Friday, April 27, 2012
Income versus Wealth
One way to think about the political economy of macropolicy is to divide people into two camps, those who are motivated primarily by threats to income and those by threats to wealth. (I will emphasize threats rather than enhancements for simplicity, and in recognition of the force of loss aversion.)
Threats to income take the form of unemployment, wage loss and the loss of public benefits (the social wage). The policies attractive to this group are generally Keynesian: looser fiscal and monetary policy, measures to increase wages, and other interventions to prevent the economy from producing below its potential due to insufficient demand.
Threats to wealth take the form of inflation and default. The policies these people are drawn to are what we usually call orthodox: tight monetary policy, restrictions on new borrowing (particularly by the public sector) and hostility to measures that would reduce the profitability seen as underlying asset and credit markets. The latter often comes dressed as labor market flexibility.
Note that I am not passing judgment (here) on what is right or wrong, good or bad, from an economic standpoint. I am only attaching particular policy constellations to particular (perceived) interests. I also recognize potential inconsistencies; in particular, those concerned to preserve the value of their wealth might lean toward Keynes if they fear that insufficient demand will lead to declining profits, lower share prices and higher default rates. (My modeling hypothesis: this effect is nonlinear in the rate of change in the output gap. If the output gap is approximately stable or falling, wealth-holders will put this concern below the others mentioned earlier. If the output gap is rising, perhaps beyond some threshold rate, the Keynesian threat to wealth takes center stage.)
Do these perspectives correspond to class interests? Yes and no. Clearly wealthier individuals are likely to be more concerned with wealth rather than income, and the reverse holds for those with little wealth. Nevertheless, it is not a strict mapping. There are high income individuals, for example in upper-level management positions, whose vulnerabilities arise far more from their future employment prospects than their portfolios. Similarly, many middle class retirees are highly dependent on the performance of their savings. In fact, this last example reminds us that there is a life cycle aspect to this divergence of interests as well as a class aspect, although the class influence is probably larger overall.
How do these perspectives reveal themselves in economic policy discourse? We know about orthodoxy: it defends itself explicitly on the grounds of wealth effects. Inflation is always just around the corner, and any additional public borrowing puts the state on the slippery slope to insolvency. People must learn to live on less and to repay all their debts in full. The one interesting twist is that, recognizing that wealth preservation is not a widespread concern, those arguing for orthodoxy have tried to present inflation as primarily a threat to income: “the cruelest tax of all”. To do this, of course, they have to put aside the identity between incomes and expenditures (as adjusted by the current account), meaning that their appeal is based on sowing confusion. The fact that this particular falsehood cannot be put to rest by rational argument suggests that political economy plays a more powerful role in shaping discourse than economics.
On the Keynesian side, much is made of the threat of demand shortfalls to profits and markets in claims on profits, and arguments are made that concerns regarding inflation and public insolvency are overblown. Perhaps the reason these arguments are only sporadically effective is that they do not address the very different weights wealth-holders place on income versus wealth threats, nor their perhaps justifiable concern (from their perspective) over tail risks.
There is an emotive side to this dispute. Keynesians, by emphasizing the potential, even in the near term, for future wealth production, express optimism—a can-do attitude. Follow the right policies and we can advance together to a higher quality of life. The orthodox, who want to protect the accumulation of past wealth, express a sort of dourness. Adjust to the hard times, tighten your belt, and eventually we will get through this. In pointing to this, I am trying draw out the implications of the difference between the two perspectives in their orientation toward time.
How well does this model capture the current debate in Europe and the US?
ADDENDUM: I left out the confidence argument that is so important to the orthodox side. In public debate, they want to portray threats to wealth as equally threats to those without wealth. The way they do this is to argue that wealth-holders play a decisive role in investment, and investment is the key to protecting incomes. If threats to wealth can be removed, they say, the resulting peace of mind (confidence) will set off an investment boom. The essential role that the confidence trope plays in selling wealth protection to an income-preoccupied public explains why so much stress is placed on a claim that, by its nature, is almost incapable of reasoned support ex ante.