Democratic Inequality: The Pernicious Effects of Unequal Distribution

I just finished reading the article by Raghurum Rajan titled Democratic Inequality.

The article examines the years surrounding the Great Depression and details how conspicuous consumption caused people to spend beyond their means, specifically through the use of debt. Because I’ve been studying Institutional Economics and just read Thorstein Veblen’s book The Theory of the Leisure Class, this notion of conspicuous consumption and “Keepin’ up with the Jones'” tickled me.

More importantly, the article details the motivation of legislators in certain districts to vote against the expansion and competition of lending as a way of leveraging inequality to the benefit of wealthy private lenders who comprised the bulk of their constituency. This consequently increased their profits, in the short term anyway. The result fueled a financial frenzy and collapse similar to the run up observed in 2008.

Rajan’s take away point: while financial expansion is not inherently bad, it is not a wise decision directly preceding a crisis.

I’ve been reading a lot on the various topics relating to inequality lately, specifically the areas of current account imbalances, household savings and debt, power bargaining, financial liberalization and other monetary policy.

This has lead me to study of Institutional Economics, and to a lesser extent Historical Economics, pointing me to the works of Thorstein Veblen, Max Weber, John Galbraith, John Schumpeter and others. The study of Institutional Economics is intimately connected to understanding Evolutionary Economics due to its emphasis on social relations as the determinants of behavior and change. It paints what I believe is a more accurate portrait of economics that exists as an organic ecology of free and independent agents competing and working together to bring about change within a given economic system. The contrary picture that mainstream economics presents is a framework of actors existing in a static equilibrium state with fixed behaviors and qualities, such as rational expectations, profit maximization, and the representative firm.

I know that may sound a bit abstract and may not translate as anything immediately meaningful at first glance, but the consequences of adopting a theoretical approach as opposed to a historical empirical approach are very real. Specifically, I believe that the theoretical economics embodied by mainstream neoclassical theory is not only a very poor framework for analyzing long term policy decisions (it’s great for short term modeling and analysis), it breeds a mentality of devoid of conscientiousness, one of instant gratification for the now irregardless of long term consequences. This attitude is embodied in the quote by economist John Keynes who said “The long run is a misleading guide to current affairs. In the long run we are all dead.”

Interestingly, conscientiousness is the single most important personality measure for predicting the long term success of individuals. And why wouldn’t this hold for institutions?

Studies show that conscientiousness dictates education achievement (and here),  longevity, and it even determines the business success of psychopath’s.

More later.

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