Raghu Rajan has a piece on income equality and its impact on the recent financial crisis.  It’s the same theme he addressed in depth in his excellent recent book, Fault Lines.  As income inequality increases, politicians come under pressure.  They have three possible ways to address the problem: fix the underlying problem, wealth transfers, or increase credit availability to increase consumption.

Fixing the underlying problem is beyond most politicians’ planning horizon, and thus of little interest to them.  Wealth transfers have well-known incentive problems, and they eventually result in high government debt.  Still, this path is popular in some countries, Greece for example.  It is, however, not sustainable in the long run.

In the United States, we choose to increase credit availability, in large part through housing markets.  Ultimately, though, this process is also self limiting.  The debt buildup eventually results in a crisis, one with huge social costs.  As Rajan notes, the current crisis is not the first where the United States tried to lend its way out of an inequality problem.

California has a huge and growing inequality problem, one that I’ve been talking about for years.  Santa Barbara and Monterey are extreme examples of what we see statewide. These are communities of the wealthy, most of whom made their fortunes elsewhere, and the mostly low-wage workers who provide services to the wealthy.

The middle class has mostly left Monterey and Santa Barbara, and they are leaving California.  California’s domestic migration has been negative for years now.  At the same time, the low-wage population is growing.  International migration contributes to the problem, but it is by no means the sole source of the problem.

California must implement two sets of reform to address the growing inequality problem.  It must stem domestic migration tide by increasing opportunity for the middle class.  This would involve several policies that would make California more profitable for business and manufacturing: increased infrastructure investment, tax reform, and regulatory reform.  The benefits of a pro-business regime would be felt most by low-wage and middle-wage workers.

Stemming domestic migration is only part of the problem.  At present, California completely fails its lower class population.  It begins with an educational system that many don’t complete, while many of those who do are often unprepared to participate in a 21st century economy.  It ends with a lack of opportunity and upward mobility.

California’s K-12 program is a failure.  Dropout rates are extraordinary, and those who finish are often unprepared for employment or college.  The failure continues when the few who do manage to prepare for college find that the price has gone up and is now unaffordable for many.  Just as bad, classes are often not offered at times that are convenient for working students.

California needs to renew its commitment to education, at all levels.  In particular, it needs to make education more effective and available to disadvantaged students.  In the end, Education and opportunity, and you need both, are the only long-term solution to inequality.  In the end, we can’t afford not to address the problem.