Thursday, January 21, 2010

Letter from Chicago - yup, inequality matters

The New Yorker is running a fascinating piece about the crisis at the Chicago school of economics, built on efficient-markets hypothesis and rational-expectations theory, which is behind this whole recent mess. The news about Chicago's intellectual crisis isn't new, but this does have some great quotes. The blurb says:

"Earlier this year, Judge Richard A. Posner published “A Failure of Capitalism,” in which he argues that lax monetary policy and deregulation helped bring on the current economic slump. Posner has been a leading figure in the conservative Chicago School of economics for decades. In September, he came out as a Keynesian. As acts of betrayal go, this was roughly akin to Johnny Damon’s forsaking the Red Sox Nation and joining the Yankees.

But there's something else worth remarking:

"Raghuram Rajan, an Indian-born Chicago professor, is one of the few economists who warned about the dangers of the financial crisis. In 2005, he said that deregulation, trading in complex financial products, and the proliferation of bonuses for traders had greatly increased the risk of a blowup. In a new book he’s working on, “Fault Lines,” Rajan argues that the initial causes of the breakdown were stagnant wages and rising inequality. With the purchasing power of many middle-class households lagging behind the cost of living, there was an urgent demand for credit."

Inequality is not only undesirable in itself. It also helped cause the crisis, on this reading. Read more on the demand for credit here. Read more about inequality here.


Blogger Physiocrat said...

Fred Harrison predicted the bust in August 2005 using the model based on the interaction between the land market and the banking system. The conventionally accepted economics theories ignore land so of course their predictions are defective. Harrison put his prediction into a book, The Great Recession of 2010. He explains the theory in brief
here Things are going to get a lot worse before they start to get better, as the government's policies have just held back the tide and cannot resist much longer.

Inequality is easily explained. There are those who have land and collect rent. There are those who do not and must work for wages and pay rent. Most people have a little bit of an interest in land so enjoy a little bit of land rental income but few, even business people, actually own the land on which they work and it is inordinately difficult to get to do so. Thus the great political division between left and right does not reflect the fundamental economic divide.

As for free markets - there can be no such thing so long as land is monopolised. So governments can tinker or they can deal with the problem. Nearly all choose to tinker, including the radical left who ought to know better. So the power remains in the land.

7:38 am  

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