Trade Wars Are Class Wars, 34 Months Later (Part 2)
What the return of inflation means, and doesn't mean, for our understanding of the link between inequality and underconsumption.
An early Happy Thanksgiving to all my U.S. readers!
A few months back I started trying to figure out how I would update Trade Wars Are Class Wars in light of everything that’s happened over the past few years. My first note in this occasional series covered the first year or so of the pandemic up through the passage of the American Rescue Plan Act. This second note will cover what happened from then up until the recent Russian invasion of Ukraine, with a particular focus on the implications of the global inflation spike for our thesis.
The Before Times: Abundance, Gluts, and Underconsumption
Our book argued that income concentration over the past few decades has undermined global growth and financial stability. This was not a general claim about inequality, but a specific one; we believe that the macroeconomically optimal distribution of income depends on the circumstances. We devoted a lot of space in Chapters 3, 4, 5, and 6 to show that total consumer spending had persistently undershot the expansion of the humanity’s productive potential. Moreover, this was not due to excessive capacity, but to insufficient consumption. (There are still plenty of poor people, after all.) As we put it in Chapter 3:
Scarcity stopped being a serious problem in the rich world sometime near the last quarter of the twentieth century. Making things has become easier and cheaper than ever before. Shortages have been replaced with gluts. The age-old tradeoff between consuming more today and producing more tomorrow is gone. Investment is now constrained by insufficient consumption, rather than by the old competition for resources. The modern condition is therefore defined by the perverse coincidence of abundant idle resources and unmet material needs.
We had a lot of evidence to support this case.
Unemployment rates across the rich world were consistently higher in the decades after 1980 than in the decades before—during downturns and booms. The business sector once relied on external finance to cover its investment needs, but switched to generating massive surpluses that are either paid out to shareholders or used to pay down old debts or build up cash hoards. Capacity utilization rates had been trending down for years as the prices of both commodities and manufactured goods have collapsed relative to incomes. Financial markets also agreed that capital was abundant relative to investment demand, with interest rates (and spreads) relentlessly grinding lower and valuation multiples (generally) marching higher.1
This has implications for the optimal distribution of income.
If it were necessary to restrict consumer spending to free up workers, machines, and material inputs for a long list of worthwhile capital projects, then regressive transfers would actually boost total production and aggregate incomes. In that world, the most important task for policymakers would be figuring out how to make inegalitarian redistribution socially acceptable—or how to obscure it enough so that it went unnoticed.
Our claim was that the particular conditions of the past few decades meant that the “suppress-consumption-to-boost-investment” agenda would actually lead to less worthwhile investment and lower living standards. Even the best projects would have difficulty becoming profitable in the absence of customer demand. The flip side of our view was that egalitarian redistribution would spur more consumer spending and more investment—without any negative side effects.
Inflation was not a serious concern for us because we believed that businesses had the flexibility to ramp production as needed. Moreover, we did not believe that rising living standards in any individual country would come at the expense of real growth and/or inflation elsewhere, because we believed that, globally, spare capacity was vast. In general, prosperity is not a scarce resource because rising consumption encourages more production in a virtuous cycle. That was why we believed that the central economic challenge before the pandemic was the persistent shortfall of demand, not supply.
In our view, the main risk associated with egalitarian redistribution was the potential for growing geographic mismatches between who was doing the additional spending and who was doing the additional production, which had the potential to translate into unsustainable financial imbalances.