How Extreme Inequality Destroys the Economy

Yves Smith (of Naked Capitalism.com) posts commentary by Robert Reich that succinctly describes how creating income inequality (via tax policy for example) can destroy the economy:

“Robert Reich has theorized for some time that there are 3 causal connections between inequality and crashes:

First, the rich spend a smaller proportion of their wealth than the less-affluent, and so when more and more wealth becomes concentrated in the hands of the wealthy, there is less overall spending and less overall manufacturing to meet consumer needs.

Second, in both the Roaring 20s and 2000-2007 period, the middle class incurred a lot of debt to pay for the things they wanted, as their real wages were stagnating and they were getting a smaller and smaller piece of the pie. In other words, they had less and less wealth, and so they borrowed more and more to make up the difference. As Reich notes:

Between 1913 and 1928, the ratio of private credit to the total national economy nearly doubled. Total mortgage debt was almost three times higher in 1929 than in 1920. Eventually, in 1929, as in 2008, there were “no more poker chips to be loaned on credit,” in [former Fed chairman Mariner] Eccles’ words. And “when their credit ran out, the game stopped.”

And third, since the wealthy accumulated more, they wanted to invest more, so a lot of money poured into speculative investments, leading to huge bubbles, which eventually burst. Reich points out:

In the 1920s, richer Americans created stock and real estate bubbles that foreshadowed those of the late 1990s and 2000s. The Dow Jones Stock Index ballooned from 63.9 in mid-1921 to a peak of 381.2 eight years later, before it plunged. There was also frantic speculation in land. The Florida real estate boom lured thousands of investors into the Everglades, from where many never returned, at least financially.

Wall Street cheered them on in the 1920s, almost exactly as it did in the 2000s.

But I believe there may be a fourth causal connection between inequality and crashes. Specifically, when enough wealth gets concentrated in a few hands, it becomes easy for the wealthiest to buy off the politicians, to repeal regulations, and to directly or indirectly bribe regulators to look the other way when banks were speculating with depositors money, selling Ponzi schemes or doing other shady things which end up undermining the financial system and the economy.” Read the full post here.

Yves’ post is right on target. Just one more reason to continue working to adjust the distortions in our economic systems so that equal access to opportunities are available for everyone – not an elite few. The fruits of our economy can’t be reserved for the insiders of Wall Street investment firms and the associated elite. Not only will this destroy opportunities for everyone else, it ultimately destroys opportunities for the top 1% as well.

It’s interesting to note that in the Bible (Leviticus 25: 8-55) the Israelites were required to return the land to its original family or clan after 49 years. This was called the Jubilee year. It was a reminder that God owned the land. We are merely inhabitants. In this way no family or clan ever gained enough land or wealth to have power over the others. It was a wise insight of the idea that extreme income inequality destroys societies. We are all interdependent and interconnected. In order for each of us to do well, all must do well.

What do you think? Do you agree that extreme income inequality has a negative impact on our economy long term? If not, why not? Comment with your thoughts.