COVER STORY • Can Economics Save the World from Rising Geopolitical Incertitude? • 4

IInterview with Dr. Mark Zandi, Chief Economist, Moody’s Analytics

ncome Inequality Destabilizes
Business Cycle & Lowers
GrowthBy Japan SPOTLIGHT
What are the implications of income inequality for macroeconomic prospects? Dr. Mark Zandi, chief
economist of Moody’s Analytics and a distinguished macroeconomist working on economic forecasts,
talks about the connections between income inequality, growth and business cycles in the followinginterview.
(Interviewed on Sept. 3, 2019)

Assessment of the Current
Global Economy
JS: There is a lot of talk about thegrowing risk of a recession. How
do you assess the possibility of arecession in the current global
economy?

on global oil prices also poses a threat. But
while there are many things to worry about,
the trade war poses the greatest concern.

Income Inequality &Economic Growth
JS: Income inequality would seemto be one of the main drivers of

Zandi: The global economy is struggling, andrising populism around the world.
How do you think income
global recession risks are rising and are
inequality affects your assessment
uncomfortably high. Parts of the globalof economic growth globally?
economy are already close to recession. In
Europe, Germany, Italy and the United
Zandi: The growing wealth and income
Kingdom are near recession. In Latin
inequality across many parts of the world is a
America, Brazil and Mexico are barely
corrosive on global economic growth. I do
growing. And in Asia, Hong Kong, Singapore
Dr. Mark Zandi
not think it is a reason for a recession thisand South Korea have weak economies. The
year, the next year or the year after, but I think it weighs on theescalating trade war between the United States and China and othereconomy’s long-term growth, particularly in places in the world
trading partners is having a negative impact on global trade, andwhere the income and wealth distribution is very significantly
making the global economy vulnerable to a downturn.
skewed. Wealthy and high-income households are able to capture
the political regulatory process and change rules in their favor, and
JS: Do you think a trade war between the US andChina is the principal reason why you consider thethis exacerbates the existing income inequality, and such anrisk of a recession to be so high?
inequality is of a structural nature.
Given the fact that the global economy is already growing very
Zandi: Yes, I think that the trade war is doing significant damage toslowly and long-term prospects are for continued slow growth given
the global economy; not only weighing on global trade but alsodemographic trends and other factors, the skewing in the income
affecting business investment. Global businesses are very uncertain
and wealth distribution means that we are more likely to suffer
and do not know how this is going to play out, and as such they haveeconomic downturns and recessions. That is a real problem because
pulled back on their investment and are turning more cautious in
there aren’t effective policy tools to navigate and manage throughtheir hiring. There are other reasons to be nervous, such as Brexit,
those downturns. Japan is a very good example of this. Monetary
which could contribute significantly to the risk. Even in Japan there
policy is now much less effective than it was in the past, and given
is a VAT increase coming that will have some negative
the heavy fiscal debt burden, there is much less capacity for fiscal
consequences. Growing tensions in the Middle East and the impact
stimulus, so this makes the economy much more vulnerable and
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COVER STORY 4

more likely to suffer periods of secular stagnation because there isno good policy response to it.
The skewing of the wealth distribution in itself is not a catalyst foran economic downturn but it certainly makes it a lot more difficult to
avoid one and to navigate around a recession if it does actually hit. It
is a very pernicious corrosive on long-term growth.
JS: You mentioned that in the short term, income

inequality could have a limited impact, but could
have a significant impact in the long term. Whatwould the “channels” of such an impact beprecisely?

Zandi: The first one is that high net worth households have theability to capture the political and regulatory process where they dobusiness. They can bend the rules in their favor and garner more of
the benefits of government policy. So, it is more likely that they cancollect the rents of protection that they receive, and these rents could
increase.
This means that economic activity is not being allocated efficiently
and that will weigh on long-term productivity growth and therefore
long-term economic growth. This varies – in some parts of the world
it is a significant problem, others less so – but as the income andwealth distribution becomes more skewed, it becomes more andmore of an issue. It is very difficult to measure and quantify but is avery pernicious problem. You can see this in the industries oftechnology, media, telecommunications, and pharmaceuticals; theseindustries are dominated by very large companies that are owned bya very small number of people who do have a lot of politicalinfluence and are able to influence the government to create rulesthat work in their favor.
The second channel goes to the fact that the long-run potential
growth of the global economy is much lower today and will be forthe foreseeable future than has been the case since World War II.
This is linked to demographic trends including aging populations.
This affects not only the growth of the labor force but also
productivity growth. So you have slower underlying growth, and theskewing in income and wealth distribution creates incentives forlower income households to take on debt leverage and greater
financial vulnerabilities that make them exposed, and then when theeconomy goes into recession it is very difficult to get out of it
because there is no effective policy response. So it is much more
likely that we will see economies that are struggling to grow and to
break free from these broader forces at work such as income
inequality.
One final point is that it is difficult to explicitly connect the dots
between income and wealth distribution and economic growth; thechannels are more indirect and not as obvious as one might think.

Income Inequality & Business Cycle
JS: You also mentioned in your essay in After Piketty:

The Agenda for Economics and Inequality publishedin 2017 that income inequality could destabilize thebusiness cycle and that the debt problem in poor
households would create this instability. Is that right?

Zandi: Exactly right. The crisis 10 years ago that emanated from the
US was caused largely by the leveraging of lower- and middleincome households motivated in significant part by the skew in
wealth and income distribution. These households had notexperienced any significant increase in real incomes or wages or
wealth for several decades and in the period prior to the financial
crisis they had access to significant amounts of credit – mortgage
debt, credit card debt, auto debt, and so forth. They took on a lot of
debt and this was the main culprit for the downturn that followed.
This kind of massive leveraging by households seems much lesslikely to happen today in the US given that in response to thefinancial crisis there were a lot of regulatory changes. It is now a lot
more difficult for those households to take on that debt. But the risk
exists in many other parts of the world – the economies whereleverage has increased significantly and continues to increasesignificantly and in part probably due to the skewing in income andwealth distribution. Places like Australia and Canada, theNetherlands, the UK have all seen significant increases in leverage ofdebt and there are lots of reasons for that, but the fact that low- andmiddle-income households have not seen any increases in theirwealth for decades may be one of the reasons.
JS: Not only poorer households, but also wealthypeople seem to be depending significantly on asset
prices. Would you agree?

Zandi: This is an excellent point. Wealthy households havesignificant assets and their spending and investment behavior is verymuch tied to the ups and downs in asset prices, much more so thanin the past. Asset prices are highly volatile and in recent decades wehave experienced significant bubbles in asset prices.
Something that also might be related to the skewing in income andwealth is that wealthier households have invested very aggressively
in these assets that have appreciated significantly in value and attimes into bubbles. This results in a more cyclical economy throughso-called wealth effects in which high income and wealthy
households change their spending behavior very sharply anddramatically in response to shifts in asset prices, including stock
prices, housing values, commercial real estate values, bond prices,and so on. This makes the global economy much more cyclical andvulnerable. If interest rates are already low or negative, then theJapan SPOTLIGHT • January / February 201917

COVER STORY 4

heightened volatility in the economy is much more dangerous as it
makes it much more likely to fall into a recession and harder to get
out of one.
JS: With regard to the impact of income inequality on

the business cycle and long-term economic growth,
could there be some differentiation among developed
economies?

Zandi: The skewing of the income distribution varies substantiallyacross the globe, and indeed has become less skewed amongdeveloping economies in recent decades. Globalization has lifted
hundreds of millions of people out of poverty; China is the best
example as the wealth and income distribution has become muchless skewed. In the developed world, and in particular in countries
like the US and European economies, income and wealth distribution
has become much more skewed as a result to the globalization
process. The US is probably the best example of the skewing inincome and wealth as it is much more unlikely to use government
policy to redistribute income and wealth. In many European
countries, there are very progressive tax codes – wealth and estatetaxes that work to mitigate the skewing of income and wealth, butmuch less so in the US. That may change; a lot of the presidential
candidates on the Democratic side are focused on this issue andwant to increase wealth taxes and mitigate the distribution in income
and wealth, but as of now this is not the case, at least not as muchas in Europe, Canada and other developed economies.

Differentiation of Income Inequality
Among Nations
JS: Do you think that income inequality in the US has

been expanding and diminishing in Europe?

Zandi: It has been widening – the skewing has becoming moresignificant in the US and to a lesser degree in the rest of the world. If
you consider government policy, taxes, benefits and other forms of
public support, the skewing of the distribution is less pronounced
everywhere, but much less so in Europe and Canada compared to
the US. But even in Europe you can see there is a lot of tension
among lower-income households, and a lot of this has fueled the
populist movements there.
JS: Income inequality is different between developed

and developing nations. In the case of developing
nations, income inequality is emerging as a “middleincome” trap; the shrinking middle class indeveloping countries could hamper long- or mid-term
economic growth. How do you evaluate the different

18 Japan SPOTLIGHT • January / February 2019consequences of income inequality upon developing
and developed economies?
Zandi: In general, in developing economies the distribution of wealthand income has become less skewed over the last quarter of acentury, but that goes to the benefits of globalization on thoseeconomies. They have been able to reap the benefits of that
globalization and have helped to lift everybody in their economy but
in particular low-income households in the last few decades. At thesame time, that is why lower- and middle-income households in thedeveloped world have struggled, because they lost incomes, wages,
and wealth to the developing world due to the globalization process,among other factors. Technology has also played a role in enabling
globalization, but also the adoption of new technologies has been
most pronounced in the developed world and that has significantly
impacted lower- and middle-income households. This has beenongoing for much of the past half century.
Having said this, the impact of globalization on income and wealthdistribution is about ready to turn, especially if the world doesn’t pullaway from globalization. Because of globalization, many developing
economies now have large and quickly growing middle classes whoare beginning to buy many of the high valued-added goods andservices produced in the developed world. The developed world is on
the cusp of selling much more to the developing world, which will
create many jobs and ultimately work to reduce the skewing inincome and wealth. It would be a dark irony if the developed world
turned away from globalization now, just when globalization was set
to benefit everyone, including lower income and less wealthy
households.
JS: If China is suffering from the middle-income trap,

its consumption would not grow so significantly andthis would impede its economic growth, wouldn’t it?

