Welcome to “A Civil American Debate”

CONTENTS TOPICS

Go here for a “table of contents” listing the topics we address in this site.  Each topic is a hot link to a page where you can quickly access all of our posts on that topic.  All posts are listed with a brief description, with the most recent first.     

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The Economics of  Wealth and Income Inequality  

Go here for a chronological list of all posts addressing the economics of America’s most fundamental problem: class warfare between the top 1% and the bottom 99% of income earners, the continuing and accelerating growth of income and wealth inequality, and inequality’s causes and solutions. These posts describe and develop the essential features of the dynamic causes and effects of income and wealth redistribution in a modern market economy, with a particular focus on the U.S. economy. 

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Visit our EXECUTIVE SUMMARY on economics (April, 2011).

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When we started this project after the Tucson tragedy, we were determined to chronicle America’s past, identifying and discussing major problems, and hoping to help America find ways to work its way out of the current crisis.  By then, we were already gravely concerned about the results of the mid-term elections and a rapidly deteriorating situation.

Our plans to conduct a relatively leisurely series of fact-based discussions and debates quickly gave way, with the facts we are discovering and the current events that are unfolding, to a sense of urgency.  We now intend to provide a broad, fact-based information and analysis service.  We want to join others who are encouraging all Americans to get involved and stay involved in the political process.  Our primary focus for now will be on detailing the stunning economic and social facts and analysis that explain how we arrived at this crisis situation, and what can be done to turn things around.

Most Americans are probably unaware of how dangerous the current situation is for everyone but the very wealthy.  Large corporations and very wealthy people mostly have it their way in Washington, and through control of the media they are able to shape public opinion in ways that serve their interests.  We will show how they are hurting the American middle class and all Americans in the economic bottom 99% , and explain why major concepts in their self-serving ideology and propaganda are wrong.

Today the middle class is shrinking, unemployment hovers around 10%, housing foreclosures and bankruptcy rates remain extremely high, and adequate health care and education are falling more and more out of the reach of middle class Americans.  The middle class is in decline, and poverty is on the rise.  In September of 2010, CBS News Reported that one in seven Americans (43.6 million people) were living in poverty, up 8 million from August of 2004.  In sharp contrast, the rich have been steadily getting richer, and the top 1% holds the majority of America’s wealth.  This is nearly the same inequality in wealth distribution that existed in 1928, just before the beginning of the Great Depression.   Within the top 1%, a small group of multi-billionaires has achieved astronomical wealth, and they are now working to expand their control of federal, state, and local governments.  Their agenda amounts to an all-out attack on what is left of a dwindling middle class.  This grew out of disastrous policies started 30 years ago in the “Reagan Revolution,” but it is not what Reagan wanted.

The Last Two Years

After the Bush Administration ended with an economic collapse into the Great Recession and a massive Wall Street bailout, we could only share America’s guarded hopefulness that the newly elected President Obama could turn things around.  His administration appeared to stem the tide of economic collapse, stemming job losses and avoiding a deeper recession or depression.  Despite his party’s majorities in both houses of Congress, however, Obama was unable to achieve any real Wall Street reform or even produce much health care reform.

Chillingly, Congressional Republicans had become the party of “no,” openly opposing the President’s recovery efforts with filibuster after filibuster and revealing a political strategy of blaming him for the failure of those efforts. We would have expected everyone in Congress to want and to work for economic recovery, but we were sadly disappointed.

When in January 2010 the Supreme Court decided in Citizens United v FEC that corporations had constitutionally protected speech permitting them to spend as much as they desired in election campaigns, a whole new level of concern set in.  Sure enough, in the November elections corporations and billionaires spent millions of dollars, often anonymously, in support of Republican and tea-party candidates.  Consequently, voters provided the party of “no” and its new tea-party allies with a House majority and gains in the Senate, insuring that Obama would not be able to advance his recovery and jobs creation agenda in the next two years.

Exit polls revealed that voters were mainly concerned about economic recovery and jobs.  Many had been persuaded that Obama’s policies were failing and that the new members of Congress they voted for would do a better job of accomplishing his goals.  The voters had been seriously misled: the radical right has no intention of accomplishing these goals.

Instead, the radical right immediately pursued its agenda of advancing the interests of America’s most wealthy people, in opposition to those of all other Americans.  Currently (March of 2011) the radical right seeks to slash spending for federal programs that benefit ordinary Americans by some $60 billion,  including funding for low-income housing, early childhood, Low Income Home Energy Assistance grants, community health centers, and other services for the poor, asserting a politically false and economically impossible “goal” of thereby eliminating deficit spending and reducing the growing federal debt.

These cuts would be counterproductive, serving only to eliminate 700,000 to a million more jobs, worsening the economy and increasing the deficit.   Closing the deficit, however, is not the radical right’s real concern.  They served notice in December of their indifference to budget deficits and the federal debt when they forced renewal of the Bush tax cuts for the wealthy.

Our  Mission

Too many people in the middle class and below, we believe, are not yet sufficiently aware of the dramatically increased consolidation of wealth and income within the top 1% of Americans over the past 30 years, and this group’s steadily increasing control of government and the media.   Nor,  we suspect,  do they yet realize how significantly that consolidation of wealth has hurt them economically.  We were not aware when we started studying these issues of how incredibly serious the economic situation had become, but we believe we have identified and explained the major economic consequences of the last thirty years of the “Reagan Revolution,” and they are stunning.  Nobel prize-winning economist Paul Krugman and Robert Reich, among others, have convincingly argued that the radical right is leading America into another depression, destroying the prosperity and freedom of everyone in the economic bottom 99%.  We too believe that a serious depression is imminent,  but can be avoided if America changes course now.  But there is no margin remaining for political error.

Today a minority group of right-wing radicals within the wealthiest top 1%, which as noted has been given the right to buy elections, seeks to advance a very radical political agenda of privatization and corporate control of government.  This threat has emerged suddenly this year in states like Wisconsin, Michigan and Ohio, where democracy and democratic self-government are now themselves under direct attack.

This site is dedicated to demonstrating the true gravity of the current situation. Within the various categories on this site you will find analyses and findings presented in bite-sized chunks, and we will be continuously adding more details and facts.

You will find this Welcome note both as a page and as a post.  A  Summary post, also posted on the menu bar as a page, summarizes our major conceptual conclusions.   We have also prepared an Economic Summary which contains our stunning conclusions about the effect of the “Reagan Revolution” on the economy over the past 30 years, cross-linked to the relevant posts.

We provide a Resources category listing recommended reading, action groups, and information sources.  Finally, we will develop a Recommendations category where we intend to post suggestions and discussions (our own and from others) about what the bottom 99% can do to turn things around.

Our most important purpose right now is to encourage everyone to get involved and stay involved until our lives, our democracy, and our American way of life are safe from the corporate attack.  We urge everyone to organize, join political action groups, learn about what is happening in America, learn the truth and broadcast it far and wide, as we are trying to do.  We can’t do this alone.

The Future Is at Stake

We especially encourage young people, the so-called “lost generation” that is finding it progressively harder to get a good education as funding and programs evaporate from elementary school all the way up to graduate school.  You are fully aware of what is happening to you: Most students like you are finding it increasingly difficult to get higher education without incurring huge debts it may take a lifetime to repay, and even to find jobs once they have their degrees.  Increasingly, only the very rich can afford high quality education.

We graduated from high school fifty years ago, and you can take it from us:  It hasn’t always been this way.  What is happening today to education in America is outrageous.  Among the most important freedoms in America are your freedoms to get a quality education, to provide economic security for yourselves and your families, and to find fulfillment in life.  Now you must work hard to preserve those freedoms. You all are the keys to regaining your freedoms and making sure that you will have a real future, so please get started.

Here is a recent tape of a political action by Coffee Party USA  that took place at Wesleyan University, to which all young people can (and should) relate.

