While looking for some current material on public debt for my intermediate macro students, I came across this article from the Economist. It highlights the important role that US government debt plays in the financial markets. As you might know, the short term debt securities act as a good collateral in financial transactions, safe haven for foreign countries US dollar reserves and hence are always in demand. A steady supply of such securities crowds out the need for other asset backed securities to act as collateral and hence may reduce systemic risk and other harmful effects of private money creation. This reminds me of this blog post by David Andolfatto a while ago. It comments on Ricardo Caballero’s paper on Macroeconomics of Asset Shortages where Ricardo proposes that the root cause for mortgage based currencies gaining demand was shortage of good assets to facilitate financial transactions.
The point I want to make here is this: usually, a rise in government spending is associated with the rise in public debt. However, while thinking about efficacy of public spending in the context of current stimulus debate, I haven’t seen this beneficial role of the public debt taken into account. If we do so, then the estimated government spending multipliers that are rarely greater than one, can be argued to be actually underestimating the total beneficial effect of government spending. The important question however is how to estimate these benefits. Looks like a good food for thought over the summer break!
The business cycle properties of data in the US says that consumption is much less volatile than the GDP. This suggests that households do engage into consumption smoothing and hence looking at consumption distribution is not a good gauge for what is happening to income distribution. A similar argument can also be made for India and hence the debate on effects of liberalization policies would do better if based on income distribution than just on consumption distribution. C.P. Chandrashekhar and Jayati Ghosh make this point quite well in their recent column in The Hindu Business Line.
According to their analysis the share of wages and salaries in the national income of India has shown a decline since 1991. This decline is evident both as a share of total NDP as well as of Organized sector NDP. It was roughly around 70% for a decade preceding the economic reforms and has declined since to 50% in the year 2009. This might seem surprising given that in the US (and probably most of the developed world ) the share of compensation of employees in national income has remained between 60-70% for last 50 years or so.
The authors suggest this as an evidence for rising income inequality after the economic reforms and I don’t necessarily disagree with that interpretation.This issue is certainly important to look into and might suggests a role for policy intervention.
However, the contrast with the US suggests that there might be some other factors at play causing the shares to settle at different values in both these countries. One reason for this contrast is that the factor shares could reflect the relative factor scarcity. Capital being relatively scarce in developing countries compared to the developed ones, higher overall returns for it might be expected. The other reason might be the declining importance and presence of unions in the Indian organized sector after reforms than before. If one admits that most of the growth of the organized sector has been because of the rising service sector, then this does makes sense. In addition, the continuing rigidity of labor laws might also mean a lower opportunity cost for ones time further reducing the bargaining power of the workers.
Overall, these empirical regularities and differences in factor shares across countries are definitely worth investigating more.
Update- January 24, 2014: The recent issue of QJE has a paper on this issue. Looks like declining labor share is not just an Indian phenomenon. The authors surmise that the relative decline in price of investment goods explains this trend. You can read it here.