The Economist noted in January:
Hu Jintao, David Cameron, Warren Buffett and Dominique Strauss-Kahn … have all worried, loudly and publicly, about the dangers of a rising gap between the rich and the rest.
A new survey by the World Economic Forum, whose annual gathering of bigwigs in Davos begins on January 26th, says its members see widening economic disparities as one of the two main global risks over the next decade (alongside failings in global governance).
Numerous prominent economists in government and academia have all said that large inequalities can cause – or at least contribute to – financial crises, including:
- Marriner S. Eccles (Federal Reserve chairman from 1934 to 1948)
Add Alan Greenspan to the list, who says:
Our problem basically is that we have a very distorted economy, in the sense that there has been a significant recovery in our limited area of the economy amongst high-income individuals…
Large banks, who are doing much better and large corporations, whom you point out and everyone is pointing out, are in excellent shape. The rest of the economy, small business, small banks, and a very significant amount of the labour force, which is in tragic unemployment, long-term unemployment – that is pulling the economy apart. The average of those two is what we are looking at – that they are fundamentally two separate types of economies.
And IMF economists. As Bnet wrote in May:
New research [shows] that high income inequality may actually hurt long-term economic growth. Two economists at the International Monetary Fund, Andrew G. Berg and Jonathan D. Ostry, released a paper in April that concludes that countries with high inequality are more likely to have shorter spells of positive growth compared to countries with less inequality. That’s another way of saying that high inequality hurts the economy.
Instead of looking purely at the relationship between inequality and growth, Berg and Ostry examined the relationship between inequality and the duration of periods of positive growth. They measure a growth spell as a period of sustained growth and estimate the effect of inequality and other factors on how long growth spells last.
Their model included a variety of factors that economics have previously found to affect economic growth, such as external shocks, the initial income of the country (ie., did it start out very poor or wealthy?), the institutional make-up of the country, its openness to trade, and its macroeconomic stability.
The finding: Only income inequality stood out “as a key driver of the duration of growth spells.”
The economics concluded with the following:
“The main results in this note are that (i) increasing the length of growth spells, rather than just getting growth going, is critical to achieving income gains over the long term; and (ii) countries with more equal income distributions tend to have significantly longer growth spells. …. growth and inequality-reducing policies are likely to reinforce one another and help to establish the foundations for a sustainable expansion.”
Economics professors Saez (UC Berkeley) and Piketty (Paris School of Economics) show that the percentage of wealth held by the richest 1% of Americans peaked in 1928 and 2007 – right before each crash:
The Washington Post’s Ezra Klein wrote in June:
Krugman says that he used to dismiss talk that inequality contributed to crises, but then we reached Great Depression-era levels of inequality in 2007 and promptly had a crisis, so now he takes it a bit more seriously.
The problem, he says, is finding a mechanism. Krugman brings up underconsumption (wherein the working class borrows a lot of money because all the money is going to the rich) and overconsumption (in which the rich spend and that makes the next-most rich spend and so on, until everyone is spending too much to keep up with rich people whose incomes are growing much faster than everyone else’s).
(The graphics above are slightly misleading, as Saez notes that inequality is actually worse now than it’s been since 1917.)
Robert Reich has theorized for some time that there are 3 causal connections between inequality and crashes:
First, the rich spend a smaller proportion of their wealth than the less-affluent, and so when more and more wealth becomes concentrated in the hands of the wealth, there is less overall spending and less overall manufacturing to meet consumer needs.
Second, in both the Roaring 20s and 2000-2007 period, the middle class incurred a lot of debt to pay for the things they wanted, as their real wages were stagnating and they were getting a smaller and smaller piece of the pie. In other words, they had less and less wealth, and so they borrowed more and more to make up the difference. As Reich notes:
Between 1913 and 1928, the ratio of private credit to the total national economy nearly doubled. Total mortgage debt was almost three times higher in 1929 than in 1920. Eventually, in 1929, as in 2008, there were “no more poker chips to be loaned on credit,” in [former Fed chairman Mariner] Eccles’ words. And “when their credit ran out, the game stopped.”
