a bewildering variety of shapes, colors and designs.

And of course, shopping.  The UAE is home to many of the world’s grandest malls, including the Emirates Mall with its glass-enclosed four-story ski slope; the Dubai Mall with its Bellagio-style fountains and every shop known from home, from Potbelly Sandwiches and IHOP to ultra-chic designer boutiques; and the brand new World Trade Center mall, which is beautifully done in dark wood latticework that at least makes you feel like you are visiting the Middle East, as opposed to having been blindfolded and dropped into Las Vegas.

I had the opportunity to visit the UAE this past weekend to lecture at the New York University campus in Abu Dhabi.  While it is hard to form impressions in just a weekend, one cannot but be jaw-droppingly amazed at how much has been built, and how fast, and in such an odd place.  After all, the climate (120 degrees F in summer) is the most absurd that you can imagine for building endless walls of glass-skinned towers.  And there are few natural resources (other than oil and gas) to justify building thousands of office and residential towers to create an expat community many times larger than the Emirates’ own native population.  So Dubai and Abu Dhabi stand as tributes to the power of imagination and money to reshape reality, no matter how unpromising or unlikely the place.

But as a good capitalist, who believes that money should be invested at least in part in things that will continue to produce value, one has to ask — is all this sustainable?  And who is it all really for?  The UAE economy is built mainly on oil, of course, but is seeking to diversify.  Using their cheap energy, they are engaging in such energy-intensive industries as aluminum smelting, using imported bauxite ore.  Using their central location midway between Europe and Asia, they are seeking to become the major air hub and marine re-export center for Eurasia.  And taking advantage of the political chaos in Lebanon and Iraq, and of their own tax-free and duty-free status and political stability, they are seeking to become the financial capital of the Islamic world.  There are also various consultancies and management and advising agencies, most focused on the energy industry and regional commerce, and as is typical in boom towns, a huge construction industry and firms to sell, lease, and resell real-estate.

In addition, of course, as befits a modern pleasure-palace, the UAE markets itself as a tourist destination to the world for luxurious hotels, shopping, even golf courses and beaches (though these are usable only a few months of the year because of the intense heat and humidity).  They are staging events from Formula 1 to a Rolling Stones concert, not mainly for their own citizens, it seems, as much as to create a magnificent party place to attract the world.

Still, the oil will not last forever, and what then?  Oil and gas fields have been discovered in the Mediterranean, the Artic, and in East Africa, while fracking is expanding the output of oil and gas in older producers such as the U.S.  So there is plenty of oil in the world and more on the way every day.  Meanwhile, cars are becoming more efficient, populations are becoming more urban and so more amenable to rapid transit, and global warming is leading to the search for alternatives to fossil fuels.  No doubt, as Chinese and Indians and Africans acquire cars, and the world is tied together by huge fleets of jumbo and regional jets (many of which will fly from Abu Dhabi and Dubai), the demand for petroleum fuels will continue.  But at some point in the future — maybe in 50 years, maybe in 100 — it is going to be cheaper to use solar generated electricity to power vehicles than gasoline, and at that point the revenues from pumping fluids and gases from wells will fall to nearly zero.

At that point, will the glass tower villages on the shores of the gulf have generated enough self-sustaining momentum to carry on?  Or if deprived of their steroids from oil revenues, will growth stall and decline?  (The cost of air-conditioning alone, if not subsidized or replaced by solar power, will make these offices too expensive to compete with space elsewhere).  It is too early to say today.  All I can suggest is that you try to visit to see a phenomena of hot-house force-fed economic growth unlike any other on the planet.  It is ecologically insane, economically questionable, and at times garishly over-the-top.  Yet it commands respect for the audacity of its vision.  Ozymandius redux!

Yet in another way, one has to give thanks for the UAE. As much of the Islamic world tears itself apart, from Libya and Egypt and Syria to Iraq and Afghanistan, the Emirates demonstrate that the Arab world can be open, and incredibly economically successful. Other places have had immense oil wealth but not achieved nearly so much. Open markets, encouragement to entrepreneurship, and generous investment combined with stability and sound laws and restrained (if non-democratic) government has produced urban centers without equal in the developing world, except perhaps for Shanghai.

Of course history and demography help. There are no old sectors of town or decaying buildings, no visible slums, and the cheap and exploited labor from the Philippines, Pakistan, and India that make everything run are kept healthier and better paid than they would be at home and always under threat of deportation if they should cause disorder. So the recent history and demography are as artificial and constructed as the buildings themselves.

