'Inequality' and the Business Cycle

I really hate the word 'inequality.'  Like so many other politically charged words, it has been so abused in the last couple of centuries as to become completely useless.  I consider this word and one other -- liberal -- to have been so damaged by misuse that I try to avoid using them altogether.

So, how about 'income disparities?'

The Economist ran a brief article about how 'income disparities' might cause economic crises:

Mr Rajan’s story was intended as a narrative of the subprime crisis in America, not as a general theory of financial dislocation. But others have noted that inequality also soared in the years before the Depression of the 1930s. In 2007 23.5% of all American income flowed to the top 1% of earners—their highest share since 1929.

Actually, I thought it was a pretty stupid article.  But it does highlight something pretty interesting -- evidence of my contention that credit expansion during the business cycle causes incomes of those higher up in bureaucratic divisions of labor to see their incomes increase disproportionately.



To my knowledge, standard Austrian theory doesn't actually predict this.  It appears mostly concerned with stages of actual physical production, which ultimately terminate at one end with commodities, and the other at consumer goods.  It is goods in these various stages which see a wave of price increases -- higher order first, then spreading down to lower order -- that constitute the business cycle.  'Upper management' isn't mentioned, so far as I know.

I took it a few steps further through an unconscious act of intuition.  But it seems to be right, again, so far as I can tell.

It is the credit expansion that causes the income disparities and the crisis.  Disparities peak just before the crisis, just as does the disparity between prices of regular capital goods and consumer goods.  The article contains a few sentences later that would seem to confirm this assertion:

Inequality occasionally rises with credit creation, as in America in the late 1920s and during the years before the 2008 crisis. This need not mean that the one causes the other, they note. In other cases, such as in Australia and Sweden in the 1980s, credit booms seem to drive inequality rather than the other way around. Elsewhere, as in 1990s Japan, rapid growth in the share of income going to the highest earners coincided with a slump in credit.

Despite the rather poor wording (which I think is close to inexcusable for a publication like The Economist), what the writer is effectively saying is that, of the examples given, Japan is the only one in which inequality did not seem to increase as a result of a credit boom, but rather the opposite seemed to happen -- inequality increased when the bubble popped.

Interestingly, I have read elsewhere that Japan has an unusually flat bureaucratic structure.  (Sorry, but unfortunately I've forgotten where I read this, so no link...)  Generally, many more people answer to a given manager in their business structures, such that management tends to be fairly lean in comparison to Western businesses.  There is also a tendency for compensation to be a function of seniority, rather than to be set as a matter of competitive bidding.  Which tends to suggest that there is much less of a division of labor for the credit boom to work over, and cultural resistance to whatever its effect may be.  Thus Japan seems to be the exception that proves the rule.

Note also that I am not trying to say that anyone should be upset by 'inequality,' or income disparity, per se.  Probably some have been confused by my statements in the past.  My point is only that, as it seems to me, free-markets tend strongly towards a general evening out of such disparities, give or take, say, a single order of magnitude or so as a standard deviation.  But, of course, that is really just an estimate on my part.  Income disparity appears to me an effect of a lack of freedom in the marketplace.  It is the action of things like market restrictions and money tampering which cause really gigantic disparities.

So, when people point to the salaries of professional athletes and CEOs and say "See?  This is the free-market at work!" I think that they are deluded.  That is the opposite of the free-market, just as if I had pointed to a Saudi prince in a Ferrari and said the same thing.  The same sort of phenomenon tends to produce both -- unfree markets.  As I recall, Catherine the Great, Ghengis Khan, and various other of the sort were also extremely wealthy.  Nobody to my knowledge credits the free-market with their wealth.

So, what do I think one should point to as evidence of what the free-market does?  I would say the middle-class family, comfortable and warm and safe, almost totally immune to the kinds of material deprivation that afflicted people in times past -- and are still found today in places that have suppressed the action of markets.

But my guess is that even this family would benefit from more freedom in the marketplace.