Equitable economics: A new strand of macroeconomic theoryTuesday, March 01, 2016
BY PHILLIP BAKER
Careful analysis of the discourse at the micro political and macro political levels reveals a growing awareness of a destabilising misalignment between economic growth and social insecurity and inequality.
At the micro political level, the quest for a credible solution to anxieties regarding unacceptably high levels of social insecurity and inequality lies at the heart of much of the economic anger being expressed during the debates leading up to the 2016 US Presidential Election.
Similar sentiments characterise the anti-austerity wave currently engulfing significant constituencies within the 28 member states making up the European Union (EU) and could materially affect the outcome of the UK’s 23 June 2016 referendum on EU membership.
Meanwhile, at the macro political level, finance ministers and central bank governors meeting in Shanghai, China for the February 2016 G20 deliberations have found it absolutely necessary to reframe their narrative to reflect advocacy of reforms to boost economic growth.
sIn like manner, the International Monetary Fund (IMF) in its 2015 Article IV Consultation with the UK encouraged the disciplined orchestration of structural reforms to sustainably underpin economic growth and employment as well as contain house price pressures — particularly in the buy-to-let segment — that risk exacerbating concerns about inequality.
Also, the Organisation for Economic Cooperation and Development (OECD) recently underscored the urgency for a shift in macroeconomic policy aimed at stimulating more inclusive global economic growth.
If anything, the confluence of micro- and macro-level awareness that the existing global economic architecture has been deficient in its response to the devastating fallout from the 2008 global economic crisis highlights the pressing need for the development of a new strand of macroeconomic theory, notably equitable economics. Therefore, with the utmost humility, what follows represents a very basic outline of this new approach which, inter alia, must navigate the subtle equity-efficiency trade-off and sufficiently recognise the heterogeneity of consumers’ consumption and savings functions (and by extension, their propensity to save as well as consume across earnings levels).
The remainder of this article is organised as follows. First, we sketch the outline of an approach to macroeconomic management that emphasises the role of aggregate demand. Second, we acknowledge the policy objective of pursuing operational efficiency through automation but argue that a new social contract is necessary to mitigate the risks of inequality. We conclude with an exploration of the implications for national debt sustainability.
This very basic outline of equitable economics rests on the premise that there is an urgent need to accord primacy to the role of aggregate demand in expanding real gross domestic product (GDP). Following from this, policy-makers will necessarily have to sustainably boost aggregate demand through a combination of:
(1) personal income tax cuts
(2) expenditure on critical infrastructure renewal
(3) concerted efforts aimed at removing existing distortions in the global trade in goods and services, and
(4) good-value-for-money spending on productivity-enhancing education and re-skilling initiatives.
However, this will require exquisite mastery of empirical data that enable targeting those consumer segments with the highest marginal propensity to consume and by extension facilitating the application of an appropriate multiplier.
For ease of discussion, it is worth reminding that in a modern four-sector economy real GDP reflects a circular flow of income among consumers, businesses, the government and the foreign trade sector. In this regard, we hasten to mention that increasingly, remittances are playing an important role in aggregate demand in many countries.
Returning to an elaboration of the concept of the multiplier, we would add that in a typical four-sector economy where withdrawals consist of savings, taxes and imports, the multiplier is represented by the inverse (the reciprocal) of the marginal propensity to withdraw. As such, it is the inverse of the sum of the marginal propensity to save, the marginal propensity to import and the marginal rate of taxation.
Accordingly, for an economy where the marginal propensity to withdraw (the denominator) assumes a value of 0.4, the multiplier will be the inverse of 0.4, which turns out to be 2.5 (ie, 1/0.4).
In these circumstances, the consumers of an economy that is characterised by a marginal propensity to consume of 80 per cent (ie, 0.8) are likely to spend US$0.80 of every US$1.00 in tax cuts, thereby raising aggregate demand by US$0.80 (i.e., by 80 per cent). By extension, the multiplier effect is likely to be US$2.00 (given by US$0.80 X 2.5).