And third, since the wealthy accumulated more, they wanted to invest more, so a lot of money poured into speculative investments, leading to huge bubbles, which eventually burst. Reich points out:
In the 1920s, richer Americans created stock and real estate bubbles that foreshadowed those of the late 1990s and 2000s. The Dow Jones Stock Index ballooned from 63.9 in mid-1921 to a peak of 381.2 eight years later, before it plunged. There was also frantic speculation in land. The Florida real estate boom lured thousands of investors into the Everglades, from where many never returned, at least financially.
Wall Street cheered them on in the 1920s, almost exactly as it did in the 2000s.
I am convinced that a fourth causal connection between inequality and crashes is political. Specifically, when enough wealth gets concentrated in a few hands, it becomes easy for the wealthiest to buy off the politicians, to repeal regulations, and to directly or indirectly bribe regulators to look the other way when banks were speculating with depositors money, selling Ponzi schemes or doing other shady things which end up undermining the financial system and the economy.
As John Kenneth Galbraith noted in The Great Crash, 1929, Laissez-faire deregulation was the order of the day under the Coolidge and Hoover administrations, and the possibility of a financial meltdown had never been seriously contemplated. Professor Irving Fisher of Yale University – the Alan Greenspan, Robert Rubin or Larry Summers of his day – had stated authoritatively in 1928 that “nothing resembling a crash can occur”.
Indeed, when enough money is concentrated in a couple of hands, the affluent can lobby to appoint to government positions, pay to endow prominent university chairs, and create think tanks and other opportunities for economics professors who spout the dogmas “everything will always remain stable because we’ve got if figured out this time” and “don’t worry about fraud” to gain prominence. For example, Bill Black has written about The Olin Foundation’s promotion over the last couple of decades of these dogmas.
As Joseph Stiglitz says:
One big part of the reason we have so much inequality is that the top 1 percent want it that way. The most obvious example involves tax policy. Lowering tax rates on capital gains, which is how the rich receive a large portion of their income, has given the wealthiest Americans close to a free ride. Monopolies and near monopolies have always been a source of economic power—from John D. Rockefeller at the beginning of the last century to Bill Gates at the end. Lax enforcement of anti-trust laws, especially during Republican administrations, has been a godsend to the top 1 percent. Much of today’s inequality is due to manipulation of the financial system, enabled by changes in the rules that have been bought and paid for by the financial industry itself—one of its best investments ever. The government lent money to financial institutions at close to 0 percent interest and provided generous bailouts on favorable terms when all else failed. Regulators turned a blind eye to a lack of transparency and to conflicts of interest.
Wealth begets power, which begets more wealth …. Virtually all U.S. senators, and most of the representatives in the House, are members of the top 1 percent when they arrive, are kept in office by money from the top 1 percent, and know that if they serve the top 1 percent well they will be rewarded by the top 1 percent when they leave office. By and large, the key executive-branch policymakers on trade and economic policy also come from the top 1 percent. When pharmaceutical companies receive a trillion-dollar gift—through legislation prohibiting the government, the largest buyer of drugs, from bargaining over price—it should not come as cause for wonder. It should not make jaws drop that a tax bill cannot emerge from Congress unless big tax cuts are put in place for the wealthy. Given the power of the top 1 percent, this is the way you would expect the system to work.
(Congress is also exempt from insider trading laws.)
The fourth factor exacerbates the first three. Specifically, when the wealthy have enough money to drown out other voices who might otherwise be heeded by legislators and regulators, they can:
- Skew the tax code and other laws so that they can get even wealthier
- Encourage a debt bubble (Bill Black has repeatedly explained that the fraudsters blow huge bubbles, knowing that the government will bail them out when the bust leads to defaults)
- Create new Ponzi schemes for speculation
(Admittedly, there might not always be a direct connection, but all of the factors are at least intertwined.)