The huge push-back in Wisconsin against the overt attack on public-sector workers and their unions shows that once they became aware of the sinister hidden agenda of the tea-bagger plutocrats, Wisconsin citizens reacted immediately and decisively.  Here is a video of a Wisconsin farmer explaining how Scott Walker’s tax-cuts-for-corporations and spending-cuts-for-people agenda will devastate Wisconsin communities.

All Americans in the bottom 99% must continue to support the people of Wisconsin as they struggle for justice and attempt to recall legislators and a governor that won election on false pretenses.  It’s not just about unions, and it’s not just about Wisconsin.  What happens in Wisconsin, Michigan, Ohio, and Florida – anywhere in America – affects us all.

There is no doubt that the American people can defeat the power of the radical right, their wealthy patrons and their corporations, once they are aware of the truth and are galvanized into action.   Many progressive organizations and unions are fighting these suddenly very extreme attacks, and they are gaining in strength.

To be sure, the right-wing media has the ability to cause many people to act against their own interests.  But these people are in the minority, and we all have the power to ignore the radical media and disregard their propaganda and their distortions.  If we remain calm and confident, through hard work we can win this class struggle.  It is up to us.

As Michael Moore pointed out recently in Madison, Wisconsin, the 400 wealthiest people in America have as much wealth as the entire lowest half of the population, 155 million people!  But we all need to remember and stay focused on this: They don’t have anywhere near as many votes.  It’s the top 1% against the bottom 99%, so make democracy work and take back your country.

Please send our link to everyone you can.  And bookmark it for our updates! Constructive comments, questions, and information are welcome.

(We invite you next to read our Summary page, where we outline our major conceptual conclusions so far, and our Economic Summary.  Mike’s initial post, The American Bad Dream, reflects on the major developments that have affected his views and concerns over the past 50 years.)

ARC, JMH – 3/16/11

(Return to the Contents Topics page.)

Posted in Welcome | 3 Comments

The Time-Warp and the Three Milliseconds

navajo couple

(“Navajo Family Receives Electricity in Their Home for the First Time,” by Candice Naranjo, AP, April 13, 2014, here, and Sara Morrison, The Wirehere.)

Spread’s tunnel was not intended to carry passengers, or even freight; it was for a fiber-optic cable that would shave three milliseconds — three-thousandths of a second — off communication time between the futures markets of Chicago and the stock markets of New York.  * * *  Who cares about three milliseconds? The answer is, high-frequency traders, who make money by buying or selling stock a tiny fraction of a second faster than other players. * * *

[S]pending hundreds of millions of dollars to save three milliseconds looks like a huge waste. And that’s part of a much broader picture, in which society is devoting an ever-growing share of its resources to financial wheeling and dealing, while getting little or nothing in return. * * * What are we getting in return for all that money? Not much, as far as anyone can tell. Defenders of modern finance like to argue that it does the economy a great service by allocating capital to its most productive uses — but that’s a hard argument to sustain after a decade in which Wall Street’s crowning achievement involved directing hundreds of billions of dollars into subprime mortgages.

In short, we’re giving huge sums to the financial industry while receiving little or nothing — maybe less than nothing — in return. [T]there is a clear correlation between the rise of modern finance and America’s return to Gilded Age levels of inequality. So never mind the debate about exactly how much damage high-frequency trading does. It’s the whole financial industry, not just that piece, that’s undermining our economy and our society. – Paul Krugman, “Three Expensive Milliseconds,” New York Times, April 14, 2014 (here).

“I always said that if I wasn’t studying psychopaths in prison, I’d do it at the stock exchange.” – Robert Hare, creator of the Hare Psychopathy Checklist and its variants, the most widely used diagnostic tools for psychopathic personalities.– Paul Rosenberg, “The Sociopathic 1 Percent: The Driving Force at the Heart of the Tea Party,” Alternet,  March 8, 2014.

The contrast is too glaring, and the stakes are too high. So as occasionally happens on a Monday morning, I must return to my blogging post. Having just completed a series of posts showing how the wealthiest Americans have used the borrowing power of the U.S. government, and a huge national debt, to amass unimaginable wealth at the expense of everyone else and of our nation’s future, I thought my work might be done for a while. But there was another issue lurking in the background, one not as straightforward as the national debt, that continued to concern me: That was the problem of private debt. Sure enough, this morning’s news provided a seemingly compelling need for an immediate comment on the conceptually more difficult private debt problem.  

Although Wall Street investment banking is just one of the vehicles seriously undermining our economy and contributing to inequality and decline, it is clearly one of the most significant, and certainly the most unscrupulous. I have been prompted to take a closer look at how Wall Street investment banking is seriously undermining our economy by today’s Op-ed from Paul Krugman.  In this article, he has reported on a Spread Networks fiber-optic cable, constructed and installed through tunnels in the Allegheny Mountains of Pennsylvania at a cost of hundreds of millions of dollars, in order to shave three-thousandths of a second off the time required to send information from the futures markets in Chicago to the stock markets in New York.        

The Time-Warp

I found today’s news filled with irony: On the same day we are told how fiber-optic cable providing such an amazingly tiny time gap will afford the crucial difference in making billions of dollars in arbitrage trading, we are also informed of a Native American community that is only now being wired, for the first time ever, for basic electricity.  Ironic it is, for sure, that pockets of American society have never received basic electric service, and it feels very much like an anachronism in the land of opportunity. But it is also truly ironic, with poverty on the rise and many Americans around the country unable to afford housing or utility services, that our society’s higher priority is to invest so heavily in the marginal ability of very wealthy people to get even wealthier.

This says a great deal about the state of American society: Surely, before pouring hundreds of millions into its project, Spread Networks concluded that the investment was worth the risk, that once in place, the expected profitability of the project would not likely be countered by legal regulation or by prohibitive taxation, either of transactions or incomes. Such is the state of Wall Street’s perception of its political power, and the power of the wealthiest among us. The only question for them, I feel certain, was whether they could do it, could procure all the necessary easements and other required permissions. When they found they could, the decision to go forward was a foregone conclusion.

Wall Street and its representatives in Congress have relentlessly shown indifference to the lives and well being of the American people, as we have seen in their positions on financial reform, health care, and all other social programs. The sociopathy of the political right gains more attention all the time. Incredibly, some Republican state governors, we are told, are intentionally hurting their own states’ citizens by declining medicaid expansion, throwing away money and jobs simply to stand in political opposition to Barack Obama.

The Three Milliseconds

This is, in my view, Paul Krugman’s most significant Op-ed in recent memory. The Krugman point emphasized in the Wall Street Journal (livemint.com, here) is this: “It’s the whole financial industry, not just high-frequency trading, that’s undermining our economy and our society.” Krugman might have argued that high-frequency trading is itself evil and harmful, that it could add to the ongoing concentration of financial wealth, or harm Wall Street trading by squeezing out marginally successful investors who lack the three millisecond advantage, but he did not. Nor did he comment on the potential addition of risk for the markets or investment firms themselves. Instead, he made a more important point, and quite strongly: Nothing the financial industry does to make money for themselves contributes anything to our real economy. All of its income consists, although he did not use the term, of what is commonly referred to as “economic rent.” 

Krugman has now taken an all-out stand against the excesses of investment banking in principle, pointedly recognizing that it is hurting our economy and creating inequality. I believe this is as far as he’s ever gone in attributing the inequality problem and economic decline to investment banking. What is more, even though he dismisses the economic significance of the three millisecond gimmick, he chose to discuss his condemnation of Wall Street in the context of relating this one quirky, hell-bent-for-glory, idea. In doing so, he has exposed the inherent, shameless evil of the Wall Street mentality. If Occupy Wall Street accomplished little else, it certainly started the conversation about Wall Street’s inherent sociopathy, and made it respectable.  I expect (and hope) that this latest Krugman post will get a great deal of attention. 

