The Threat of Inequality: Macroeconomics Impact Series-Part 3

Hello everyone.
I really hope that you guys have been following the Macroeconomics Impact Series because I don’t know about you guys but I am having a lot of fun writing them. As I have said before, I am someone who religiously believes that “Macro is God“, and not just in economics but to be honest even in real life.
So in my previous two articles, I have talked about the need for a growing workforce population and dynamic leadership for the improvement of any country’s economy. If you have not read them, I would really like if you can do that by following this link.

Now with that aside, today I will be telling you about the threat of inequality in terms of income, wealth and spending power.
Inequality is quite common in any developing country because of the slow migration of people from villages to the cities. But the government needs to make sure that the wealth gap does not exceed beyond a point otherwise it makes the country’s economy very unstable and susceptible to change in market prices of commodities. This widening gap can easily bring about a major social unrest which has the potential of blowing up into a catastrophic civil war, between the rich and the rest.

When a country is going through an economic boom and everything seems to be going right, it will lead to rising in the number of billionaires that a country has. This phase will allow new faces to become billionaires. Now the problem comes up when we look into how these billionaires earn their wealth. Any growing economy needs to make sure that its money is being used in productive projects which generate employment and help people lead a better life. But what if a billionaire is born by being a giant in the real estate sector, or maybe the billionaire is from the oil and gas industry. Such billionaires don’t really increase the productivity of the people.
Here the focus is on getting more control of the natural resources and reducing the number of regulations. There is no real development taking place. There is nothing new for them to offer. These billionaires are also usually responsible for shady backroom deals with the government. The corruption involved prevents the nation’s capital and resources from being used productively. This leads to a rise in crony capitalism. Billionaires from industries like mining, real estate, commodities(like oil, gas, coffee etc) are called bad billionaires.

But if the billionaire is from the technology sector, or from the telecom industry or even the automobile industry then that is one of the best ways to generate future productivity. These industries usually allow for innovation that leads to better technology and healthier competition. There are low chances for crony capitalism in this scenario. These good billionaires are very important for the country’s economic growth.

When a country has many bad billionaires, resentment among the people starts to brew. People start demanding a policy to redistribute the wealth rather than creating new wealth. This is typically a bad time for a nation because. Because usually with resentment brewing, there is a change of tides which more than often leads to a change in government bringing in a more of firebrand character. And this government brings in populist policies that do more harm than good.
For example, let us see the case of Zimbabwe under President Mugabe in 2000. He started displacing the white farmers with black farmers. This move backfired because the new farmers had very less knowledge about farming. This caused a major downfall in the country’s food production capacity. Unemployment rates spiked up to 90%. And soon hyperinflation broke out. The country’s economy just committed suicide at that point. The exchange rate became so ridiculous that it took almost 35 quadrillions of the Zimbabwe Dollar to buy one US dollar. By 2015, Mugabe was forced to scrap the currency. Currently, the country uses a basket of different currencies to support their economy.

A similar situation can be seen in the Philippines under Joseph Estrada in late 1990’s. He was voted in by the poor who had seen enough of the rampant inequality in their nation. After coming into power he started increasing government spending through subsidies and pensions and redistributing land. This immediately translated into higher government debts and deficits. Soon there was an upward spiral of inflation and unemployment rates. Estrada said goodbye to his office in just three years.

Ruchir Sharma mentions in his book, The Rise and Fall of Nations that when the billionaires of a country start controlling more than 10% of a country’s wealth in terms of GDP then it is the time to worry.
And it quite rightly so. Let us have a look at some of the economies of the world and how much of its wealth is concentrated with the top business elites.

The best country that shows the cons of a widening inequality gap is Russia. Currently, in Russia, over 15% of the nation’s wealth is accumulated by the billionaires. And most of these billionaires are from real estate, gas, oil, and fertilizer industry, all of which are rent-seeking industries. They are heavily bloated and often show off their wealth extravagantly. All of this is derogatory for a country’s economy.

Mexico is another country where there is a lot of public resentment over the dominant billionaire class. Most of the billionaires are major state-supported monopolies and hence have no motivation for innovating and providing better services. They live in a constant fear of public outrage and can often be seen in their intense high-security homes.

This is in contrast with the billionaires from the Asia region where they are often seen as iconic personalities. Individuals like Azim Premji, Ratan Tata, Mukesh Ambani, Jack Ma, Leo Chen, Dilip Sanghvi amongst many, are respected for their ideologies and lifestyles.

It is very important that the government work towards creating an environment that pushes bad billionaires to adapt to changing times and innovate. Rather than spending wastefully in unproductive ventures, the government needs to work towards investing in productive projects and creating a level ground for new ventures to compete against these bad billionaires.

The problem with billionaires is that after reaching a stage of wealth their ability to consume just ends. It becomes way too extravagant and wasteful. Simply their marginal consumption is very less. If a middle-class person were to see an income hike, that person would spend on services and goods to increase the standard of living. This acts as a source for somebody else’s income and this cycle keeps repeating, which is good for the economy.
But with the rich, it is completely different. They start saving up their capital in the form of non-productive assets like real estate, gold, art, and jets. This is very unfruitful for a growing economy.

The policies of the government during such rising inequalities are also very important. Because due to this inequality gap the government is forced to increase its spending in the form of subsidies, pensions and salary hikes. This causes a lot of strain on the budget, which leads to bigger debts and widening deficits.
For example, the current government of India under Narendra Modi recently launched a medical health cover scheme for the poor. This is a very populist move which can prove really costly in the long run. The government has already exceeded the target fiscal deficits of 3% for the year. And with high unemployment rates coupled with fall in GDP, there is a possibility of inflation rise.

Throwing free money at poverty is not the solution. Helping the people in improving their skills and making them competent in the world market is the best solution for it. The government should be investing in skill development programmes, education, research, and infrastructure. Its policies should reflect its ability to be disciplined in its spending and help decrease the wealth inequality gap in the nation.
A country needs a constant change in productive business elites rather than corrupt business tycoons who become stagnant.