"DOES economic inequality cause crises?" asks economist Ed Glaeser at the New York Times' Economix blog. Mr Glaeser surveys the literature as it relates to a handful of different inequality-crisis mechanisms and he concludes that inequality was likely "only a small part of the story", at least during the most recent crisis. But Mr Glaeser neglects one potential causational avenue in his analysis. Happily, that relationship is explored in a thoughtful piece in the American Interest magazine by economist Tyler Cowen.

Mr Cowen begins his essay by describing the ways in which inequality is not a problematic feature of American society. Much of the recent rise in American inequality can be explained, he writes, by demographic shifts or education, as well as the changing return to high achievement thanks to improvements in communications technologies. But one aspect of rising inequality is more pernicious:

If we are looking for objectionable problems in the top 1 percent of income earners, much of it boils down to finance and activities related to financial markets. And to be sure, the high incomes in finance should give us all pause... In normal years the financial sector is flush with cash and high earnings. In implosion years a lot of the losses are borne by other sectors of society. In other words, financial crisis begets income inequality. Despite being conceptually distinct phenomena, the political economy of income inequality is, in part, the political economy of finance. Simon Johnson tabulates the numbers nicely: From 1973 to 1985, the financial sector never earned more than 16 percent of domestic corporate profits. In 1986, that figure reached 19 percent. In the 1990s, it oscillated between 21 percent and 30 percent, higher than it had ever been in the postwar period. This decade, it reached 41 percent. Pay rose just as dramatically. From 1948 to 1982, average compensation in the financial sector ranged between 99 percent and 108 percent of the average for all domestic private industries. From 1983, it shot upward, reaching 181 percent in 2007. If you're wondering, right before the Great Depression of the 1930s, bank profits and finance-related earnings were also especially high.

Mr Cowen describes a financial world in which banks make easy bets that pay off most of the time but occasionally explode spectacularly. In the good times, the financiers get very rich. In the bad times, they get bailed out. This encourages them to take even bigger risks during good times, which makes them even more rich, and which increases the size of future bail-outs. Ultimately, Mr Cowen laments:

A key lesson to take from all of this is that simply railing against income inequality doesn't get us very far. We have to find a way to prevent or limit major banks from repeatedly going short on volatility at social expense. No one has figured out how to do that yet.

Why is it so difficult? Well, regulation may not be up to job of restraining rich financiers. Libertarians may argue that if banks are allowed to fail then the cycle will be broken. But, Mr Cowen says, this is a difficult solution to adopt in practice, not least because rampant bank failures will cause substantial pain among taxpayers at large.

It's a compelling story, but Mr Cowen appears to leave one important cog in the inequality-crisis mechanism underexplored. Conveniently, my colleague W.W. has explored that cog, but outside the context of the broader mechanism. At Democracy in America, he writes:

Last July Peter Orszag stepped down from his post as the head of the Office of Management and Budget. As budget director, Mr Orzsag helped shape the first stimulus package and, more visibly, the health-care reform legislation. Apparently, the market values this sort of experience. Last week, Mr Orszag accepted a senior position at the investment-banking arm of Citigroup, an institution that exists in its present form thanks to massive infusions of taxpayer cash. Exactly how much Citigroup pay Mr Orszag is not public knowledge, but swapping tweed for sharkskin should leave him sitting pretty. Bankers who spoke to the New York Times ballparked his yearly salary at $2-3m. James Fallows rightly observes that not only is the revolving door between Washington and Wall Street unseemly, its frictionless gliding action suggests corruption is built right into the interface between our government and our great profit-seeking institutions. Mr Fallows hesitates to impugn Mr Orszag's personal character. Who can blame a fella for throwing open the door when extravagent opportunity knocks?! But in the grander scheme, his move illustrates something that is just wrong. The idea that someone would help plan, advocate, and carry out an economic policy that played such a crucial role in the survival of a financial institution—and then, less than two years after his Administration took office, would take a job that (a) exemplifies the growing disparities the Administration says it's trying to correct and (b) unavoidably will call on knowledge and contacts Orszag developed while in recent public service—this says something bad about what is taken for granted in American public life.

Interestingly, my colleague suggests that Mr Orszag's passage through the revolving door illustrates a key weakness of progressivism:

In my opinion, the seeming inevitability of Orszag-like migrations points to a potentially fatal tension within the progressive strand of liberal thought. Progressives laudably seek to oppose injustice by deploying government power as a countervailing force against the imagined opressive and exploitative tendencies of market institutions. Yet it seems that time and again market institutions find ways to use the government's regulatory and insurer-of-last-resort functions as countervailing forces against their competitors and, in the end, against the very public these functions were meant to protect. We are constantly exploited by the tools meant to foil our exploitation. For a progressive to acknowledge as much is tantamount to abandoning progressivism. So it's no surprise that progressives would rather worry over trivialities such as campaign finance reform than dwell on the paradoxes of political power. But it really isn't the Citizens United decision that's about to make Peter Orszag a minor Midas. It's the vast power of a handful of Washington players, with whom Mr Orszag has become relatively intimate, to make or destroy great fortunes more or less at whim. Well-connected wonks can get rich on Wall Street only because Washington power is now so unconstrained. Washington is so unconstrained in no small part because progressives and New Dealers and Keynesians and neo-cons and neo-liberals for various good and bad reasons wanted it that way.

Both Mr Cowen and Mr W are saying that Wall Street's great wealth flows from the government, and in particular from the one-sided bets it hands out in order to protect the country against various ills, namely, economic depression. Both men also seem to wish, as a solution, for a sadly unobtainable libertarian world in which markets handle their own business. Here's my colleague:

The monstrous offspring of entangled markets and states can be defeated only by the most thorough possible separation. But public self-protection through market-state divorce can work only if libertarians are right that unfettered markets are not by nature unstable, that they do not lead to opressive concentrations of power, that we would do better without a central bank, and so on. Most of us don't believe that. Until more of us do, we're not going far in that direction.

I'm sympathetic to this view. The financial system is shot through with moral hazard problems stemming from financial rescues of the recent and more distance past. Much good would come of efforts to restore market discipline by allowing investors to take their lumps. Still, there seems to be another plausible narrative lurking within the stories told in the pieces quoted above. It's one in which governments support the financial sector not simply to protect against harm in the real economy, but because of the political power of the financial sector. This story is one of a plutocratic cycle, in which the rich write their own financial rules and become richer still, and in which well-meaning public figures are co-opted by the enormous sums available to those willing to embrace the Wall Street worldview.

In this telling, it isn't the power of Washington that's the problem (even a much weaker federal government would have had the wherewithal to bail out the big banks). Rather, it's the power of Wall Street. And the solution to the problem might well be a highly progressive system of financial regulation and taxation. Certainly this is the argument made by prominent writers like Paul Krugman. And they can point to the period from the end of the Second World War to the early 1980s, during which government was big, inequality was low, and crises were rare, as evidence for their ideas.

This is no foolproof solution. Banking has changed since the 1960s, and effective regulation may be more difficult to put in place than it once was. Mr Cowen points out ways in which some high incomes have resulted from healthy economic trends, and high earners in those categories could be unfairly punished by high tax rates, in ways that would reduce healthy investment and risk-taking.

But if we can draw a line between government policy and fabulous financial wealth, and if we then see the fabulously financially wealthy putting former members of the government on the payroll, it stands to reason that the financial sector is acting, quite purposefully, to use its vast wealth to influence government policy in ways that will make it rich. And if that's the case, then it could be that policies cutting financial sector pay are just as effective a means to break the plutocratic cycle as policies that limit the scope for government bail-outs.