My position on the economics of inequality is slightly different, of course. I maintain that: “It’s the whole economic process, not just the financial industry, that’s undermining our economy and our society.” But a strong case can be made, and Barry Lynn does a heck of a good job of making it in his 2010 book Cornered: The New Monopoly Capitalism and the Economics of Destruction, that Wall Street strategies lie behind all or nearly all of the elements of the inequality machine that is bringing us down. 

At this point it’s hard to know which of those factors are the most crucial, but financial industry excesses are clearly in the running, and we need to continue to take them very seriously. They were, after all, the cause of the Crash of 2008, and they seem likely to provide the vehicle of our eventual downfall.

The Private Debt Concern

Money is debt, and the ability to increase or decrease the money supply lies in the system of private banks controlled by the Federal Reserve Bank. Banks create money when they extend loans, for example mortgage loans, up to multiples of their own assets, and they profit by charging interest on those loans.

In my last post, I discussed how the $17 trillion of national debt is contributing to inequality, among other things, by creating a “perpetual annuity” for the government’s creditors. It has been argued that, as much of a bind as we are in with the national debt, an even bigger problem is an out-of-control level of private debt.  That would include all business loans and home mortgage loans, all of the student debt, and the like. Consider this chart (from “It’s private debt, not public debt, that got us into this mess,” Michael Clark’s Instablog, May 7, 2012, here):

private debt 428250-13363801587809994-Michael-Clark

This chart uses the traditional approach of showing balance sheet items as a percentage of GDP. Thus, the national debt is shown as approaching 100% of GDP in 2012, the prime observation behind the Reinhart/Rogoff controversy discussed elsewhere in this blog. I disagree, however, that this chart shows a correct level of “private debt,” so I can see no basis in this chart for concluding that a high level of private debt relative to public debt is necessarily a major cause of concern. 

It is now clear that our public debt is undermining our government and society, through rapidly increasing income and wealth redistribution, and there may be a similar problem with private debt, but it’s not clear how big of a problem that might be. This graph does reflect the collapse of private debt and a simultaneous increase in public debt following the Crash of 2008: We know that the 2008 crisis was brought on by repackaging toxic debt and reselling it as subprime mortgages, resulting in defaults by unwary home owners who had refinanced their homes. The amount of private debt fell substantially with the defaults and foreclosures, and public debt rose when the Federal Government bailed out failing investment firms. The collapse of the housing bubble was a criminal “double-whammy” that drove the bottom 99% into a mild depression from which we have yet to emerge. 

Here is a graph of the finance industry’s share of GDP. This one is from the 2009 abstract, cited by Krugman, by Thomas Philippon, NYU, “Finance vs. Wal-Mart: Why are Financial Services so Expensive?” (p.3, here). Note that the shape of this graph is identical, from 1930 to 2012, to the Clark graph. If this is the same data in both cases, the Clark graph misrepresents that data showing the financial industry’s share of GDP as growing to several times total GDP:

Pages from Philippon_v3 (1)

What this graph shows is the “income share of finance,” and the designation “WN fin. NIPA” represents the data series from the Bureau of Economic Analysis that compares financial sector employee compensation to aggregate compensation, where the financial sector includes finance and insurance, but excludes real estate (here).

There is no way to directly know from this kind of information whether the entire economy is over-leveraged, but Krugman appears to be growing more concerned on that score, because of the rapid growth in financial sector income. In his post, he states: 

Specifically, the share of G.D.P. accruing to bankers, traders, and so on has nearly doubled since 1980, when we started dismantling the system of financial regulation created as a response to the Great Depression.

Krugman’s point is confirmed by the Philippon graph, which shows about a 4 percentage point increase in the financial market’s share of income since 1980, a considerable portion of the over 2o% increase in the top 1% share of income over that period identified by Piketty and Saez. This is clearly a major share of the problem.

I have noted in other posts a rising concern about the developing student loan bubble, with the balance of outstanding student loans now totaling well over $1 trillion. There may be others as well. We do not know where and when the next crisis point may arise, but Wall Street’s continuing drain on the economy is clearly a major factor driving the inequality growth cycle. Another bursting bubble would have catastrophic consequences, and an overall collapse at the top, of course, would ruin everything. 

Conclusion

The main point of connection between the bottom 99% economy and the top 1% economy is in demand and jobs. I have concluded that the top 1% has increased its net worth since 1980 by a reasonably estimated  $22-25 trillion. Our federal government is shutting down as a result, the bottom 99% is in an inexorable inequality spiral and a slowly deepening depression, and the level of the federal debt is almost beyond redemption. The United States needs a far more progressive tax structure in order to save its economy.

One of the main vehicles for top 1% wealth concentration has been the gaming of the financial markets. Remember, market economies are inherently unstable. If a small handful of traders were to increase its gains by getting a significant jump on the rest of the market in trading, that could seriously hurt the market, with unforeseen consequences. Such a trend would not bode well for growth, or for the reduction of unemployment. If stocks are trading at speculative prices now, and they may well be, the stock market would likely be a candy store for these rapid traders, who might remove a great deal more money from the active money supply as more people became mega-rich.

Importantly, Paul Krugman has reminded us that this strangely sociopathic development (my characterization, not his) is not our primary concern. The entire history of investment banking since the repeal of Glass-Steagall has had terrible consequences for our economy. Clearly, there is no upside for the bottom 99% — or, for that matter, for anyone — in an economy that could tumble out of control in a matter of milliseconds.

JMH – 4/14/2014 (ed. 4/15/2015)

Posted in - FEATURED POSTS -, - MOST RECENT POSTS -, Decline in America, Economics, Wealth and Income Inequality | Leave a comment

Inequality and the National Debt

national-debt-elmo-2012

(Mark McHugh, “Understanding the National Debt – Sesame St. Addition,” September 24, 2010 here) , updated April 17, 2012 (here)

Public credit affords such facilities to public prodigality, that many political writers have regarded it as fatal to national prosperity. For, say they, when governments feel themselves strong in the ability to borrow, they are too apt to inter-meddle in every political arrangement, and to conceive gigantic projects, that lead sometimes to disgrace, sometimes to glory, but always to a state of financial exhaustion; to make war themselves, and stir up others to do the like; to subsidize every mercenary agent, and deal in the blood and the consciences of mankind; making capital, which should be the fruit of industry and virtue, the prize of ambition, pride, and wickedness.

A nation, which has the power to borrow, and yet is in a state of political feebleness, will be exposed to the requisitions of neighbors. It . . . perhaps must lend, with the certain prospect of never being repaid. These are by no means hypothetical cases: but the reader is left to make the application himself. * * * 

The command of a large sum is a dangerous temptation to a national adminis-tration. Though accumulated at their expense, the people rarely, if ever profit by it: yet in point of fact, all value, and consequently, all wealth, originates with the people. – Jean-Baptiste Say, A Treatise on Political Economy, Chapter IX, Of National Debt, 1803 (here).

Two French economists, Emmanuel Saez and Thomas Piketty, have in recent years awakened us to the significance of growing income and wealth inequality, and in his much-hailed 2014 book Capital in the Twenty-First Century, Piketty has called our attention to an important aspect of the problem, the need to control the concentration of wealth. Two centuries ago, when rudimentary ideas about how economies work were just beginning to be formulated in the minds of political philosophers, another Frenchman, Jean-Baptiste Say, was among the first and the best of the new “classical” economists.   