Of course one has to ask, can this artificial construct be sustained politically? Again, as long as the oil and gas money allow the rulers immense leverage over everyone, most likely yes. The real question is what happens when the non-oil economy becomes larger than the oil economy, or when the oil revenues cease. Will the non-native population simply return home, leaving empty shells? Or will they demand a role in running the new Oz they have created with their labor? It will be an interesting future for the UAE in the generations that lie ahead.

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And the jobs report is …. (ugh, don’t ask)

As I expected, the jobs report released by the BLS today was terrible — at least terrible for those clinging to the belief that America’s economy is roaring back, and not great either for workers seeking jobs.  Yes, unemployment went down to 6.6%; but that was a genuine advance for reasons I will cover below.

The big number was a tiny number — the revision to the December jobs report.  That report was so anomalously awful: 74,000 jobs created in the month, about one-third the number in the preceding months, that it was widely expected to be revised upwards significantly when more data came in.  In fact, the revision was only 1,000 more jobs, to a still awful 75,000.  What’s more the bounce-back in January was very modest: 113,000 new jobs in January was only one-half the average level of 2013.

So we have now had two back-to-back months of truly dreadful job creation numbers.  And the Fed is determined to continue to taper (as they probably should; the economy needs fiscal stimulus, not monetary), and the European Central Bank is not going to aggressively fight the signs of possible deflation there.

The unemployment number went down.  That is because of an annual population adjustment that the Bureau makes to its estimate of the number of workers.  Based on these adjustments from the household survey, the nation had 499,000 more people in the civilian labor force, and 616,000 more who were employed, than were counted in the previous year.  These adjustments led to an increase in the estimate of people in the labor force, raising participation by a few tenths of a point, and the percentage employed, reducing the unemployment number by a tenth of a point.  But these are technical adjustments, not evidence of real growth.

Here are some other, more informative numbers on what is going on in the real economy from this morning’s report: In January the average work week (hours worked per worker) was unchanged, but the manufacturing workweek declined by .2 hours, and factory overtime was down .1 hour.   Over the year, average hourly earnings for all private employers (non-farm) rose by 1.9%, or a bit under inflation.  These are hardly indicators of an economy that is catching fire.  Rather it is a picture of an economy comfortably under full capacity.

So what have we got? — the main motor of the global economy (the US) is sputtering; Europe looks to be  stalling out in its recovery; and the central banks are continuing to very slowly ease off the monetary accelerator.

Secular stagnation indeed!

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Worry Beads, Anyone?

Readers of this blog know that I have been a pessimist on the “real” economy of the world. With population growth slowing or declining in Europe, the US, Japan, Korea, China, India, and Brazil, it seemed to me the demand for cars, houses, and other major goods that depend on the formation of new household could not continue to grow at the rates common from the 1960s through the 1990s. Growth could only continue based on productivity pushing up wages, and people replacing older goods with newer and more expensive, higher-quality ones.

But we have not seen anything like that. What we have seen is productivity growth, but with the gains going to the top 1% of rich country consumers, although more generally to emerging market consumers. Still, it has become clear that in emerging markets much of the growth has been driven by government and private investment, not growth in consumption (except for the top 10-15% who have entered the global middle class). And that investment, in turn, was driven by cheap money provided courtesy of the Federal Reserve and state policies to funnel funds into urbanization, transportation, mines and factories.

All of this managed, surprising me, I will admit, to drive up stock market prices by 30% last year. But I had to wonder — how could such a price increase be justified when underlying consumption and production was not growing at anywhere near that rate. Indeed unemployment remained way too high in Europe, people were dropping out of the labor force by the millions in the US, and wages in both were stagnating. Brazil, Turkey, and India remained badly managed, with inadequate infrastructure high government spending and dependence on external financial flows. Japan’s aging and debt are starting to catch up with it and reach critical levels. Still, all of these underlying problems were happily ignored, obscured by the flood of cheap money issuing from the Fed and the ECB. With unlimited funds available at negative real interest rates, why worry?

All this has started to change with the Fed’s tapering off from its stimulus. Will we get a soft landing, in which the stimulus being withdrawn is substituted for by real growth? Despite some recent good news on US and British GDP growth, it seems doubtful. Signs of the slowdown in China keep growing; much of the US GDP gain was inventory build up and spending of savings, not gains based on improvements in employment and income; European unemployment remains well over double-digits and deflation risk is again growing. Add to this that emerging markets are now beginning to feel a panic as to whether they can continue growing when cheap outside finance starts to dry up. This panic has already led to major drops in the Turkish lira, Russian rouble, South African Rand and other EM currencies.

