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.


Unknown said...


As a relatively new reader, I really enjoy your line of thinking and writing style.

In terms of the question, I think the model does a pretty good job of capturing the current debate. One point of note is the difference between currency regimes in the US and Europe. The US fiat system prevents the possibility of insolvency, while Europe's common currency ensures that possibility remains very present. From my perspective, this constricts Keynesian measures in Europe in a manner not present in the US.

Looking specifically at the US, it seems the political economy has led to a combination of Keynesian and orthodox policies that together largely favors wealth preservation. On the Keynesian side, fiscal stimulus is providing significant support to corporate profits (using Minsky's work). Meanwhile, monetary policy has become increasingly concerned with pushing stock and asset prices higher. At the same time, orthodox monetary policy remains determined to hold inflation below 2% with an apparent focus on wage inflation.

Lastly, I wonder how the difference in unemployment across education levels affects the political economy debate. The income uncertainty for highly educated individuals has likely been affected far less during this crisis than for less educated individuals, especially youth. This seems particularly true in peripheral Europe, yet the youth vote appears to have significantly less impact in economic policy discourse.

John said...

One of my pet peeves is that most discussions of taxes conflate income and wealth as though they were interchangeable. And of course, nothing could be further from the truth.

Wealth = total assets (net worth)

Income = the revenue stream from which NEW or ADDITIONAL wealth may (or may not) be forthcoming.

A good income is typically associated with decent wealth, but many with good incomes may have little or nothing in the way of wealth (i.e. net worth). Plenty from the so-called middle class have good incomes, but when the liabilities of mortgage, credit card, HELOC and student loan debts are taken into account, they may very well have a negative net worth.

Wealth is also a static metric, stated in aggregate terms.
Income, on the other hand, is not only dynamic, but the increments are usually pegged to annual numbers, subject to wide swings and interruptions.

Shag from Brookline said...

Even some without wealth are concerned with threats to wealth if and when they hit the lottery and have to pay big taxes on their winnings, in spite of the long odds on finding the pot of gold. Per Citizens United, the 0.01% can get the attention of these "lottery democrats" to vote against their pocketbooks.

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