Crisis and Inequality. Mattias Vermeiren
was 37 per cent in Europe and 47 per cent in North America (even higher than in Russia and China, where the top 10 per cent income share was respectively 41 and 46 per cent of total national income).2 From 1980, income inequality increased rapidly in North America, while inequality grew more moderately in continental Europe. From a broad historical perspective, the rise in inequality marks the end of a post-war ‘Golden Age’ of egalitarian capitalism. Many lower- and middle-class consumers in the United States and other Anglo-Saxon countries like Ireland and the United Kingdom increasingly had to borrow to maintain and finance their consumption patterns in the face of stagnating incomes. In this way, the rise in inequality contributed to the global financial crisis of 2008 by leading to an unsustainable rise in household debt. Fiscal austerity reinforces these dynamics of inequality by cutting spending on social programmes that primarily benefit the bottom half of the income distribution. Finally, high levels of inequality can be a cause of low economic growth and ‘secular stagnation’, as even mainstream neoclassical economists at the Organisation for Economic Co-operation and Development (OECD) and the International Monetary Fund (IMF) have increasingly acknowledged.3
There is a growing consensus that excessive levels of inequality could also endanger the endurance of liberal democracy. Based on their analysis of recent public opinion data, political scientists Roberto Stefan Foa and Yascha Mounk come to a sobering conclusion:
Citizens in a number of supposedly consolidated democracies in North America and Western Europe have not only grown more critical of their political leaders. Rather, they have also become more cynical about the value of democracy as a political system, less hopeful that anything they do might influence public policy, and more willing to express support for authoritarian alternatives.4
Since the 1980s, both voter turnout and trust in democratic institutions such as independent parliaments and judicial courts have sharply declined across the established democracies of North America and Western Europe: ‘As party identification has weakened and party membership has declined, citizens have become less willing to stick with establishment parties. Instead, voters increasingly endorse single-issue movements, vote for populist candidates, or support “anti-system” parties that define themselves in opposition to the status quo.’5 An increasing number of recent studies claim that the rise in ‘populism’ in most Western societies is closely connected to the rise in income inequality, the stagnation of middle-class wages and growing economic insecurity linked to financial and economic globalization.6
The economic instability of capitalism and its inherent tendency to fuel inequality are therefore topics that should be of interest to any student and scholar in social sciences. This book aims to deepen our understanding of these two central challenges of advanced capitalism from a political economy perspective. Political economy is a field of study that is based on the assumption that it is impossible to say much sensible about the economy and the functioning of ‘markets’ without taking into account the broader political and institutional context in which these markets are always embedded. It is a research tradition whose principal objective is to break down disciplinary boundaries between economics, political science and sociology and to ask basic questions about the distribution of resources in capitalist ‘market economies’. Thus, political economy applies Harold Lasswell’s classic definition of politics – the study of ‘who gets what, when and how’ – to the economy and is, as such, a research approach that is ideally suited to identify the political and social causes and consequences of rising inequality and instability.
Perhaps the best way to clarify the distinctive features of political economy as a field of study is by setting it against its main contender: neoclassical economics, which has become the dominant approach to study the economy in our contemporary society: it is the research tradition in which most economics students are nowadays educated. Neoclassical economics has become increasingly formalistic, developing mathematical models and quantitative methods that are completely detached from the social, political and historical context of economic dynamics in the real world. The global financial crisis exposed the failures of neoclassical economics.7 Understanding and deepening our knowledge of the global financial crisis and its longer-term causes and consequences should be central objectives in the social sciences, but neoclassical economics seems to have failed in reaching these objectives. In a famous event symbolizing this failure, Queen Elizabeth II of the United Kingdom asked, during a briefing by economists at the London School of Economics in 2008, why nobody had seen the crisis coming. Since then a growing group of students (and teachers) have started to complain that existing textbooks in economics had not done a sufficiently good job of explaining what exactly had happened and – even more importantly – why it had happened. In many countries, groups of students have demanded an overhaul in how economics is taught, with more pluralism and more emphasis on real-world problems like inequality and financial instability.
Critics of neoclassical economics have argued that the assumptions behind its mathematical models are often simplistic and unrealistic, revealing a conservative bias that is overly optimistic about the efficiency of free markets and pessimistic about the effectiveness of government intervention. The homo economicus is one of the most contested of these unrealistic assumptions: individuals are seen as rational and self-interested actors who maximize their utility by making decisions that are based on full information. This assumption allows neoclassical economists to design mathematical and law-like models of human behaviour and economic decision-making: these economists tend to engage in a logical exercise based on assumptions that are adopted because they can be quantified and modelled, not necessarily because they are true or even sensible. For example, in order to predict consumer behaviour, neoclassical models assume that all people have perfect information about all of the goods that they might want to buy: they know all of the prices and qualities involved and they know how much satisfaction they would receive from every product. Another assumption of neoclassical economics, closely associated with the first one, is that free markets balance supply and demand in the long term and are self-adjusting: it is presumed that the economy disturbed by a shock will always return to a new equilibrium (see chapter 1 on the meaning of market equilibrium). There is, obviously, a liberal bias to this line of thinking: if markets are assumed to be stable and self-correcting, it is better to allow them to function on their own, without excessive government intervention. This efficient market hypothesis provided, as we will see, ideological support for the excessive deregulation of the banking system, which – together with the rise in inequality – was an important cause of the global financial crisis.
In response to such criticisms, neoclassical economists usually reply that the main purpose of their mathematical models is to predict economic behaviour rather than formulate realistic assumptions about how the world really works. In his essay on the methodology of positive economics, US economist and Nobel laureate Milton Friedman argues that it does not really matter that the assumptions behind a theory are unrealistic as long as the theory’s predictions are correct:
the relevant question to ask about the ‘assumptions’ of a theory is not whether they are descriptively ‘realistic’, for they never are, but whether they are sufficiently good approximations for the purpose in hand. And this question can be answered only by seeing whether the theory works, which means whether it yields sufficiently accurate predictions.8
Friedman’s argument was reiterated by William Prescott – another Nobel laureate – in his 2016 paper RBC Methodology and the Development of Aggregate Economic Theory: ‘Reality is complex, and any model economy used is necessarily an abstraction and therefore false. This does not mean, however, that model economies are not useful in drawing scientific inference.’9
Nonetheless, neoclassical economists have a bad track record in making correct predictions. The global financial crisis of 2007–9 caught most neoclassical economists by surprise. As Ben Bernanke, former president of the US central bank, conceded, neoclassical economists ‘both failed to predict the global financial crisis and underestimated its consequences for the broader economy’.10 To be fair, some experts warned about the dangers of housing bubbles. But in the final analysis, the consensus was that the situation was not as bad as it seemed. In the wake