It’s The Income Inequality Stupid!

May 5, 2012
By

Before the late 1970s, few economists in the United States gave much thought to the idea of economic inequality. In fact, it was hardly mentioned at all. However, as conditions have changed in the last 30 years, the incomes of the nation’s wealthiest 1 percent have surged, and drawn the scrutiny of a growing field of prominent economists.

Income in the United States by percentile, nor...

However, there’s still plenty about economic inequality that’s not well understood. Among those are :

  • What’s actually driving the gap between the richest and poorest
  • Does it hurt economic growth, or is it largely benign
  •  Should it be reversed
  •  Can it be reversed.

In his fascinating new book James K. Galbraith, an economics professor at the University of Texas at Austin, takes a more detailed look at inequality by assembling a
wealth of new data on the phenomenon in his new book, “Inequality and Instability,”.

He details that economic inequality has been rising in similar ways around the world since 1980. Moreover, this rise is driven mostly by the financial sector. Among the more interesting coincidence-defying findings are:

  • There are common global patterns in economic inequality across different countries that appear to uncannily consistent with major events affecting the world economy as a whole. The most important have been changes in financial standings and changes in systems of financial governance.

Among the more well-known, big difference occurred when:

  1. § The Bretton Woods system ended in 1971.
  2. §  The S&L crash and crisis of the 1980s
  3. §  The year 2000 NASDAQ crash
  4. §  The Real Estate and Investment Bank crash in 2008

These events all had global repercussions, and they affected inequality around the entire world in different ways.

The most unconventional finding in his book is how inequality relates to macroeconomic performance and financial factors. The discussion of inequality tends to indicate a marketplace perspective that stresses individual-level characteristics.

Economists have always classified this as a microeconomic problem. But when something’s happening at the same time around the world, in different countries that are widely separated geographically and by governing philosophies from Capitalism to Socialism to Communism, that’s a macro issue. These indicate a distinct global movement toward higher inequality as a direct result of the financial stresses that the world is under; and is not limited to the United States by any means.

So What Caused the Change in the U.S.?

  1.  Between the end of World War II and 1980, economic growth in the United States is mostly an equalizing force, and job creation was not directly tied to rising economic inequality. But after 1980, economic booms and rising inequality go hand in hand.
  2.   In 1980, we essentially went through a fundamental transformation. We stopped being a wage-led economy with a growing public sector that was providing new services for a demanding consumer base. Programs like Medicare and Medicaid were also major drivers of growth in the 1970s.
  3.   Instead, after the early 1980s we became a credit-driven economy. The evidence in the U.S. shows that the rise in inequality is associated with credit booms, which almost always occur in times of prosperity.
  • 1)  One was in the late 1990s with information technology and
  • 2)  One was in the 2000s with housing, before everything fell apart.

< Now, during the drastic downturn, U.S. consumers have de-leveraged more than any other western country.>

The downside is that this is also a sign of instability, i.e. the crash that follows credit-driven booms is very ugly business. If we’re going to go forward with growth on a more sustainable basis, then controlling inequality and controlling instability are the same issue. One, indeed, defines the other.

Different Types of Economic Inequality

Galbraith further points out that inequality of pay is an attempt to measure what people actually earn for their work, and is strongly dependent on the state of the economy. It goes up and down with the unemployment rate. Workers down at the bottom of the wage spectrum are often hourly workers, and their hours are dramatically affected by slack demand which drives down their household income, not their willingness to work.

Inequality of income, however, is a tax concept. It is wholly defined by politicians with the IRS as Congress’s enforcer.  The income inequality in the United States is very strongly influenced by the incomes at the very top, which is driven by the stock market and related capital markets and remains largely unaffected by downturns as evidenced with the current disparity in household incomes with record market levels.

This is clearly evident, not only by looking at the timing, but also where incomes are rising. During the technology boom, it was in Silicon Valley. During the Real Estate debacle it was Wall Street and Manhattan. This was a small group of people grouped into relatively small geographic units. It may be the top 0.1 percent, but it had an extreme effect on overall income inequality.

What About the Skills/Education  Affect?

Professor Galbraith goes on to say that the notion that inequality is being driven by technological change and education and the supply of skills is comprehensively rebutted by the evidence.

What we have historically witnessed was a concentration of income in specific sectors. In addition to finance, in the 1990s it was technology, and in the late 2000s it was in real estate; both closely related to the credit cycle. That’s what’s driving the data.

