To the Point - discussion on economy by Chief Economist cecilia Hermansson.

1. To the Point
Discussion on the economy, by the Chief Economist January 31, 2011
An increasingly angry world
The first edition of this year’s To the Point focuses on popular reactions to
increased food and energy prices, rising unemployment, weaker welfare systems,
and demand for democratisation in the Arab world.
Although the global recovery continues, and growth prospects look better than
half a year ago, including lower probability of a double dip and deflation, new
risks are building up: as commodity prices are again taking off, social unrest may
then become more frequent. Income inequality – especially within but also
Cecilia Hermansson
Group Chief Economist between countries - is back in focus!
Economic Research Department
+46-8-5859 7720 All regions can feel some anger
cecilia.hermansson@swedbank.se The wave of popular protest sweeping the Arab world is just one example of the
anger that may characterise the world during 2011. In Tunisia and Egypt, the
demand for democratisation is the underlying factor creating anger, but the recent
price hikes on food and energy also explain the outbreak of frustration. On top of
this, the large share of young people facing nothing but unemployment in these
countries, where growth-oriented reforms have been absent for decades, is key to
what is happening.
Another example of anger can be seen in the US, where the richest 1% earns
almost 20% of the national income, and where this share has increased over time,
reaching the same inequality as in the years leading up to the 1930s depression.
Long-term unemployment has at the same time increased to levels seldom seen,
and middle-class families’ incomes have stagnated. The gap between the “haves”
and the “have-nots” is widening. Frustration with increasing public debt,
insufficient growth prospects, and what is seen as the wrong economic policy
response to these conditions is also giving rise to new movements, such as the Tea
Party.
In Europe, the population in southern Europe and Ireland is protesting against
having to pay higher taxes and receiving lower wages; the main culprits of the
situation have been identified as bankers and politicians, who are not seen as taking
full responsibility. The many reforms needed are creating uncertainties, such as
having to work longer before retirement and facing increased competition for
work. The generous European welfare systems are at a crossroads, as public debt is
rising to the sky and deleveraging is becoming necessary.
In China, the inflation rate decreased from more than 5% in November to 4.6% in
December. Even so, the price increases ordinary people face are much higher than
4-5%, depending on whether one is living in the countryside or in an urban area,
and on the weights of food and energy in the consumption basket. Some have seen
prices of their most-bought items rise 100-200 percent over the last year, while
salaries have increased in nominal terms some 0-20%. For the administration in
Beijing, the task is to strike the right balance between growth and the increasing
risks of overheating, as both too-low growth and too-high price increases can
create the conditions for revolution.
No. 1
2011 01 31

2. To the Point (continued)
January 31, 2011
Chart 1: The income inequality measured by the Gini-
coefficient (0=total equality, 1= total inequality) for What are the implications of greater income
various countries inequality?
0.45
It is easy to brush off the issue of wealth and income inequality, as
0.40
Mid 1980's these issues, while present for a long time, do not seem to have had
Mid 2000's
0.35 large economic consequences.
0.30
0.25
However, during a seminar at the American Economic Association in
0.20
Denver in early January, Raghuram Rajan, Economics Professor at the
0.15 University of Chicago, argued (as he did in his book Fault Lines) that
0.10 increased inequality also helped creating the financial crisis in the US.
0.05 He contends that, as people were falling behind, pressure increased to
0.00
keep them happy with housing credit. As house prices went up, people
China USA India UK Japan Germany Sweden
could feel they had a stake in the future and a participation in growth.
Rajan views this as being an implicit or explicit policy failure, and that
the US – having a less-developed welfare system – had to use
aggressive monetary policy in response to recessions to compensate for
inadequate safety nets.
Regardless of taking a leftist or a rightist political perspective, the
economic policy towards the lower and middle class was “let them eat
credit.” Rajan does not pretend that the causality between the credit
policy towards the households and the financial crisis is
straightforward, but he concludes that there is “enough smoke.” The
right economic policy would in his view be to support more strongly
the reform of the educational system in order to give better access to
education and reduce income inequality, but he does not seem to be
optimistic about the prospects for this outturn.
As the policy of making growth dependent on loan-driven households
no longer seem to be a viable solution, the question is whether
developed nations will adhere to more fundamental policy solutions,
such as reforming education and improving the functioning of the labor
markets. Without reform-oriented growth policies, the lower and
middle classes may be especially vulnerable.
The “haves” will always create more wealth out of the present wealth,
as investing in growth-oriented emerging markets is a source of yield,
albeit perhaps not without interruptions in the years to come. However,
slow growth, as well as deleveraging in both the public and private
sectors in the advanced countries, will hurt welfare systems and
ultimately hurt income prospects for those with lower incomes. The
economic and financial alienation will most likely increase in the
coming years.
The question is whether the various groups responsible for political,
economic, and social developments will be responsive to the increased
anger around the world. Bonuses are again becoming the natural
outcome for many leaders in industrial and service companies,
including banks. In many countries, wage negotiations may become
more complicated as wage agreements for the richest are reaching new,
excessive highs.
It is reasonable to expect that income inequality in emerging markets
will narrow because growth continues to be high, allowing the poorer
people to catch up; however, this inequality will worsen in developed
countries as the deleveraging will dampen growth.
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3. To the Point (continued)
January 31, 2011
Chart 2: Commodity prices in US dollars
The consequences for this latter group may be that it may be harder to
175 accept changes from increased competition from abroad. Technology
150
Totala råvarurpriser, enables the automation of work, while globalisation exports blue-collar
exklusive olja
jobs to countries with lower incomes. The risk is that, as the credit
125 option is no longer viable, protectionism movements in advanced
100 countries will grow larger, with the belief that it could save jobs for
Index
those at the bottom of the income ladder.
Totala
75 råvarupriser
That rich people get richer has not been a problem, as long as poorer
50 people get richer too. However, in the years to come, there is a risk that
Livsmedelspriser
25 growth will be low and unevenly spread, leading to stagnation for
many less-well-off groups. The degree of harmonisation in the society
0 will decrease, and the risk for social unrest may increase.
96 98 00 02 04 06 08 10
Source: Reuters EcoW in
In developing and emerging countries, higher commodity prices are
already seen as nonnegligible political and social risks. The share of
the population in poverty has decreased lately, but there is a risk that
the share may increase again as prices rise above what is seen as
reasonable.
The recent World Economic Forum in Davos highlighted several risks
to a continuation of the global recovery. Commodity prices are one
risk, and the lack of social inclusion is another. Insufficient
democratisation and human rights could alter economic prospects not
only in the Arab world, but also in other parts of the world, including
China. The linkages between economic policy in the advanced
countries and in the emerging markets are becoming stronger, and risk
interconnectedness is becoming more complex. Tunnel vision is not a
viable strategy – instead holistic thinking is key including more areas
of development. Thus, the anger of the world’s populations is certainly
no longer an aspect to be ignored by policymakers.
Cecilia Hermansson
Economic Research Department
SE-105 34 Stockholm, Sweden
Telephone +46-8-5859 1000
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