'Just World News' with Helena Cobban

Milanovic: 'The crisis of maldistribution'

Publisher’s 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 exploded.

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 20^th 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 the past.

REFERENCES

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 perspectives”, American 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.