Reuters discussed Reich’s first three factors last year:
Economists are only beginning to study the parallels between the 1920s and the most recent decade to try to understand why both periods ended in financial disaster. Their early findings suggest inequality may not directly cause crises, but it can be a contributing factor.
There is little agreement among economists about what precisely links high inequality to crises, which helps explain why so few officials saw the financial upheaval coming.
Rapid expansion of credit is one common thread.
Raghuram Rajan, a professor at the University of Chicago’s Booth School of Business and a former chief economist of the International Monetary Fund, believes governments tend to promote easy credit when inequality spikes to assuage middle-class anger about falling behind.
“One way to paper over the rising inequality was to lend so that people could spend,” Rajan said.
In the 1920s, it was expansion of farm credit, installment loans and home mortgages. In the last decade, it was leveraged borrowing and lending, by home buyers who put no money down or investment banks that lent out $30 for each $1 held.
“Housing credit gave you an instrument to assist those falling behind without them feeling they’re beneficiaries of some sort of subsidy,” Rajan said. “Even if their incomes are stagnant, they feel really good about becoming homeowners.”
Another theory is that concentration of wealth at the top sends investors searching for riskier interest-bearing savings. When so much cash is sloshing around, traditional safe investments such as Treasury debt yield very little, and wealthy investors may seek out fatter returns elsewhere.
Mark Thoma, who teaches economics at the University of Oregon, wonders if the flood of investment cash from the ultra-rich — both in the United States and abroad — encouraged Wall Street to create seemingly safe mortgage-backed securities that later proved disastrously risky.
“When we see income inequality rising, we ought to start looking for bubbles,” he said.
Kemal Dervis, global economy and development division director at Brookings and a former economy minister for Turkey, said reducing inequality isn’t just a matter of fairness or morality. An economy based on consumption needs consumers, and if too much wealth is concentrated at the top there may be times when there is not enough demand to support growth.
“There may be demand for private jets and yachts, but you need a healthy middle-income group (to drive consumption of basic goods),” he said. “In the golden age of capitalism, in the 1950s and 60s, everyone shared in income growth.”
The fact that economists are even examining the link between inequality and financial crises shows just how much the thinking has changed in the wake of the Great Recession.
***Ajay Kapur, a Deutsche Bank strategist, spotted the inequality parallels between the 1920s and the most recent decade, but didn’t see the meltdown coming. The former Citigroup strategist created a stir five years ago when he built an investment strategy around his thesis that essentially divided the world into two camps: the rich and the rest.
Kapur told clients in 2005 that the United States and a handful of other economies were developing into “plutonomies” where the wealthy few powered economic growth and consumed much of its bounty, while the “multitudinous many” shared the leftovers.
Plutonomies come around only once or twice a century, he argued — 16th century Spain, 17th century Holland, the Gilded Age. The last time it happened in the United States was during the “Roaring 1920s”.
At least one new arrival to Washington’s policy-making scene, Fed Vice Chairman Janet Yellen, has expressed concern that extreme inequality could ultimately undermine American democracy.
“Inequality has risen to the point that it seems to me worthwhile for the U.S. to seriously consider taking the risk of making our economy more rewarding for more of the people,” she wrote in a 2006 speech.
No One Likes Inequality
The father of modern economics – Adam Smith – didn’t believe that inequality should be a taboo subject. As Warren Buffet, one of America’s most successful capitalists and defenders of capitalism, points out:
There’s class warfare, all right, but it’s my class, the rich class, that’s making war ….
Conservatives – as well as liberals – are against rampant inequality. If Americans understood how much inequality we have, they would be outraged.
For example, Dan Ariely of Duke University and Michael I. Norton of Harvard Business School demonstrate that Americans consistently underestimate the amount of inequality in our nation. As William Alden wrote last September:
Americans vastly underestimate the degree of wealth inequality in America, and we believe that the distribution should be far more equitable than it actually is, according to a new study.