Say, and several decades later the Englishman John Stuart Mill, each devoted a chapter in their books on economic principles to the important issues raised by the raising of national debt. Say opined, listing detriments that sound all too familiar today, that national debt in effect reallocates “value” and wealth originating with people in efforts that rarely benefit them. He regarded the activities of the state thus financed as frequently unvirtuous and, from society’s viewpoint, mostly wasteful. Mill (The Principles of Political Economy, Chapter V, “Of a National Debt ,” 1848, here) was at least equally critical of national debt:

The question must now be considered, how far it is right or expedient to raise money for the purposes of government, not by laying on taxes to the amount required, but by taking a portion  of the capital of the country in the form of a loan, and charging the public revenue with only the interest. * * *

[I]f the capital taken in loans is abstracted from funds either engaged in production, or destined to be employed in it, their diversion from that purpose is equivalent to taking the amount from the wages of the laboring-classes. Borrowing, in this case, is not a substitute for raising the supplies within the year. A government which borrows does actually take the amount within the year, and that too by a tax exclusively on the laboring-classes, than which it could have done nothing worse, if it had supplied its wants by avowed taxation; and in that case the transaction, and its evils, would have ended with the emergency; while, by the circuitous mode adopted, the value exacted from the laborers is gained, not by the state, but by the employers of labor, the state remaining charged with the debt besides, and with its interest in perpetuity. The system of public loans, in such circumstances, may be pronounced the very worst which, in the present state of civilization, is still included in the catalogue of financial expedients. 

Thus, Mill observed that in its practical effect national debt is a vehicle for redistribution of wealth to employers — a point ignored today. Beyond that, on the general question of whether to tax or borrow, he offered the common-sense test with which we are all familiar:

[T]he question really is, what it is commonly supposed to be in all cases—namely, a choice between a great sacrifice at once, and a small one indefinitely prolonged. On this matter it seems rational to think that the prudence of a nation will dictate the same conduct as the prudence of an individual; to submit to as much of the privation immediately as can easily be borne, and, only when any further burden would distress or cripple them too much, to provide for the remainder by mortgaging their future income. It is an excellent maxim to make present resources suffice for present wants; the future will have its own wants to provide for.

Among the classical economists, so far as I have discovered, there was no dissent from this “excellent maxim.” It was expected, in any event, that debts incurred were to be repaid as soon as possible after the financial emergency had passed. Say’s views also reflected Mill’s later understanding that national borrowing has the general effect of retarding private investment and employment:

There is this grand distinction between an individual borrower and a borrowing government, that, in general, the former borrows capital for the purpose of beneficial employment, the latter for the purpose of barren consumption and expenditure. A nation borrows, either to satisfy an unlooked-for demand, or to meet an extraordinary emergency; to which ends, the loan may prove effectual or ineffectual: but, in either case, the whole sum borrowed is so much value consumed and lost, and the public revenue remains burthened with the interest upon it.

That would not be entirely true, of course, if a government endeavored to invest in domestic growth; but why, other than to escape from a depression, would government borrow extensively to try to do that? And has the U.S. budget, over the last three decades, generally been a pro-growth budget?  

Say also discussed what would happen if a government ignored the maxim to borrow only when absolutely necessary, and engaged in perpetual borrowing:

When a government borrows, it either does or does not engage to repay the principal. In the latter case, it grants what is called a perpetual annuity.  * * * The governments best acquainted with the business of borrowing and lending have not, of late years at least, given any engagement to repay the principal of the loan. Thus, public creditors have no other way of altering the investment of their capital, except by selling their transferable security, which they can do with more or less advantage to themselves, according to the buyer’s opinion of the solidity of the debtor government, that has granted the perpetual annuity.

The U.S. Debt Problem

The United States has not run up more than $17 trillion of national debt to respond to any financial exigency, but rather to finance tax cuts for the wealthiest Americans and, consequently, to provide them with a vast increase in wealth (net worth). To help come to grips with this horrendous reality, let’s keep McHugh’s chart in front of us for closer inspection.

national-debt-elmo-2012The meaning of the information provided here bears closer attention:

          Per Capita Income

McHugh has, appropriately, shown the change in aggregate per capita income in the black columns in nominal dollars; adjusted for inflation, the black columns would show the median “real” per capita income declining over the past few years. Notably, these aggregate income numbers include both top 1% and bottom 99% income. The trend line for the top 1% per capita income would slope up (erratically, reflecting the Crash 0f 2008) indicating the generally increasing per capita income of the top 1%; the bottom 99% line, however, would be declining after 2007, reflecting the declining nominal median per capita income of the bottom 99%. 

There was some income growth after 1990, but as shown for example on the Piketty/Saez chart in the last post, this was an already severely reduced growth rate, as the growth of bottom 99% income had already declined sharply after 1980 when income inequality began to grow.

          Per Capita National Debt 

The exponential growth of per capita debt reflects debt interest compounding faster than the U.S. population. The U.S. debt has been a “perpetual annuity” for many years, meaning that all of the money needed to pay the interest is borrowed each year, and the principal balance keeps growing. In fact, the principal balance is growing rapidly, and as the interest burden grows relative to other government functions, the debt gets increasingly unmanageable.  The Obama Administration has been stressing that the deficit has recently been reduced. To reverse the growth of the debt, however, the government must run surpluses, and as long as lower 99% incomes continue to decline, given the regressive state of taxation, there is no prospect of surpluses ahead.  

Indeed, the Congressional Budget projects increases in budget deficits. In its latest report, “The Budget and Economic Outlook: 2014 to 2024,” February 2014 (here), and summary dated February 4, 2014 (here), the CBO projects increasing interest rates and inflation through 2014, and declining unemployment (from an estimated 7.0% in 2013 to 5.8% in 2017 and 5.5% in 2024 (p. 6). With this forecast in the background, here is the projection for the budget deficits looming ahead:

Year          Deficit ($billions)              Year          Deficit ($billions)

                        2013                -680                             2019                -752 

                        2014                -514                             2020                -836 

                        2015                -478                             2021                 -912 

                        2016                -539                             2022              -1,032

                        2017                -581                             2023               -1,047  

                        2018                -655                             2024               -1,074

This is not movement in the right direction. GDP is not predicted to double between 2014 and 2024, nor is population, so the perpetual annuity is projected to increase its stranglehold on federal government finance. The problem is not spending (see Outlays, Table 3-1). Government non-discretionary spending is, of course, projected to rise, but Social Security and Medicare expenditures are funded separately, and Social Security funding is not yet in trouble.  The expenditure that is rising the fastest, by far, is net interest expense, rising from the 2013 actual of $211 billion to $880 billion in 2024. Compare that steep rise, for example, with the expected growth in the discretionary defense budget from $625 billion in 2013 to $719 billion 2024. 

The fact that interest expense will soon exceed the entire defense budget underscores the awfully high price we pay for setting up this perpetual annuity for government creditors: Interest expense is projected to rise from 1.3% of total outlays in 2013 to 14.7% in 2024. Because interest compounds exponentially, the problem going forward is obvious.  

And every discussion of CBO projections of government tax revenues must be qualified by recognition that mainstream forecasting begins with the wildly inaccurate “supply-side” assumptions inherent in neoclassical thinking. We are not told how the CBO takes reduced consumption and incomes into effect, though we know that Fed forecasters have recently stumbled over this problem. We can, however, be reasonably certain that the bases for their growth assumptions, and for decline in unemployment to 5.5% by 2024, are no more than wishful thinking.

Here’s why: The increases in per capita national debt reflected in HcHugh’s chart, and the future debt increases reflected in the CBO projections, mirror and closely match the continuing increases in top 1% wealth. It bears repeating that the $17 trillion of national debt is the direct result of tax cuts for the rich; the national debt has done nothing but finance an increase in top 1% net worth. The rich have been allowed to retain more income as wealth, and that has caused and accentuated an inequality cycle driven by government spending. 

