DISSERTATION INEQUALITY AS A CAUSE OF MACRO-INSTABILITY AND PRODUCTIVE INEFFICIENCY Submitted by Mark Friedman Department of Economics In partial fulfillment of the requirements For the Degree of Doctor of Philosophy Colorado State University Fort Collins, Colorado Fall 2015 Doctoral Committee: Advisor: Alexandra Bernasek Dimitris Stevis Daniele Tavani Ramaa Vasudevan Copyright by Mark Friedman 2015 All Rights Reserved ABSTRACT INEQUALITY AS A CAUSE OF MACRO-INSTABILITY AND PRODUCTIVE INEFFICIENCY These essays will examine the impact of inequality from both macro and micro perspectives. The first issue to be raised will be the contribution of inequality to macroeconomic instability. In the third chapter the focus will expand to determine whether an optimal level of inequality can be found. Much of the examination will be informed by principles outlined in the Progressive Utilization Theory (PROUT) developed by the philosopher P. R. Sarkar. As this dissertation was written during the recovery from the Great Recession, a timely controversy is addressed in the first chapter – whether growing inequality contributes to economic instability. Arguments for and against the proposition are critically examined in detail. It is concluded that the accumulated weight of the arguments favor the position that inequality can indeed help destabilize economies. In the second chapter econometric evidence is presented to show that high inequality contributes to the severity of economic downturns, both in terms of GDP declines and in consumption losses. Attention is also given to the impact of inequality in contributing to the global crisis leading to the Great Recession. While the initial evidence presented here cannot be considered conclusive in demonstrating a causal link between inequality and that specific crisis, it is shown that rising inequality was present in most of the 15 countries included in the study which were suffering recessions. An attempt to define an efficient limit to inequality will be the focus of the third chapter. The discussion will extend from the PROUT principle that any inequality that is accepted by society is only justified to the extent that it provides incentives for greater service to society by those receiving more than others. Any amount of income or in-kind amenities provided to a person that is beyond the ii minimum requirements by the standards of that society should not exceed the value of the extra services coaxed from that person by the extra incentives. A humanistic model of motivation for productivity is developed that suggests that people are productive for a variety of reasons besides material rewards. This is intended to place the need for incentives, and by extension inequality, in a perspective that suggests wide inequality is unnecessary and economically inefficient. Diagramatic analysis that introduces the Sarkarian Individual Productivity Curve demonstrates reasonable limits to inequality. iii TABLE OF CONTENTS ABSTRACT ...................................................................................................................................................... ii LIST OF TABLES ............................................................................................................................................. vi LIST OF FIGURES .......................................................................................................................................... vii Introduction .................................................................................................................................................. 1 1 Inequality and Macroeconomic Instability ................................................................................................ 3 1.1 No connection ........................................................................................................................................ 5 1.2 Unclear linkage ..................................................................................................................................... 11 1.3 Simultaneous causation ....................................................................................................................... 17 1.4 Inequality as a major cause of instability ............................................................................................. 32 1.5 Instability comes from above ............................................................................................................... 33 1.6 Instability comes from below ............................................................................................................... 45 1.7 Government caused the crisis .............................................................................................................. 59 1.8 Summary .............................................................................................................................................. 78 Works Cited ................................................................................................................................................. 81 2 Empirical Project: Linking Inequality with the Severity of Economic Crises .......................................... 86 2.1 Procedure ............................................................................................................................................. 89 2.2 The basic model ................................................................................................................................... 89 2.3 The basic probit model at 10% GDP and consumption drops ............................................................. 94 2.4 The basic probit model with varying thresholds of GDP and consumption drops ............................ 100 iv 2.5 Further variations in the model ......................................................................................................... 105 2.6 Inequality and the Great Recession ................................................................................................... 111 2.7 Conclusion .......................................................................................................................................... 113 2.8 Forward to the Third Chapter ............................................................................................................ 114 Works Cited ............................................................................................................................................... 115 3 Living Wage and Optimal Inequality in a Sarkarian Framework ........................................................... 116 3.1 he Sarkarian framework ..................................................................................................................... 117 3.2 Maslow and eupsychian management .............................................................................................. 124 3.3 Elements of productivity .................................................................................................................... 126 3.4 Toward an optimal level of inequality ............................................................................................... 129 3.5 The persistence of unjustifiably high wages ...................................................................................... 136 3.6 Conclusion .......................................................................................................................................... 137 Works Cited ............................................................................................................................................... 141 v LIST OF TABLES Table 1-1 Summary of theories linking inequality and instability .............................................................. 79 Table 2-1 OLS results, basic model ............................................................................................................. 92 Table 2-2 Basic probit model, GDP drop at least 10% ............................................................................... 96 Table 2-3 Basic probit model, consumption drop at least 10% ................................................................. 96 Table 2-4 Severe GDP and consumption declines categorized .................................................................. 98 Table 2-5 Comparing thresholds of GDP drops with Gini-related measures ........................................... 101 Table 2-6 Comparing thresholds of GDP drops with top income-related measures ............................... 102 Table 2-7 Comparing thresholds of consumption drops with Gini-related measures ............................. 103 Table 2-8 Comparing thresholds of consumption drops with top income-related measures ................. 105 Table 2-9 Variations on the basic model .................................................................................................. 108 Table 2-10 Regression results, change in top income shares and recession severity in the recent global crisis .......................................................................................................................................................... 111 vi LIST OF FIGURES Figure 1.1 U.S. top income shares over the past century ............................................................................ 4 Figure 1.2 Average hourly earnings 1920s (U.S.) (Source: Statistical Abstract of the United States) ....... 10 Figure 1.3 Average income U.S., past century