Or, as the study’s authors put it: “All demographic groups — even those not usually associated with wealth redistribution such as Republicans and the wealthy — desired a more equal distribution of wealth than the status quo.”
The report … “Building a Better America — One Wealth Quintile At A Time” by Dan Ariely of Duke University and Michael I. Norton of Harvard Business School … shows that across ideological, economic and gender groups, Americans thought the richest 20 percent of our society controlled about 59 percent of the wealth, while the real number is closer to 84 percent.
Worse Than Third World Banana Republics
Inequality in the United States is at insane levels. Inequality among Americas is worse than in Egypt, Tunisia or Yemen. As NPR notes, inequality is higher in America than in many Latin America banana republics. And social mobility is lower in America than in most European countries (and see this, this and this).
Inequality between Wall Street and Main Street harms the economy. For example, Steve Keen notes that “a sustainable level of bank profits appears to be about 1% of GDP”, and higher bank profits lead to a Ponzi economy and a depression.
Moreover, as the Atlantic points out, inequality is fracturing the nation geographically as well:
Most stories about inequality in America miss an important point: rising disparities are not just about investment bankers versus auto workers. They’re about entire communities of “winners” and “losers.” And as these communities continue to diverge, the idea of “an American economy” looks more and more like an anachronism.
Economics professor Robert Frank noted last year:
In a recent working paper based on census data for the 100 most populous counties in the United States, Adam Seth Levine (a postdoctoral researcher in political science at Vanderbilt University), Oege Dijk (an economics Ph.D. student at the European University Institute) and I found that the counties where income inequality grew fastest also showed the biggest increases in symptoms of financial distress.
For example, even after controlling for other factors, these counties had the largest increases in bankruptcy filings.
Divorce rates are another reliable indicator of financial distress, as marriage counselors report that a high proportion of couples they see are experiencing significant financial problems. The counties with the biggest increases in inequality also reported the largest increases in divorce rates.
Another footprint of financial distress is long commute times, because families who are short on cash often try to make ends meet by moving to where housing is cheaper — in many cases, farther from work. The counties where long commute times had grown the most were again those with the largest increases in inequality.
And as WBUR reports:
Two British epidemiologists say inequality is a public health issue, a national health issue. From crime rates to drug use to teenage pregnancy to heart disease and more, they say, the evidence shows inequality makes countries sick, even the rich.
Government Policy Is Increasing Inequality
The New York Times notes:
Economists at Northeastern University have found that the current economic recovery in the United States has been unusually skewed in favor of corporate profits and against increased wages for workers.
In their newly released study, the Northeastern economists found that since the recovery began in June 2009 following a deep 18-month recession, “corporate profits captured 88 percent of the growth in real national income while aggregate wages and salaries accounted for only slightly more than 1 percent” of that growth.
The study, “The ‘Jobless and Wageless Recovery’ From the Great Recession of 2007-2009,” said it was “unprecedented” for American workers to receive such a tiny share of national income growth during a recovery.
The share of income growth going to employee compensation was far lower than in the four other economic recoveries that have occurred over the last three decades, the study found.
Robert Reich has noted:
Some cheerleaders say rising stock prices make consumers feel wealthier and therefore readier to spend. But to the extent most Americans have any assets at all their net worth is mostly in their homes, and those homes are still worth less than they were in 2007. The “wealth effect” is relevant mainly to the richest 10 percent of Americans, most of whose net worth is in stocks and bonds.
The recovery has been the weakest and most lopsided of any since the 1930s.After previous recessions, people in all income groups tended to benefit. This time, ordinary Americans are struggling with job insecurity, too much debt and pay raises that haven’t kept up with prices at the grocery store and gas station. The economy’s meager gains are going mostly to the wealthiest.
Workers’ wages and benefits make up 57.5 percent of the economy, an all-time low. Until the mid-2000s, that figure had been remarkably stable — about 64 percent through boom and bust alike.