So far as I know, I am the only one so far to publish the estimated increase in top 1% net worth since 1980, and here is my graph:

my graph 1952-1982 c

The crucial point is that the increase in top 1% net worth has risen at about the same pace as the national debt (compare 1980 with 2012), only slightly faster. These numbers, derived from government net worth data, show top 1% net worth increasing by $17 trillion between 1980 and 2012 (in constant 2005 dollars). However, when account is taken of U.S. top 1% wealth increases from the “shadow economy” discussed in the last post, and stored in “off-shore” accounts, a reasonable estimate of the actual gain is $22-25 trillion.

Two points: First, in addition to money the federal government has borrowed ($17 trillion) to finance their growing wealth, the top 1% has gathered in an estimated $5-8 trillion from the bottom 99% over these years. The lower incomes and wealth of the bottom 99% have substantially reduced bottom 99% tax revenues. Second, and this is a critical point, this is going on right now: Between 2008 and 2012, $3 trillion transferred up. This should have been revenue provided to the federal government: instead of reversing this confiscatory trend, however, our representatives in Congress are letting it continue, and plotting to increase it.

          The budget death spiral

It cannot be over-emphasized that this destruction of our federal budget is the natural consequence of the reduced tax obligations of the rich and their corporations that have led to unimaginable inequality and depression for the bottom 99%.  Not only does a huge portion of the interest on the debt increase top 1% wealth, the proceeds of all of the government debt, including money borrowed from China or other countries, ends up profiting the top 1% as well: We are in an advanced stage of the income and wealth concentration process reflecting a systemic change in the economy; now virtually all income growth is at the top, and more inequality growth is a nearly automatic result of all government spending.  

Nor can it be over-emphasized that there was never any purpose for these tax cuts other than to make the very rich still richer. That these moguls did not anticipate the devastating consequences of their actions, looming just a few decades ahead, is no excuse. They are still denying those consequences, perpetuating a neoclassical “trickle-down” fantasy that requires total ignorance of economic reality to believe. The Paul Ryan budget calls for still more tax reductions for the wealthy (here). And the political right disingenuously and improperly argues for still more slashing of government programs in the name of “responsibility.” (E.g., “Analysis of CBO’s 2014 Budget and Economic Outlook,” Committee for a Responsible Federal Budget, here). 

Note that while CRFB correctly points out that our budget problems are not going away, on behalf of the wealthy it merely offers, like the Ryan budget plan, to make things worse, calling for a vague package of tax “reforms” which it surely must know, or at least suspect, is based solely on the no longer even marginally credible “trickle-down” myth. The economic right is either ignorant of economic realty or content to preside over the demise of the U.S. economy and society. 

Think about it  

The scope of this problem is beyond the abilities of our imaginations to comprehend, but let’s try. Mark McHugh, in “Understanding the National Debt (Sesame Street edition)” said this:

I’m tired of convoluted explanations of simple problems.  It distracts people from the truth, which is usually the intent of those doing the explaining.  The end result is large numbers of people pretending to understand things they don’t. Bernie Madoff’s “success”, ETFs, Treasury auctions, the housing market. 

The easiest way to confuse people is with numbers so mind-numbingly  big they mean nothing to the average person.  What’s 13 and a half Trillion dollars supposed to mean to Joe Sixpack?  

Thank you Mark, for that, and for translating the debt numbers into per capita figures for us. But now, let’s really think about it: McHugh’s figures show that the share of the national debt of every man, woman, and child in the U.S. grew from $32 thousand ($128 k for a family of four) in 2007 to $40,000 ($160 k for a family of four) in 2011. What could possibly have happened to our country, and in our lives, to have put each of us so deeply in (collective) debt? And perhaps more poignantly, how could each of the more than 300 million of us have picked up an additional $8,000 of national debt (federal spending for which our considerable tax dollars were somehow insufficient to pay) in just four years?

We can begin to see, I think, that such numbers are so mind-numbingly big that the answers to these questions actually become obvious. There really is no mystery here: The vast bulk of this money simply could not have been spent on us or on our country. And it does not take a lot of research to learn where the money actually went. 

Epilogue

These are the evils of which classical economics warned, but which have been rationalized and denied by neoclassical economics. Our country borrowed many trillions of dollars not because we needed to, but because the richest among us wanted to get richer, and didn’t want to pay taxes. Perhaps Martin Feldstein, the Harvard professor who helped Ronald Reagan get this debacle underway, merely didn’t understand how economies work. But then again, very few who professed to be economists back then actually did — and most still don’t. But a growing handful are learning. We are deeply indebted to Robert Reich and Joseph Stiglitz for all they are doing. Hats off as well to Mark McHugh, and to Société Générale strategist Albert Edwards who, I have recently learned, is sticking tenaciously to what appears to most analysts to be excessively bearish views about our economic future. 

The inequality problem has gotten so huge that it is sensible to worry about a backlash of denial or avoidance among reasonable people. But avoiding economic collapse is not our only serious problem. The world faces serious human population and environmental problems as well. This evening, Showtime debuts its climate change series “Years of Living Dangerously.” I watched the first episode on the internet yesterday, and one thing stands out in my mind today: A climate scientist whose work was followed by Don Cheadle showed how a devout Christian like herself could still be a scientist, and believe in the lessons of real world evidence. And she showed how other Christians could change their perspective and avoid denial: God has given us the ability to think for ourselves and make our own decisions, she explained, and in the end it is our own responsibility to help ourselves.

It does not appear that human civilization as we know it will last another century. My immediate concern is whether the U.S. economy can survive another decade. That could scare me into denial or inaction. What I fear more, however, is failing to do my best to help preserve our way of life for our children and our grandchildren.      

JMH – 4/13/2014 (ed. 4/14/2014)

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Inequality and Taxation

It’s not just Occupy Wall Street protesters that are worried about wealth and income inequality. Now people like Bill Gross, manager of the world’s largest bond fund at Pimco, are warning that the problem is making the U.S. less productive.

As noted by Société Générale strategist Albert Edwards, “you don’t have to be a communist to conclude that high levels of inequality not only adversely affects long-term growth, but also increases the economy’s vulnerability to recession.” * * * Wealth and income inequality in America is still getting worse by many measures. – Gus Lubin, Business Insider, November 12, 2013 (here).

Previous posts have established that market economies are unstable, meaning that income and wealth concentrates naturally at the top, and that growth rates decline with growing inequality. Thus, inequality growth and reduced overall growth are “two sides of the same coin.” The neoclassical notion that economies bounce along from one financial crisis to another, recovering toward optimal productivity and “full” employment between crises, is wrong. Rather, there is a gradual, inexorable decline — and the U.S. economy’s decline has been the least gradual in the world. This post and the next will explain how taxation is involved and show how it has been used to engineer the U.S. decline.

The remedy for stabilizing a market, as has long been known, is a system of “progressive” taxation, graduated taxation with the effective rates charged the highest levels of income and wealth sufficiently high to prevent increasing inequality. Progressive taxation both retards concentration and enables government to establish well-being and higher growth throughout an entire economy. This post explores the implications in the United States for growth and inequality of the abandonment of progressive taxation, and the following post explores its implications for the Federal government and the national debt.

The deterioration of the U.S. economy is the worst in the world among developed economies, by far. It isn’t just that the rich here have tended to get rich faster than the rich elsewhere: There has been a huge boost for them established by the reduction of their taxes over a 35-year period. Here is what has happened in the United States:

By 1980, wealth concentration in the U.S. was already substantial, due to the natural operation of the economy. Under the influence of wealthy interests and Milton Friedman’s “free market” philosophy, the Reagan administration began to lower the top rate of income taxation, among other things, making the tax system increasingly regressive. Inequality grew and the rate of growth slowed, both significantly. To maintain a high level of spending, the federal government began to run up the national debt as it continued to reduce taxes at the top, in several precipitous steps.