Put differently and as a first estimation, in our example, every US$1.00 in tax cuts is likely to generate an attendant increase of US$2.00 in GDP.
Why as a first estimation? This is owing to the fact that we would need to refine our calculation by including empirical estimates of the weighted average income elasticity of demand. This captures the proportional change in demand engendered by an incremental adjustment in after-tax (ie, disposable) income.
With this important caveat considered, it necessarily follows that the expansion in GDP is likely to trigger a beneficial behavioural response on the part of businesses as they seek to attain profit-maximising goals by commanding and deploying additional factors of production and utilising hitherto idle production capacity.
As the economy moves to an expanded production possibility frontier, the challenge for policy-makers then becomes one of calibrating the available levers to prevent a buoyant economy from overheating.
This, arguably, is a far better position to be in than to be carrying the dead-weight burden of being trapped in a persistently low-growth, fiscally austere cycle – which, as we shall see in the concluding section of this article, can be inimical to national debt sustainability.
However, much will also depend on investors’ and consumers’ confidence in the future as well as on the introduction of policies that mitigate the unintended risks of the wider application of additive manufacturing (ie, 3D printing) and robotics as part of the next wave of automation of existing job functions.
Then there is also the urgent need to address unsustainable anomalies in the distribution of national income among citizens.
According to the most recent data published by the OECD, average inequality has risen in its member countries by almost 10 per cent since the mid-1980s. Indeed, over the same period the share of pre-tax income accruing to the richest one per cent of earners in the US more than doubled, approximating just under 20 per cent in 2012.
Therefore, to allay growing anxieties regarding job insecurity and income inequality, policy-makers will have to do a lot more than merely provide a fillip to aggregate demand.
A UNIVERSAL BASIC INCOME
They will also be called upon to explore the introduction of a new social contract that includes some variant of a universal basic income. What, then, are the distinguishing features of a universal basic income? Essentially, we are talking about payment of a flat, unconditional (as against a means-tested) monthly income to all citizens.
More concretely, it also allows claimants the option of retaining any additional income earned resulting from upskilling, embarking on entrepreneurial ventures or taking up new job opportunities.
As such, it acts as an antidote to the proverbial poverty trap by which claimants lose benefits for earning additional income, which in turn could potentially make them economically worse off. Its critics point to the size of the required funding commitment as well as to the likely creation of a disincentive for claimants to actively seek work.
For completeness, we now turn to an examination of the implications for national debt sustainability.
We begin by arguing that in a context where there is no real prospect of obtaining either debt relief or debt restructuring, the national debt is sustainable if its ratio to GDP is either low, stable or declining.
Conversely, the national debt is deemed to be unsustainable if its ratio to GDP is high and/or increasing.
Furthermore, it is generally accepted in the substantial public finance literature that national debt dynamics are greatly influenced by the interest rate-growth differential (represented by r – g). Therefore, policy-makers will have to keep a very close watch on the relationship between the rate of real GDP acceleration (economic growth) and the average rate of interest applicable to servicing the national debt.
As long as aggregate demand and GDP are sufficiently robust (while not fuelling uncontrolled inflation) to provide more than adequate coverage of debt servicing, national debt dynamics are unlikely to deteriorate. On the contrary, national debt dynamics are likely to improve.
To sum up, we have cursorily examined growing concerns at both the micro and macro levels regarding the sluggishness of economic growth amid disconcerting evidence showing a pattern of unequal distribution of national income among citizens.
As a measured response, we have humbly proposed a counter-narrative that gives primacy to the non-inflationary expansion of aggregate demand within the context of a new social contract that includes a universal basic income. This is intended to mitigate the risks of social insecurity and income inequality and serve as an effective buffer against an irreversible new wave of automation.
Besides, we have called attention to the role of the interest rate-growth differential in national debt sustainability. On this basis, we hope to stimulate a discourse on the very parsimonious outline for a new strand of macroeconomic theory, notably equitable economics.
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