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Economic Crises in a World of Resource Scarcity and Wealth Inequality

Friday, 20 May 2011 04:57 By Ramn Lpez, Triple Crisis | News Analysis
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Repressing labor unions, reducing enforcement of minimum wages and lowering them over time, cutting unemployment benefits and welfare to the poor, are some of the new "institutions" to enhance labor supply and to lower reservation wages implemented in the USA and other countries over recent decades. These policies were complemented with massive tax cuts for the rich and financial deregulation. All this responded to the old bromides of the right, once sarcastically described by Galbraith as the doctrine that considered that the rich were too poor and the poor too rich to be productive.

This model of course brings much joy to the elites. It causes real wage stagnation so that productivity growth is entirely captured by the elites and income growth stagnates for almost everyone except the very rich. But the stagnation of the income of almost everyone also constitutes a problem for the model because it causes insufficient demand to sustain the expansion of production and profits.

The problem is "solved" by inducing the average citizens to borrow more to allow their consumption to expand even though their income stagnates. The unbridled expansion of credit is made possible by promoting financial recklessness (through deregulation) and by lax monetary policies which together encourage financial corporations to grow as fast as possible, taking large risks. The incentives to do this are the understanding that the larger these corporations become the greater their capacity to bribe politicians to obtain even greater tax breaks and public subsidies, and if things turn difficult they will be "too large to fail" and thus be generously bailed out.  A great party for the elites ensues: the economy grows fast, profits and compensations to top executives grow even faster and ordinary citizens who are able to increase their consumption, albeit at the cost of ever higher debt levels, are happy. However, a model founded on ever-rising debt is increasingly vulnerable to shocks.

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Which shocks? There was a time when the limits to fast growth were due to the fact that wages increased rapidly when unused production capacity and unemployment became low. This limited profits and caused inflationary pressures forcing the Fed to raise interest rates, thus cooling the economy.  Nowadays, given the new labor market "institutions" real wages do not increase even after long periods of rapid growth. Workers have been left powerless to negotiate with the large conglomerates. So the elites' parties can now be more luscious and longer than in earlier times.

However, the parties of the elites face nowadays a new foe that even their might cannot overcome: the finiteness of the physical world.  As scarcity of natural resources emerges, primary commodity prices have become for the first time in history responsive to economic growth, a phenomenon that did not happen in times of abundance of natural resources when the commodity supply curve was essentially flat. Now, the world commodity supply has become increasingly inelastic. Moreover, the continuous reliance of consumption in both advanced and emerging countries on material goods rather than on intangibles means that world economic growth causes a rapid shift outward of the commodity demand curve.

The combination of inelastic supply and fast demand shifts means that world economic expansion is followed by rapidly rising commodity prices. Increasing commodity prices induce first headline inflation and then "core inflation" that, in turn, forces the Fed to raise interest rates as in the 2005-07 period. Higher interest rates in an economy affected by large levels of debt have dramatic effects on disposable income and hence on demand for assets and final goods. Insolvency is exposed and a deep crisis as in 2008-09 follows.

At this point the government steps in to bail out the large corporations and to support aggregate demand via expansions of fiscal spending and the Fed lowers interest rates for the big financial institutions to almost zero. Since taxes for the rich are sinful in the new model and taxing the middle class would diminish demand even further the new "solution" is to increase the government debt. Even the timid recovery that emerges quickly triggers increasing commodity prices and inflation as in 2011 which make it difficult to sustain the lax money policy. Also, even governments face economic and political debt limits; a new crisis now associated with unsustainable government debt arises, at which point a second round of draconian cuts of government social programs is presented as the only way out.

It is anyone's guess what is next, but it is clear that while government intervention averted an immediate depression, it has exacerbated the structural conditions that make the economy crisis-prone. Bail-outs and near-zero interest rates for the big corporations, and further tax cuts magnified the concentration of wealth, and the dependence of consumption on material goods, which makes world growth so demanding on ever-scarcer natural wealth, was not dealt with.

Ramn Lpez

Ramón López is Professor of Agricultural and Resource Economics at the University of Maryland.

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