Instead of taxing rich people and corporations for its revenues, our government borrowed from them, adding still more inequality. After the crash of 2008, although an imminent depression provoked by the Bush tax cuts was narrowly avoided, declining revenues and increasing federal debt continued to hamper the federal budget. Since then, pressure from the political right developed to act “responsibly” and balance the budget, but not by raising the taxes the lowering of which had caused the problem, but by further eviscerating government programs. Such a plan is the height of irresponsibility, for it would further accelerate the already rapid decline and, in the process, eviscerate government. 

Personal Income Taxes

A series of charts will provides the clearest way to focus on the problem. This first chart, published by the Center on Budget and Policy Priorities (CBPP) in April of 2012 (here), shows a long decline in federal income tax revenue from a median-income family of four. The effective tax rate for the median family had declined from 12% in the early 1980s to 6% just before the Crash of 2008:    

Income tax rate US

We would expect federal income tax revenues to decline with a declining economy, but this trend also reflected growing income inequality within the economy, increasing the drag on federal revenues. Wages as a percent of the U.S. economy had also fallen over this same period from 49% to 44%, according to the St. Louis Fed chart presented by Gus Lubin (here):

wages-as-a-percent-of-the-economy

Thus, both wages as a percent of GDP and the average effective taxation of wages declined. Both of these trends can be traced to the growth of income inequality over this period, caused by the reduction of amount of taxation at the top, which of course meant lower revenue contributions from the wealthiest households as well. This next chart from CBPP (here) shows the trend between 1992 and the start in 2008 of the Great Recession in the average tax rate for the highest 400 households by income and the average level of their adjusted gross income:

Income tax rate plus top incomesOver a ten-year period, from 1996-2006, Average AGI of the top 400 taxpayers grew five-fold, yet their average tax rate declined from about 28% to about 18%. This shows the massive tax avoidance at the very top; this is the worst case of a much broader problem: The major decline in the progressiveness of income taxes, the principal control factor for income and wealth distribution, started much earlier (just after 1980) and it redounded to the benefit of far more than the top 400 American taxpaying households. The total impact is enormous: While inequality grew and federal revenues declined, our national debt increased from under $1 trillion in 1980 to over $17 trillion currently, replacing revenue that would have been collected from top incomes and corporations, had the effective federal taxation (of top incomes, capital gains, and corporate earnings) not been substantially reduced.

Income Inequality 

This chart, prepared by Thomas Piketty and Emmanuel Saez (here), shows the changing growth of top 1% income and bottom 99% income together with the trend in the top federal income tax rate:

DP8675b

(Note that the real income per adult of both the top 1% and the bottom 99% are indexed to 1913 = 100; the top 1% level was of course much higher than the bottom 99% level back then. Consequently, the actual difference between income levels is not shown.)

This graph shows that the reductions in the top (marginal) income tax rate immediately resulted in growing inequality, as reflected in the top 1% and bottom 99% income growth rates. This shows a remarkably close correlation between the change in the top marginal rate and change in the top 1% effective rate over the entire 1979-2008 period. Following each tax reduction, income at the top grew at a continuously faster rate thereafter because of the resulting higher concentration of wealth.

The reverse effect on the bottom 99% — the reduced rate of income growth — means that the aggregate rate of growth is somewhere in the middle; the aggregate income growth rate actually declined considerably over this period, as reported frequently on this blog.

The fact that this happened despite steadily increasing productivity explains the high degree of bottom 99% stagnation over the entire period, as shown in the previous post and in this chart (Mother Jones, July/August 2011 issue, here):

change-since-1979-300

It has been frequently observed, recently, that although productivity has steadily grown since WWII, since the start of the Reagan Revolution with the tax reductions for the very rich the top 1% has received an out-sized share of the rewards of increased productivity. We also know from other sources that only the top 10% has seen any income growth at all since 1979, and that since the Bush decline began (with the tax cuts for top incomes) in 2003, there has been no growth except within the top 5%. Since 2010, moreover, there has been no income growth outside of the top 1%. Both the increased rate of income growth at the top and the reduced rate of income growth at the bottom, accordingly, have resulted from the reduction of taxation of income and wealth at the top.

These developments were enabled by the growth of corporate power; individuals on their own could not command such a high level of income growth outside of the capitalist economic structure. Within the corporate structure, the growing spread between CEO pay and average worker compensation in the U.S. is startling. This report from August of 2011 (here) is one of several reporting a huge leap in the spread during the Clinton dot.com era, followed by a decline in the Bush years:

corp disparity-300x251 (1)The chart shows a multiple at 50x at the start of the inequality growth period in 1980, growing to 500x during the Clinton.com boom years before falling off in the Bush recession years. With the record success of the stock market in 2013-2014, these multiples are no doubt rising considerably again. This same source reported this comparison of the U.S. CEO/worker pay multiple in 2011 with that of other countries: 

corp tableThe information on CEO pay, however comprehensive it may or may not be, shows the U.S. to be in a category of its own. This is a graphic illustration of the high level of growing income inequality over the last 3-4 decades.

Corporate Taxes

Corporate CEOs and other heavily invested owners and officers have a great deal of flexibility today in deciding where to locate their operations and where to pay corporate and individual income taxes, if at all. Gone, for the most part, are the days when a company like GE was in integral part of a community (like Schenectady, NY or Pittsfield, MA) by virtue of the location of huge investments in relatively immobile industrial plant. Changes in the nature of work, the installation of massive fiber-optic communications networks, and a well-developed culture of mergers and acquisitions in investment banking, have made it easier for big companies to move around and “forum shop” taxing jurisdictions.   

Currently there is a “race to the bottom” today as states compete in attracting wealth and businesses to locate within their borders. For example, New York State continues to emphasize a program of  reducing the cost of government with strategies for attracting industry and jobs (Governor Cuomo’s “FY 2015 Executive Budget Plan,” here). The General Fund Financial Plan (p. 29), among other things: (a) combines the corporate franchise and bank taxes for “simplification and relief;” (b) reduces the tax rate on net income from 7.5% to 6.5%, “the lowest since 1968;” (c) reduces the net income tax rate on upstate manufacturers from 5.9% to zero, for 2014 and thereafter; (d) announces the elimination over three years of the temporary extension of the “18-a temporary assessment” (funding for utility company regulation) applicable to industrial customers, and acceleration of its eventual complete phaseout, and; (e) increases the exclusion threshold for the estate tax from $1 million to $5.25 million over five years.

Federal taxation of corporations has been declining since WW II, and the effective corporate tax rate has declined more sharply since 1987 (here):

corp tax corporate_profit_1950_2010

It has declined as a percent of GDP (here),

corp tax percent gdp

and very similarly as a percent of all U.S. tax revenue (here):

corp tax percent of total revs

Notably, although the effective corporate tax rate (the percent of profits) has steadily declined since the mid-1980s, corporate taxes bottomed out then as a percentage of all federal revenues, and of GDP, and have remained low.  The implication is that corporate profits have increased substantially as a percentage of GDP, while corporate tax revenues have remained at or near historic lows.

The tax loopholes built into federal laws for major oil companies, and the zero-tax returns of companies like G.E., in 2011, have become infamous. More recently, so have the tax avoidance approaches of major corporations as they “locate” their activities and profits in other countries. Consider these excerpts from a recent report by Flooyd Norris, “Switching Names to Save on Taxes,” New York Times, April 4, 2014 (here):

What was most impressive about this week’s Senate hearing into the way Caterpillar ducked billions of dollars in United States income taxes was the simple strategy involved. There was no subsidiary that somehow qualified to be taxed nowhere, as at Apple. There was no “Double Irish With a Dutch Sandwich,” a strategy made famous by Google in its quest to avoid taxes.

Instead, back in 1999, Caterpillar, helped by its audit firm, PricewaterhouseCoopers, decided that to sharply reduce the American tax on profits from the sale of parts sent from the United States to customers around the world, it had to do little more than take the name of the American parent off the invoices and put in the name of a Swiss subsidiary.