This distinction has important implications for policy and for how one thinks about what can and should be done about this condition. If skills bias is the explanation, then that, at most, supports a case for more investment in education and training. It’s essentially saying that inequality is the result of technological change, and since technological change is wonderful, we should just accept it. But that’s clearly not what the evidence shows.

We’ve Seen What is Happening in the U.S. What About Europe?

According to Galbraith, one needs to take the concept of an integrated European economy seriously, and that means measuring inequality on a Europe-wide scale, not the extremes of the curve.

Countries in the north tend to be very egalitarian, but the gap between the north and south in Europe is larger than the gap between north and south the United States. That’s an illustration of the stresses affecting the European Union right now. They simply don’t have effective mechanisms to allow the poorer regions to pay their debts to the richer ones.

The United States, however does: Since the 1930s we’ve had an integrated Social Security system, regional development programs like the TVA; the kind of things that help bring up the poorer regions of the country. Those simply aren’t present in Europe to the same degree. But if the U.S. does not take advantage of that advantage a similar result to Europe’s mess is not only possible, but probable.

Politicians are not the solutions to problems. Politicians are the problem.

Today’s below par employment report demonstrates the stark reality facing U.S. policy makers: If they want to create more jobs, they will have to find a way to generate more economic growth. Tax cuts and reduced spending has been proven to fail miserably in spurring growth.

The Labor Department reported that U.S. nonfarm payrolls grew by 115,000 in April. That is just barely enough to reduce the unemployment rate, which inched down to 8.1 percent in April from 8.2 percent in March as the number of people looking for work declined.

The weakening trend that has been emerging for months simply confirms a fundamental rule of economics: It takes better-than-average momentum to achieve a significant decline in unemployment. According to an economic theory known as Okun’s Law — named after Arthur Okun, an economic adviser to Presidents Johnson and Kennedy– growth must exceed its long-term potential rate by two percentage points to lower unemployment by one percentage point.

For a brief period, the labor market actually seemed to be defying this tenet. The jobless rate fell 0.9 percentage point in 2011, even though the economy grew at a rate of only 1.7 percent.

Nice While It Lasted

The trajectory of the employment-to- population ratio in the three months through April suggests an annualized decline of only 0.4 percentage point in the unemployment rate. This is more in line with economists’ average forecast of 2.3 percent growth this year, and with their expectation that the jobless rate will still be well above 7 percent at the end of 2014.

So if policy-makers in Washington are going to make a move, it had better be soon. It’s obvious that the Republicans are gambling with the economic welfare of the U.S. to procure the stated primary goal of Senate Minority Leader Mitch McConnell; which is to do whatever necessary to bring down President Obama, even if it destroys the U.S. economy and millions of lives.

I say this because the only feasible, logical, and reasonable answer to the economic cancer that is metastasizing with every passing day is more growth through fiscal stimulus. Research from the Brookings Institute just this past March shows that added government spending tends to be particularly effective during economic downturns, despite the rhetoric to the contrary from the Neo-Confederate Party, which has never given up on the rejection of the Articles of Confederations (and its emphasis on state’s rights), in favor of the U.S. Constitution.

When interest rates are extremely low, and long-term unemployment is threatening to do permanent damage, the growth boost would reduce the U.S. government’s debt burden.

Unfortunately, the Republican Congress seems likely to do precisely the opposite while using the despicable cover of politics for political gain as the reason for their actions. If politicians can’t agree on a way to extend some of the Bush tax cuts beyond the end of this year and to postpone the automatic spending reductions dictated by last year’s debt-ceiling deal, the negative effect will be exponentially worse. And one only has to look at the U.K. and the euro zone for proof.

The political stalemate leaves the Federal Reserve as the only entity capable of providing stimulus. As the Republicans in general, and the ignominious, clueless followers of Ron Paul in particular, decry the Federal Reserve as an aberration, its arsenal of economic effect is waning more quickly than Paris Hilton’s celebrity status. In short, this will get ugly unless there is an unexpectedly uptick in voter understanding of the issues at hand.

Because the Republican Party has placed its own agenda over the good of the country, the Fed must stand ready to act again as a desperate move of last resort.  Congress has only worked 41 days in the first five months of 2012. The Fed might not be able to put millions of people back to work single-handedly, but it can help protect what little we have gained. And the Neo-Confederate, state-ist Republicans seem determined to return the U.S. to the days before the “UNITED” in United States really meant nothing at all.

 

 

Harvey Gold

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