Saturday, December 04, 2010

How Smaller Government Leads To Increased Inequality

David Ruccio hypothesizes that the current worldwide macroeconomic difficulties are related to increased inequality in the distribution of income in, say, the United States over the last few decades. I have been considering hypothetical mechanisms that expand on this idea. Previously I have put forth the Harrod-Domar growth model as a framework in which increased inequality leads to a tendency towards recessions. In this post, I focus on causation in the other direction. (A full analysis of the issues will likely describe a process of cumulative causation.)

Active macroeconomic fiscal policy is assisted if government spending is already a somewhat large component of a nation's economy. It is easier to raise government spending by some given fraction of national income if that change is a smaller percentage of current government spending. We have seen this issue in connection with the Obama administrations talk of "shovel-ready" projects and the stimulus policy. Perhaps this consideration even applies to automatic stabilizers.

So governments that are smaller with respect to their national economies might be expected to exhibit worse macroeconomic performance. And James Galbraith has shown quite some time ago that poor macroeconomic performance leads to increased greater inequality in wages.

Perhaps the above is part of the explanation for the empirical cross-section correlation between decreased government size and increased inequality. I think Hacker and Pierson give some explanation why increased inequality engenders political forces tending towards smaller government size.


Anonymous said...

"Among the Western countries alone, inequality appears to be less, in any meaningful sense, the more highly capitalist the country is . . . With respect to changes over time, the economic progress achieved in the capitalist countries has been accompanied by a drastic diminution in inequality . . . a free society [i.e. capitalism] in fact tends towards greater material equality than any other yet tried." (Capitalism and Freedom)

When Friedman's own ideology was applied inequality exploded. Strangely, he failed to mention this awkward fact in the preface to the 40th anniversary edition of his book...

One of the many things Friedman was utterly wrong about -- still, he helped the rich get richer so such a minor thing as being wrong does not hinder his claim to being a great economist...

An Anarchist FAQ

Anonymous said...

Inequality and crisis: