Income Inequality: Why It Matters and Why Most Economists Didn't Notice

by Matthew P. Drennan

The first book-length treatment to conclusively demonstrate the link between income inequality and the 2008 financial crisis and Great Recession

Prevailing economic theory attributes the 2008 crash and the Great Recession that followed to low interest rates, relaxed borrowing standards, and the housing price bubble. After careful analyses of statistical evidence, however, Matthew Drennan discovered that income inequality was the decisive factor behind the crisis. Pressured to keep up consumption in the face of flat or declining incomes, Americans leveraged their home equity to take on excessive debt. The collapse of the housing market left this debt unsupported, causing a domino effect throughout the economy. Drennan also found startling similarities in consumer behavior in the years leading to both the Great Depression and the Great Recession. Offering an economic explanation of a phenomenon described by prominent observers including Thomas Piketty, Jacob Hacker, Robert Kuttner, Paul Krugman, and Joseph Stiglitz, Drennan’s evenhanded analysis disproves dominant theories of consumption and draws much-needed attention to the persisting problem of income inequality. 

Genres: Economics

167 pages, Hardcover

First published November 24, 2015

Reviews

[Adam · Rating 2 out of 5]

This is essentially a lit review and reads about as exciting as one. Drennan doesn't present much of his own ideas and spends most of his time summing up what other economists have wrote on the topic. I'd highly recommend reading Stiglitz or Piketty directly and cut out the middleman. And for such a short book, there was way too much on pseudo-economists like Malthus and Friedman. I don't need a dozen pages on Friedman's critics...I just need a single line saying he was mathematically incompetent and his theories have been proven bunk.

[Syed Fathi · Rating 2 out of 5]

This book is a very short one, discounting the notes, bibliography, and index, it stood only at 132 pages. Despite of a very short book, it is painfully hard to read, on maximum I can only read around 2-3 pages. It is too academic, layman reader will certainly lost with the data and graph.

But I'll try to write what I get from this book (I am a layman).

What was missing in the economic theory that lead to the financial crisis in 2008-09? This was the first question Drennan want to answer in this book. His thesis is that income inequality plays a role in the lead-up to the financial crisis by maintaining consumption through surging household debt. The second question he asks was ‘Why the economist get it wrong?’. Drennan’s answer to the second question is that the consumption theory of neo-classical economics does not include income distribution to their economic theory.

To prove his points, Drennan brought forward econometric evidence to link income inequality with the financial crisis. He also used various set of data to show that many people resort to debt to maintain their consumption, meaning that people borrow more money to buy the necessities to maintain their lifestyle. He also present historical data as evidence to show that the 2008-09 crisis is not something new and has happen before.

Drennan also noted that the two feature that were on the rise leading to financial crash were the stagnant growth of income and income inequality - although this two do not necessarily occur together.

In analyzing the data, Drennan also drew his criticism towards Milton Friedman model for theory of consumption, noting that the theory does not true for the period 1984-2007 and for the early twentieth century. He went further to underline the basic flaw of Friedman, Modigliani, and Brumberg’s model which become the mainstream theory for consumption, the models devoid of motive and proclivities, whereas in real life human behavior play an important role in their daily choices and consumption.

In his final chapter Drennan drew attention that this crash has happen before, and in his conclusion he argue for the need to drop traditional economic theory that did not stood the empirical test from the data. Unless we take into account other element such as ‘behavior’ in our economic theory, we will be chasing unrealistic economic development using unrealistic theory.

[Aishah Nurfitri · Rating 4 out of 5]

Well, just take this with a grain of salt. I’m no economist & I skimmed through this one quite quickly but from what I gathered the central thesis of this book is in short how income inequality leads to economic stability and becomes a decisive factor (and the root cause) of the financial crisis in 2008. This theory that Drennan attempts to put forward in this book is contrary to the prevailing economy theory at that time which attributes the 2008 crisis to low interest rates and relaxed borrowing standards, and most parts of the book were essentially Drennan attempting to prove his theory through figures and statistics (the parts of which I skimmed through hehe).

One of the points I picked out was how stagnant, or in some cases, declining income growth has made it difficult for consumers to afford basic necessities like shelter and education and in turn made heavy loans a necessity to most. Consumers who own houses are thus forced to resort to home equity loans / refinanced mortgages to take out cash. When the housing market collapses and housing prices began to decline sharply, the debt becomes unsupported and no longer sustainable and leads to a hell of domino effect throughout the economy and hence the 2008 financial crisis. He also went on to criticize the failures of other economists to acknowledge income inequality as a contributing factor to the crisis and also explicitly concluded that the classical theory of consumption is wrong as it does not consider income distribution in the theory.

Yall know the drill, it’s easy to get lost in economic concepts especially when jargons are used, but to me Drennan explained them in a way that is simple enough for those of us with no economics background (welp I kinda did take an elective economics course and fail but anyway) to keep up with what he’s trying to deliver. All in all, it serves the purpose of me picking out this book in the first place (though I left in untouchable for a long time hew hew) - and that is to understand why income inequality matters.

[Ahmed Al-Majid · Rating 5 out of 5]

Excellent read that critiques mainstream economic theory and backs up his assertions with data. A must read for *every* economist.