David Rosenberg points out:
The “labor share of national income has fallen to its lower level in modern history … some recovery it has been – a recovery in which labor’s share of the spoils has declined to unprecedented levels.”
The above-quoted AP article further notes:
Stock market gains go disproportionately to the wealthiest 10 percent of Americans, who own more than 80 percent of outstanding stock, according to an analysis by Edward Wolff, an economist at Bard College.
Indeed, as I reported last year:
As of 2007, the bottom 50% of the U.S. population owned only one-half of one percent of all stocks, bonds and mutual funds in the U.S. On the other hand, the top 1% owned owned 50.9%.
(Of course, the divergence between the wealthiest and the rest has only increased since 2007.)
Professor G. William Domhoff demonstrated that the richest 10% own 98.5% of all financial securities, and that:
The top 10% have 80% to 90% of stocks, bonds, trust funds, and business equity, and over 75% of non-home real estate. Since financial wealth is what counts as far as the control of income-producing assets, we can say that just 10% of the people own the United States of America.
The New York Times notes:
The median pay for top executives at 200 big companies last year was $10.8 million. That works out to a 23 percent gain from 2009.
Most ordinary Americans aren’t getting raises anywhere close to those of these chief executives. Many aren’t getting raises at all — or even regular paychecks. Unemployment is still stuck at more than 9 percent.
“What is of more concern to shareholders is that it looks like C.E.O. pay is recovering faster than company fortunes,” says Paul Hodgson, chief communications officer for GovernanceMetrics International, a ratings and research firm.
According to a report released by GovernanceMetrics in June, the good times for chief executives just keep getting better. Many executives received stock options that were granted in 2008 and 2009, when the stock market was sinking.
Now that the market has recovered from its lows of the financial crisis, many executives are sitting on windfall profits, at least on paper. In addition, cash bonuses for the highest-paid C.E.O.’s are at three times prerecession levels, the report said.
The average American worker was taking home $752 a week in late 2010, up a mere 0.5 percent from a year earlier. After inflation, workers were actually making less.
AP points out that the average worker is not doing so well:
— Unemployment has never been so high — 9.1 percent — this long after any recession since World War II. At the same point after the previous three recessions, unemployment averaged just 6.8 percent.
— The average worker’s hourly wages, after accounting for inflation, were 1.6 percent lower in May than a year earlier. Rising gasoline and food prices have devoured any pay raises for most Americans.
— The jobs that are being created pay less than the ones that vanished in the recession. Higher-paying jobs in the private sector, the ones that pay roughly $19 to $31 an hour, made up 40 percent of the jobs lost from January 2008 to February 2010 but only 27 percent of the jobs created since then.
Corporate profits are up. Stock prices are up. So why isn’t anyone hiring?
Actually, many American companies are — just maybe not in your town. They’re hiring overseas, where sales are surging and the pipeline of orders is fat.
The trend helps explain why unemployment remains high in the United States, edging up to 9.8% last month, even though companies are performing well: All but 4% of the top 500 U.S. corporations reported profits this year, and the stock market is close to its highest point since the 2008 financial meltdown.
But the jobs are going elsewhere. The Economic Policy Institute, a Washington think tank, says American companies have created 1.4 million jobs overseas this year, compared with less than 1 million in the U.S. The additional 1.4 million jobs would have lowered the U.S. unemployment rate to 8.9%, says Robert Scott, the institute’s senior international economist.
“There’s a huge difference between what is good for American companies versus what is good for the American economy,” says Scott.
Many of the products being made overseas aren’t coming back to the United States. Demand has grown dramatically this year in emerging markets like India, China and Brazil.Government policy has accelerated the growing inequality. It has encouraged American companies to move their facilities, resources and paychecks abroad. And some of the biggest companies in America have a negative tax rate … that is, not only do they pay no taxes, but they actually get tax refunds.
Quantitative easing doesn’t help Main Street or the average American. It only helps big banks, giant corporations, and big investors. See this and this. And by causing food and gas prices skyrocket, it takes a bigger bite out of the little guy’s paycheck, and thus makes the poor even poorer.
