Jon D. Wisman — How Mainstream Economics Failed To Grasp The Importance Of Inequality

This soaring inequality generated three dynamics that set the conditions for a financial crisis.
The first resulted from limited investment potential in the real economy due to weak consumer demand as those who consume most or all their incomes received proportionately much less.... 

The second dynamic resulting from wage stagnation and soaring inequality is that as the elite with ever more income and wealth ratcheted up their consumption on luxury goods in competition among themselves for the pinnacle of status, everyone below was pressured to consume more both to meet family needs and to maintain their relative status or social respectability.... Pressure was especially strong in housing, the most important asset and symbol of social status for most Americans.... 

The third dynamic is that as the rich took an ever-greater share of income and wealth, they and their corporate interests gained greater command over politics and ideology so as to further change the rules of the game in their favor.... 

Economists might have stood a better chance of foreseeing the developing financial crisis had they thrown their nets far wider to catch the insights that have been harvested by a wide range of so-called heterodox economists. From the underconsumptionist tradition of Keynes, Kalecki, and Minsky they could have developed an understanding of how inequality affects aggregate demand, investment, and financial stability. From the institutionalist tradition of Thorstein Veblen they could have learned how consumption preferences are socially formed by humans who are as concerned with social status and respectability as with material well-being. And from the Marxist tradition they could have seen how economic power translates into political power.

Social Europe
How Mainstream Economics Failed To Grasp The Importance Of Inequality (05/02/2014)
Jon D. Wisman | Professor of Economics at American University