Zandi: Yes, it would and I think they realize that and are trying toaddress it. One potential solution to that problem is to strengthen
their social safety net. Unlike many developed economies, they havevery little in the way of retirement benefits or healthcare benefits orunemployment benefits, and therefore the population has to save a
lot and does not spend very much; consumers and households bear
all the risk. I think the Chinese understand that they need to harden
their social safety net to address the problem and I believe they havebeen moving in that direction for the last decade. China is
symptomatic of this problem in many developing economies.

Income Inequality & Policies
JS: Do you think this income inequality is the main

driver of increasing populism today?

COVER STORY 4

Zandi: It is a very significant factor, as lower- and middle-income
households have not seen their wages or wealth increase for many
decades. They now feel helpless and are worried that their children
are going to do worse than they are financially and they are very
upset by that. On top of that, massive global migration flows makethem very nervous because they worry that immigrants will taketheir jobs and their incomes. So the combination of the skewing ofincome and wealth distribution and the very significant flows ofpeople across borders has fuelled the populism that is evident
across the globe, particularly in developed economies.

educational opportunities. There are many open questions regarding
the efficacy of wealth taxes, as these households have significant
means to avoid paying them, but increasing thought is being put into
how to design these taxes to address these issues. Other types oftaxes being debated to address income and wealth inequality include
carried interest taxes on private equity firms and financial transaction
taxes. Finally, increasing the income threshold for the payroll tax thatfunds the nation’s retirement system is also a possibility. The
effective tax rate on high income and wealthy households isgenerally much lower than in other parts of the developed world.

JS: Do you think that the capacity of the current fiscal

JS: In the future, do you think it would be necessary to

Zandi: I worry about it; I am not sure that policymakers are up to thetask. I might have had a different view several years ago, but now I
worry that populism is overtaking the political process and theresulting policy response is wrong-headed. Anti-globalization
sentiment is not to anyone’s benefit and will hurt everybody from the
top to the bottom of the income and wealth distribution. We are also
underinvesting in educating, training and re-training the workforce
and we are not building the public infrastructure that is needed for
economic development, especially in poor areas. I worry that policy
is not moving in the right direction. On top of that, the fiscal health ofmany countries is deteriorating, reducing the resources available toaddress the skewing of income and wealth.
The political capacity for governments to address the income andwealth distribution is also eroding. Populist sentiment is overtaking
the political process and we are unable to collectively deal with these
serious problems and as such they are becoming self-reinforcing. I
am as pessimistic about this as I have ever been, and I’m not at all
sure we are going to be up to the task globally to address thisproblem. Something has to shift fundamentally before we canaddress these problems in a meaningful way.

Zandi: Yes, macroeconomic models need to catch up to the growing
chasm between the wealthy and the poor in many parts of the world.
Until recently, most macroeconomists, at least those focused on theeconomy’s prospects, have all but ignored inequality in theirthinking. Their implicit, if not explicit, assumption is that inequality
doesn’t matter much when gauging the macroeconomic outlook.
This is a mistake, as inequality makes the financial system lessstable, as credit-constrained low-income households are potentiallysignificant risks, and the economy more cyclical, as wealthierhouseholds that account for the bulk of the spending are sensitive toswings in increasingly volatile asset markets. This may not be a big
deal if financial markets and the economy move in a more-or-lessstraight line, but it could be a huge deal if they don’t.
This is especially true given that the economy’s potential growth
will be much slower going forward than in the past, suggesting that
recessions will be more likely. With monetary and fiscal policy
almost certainly rendered more impotent by the zero lower boundand tighter political fetters, future recessions could be more severe.
A critical lesson of the Great Recession is that recessions dopermanent damage to the economy, diminishing its potential. Few, ifany, macroeconomists have models that account for this in theirlong-term projections. Macroeconomists should thus not be
comfortable that they have a good grip on what inequality means forour economic prospects.

and monetary authorities is good enough to stabilize
the economy and business cycle by mitigating
income inequality?

JS: You mentioned tax policy and regulations in orderto mitigate income inequality. Assuming that ourgovernment has serious constraints on fiscal andmonetary policies, what kind of tax policies would benecessary to mitigate income inequality?

Zandi: In the US, there is increasing attention to the possibility ofincreasing existing estate taxes and implementing new wealth taxes
on those at the very top of the wealth distribution. The tax revenues
that would be generated would be used to finance policies that
support lower- and middle-income households, including more
affordable housing, increased childcare and health care, and greater

create a macroeconomic model taking income
inequality’s long-run impact on the economy into
consideration?

Written with the cooperation of Joel Challender, who is a translator, interpreter,
researcher and writer specializing in Japanese disaster preparedness.

Japan SPOTLIGHT • January / February 201919