So even though the parts might have never come within a thousand miles of Switzerland, the profits accrued to the Swiss subsidiary. And Caterpillar negotiated a deal to tax those profits well below Switzerland’s norm. Senator Carl Levin, the Michigan Democrat who is chairman of the Senate Permanent Subcommittee on Investigations, put the rate at 4 to 6 percent. That cut the Caterpillar tax bill by $300 million a year. Was that legal? Opinions differ. * * *

What was most notable about the Caterpillar strategy was its sheer lack of creativeness. “This is boring as an intellectual matter,” said Edward D. Kleinbard, a tax law professor at the University of Southern California and a former chief of staff at the congressional Joint Tax Committee. If this strategy is vulnerable to legal challenge, he said, it would largely be because Caterpillar changed its corporate structure to save taxes. Had it had the foresight to adopt the structure decades earlier, the company would be on much safer ground.

Apple, he told me, set up an Irish subsidiary “as soon as it moved out of the garage.” He conceded that was an exaggeration, but not, he said, a large one. Under current corporate tax law, it is easy for multinational companies to park profits in subsidiaries based in low-tax countries. Companies that operate only in the United States find it much harder, although not always impossible, to avoid taxes.

It was interesting that Senator Levin was the only senator who appeared to be exercised over what Caterpillar and PricewaterhouseCoopers had done. “The revenue lost to those strategies increases the tax burden on working families, and it reduces our ability to make investments in education and training, research and development, trade promotion, intellectual property protection, infrastructure, national security and more — investments on which Caterpillar and other U.S. companies depend for their success,” he said. “It is long past time to stop offshore profit shifting and start ensuring that profitable U.S. multinationals meet their U.S. tax obligations.”

Not all the Republicans joined Senator Rand Paul, Republican of Kentucky, in offering an apology to Caterpillar for the existence of the hearing, but they generally agreed that it was proper for a company to do everything it could to avoid paying taxes. None of them seemed interested in the question of who should pay taxes if the companies do not. Nor was there the slightest indication of agreement with Senator Levin that corporate citizens, like individual ones, had an obligation to help pay for their government.

Instead, the preferred cure was to cut the corporate tax rate — now 35 percent, though virtually no multinational company pays anything near that amount. The country must become more competitive in attracting these companies, the senators said.

The current law of the land in America, as I understand it, is that corporations are “people” with constitutionally protected speech. “Money,” moreover, constitutes “speech,” so in spending their money corporations are exercising protected speech, and therefore they can spend their money virtually any way they want without government restraint. Resident “people” do have a legal obligation to pay taxes, but American culture appears to regard tax avoidance as a perfectly understandable, appropriate aspect of legitimate business practice; thus, corporations, whenever they can avoid or circumvent the normal rules of “residence,” legitimately have no obligation to support the operations or infrastructures of nations they inhabit, and whose people they profit from.    

The Shadow Economy

Not everyone sees it that way. The Tax Justice Network (TJN), for example, studies “tax evasion” in “shadow economies” around the world. In its 2011 report (“The Cost of Tax Abuse: a briefing paper on the cost of tax evasion worldwide” (here),  TJN argues that “tax evasion is the illegal non-payment of tax to the government of a jurisdiction to which it is owed by a person, company, trust or other organisation who should be a taxpayer in that place.” TJN estimated the absolute size of a country’s shadow economy, which is the portion of economic activity associated with tax evasion, based upon the country’s own published measure of GDP and recently reported data on the size of shadow economies published by the World Bank:

By the definition used here, economic activity in the shadow economy of a country will be tax-evading. So we next calculate an estimate of the amount of tax lost as a result of the existence of that shadow economy. We do this by looking at how much taxes are on average in the state as a share of GDP, and then apply that same tax share to the shadow economy, to reveal our estimates of lost taxes by state. (p. 2)

On this basis, TJN reported on 145 countries with a total of $61.7 trillion of reported GDP, 98.2% of the world’s total GDP, covering 61.7% of the world’s population. It estimated a world-wide shadow economy of $11.1 trillion which, at an average tax rate as a percent of GDP of 28.1%, resulted in a total tax evasion loss of $3.1 trillion. 

In its table of the ten biggest losers (p. 3) the U.S. ranks first, both in GDP and the size of the shadow economy. Total GDP is reported as $14.6 trillion, the size of the shadow economy is estimated at $1.3 trillion, a the tax revenue lost as a result of the shadow economy is estimated at $337 billion.

Inequality Growth

Corporations are the vehicles of huge incomes. Corporate executives minimize their own tax obligations by arranging corporate payments to them in ways that minimize their effective personal income tax rates. They lobby to create and take full advantage of tax shelters in federal law for the earnings of their corporations and lobby for grants, support payments, and lucrative government contracts. To the extent they can, they “locate” their domestic income in shadow economies overseas to avoid domestic taxation. They negotiate with state governments around the country in a “race to the bottom” to get the most favorable tax treatment they can for themselves and their companies in states in which it is viable for them to locate.

The end result of all of this collective activity is to greatly increase income and wealth inequality, reducing aggregate growth and causing a major decline in the economy of the bottom 99%. Because the collective tax system is regressive — that is it permits substantial transfers of wealth to a small handful of taxpayers at the very top, increasing their net worth by many billions of dollars each year — this is a continuing problem, and it is an accelerating problem with their compounding wealth.

The next post will take a close look at the implications of this trend for the federal budget and the operation of the federal government.

JMH — 4/10/2014 (ed. 4/11/2014)

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Inequality and Growth – Two Sides of the Same Coin

Two-sides-of-the-Same-Coin

In a cogent and extremely relevant article posted on January 16, 2014 (here), Neil Buchanan asked: Where Have the Academic Experts Been Hiding? Here’s the part I want to talk about:

The Role of Scholars in Economics in Downplaying Inequality

What is surprising is that, especially among economists (even nominally liberal economists), there has long been a tendency to treat inequality as an unworthy subject of discussion. This is not a matter of the conversation simply being hijacked by academic conservatives.  There are plenty of conservative economists in top-tier economics departments.  (Harvard’s Economics Department alone is the home to four of the most high-profile conservative economists in the world.)  The interesting dynamic has been the complicity of mainstream economists in taking inequality off of the agenda of “respectable” research.

Why would they do this?  The innocent (and, I think, mostly accurate) explanation is that economists, after the 1970’s, wanted to focus on how to get the economy as a whole to grow.  At that point, distribution of wealth and income was not much of an issue, as described above, because it seemed that the fruits of growth would automatically be spread widely. The analytical move by academic economists was to say that growth and equality were simply different issues, and that the issue driving the conversation should be how to maximize growth.  That did not require that the conversation would never return to the question of inequality, but that is the way it turned out.

I certainly observed many situations, among both economists and legal scholars whose research is modeled on mainstream economic reasoning, in which anyone who even raised the question of equality was all but laughed out of the room.  The mockery was not always (or even most of the time) an attack on someone for caring about inequality; rather, it was instead a condescending statement that the offending party “just doesn’t get it.” In other words, the ideologically neutral form of the conversation was, “Let’s talk about growth, and set inequality aside to discuss later, in a different conversation.”  Unfortunately, that quickly became “You’re talking about the wrong thing if you try to talk about inequality,” and then, “Talking about inequality is not allowed.”

