Crisis And Income Inequality, developing ...

This issue was "sitting in my head" for some time, but came to the fore-front of my daily thinking at the end of November of last year (2008), when the strategy team at Societe Generale published an interesting report named "It started like 1929...". You may try to access the web-cast, presentation and the research paper at: http://www.streamingbox.com/socgen/research_webcast/10122008/.

This issue is especially alarming, in my view, because of current fiscal policy of Latvian government that, in order to "fight the crisis", among others, has increased the VAT (value added tax). The VAT is higher not only for items with "general" rate of 18% last year, now at 21%, BUT also for "special" items that were "treated" with 5% VAT rate previously - (many of them are at the bottom of Maslov' s Pyramid of Needs, see here: http://en.wikipedia.org/wiki/Pyramid_of_needs) pharmacy, heating, media etc., now taxed at 21% too ... Government argues that they are decreasing the "personal" income tax as a compensation for increased VAT, but the fool will take it as an argument in the time of economic crisis. The basis of income tax is the taxable income (wages, salaries, bonuses etc.), but during economic crisis the employment - the main source for "personal" income tax - is decreasing. So, the Latvian government is taxing more the basic consumption needs to fund its expenditures in the time of global consumption bust... This step by Latvian government is in favor of rich, and clearly discriminating the poor. Geniuses?

Now back to the background of the issue. The analysts and strategists at Societe Generale wrote then in "It started like 1929...":

Another similarity between the 1920s and 2000s is income inequality, an issue closely tied to the extensive leverage taken on by households. Income inequality in the US has been growing since the 1970s, and some studies suggest that it has climbed to the highest levels since the 1920s. For example, one study estimates that the top 1% of all income earners reported 22.9% of all income in 2006, the highest since 1928, when the top percentile earned almost 24% of all income. The share of income for the top 10% is even more staggering. The top 10% earned 49.7% of all income in 2006, a level that surpasses 1928, the peak of the Roaring Twenties.

The problem with excessive income inequality is that propensity to consume declines at high income levels. Mass production requires mass consumption. When a majority of national income accrues to capital owners rather than labour, mass consumption can only be maintained via borrowing. This was particularly true during the Roaring Twenties as well as the 1990s and 2000s, when technological improvements produced a new array of consumer goods. In order to buy the goods, the lower and middle classes had to borrow extensively. When borrowing stopped, the ability to consume was impaired and the economy contracted.

The Fed’s actions in the years leading up to the crisis may have also contributed to the problem. The Fed’s easy monetary policies in the mid 1920s helped to drive the credit bubble as they did in the middle of the first decade of the 21st century. From 1924 until 1927, the Federal Reserve pursued easy monetary policies that may have fuelled speculative investment. There were two motivations behind the policy easing: a desire to promote domestic recovery from a recession and, more controversial, an effort to redirect the international flow of gold away from the US and towards the UK. This was part of a drive to help Britain return to the gold standard following WWI. Britain’s efforts to restore convertibility to gold at the pre-war parity rate had generated significant deflationary pressures in its economy. By inflating its own currency, the Fed helped Britain return to the gold standard while avoiding deflation. The unintended consequence was to create an asset bubble which later led to far more serious problems for the global economy.

This issue was refreshed in my brain today (11 January 2009) by Ronald U. Mendoza at WoxEU.org, see the full article here: http://www.voxeu.org/index.php?q=node/2774. Unfortunately, except some statistics and political slogans there is little in the post, but all-in-all the content appears to be more or less correct, in my view.

I have little "research evidence", but I am very convinced that the spike of commodity prices in the 2nd half of 2007 and the first half of 2008, especially, of food and energy did the final blow to unleash the the full extent of the financial and economic rout, caused of global imbalances.

Developing ...