note: I am very happy to publish the following short essay on the economic
crisis by the distinguished economist Branko Milanovic, a senior associate with the
Carnegie Endowment for International Peace and for a long time a lead economist
in the World Bank’s research department. Milanovic is
an expert on income and wealth distribution both within and among countries,
and was the author of Worlds
Apart: Measuring International and Global Inequality (Princeton UP, 2005.)
Like all JWN content, this essay is published under a Creative Commons License. ~HC.
The crisis of maldistribution
By Branko Milanovic,
Carnegie Endowment for International Peace
The current financial crisis is
generally blamed on feckless bankers, financial deregulation, crony capitalism,
and the like. While all of these elements may be true, this purely financial
explanation of the crisis overlooks its fundamental reasons. They lie in the
real sector, and more exactly in the distribution of income across individuals
and social classes. Deregulation, by helping irresponsible behavior, just
exacerbated the crisis; it did not create it.
To go to the origins of the crisis,
one needs to go to rising income inequality within practically all countries in
the world over the last 25 years. In the United States, the top 1% of the
population doubled its share in national income from around 8 percent in the
mid-1970s to almost 16 percent in the early 2000s. (Piketty and Saez,
2006). That replicated the
situation that existed just prior to the crash of 1929, when the top 1% share
reached its previous high watermark
In the UK, the top 1% receives 10% of total income, a share greater than
at any point since World War II (Atkinson, 2003, Figure 3). In China, inequality, measured by the
Gini coefficient (the most common measure of inequality), almost doubled
between 1980 and 2005. The top 1% of the population is estimated to garner
around 9% of national income. Even more egregious were developments in Russia,
where the combined total wealth of thirty-three Russian billionaires listed on
the Forbes list in 2006 was $180 billion as against total country’s GDP of
about $1,000 billion that same year (Guriev and
Rachinsky, 2008). Just before his
downfall, the richest oligarch, Michael Khodorovsky
had an estimated income equal to average Russia-wide incomes of 250,000 people.
(The same number for Bill Gates and the United States in 2005 was 75,000.)
Think of it. With his income alone, that is without touching
a penny of his wealth, Khodorovsky could create (if need be) an army of
quarter million people. No wonder the Kremlin took notice, and Khodorovsky
ended up in jail. But the time of oligarchs in Russia did not end with him.
Similarly, in Mexico, Carlos Slim’s wealth, prior to the crisis, was estimated
at more than $53 billion. Assume a conservative return of 7% on his assets, and
that gives an annual income of $3.7 billion with which, given Mexican GDP per
capita in the same year, Slim could command even more labor than Khodorovsky:
440,000 people. These are only a few examples. But they were replicated, albeit
on a smaller scale, in practically all countries of the world.
What did it mean? Such enormous
wealth could not be used for consumption only. There is a limit to the number
of Dom Perignons and Armani suits one can drink or
wear. And, of course, it was not reasonable either to “invest” solely in
conspicuous consumption when wealth could be further increased by judicious
investment. So, a huge pool of available financial capital—the product of
increased income inequality—went in search of profitable opportunities
into which to invest.
But the richest people and the
hundreds of thousands somewhat less rich, could not
invest the money themselves. They needed intermediaries, the financial sector.
Overwhelmed with such an amount of funds, and short of good opportunities to
invest the capital, as well as enticed by large fees attending each
transaction, the financial sector became more and more reckless, basically
throwing money at anyone who would take it. Eventually, as we know, the bubble
But its root cause was not to be
found in hedge funds and bankers who simply behaved with the greed to which
they are accustomed but to large inequalities in income distribution which
generated much larger investable funds than could be profitably employed. The
under-consumptionist explanation of crises, of course, has a long history. When the times are good, such theories
are covered by oblivion and often held in disrepute. But when the economy
implodes, people remember them. Keynes in 1936 brought them back from
semi-obscurity in which they vegetated between the early 20th
century (when they were used to explain European colonial expansion) and the
Great Depression. Begrudgingly, he
granted them a measure of respectability. But, in the roaring 1990’s, they were
forgotten. Moreover, as underconsumptionism had an unmistakable Marxist pedigree,
it always seemed suspect to those brought up in the Marshallian tradition, and
later to neoclassical economists.
But today, when we face the need to
explain the crisis, there are, it seems, only two possible culprits: to lay the
entire blame on the human factor and greed (which would be rather odd for the
economists to do since they routinely praise greed as the spiritus movens of all change), or to look for structural causes
of the crisis. It may not be entirely coincidental that Robert Lucas,
a Chicago economist and the recipient of the Nobel prize in economics, was the
man who both declared in 2003 (as we were recently reminded by Paul Krugman) that “the central
problem of depression-prevention has been solved”, and a year later, poured scorn on all these concerned
with rising inequality by writing that “of the tendencies that are harmful to
sound economics, the most seductive, and …the most poisonous, is to focus on
questions of distribution.” If you do not understand why income distribution
may be important, it seems natural not to get it that crises are not a thing of
Robert Lucas (2004), “The Industrial revolution: past and
future”, Federal Reserve Bank of Minneapolis, pp. 5-20. 2003
Annual Report Essay. Available at http://www.minneapolisfed.org/publications_papers/pub_display.cfm?id=3333.
Atkinson, Tony (2003), “Top incomes in the
United Kingdom over the Twentieth Century”, December 2003.
Thomas Piketty and Emmanuel Saez, “Income Inequality in the
United States, 1913-1998”, Quarterly Journal of Economics, February 2003.
Thomas Piketty and Emmanuel Saez (2006), “The evolution of
top incomes : a historical and international
Economic Review, vol.96, no.2, 2006, p. 200-2005.
Sergei Guriev and Andrei Rachinsky (2008), “The evolution of personal wealth in the
former Soviet Union and Cental and Eastern Europe”,
in James B. Davies (ed.), Personal Wealth from a Global Perspective, Oxford, UNU-WIDER
Studies in Development Economics, 2008.