As I noted in March 2009:
The bailout money is just going to line the pockets of the wealthy, instead of helping to stabilize the economy or even the companies receiving the bailouts:
- Bailout money is being used to subsidize companies run by horrible business men, allowing the bankers to receive fat bonuses, to redecorate their offices, and to buy gold toilets and prostitutes
- A lot of the bailout money is going to the failing companies’ shareholders
- Indeed, a leading progressive economist says that the true purpose of the bank rescue plans is “a massive redistribution of wealth to the bank shareholders and their top executives”
- The Treasury Department encouraged banks to use the bailout money to buy their competitors, and pushed through an amendment to the tax laws which rewards mergers in the banking industry (this has caused a lot of companies to bite off more than they can chew, destabilizing the acquiring companies)
The Fed has given trillions to the biggest banks, and virtually nothing to main street. This has gone to Wall Street bonuses and made the big banks’ executives richer, but the rest of us poorer (and it hasn’t help the economy).
As I wrote in 2008:
The game of capitalism only continues as long as everyone has some money to play with. If the government and corporations take everyone’s money, the game ends.
The fed and Treasury are not giving more chips to those who need them: the American consumer. Instead, they are giving chips to the 800-pound gorillas at the poker table, such as Wall Street investment banks. Indeed, a good chunk of the money used by surviving mammoth players to buy the failing behemoths actually comes from the Fed.
And Tyler Durden notes today, summarizing many of the above-described trends:
In today’s edition of Bloomberg Brief, the firm’s economist Richard Yamarone looks at one of the more unpleasant consequences of Federal monetary policy: the increasing schism in wealth distribution between the wealthiest percentile and everyone else. … “To the extent that Federal Reserve policy is driving equity prices higher, it is also likely widening the gap between the haves and the have-nots….The disparity between the net worth of those on the top rung of the income ladder and those on lower rungs has been growing. According to the latest data from the Federal Reserve’s Survey of Consumer Finances, the total wealth of the top 10 percent income bracket is larger in 2009 than it was in 1995. Those further down have on average barely made any gains. It is likely that data for 2010 and 2011 will reveal an even higher percentage going to the top earners, given recent increases in stocks.” Alas, this is nothing new, and merely confirms speculation that the Fed is arguably the most efficient wealth redistibution, or rather focusing, mechanism available to the status quo. This is best summarized in the chart below comparing net worth by income distribution for various percentiles among the population, based on the Fed’s own data. In short: the richest 20% have gotten richer in the past 14 years, entirely at the expense of everyone else.
Lastly, nowhere is the schism more evident, at least in market terms, than in the performance of retail stocks:
Saks chairman Steve Sadove recently remarked, “I’ve been saying for several years now the single biggest determinant of our business overall, is how’s the stock market doing.” Privately-owned Neiman- Marcus reported “In New York City, business at Bergdorf Goodman continues to be extremely strong.”
In contrast, retail giant Wal-Mart talks of its “busiest hours” coming at midnight when food stamps are activated and consumers proceed through the check-outs lines with baby formula, diapers, and other groceries. Wal-Mart has posted a decline in same-store sales for eight consecutive quarters.
(Indeed, as CNN Money pointed out in March, “Wal-Mart’s core shoppers are running out of money much faster than a year ago …”)
Durden also notes:
Another indication of the increasing polarity of US society is the disparity among consumer confidence cohorts by income as shown below, and summarized as follows: “The increase in equity prices has raised consumer spirits, particularly among higher-income consumers. The Conference Board’s Consumer Confidence index for all income levels bottomed in February/March of 2009. The recovery since then has been notable across the board, but nowhere as much as for those making $50,000 or more.”
Indeed, that could be a fifth factor (adding to Reich’s third factor and the fourth factor of political corruption): inequality dampens the confidence of most consumers.
The bottom line is that government policy is increasing inequality by helping the big boys and hurting just about everyone else.
From Washington’s Blog