Tuesday, May 27, 2014

An earthquake on inequality is coming….

In the debate about rising inequality, the behaviour of Chief Executive Officers (CEOs) has been cited as a major cause.  They are accused of putting short-term (shareholder) interests ahead of long-term (firm) interests.  Their actions are hardly surprising considering that CEO remuneration has historically been tied to short-term objectives such as annual shareholder returns.

But are politicians equally guilty of short-termism?  Consider that their time horizon is the electoral cycle.  Their objective is to be re-elected.  Their method is policies that target the median voter.  A problem that, until recently, affected only a minority, is unlikely to be adequately addressed by the political process.  Cue civil society.  Over the past few years, as a direct response to the discontent caused by rising inequality, we have seen the emergence of the Occupy movement, the UK Living Wage campaign and the Arab Spring. 

Grass-root movements have a long history of affecting change in the United States and beyond.  Giving women the right to vote in the UK, the campaign for equal rights in the US, the fall of the Berlin Wall in Germany.  Activists were drawn together by a shared set of principles, which helped spread their reach and eventually spurred national and global campaigns. 

But in generating a sufficient mass, they also drew the attention of political parties.  The slow rumblings of discontent transformed into substantive political pressure, that forced the hand of politicians into declaring an active policy response.  Such events mimic the “stick-slip” dynamics of an earthquake, where the forces below the earth’s surface eventually generate enough strength to push against the forces holding the plates together, to produce an earthquake (Jones and Baumgartner (2012)).  In this case, the political system with its procedures, rules and norms acts as a retarding friction against the public movements that generate information about pressing issues of the day that require action.
The rise of the Occupys, the election of Bill de Blasio to Mayor of New York on an agenda of tackling inequality, the rejection of the Conservative-led coalition in recent UK elections, all suggest that the time is ripe for a major political earthquake.  Yet, the world is still waiting for a major set of policies to resolutely tackle income inequality in the US and beyond.  In the language of our earthquake analogy, what further information is required to overcome such political frictions, taking into consideration the time horizon over which politicians operate? 

First, dispelling the myth that monetary and fiscal stimulus have put the economy on a path of stable, inclusive growth and that no further action is required.  In the US, the wealthiest one per cent captured 95 per cent of post-financial crisis growth between 2009 and 2012, while the bottom 90 per cent became poorer (Oxfam (2014)). The vulnerabilities that formed the basis of the 2008 financial crisis still exist and could generate another crisis in the near-term.  
Second, agreeing that reducing inequality can be growth enhancing, as the IMF has strongly argued.  Elections have been won and lost on the state of the economy.  The 2015 election in the UK and the 2016 Presidential election in the US will be no different.      

Third, an acceptance that, because of the nature of technological progress that is driving rising income inequality, for the first time, our children could be worse-off than us (Kotlikoff and Sachs (2012)).  This, unlike the first two, may fall outside of a politician's traditional time horizon, but is surely the strongest argument for action.


Sam Ahir said...

Enjoyed your comments very much. Loved the stick slip earthquake analogy. Please consider the volume of work on criticality started by Per Bak (not sure name spelling). I can send you book details but all you need are the opening comments and chapters. You might find equations that are an excellent basis for meaningful predictive models. Sam

Alok Gupta said...

Interesting analogy. I suppose it doesn't help that, especially in the US, the top 1% of earners overlap significantly with politicians? Take for example the recent pressure major hoteliers have applied to the NYC DA office to stop home sharing on websites such as Airbnb. Does this closeness of the money to the policy-making stop the earthquake or simply delay it?

Priya Kothari said...

You're exactly right, and I would suggest that it delays the earthquake because of the prevalence of short-termism among this group (typically senior executives from the finance, real estate and medical sectors). But imagine what could be achieved if this group collectively shifted their stance!

For facts on the political 1%, see, for example, http://sunlightfoundation.com/blog/2013/06/24/1pct_of_the_1pct/.

"In the 2012 election, 28 percent of all disclosed political contributions came from just 31,385 people. In a nation of 313.85 million, these donors represent the 1% of the 1%, an elite class that increasingly serves as the gatekeepers of public office in the United States."

Priya Kothari said...

Yes! Self-organised criticality formalises the notion that the system is on a permanent knife-edge. A little shock can tip it over. So it could be part of the problem and the solution.

A nice, concise explanation is available in Haldane and Nelson (2012) at http://www.bankofengland.co.uk/publications/Documents/speeches/2012/speech582.pdf pp11

Nish Fofaria said...

Very interesting Priya and I agree we do need to change. To give everyone a more equal share in society, the ownership of assets/shares needs to be more equally distributed. Ideas for how this could be achieved include introducing a ways to broaden the distribution of shares to workers .A successful example in the UK is the John Lewis partnership . Reducing the huge differences in pay from the top down. Changing the ownership of assets also allows us to consider the spread of profits among and between individuals. This may re balance producing equilibrium between 'short-term interests and long-term interests'

Priya Kothari said...

Thanks Nish, agree that reform of corporate governance is required and one way to do this is to widen ownership to a greater number of stakeholders. Paying all employees in equity (particularly long-dated equity) is another way of aligning interests.