So which is more likely — that this month’s market drop is a just a blip, a correction in what is an otherwise happy story of rising output and growth that will continue? Or that last year’s market rise was a credit-fueled uptick that hid but did not cure underlying restrictions on growth? We should know more by the end of this year, but in the meantime, I’d keep some worry beads handy.

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Is Inequality a Moral or Economic Issue?

There is so much talk about inequality these days — it is clear that no consensus has arisen because parties are simply talking past each other.

Most of those who argue that inequality is NOT a problem argue from economic grounds. They state that inequality provides strong incentives for economic effort (the bigger the carrots for success the better the incentives), and that capitalism inevitably produces inequality as certain people produce more goods and services and add value to society. Inequality is thus necessary and unavoidable in a well-functioning competitive economy; and to some degree the better it functions the greater the inequality.

Most of those who argue that inequality IS a problem argue from moral grounds. They start with the conviction that a person’s opportunities to deploy their skills and efforts and reap the rewards should NOT be limited by the income of their parents; to the extent that large inequalities of wealth favor the children of the wealthy in getting education, jobs, health, and opportunities, such inequalities undercut the moral basis of a society that professes equality of opportunity for all its citizens. Moreover, they argue that democracy requires all citizens to have a stake in their society and the ability to participate in political dialogue and decisions; if inequality is so great that the wealthy can drown out the voices and interests of ordinary citizens, what is left of democracy in practice? Finally, in a wealthy society of equal citizens, can it be tolerated that even families with adults who work full-time and contribute their efforts to the economy and society are nonetheless unable to secure housing in safe neighborhoods, sound schooling for their children, access to recreation, nutritious and adequate diets for their families, and necessary health care without constant stress and dependence on private or public charity?

These alternative positions tend to polarize and by-pass each other in frankly foolish arguments about inequality, looking at all or nothing positions. I actually heard a commentator on radio condemning the absurdity of having a society in which the “government redistributes all income to make everybody equal” — even though no sensible critic of inequality would ever make that request and such extreme socialist practice has disappeared by common consent. At the same time, defenders of inequality treat ANY even minor effort to balance social obligations and wealth — such as taxing the income earned by workers as salary at the same rate as income earned by wealthy investors from dividends and capital gains at the same rate — as a Nazi-style attack on the principles of humanity.

We need to leave such absurdities on both sides far behind. What we need is a temperate, thoughtful debate on just HOW MUCH inequality is compatible with BOTH a strong economy AND a functional and legitimate democracy. That is a debate we have not yet begun to have.

Arthur Laffer gained fame by drawing a picture on the back of a napkin noting that if taxes are too low, then government cannot function to regulate and defend society and society will fail; but if taxes are too high, then effort is discouraged, capital flees, and society will fail. So there must be an optimal point in between at which taxation is sufficient to support vital government services, but low enough not to impede entrepreneurial and business effort.

The same is clearly true of inequality. If there is too much inequality, a minority will dominate the economy and politics and democratic society will fail; if there is too little inequality effort will be discouraged and government interference will be too high and society will fail. So there should likewise be an optimal point (or range) in the middle where inequality is sufficiently high to call forth business, worker, and entrepreneurial effort, but not so high as to discourage efforts by those at the bottom and undermine the value of citizenship and democracy.

Where are we now in the United States? Here are a few bits of evidence: overall inequality as measured by the Gini coefficient is the highest for any advanced industrial society in the world; the portion of national income going to the top 1% is at all-time historic highs; and the rate of participation in the labor force and in elections is at historic lows. Economic growth, however, is not very strong. So it seems pretty clear that we are at a point where inequality is high enough to discourage effort in job-seeking and voting; but not doing much of anything to promote strong economic growth. That seems to me to argue for taking some measures to reduce inequality, and see if things improve!

There are many ways to improve equality without undermining all rewards for business: raising the minimum wage; equalizing capital gains and earned income taxes; increasing inheritance taxes; all of these make it bit harder to accumulate vast fortunes, but not impossible. People have become rich in America during periods when all these measures were different in real terms than they are today.

Reducing inequality a little bit from the historically highest levels in our history and among the highest in the world will not eliminate inequality; it will just push it back to historically more common levels. If we cannot even pursue that goal, we are far from a democracy indeed.

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