The perils of irrational exuberance

One of the apparent economic riddles of the current times is the stock market exuberance despite the unabated pace of the Covid-19 pandemic and global contraction of economic activities. Notwithstanding the substantial economic slowdown in the world during 2020, stock markets are on a bull run since April 2020.

A few factors may explain this boom amidst the poor overall growth.

First, the stock market indices only cover the top firms, and therefore, this increase only shows the performance of the leading firms and does not cover the entire spectrum of the stock markets.

Second, index movements may mask the dispersions among the firms which make up the index.

And third, there may be some genuine growth in sales and profits among most of the firms which are part of the stock market indices.

While these factors may explain some part of this massive boom, it is more likely that the exuberance in the stock market is also due to the flood of liquidity across different geographies arising out of an active pursuit of unmatched fiscal and monetary stimuli. The balance sheet of the US Fed alone went up by more than $3 trillion during 2020.

Collateral damage

We now have learnt the unpleasant lesson that the Main Street (or even large number of Covid-related deaths) hardly matters for Wall Street, at least, as long as the liquidity taps of the central banks of advanced countries are over-active. But the collateral damage of such a phenomenon could be its adverse impact of inequality. It is here that we turn to Thomas Picketty, whose 2014 magnum opus Capital in the 21st Century continues to shape global thinking.

Piketty's primary finding on trends in global inequality is best summed up in his own words as follows: “Since the 1970s, income inequality has increased significantly in the rich countries, especially the United States, where the concentration of income in the first decade of the twenty-first century regained — indeed, slightly exceeded — the level attained in the second decade of the previous century.”

But what drives such an increase in inequality? One of Piketty's basic contention is that inequality (in particular, wealth inequality) is determined by the difference between the returns to wealth (r) and growth in national income (g). Picketty refers to r > g as “the central contradiction of capitalist economics”. Has this central contradiction got exacerbated in recent times?

A look at the data prompts us to infer that it is indeed the case. Illustratively, despite a contraction of the US economy by 3.4 per cent, the return from S&P 500 was as high as 70 per cent. Many other countries, including India, exhibit similar trends (Table).

What are the implications of these enormous wedges between r and g across the world? Following Picketty, the straightforward answer would be a massive increase in inequality. While data on various inequality indicators will take some time to emerge, a few early pointers may be flagged.

The recently published World Economic Outlook of April 2021 of the International Monetary Fund (IMF) has highlighted “divergent recovery” as the current trend of the global economy.

Specifically, it noted, “The divergent recovery paths are likely to create significantly wider gaps in living standards between developing countries and others, compared to pre-pandemic expectations.”

Extreme poverty

As per its calculations, cumulative per capita income losses over 2020-22, compared to pre-pandemic projections, are equivalent to 20 per cent of 2019 per capita GDP in emerging markets and developing economies (excluding China); in advanced economies, the losses are expected to be much smaller, at 11 per cent.

The IMF went on to say, “This has reversed gains in poverty reduction, with an additional 95 million people expected to have entered the ranks of the extreme poor in 2020, and 80 million more undernourished than before.”

On another dimension, one tends to hear about a K-shaped recovery of the global economy, whereby technology and large-cap firms could have made significant gains but at the cost of the small and medium sector and some of the traditional industries. For example, in October 2020, the market capitalisation of Zoom, the video conferencing company, was more than the market capitalisation of the 15 largest airlines in the world.

It is deeply worrying that the pandemic is likely to exacerbate and intensify the increasing inequality that we are witnessing since the beginning of the millennium. Now is the time for effective public policies.

While we see some rationale in US President Biden’s call for higher taxes on the wealthy to help paying for additional federal spending on infrastructure and other priorities, including proposals for a wealth tax and reforms to capital gains and estate taxes, it may too early to see the light at the end of a long dark tunnel.

Other strong redistributive policies like a universal basic income may be needed to alter this trend of increasing disparity.

Parthapratim Pal is Professor, and Partha Ray is former Professor, IIM Calcutta

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