In short, even the non-conservative parts of academia have helped to feed the “centrist” obsession with repressing any discussion about inequality and redistribution.  Happily, that has started to change over the last few years, with more and more economists and legal scholars noting that the growth/distribution divide never made all that much sense, and that the social problems that are associated with gross inequality have reached crisis proportions.  (Emphasis added)

The ideological problems are far deeper than Buchanan’s discussion reveals. The issue of whether and how inequality is related to growth is itself deeply steeped in ideology (let’s call it “level 1″ or “L1″ mythology), and our difficulty understanding the full extent of the problem, or even with understanding how the economy works, is almost entirely due to our failure to understand that fundamental point. If you are conservative, as opposed to “non-conservative,” you extend your ideology to a more extreme, and more obviously faulty level (which I’ll call “level 2″ or “L2″ mythology). This post will explain the difference between these two levels of ideology.   

Level 1 Mythology

I have been saying ever since I began to focus extensively on inequality, about three years ago, that growth and inequality are “two sides of the same coin.” For most of the that time, it seemed like only Robert Reich, among the few economists who were speaking up about inequality, shared that perspective. Then, in July of 2012, Joseph Stiglitz published his book The Price of Inequality, and I had another ally. Highly unequal societies are highly unstable, he has been saying, and that is exactly what “unstable” means: Inequality depresses growth. 

Most economists, among them notably Paul Krugman, didn’t agree. This disparity of views is explained by a difference in perspective: Today’s mainstream economists are raised in the “neoclassical” school of economics, and those in the mainstream like Krugman who consider themselves Keynesians are actually to a large extent “neo-Keynesians,” which is considerably different from the true Keynesian perspective. The neo-Keynesian perspective emphasizes Keynesian theory in connection with policy matters, but is locked into the neoclassical perspective of how the economy works, a very awkward position to be in. Together, the neoclassical and neo-Keynesian schools of economics constitute the vast bulk of what Buchanan refers to as “mainstream economics” today, and that includes nearly all of the economics taught since I learned economic theory in the early 1960s.

Both of these schools are based on solely on an ideology — the L1 mythology — which is fundamentally wrong (by 180 degrees) about how market economies work. Put simply, it is bottomed on a “supply-side” vantage point in its conception of growth: Make it, this point of view insists, and people will buy it. But this perspective turns out to depend on a whole host of assumptions (e.g., perfect competition, perfect knowledge, perfect efficiency, full employment equilibrium) that are not, and have never been, true. Thus, the argument that growth results from expanding investment is like the argument that you can push a piece of string in a straight line across a table. It confuses cause and effect.

Consequently, forecasts or retrospective analyses of growth designed to reflect supply-side assumptions, as frequently discussed on this blog, are fraught with confusion and contradiction. I have reviewed reports on studies involving growth or inequality as I learn about them, and I have routinely found timidity and candid admissions of confusion from the analysts that the studies did not produce the results they expected.   

John Maynard Keynes taught us that investment responds to demand. Keynes’ “demand-side” perspective, put simply, reminds us that people need money (from income, wealth, or debt) before they can buy anything. A piece of string must be pulled across the table. Conceptually, this understanding was the basis of his General Theory of Employment, Interest and Money (1935). It was all but abandoned by mainstream economics after the 1960s, however, because it implied that instability and decline were natural developments in market economies, and therefore that central governments would have to step in and stimulate demand throughout the economy. The L1 myth developed around a rejection of Keynes’s General Theory.

The Keynesian Logic

The General Theory focused on how much demand would be generated by a given (initial) level of “income” (GDP), defined essentially as the total of all transactions, including all payments for labor, capital or consumption. Keynes specified three independent variables in his model: The interest rate, the propensity to consume, and the marginal efficiency of capital. These three factors, acting independently, Keynes argued, determine income and growth. The cyclical level of economic activity revolves initially around the propensity to consume; i.e., as people decide to reduce current spending and increase deferred spending (saving) current economic activity declines, resulting in an initial decline of GDP, compounded (as money circulates) by a bounded multiplier effect.    

This was Keynes’s major contribution to theory. Classical (hence neoclassical) theory ignored the demand function, and therefore had no way to explain growth or decline. The neoclassical model (as developed via Ricardo, Walrus, Marshall and eventually Paul Samuelson, among others) erred by assuming that “supply creates its own demand,” essentially treating the economy as a static aggregation of transactions. Because the interest rate is independent of the other two variables and is not an equilibrium of the supply and demand for money, and because a decline in current consumption does not automatically imply an increase in future consumption, Keynes famously reasoned, an increase in saving, instead of resulting in more investment, results in increased unemployment. No, this was not intuitively obvious to many, though Keynes said it was, which is why it was such a major theoretical development. The upshot, however, is that a market economy is inherently unstable, and that because investment depends on expectations of future demand, an economy’s current level of demand must be stabilized as it rumbles along by infusions of government spending.

The point is that the entire basis for neoclassical economics is itself a myth: As James Galbraith has pointed out, most economists take it as a matter of faith that economies will return on their own to full employment after brief down periods, that is without the stimulation Keynes demonstrated was necessary; but when an economy is always declining, that cannot happen, and eventual collapse into deep depression is inevitable. That is the ultimate reality revealed by Keynesian demand-side economics.

Mainstream academic economics was destined to be controlled, however, not by science but by philosophy; in particular, the philosophy of Milton Friedman, who wanted to keep government from interfering with the “free” economy. So he argued that economies will grow and prosper even while wealthy people are making and keeping as much money as a “free” market will allow. Ignoring considerations of social utility, Friedman made it clear that he opposed interference with the natural distribution of wealth and income established by the free market, which he analogized to the operation of a lottery:

Consider a group of individuals who initially have equal endowments and who all agree voluntarily to enter a lottery with very unequal prizes. The resultant inequality of income is surely required to permit the individuals in question to make the most of their initial equality. Redistribution of the income after the event is equivalent to denying them the opportunity to enter the lottery. (Capitalism and Freedom, U. Chicago Press, 1962, 2002 ed. p. 162)

Note that, from the outset, the underlying issue was distribution, and a separate elaborate line of argument was subsequently constructed by the “conservative” economic community to the effect that income and wealth distribution has no macroeconomic significance, and should be ignored. That line of argument forms the basis of L2 mythology.

Level 2 Mythology

The best example of that argument, “Reducing poverty, not inequality” (here) was offered in 1999 (here) by the former chairman of Ronald Reagan’s Counsel of Economic advisers, Harvard professor Martin Feldstein, who asked us to imagine that a “magic bird” made a small award that would not affect anyone else’s “material well-being.” The truth, however, is that many trillions of dollars of wealth have transferred to the top 1% over the last 30-40 years, both from the bottom 99% and the proceeds of America’s escalating national debt. So the “material well-being” of the bottom 99% has been drastically reduced by redistribution:

productivity veresus inflation-adjusted-wagesThis chart, published by Gus Lubin (November 12, 2013, here), shows that since the advent of the Reagan Revolution presided over by Martin Feldstein and other ideologues, America’s productivity continued to grow, but the gains have remained with the producers while median wages have fallen.   

By now, nearly all informed Americans should be clear on the bankruptcy of the “magic bird” myth. Paul Krugman is getting more serious recently in attacking this issue (“That Old-time Whistle,” New York Times, March 17, 2014, here):

But over the past 40 years good jobs for ordinary workers have disappeared, not just from inner cities but everywhere: adjusted for inflation, wages have fallen for 60 percent of working American men. And as economic opportunity has shriveled for half the population, many behaviors that used to be held up as demonstrations of black cultural breakdown — the breakdown of marriage, drug abuse, and so on — have spread among working-class whites too.  

Meanwhile, media reports continue to amaze us. Detroit is in bankruptcy, its residents wallowing in third-world poverty. Syracuse, NY and many other cities face intractable fiscal problems. Just yesterday, I heard a PBS radio news report that a hospital in northern Massachusetts actually shut its doors because it cannot afford to stay open; sufficient funding could not even be found to keep the ER open. It is becoming increasingly evident that America’s economic woes are attributable to a fundamental shortage of money in the active money supply available to the bottom 99%. This is the stuff of stagnation, of depression.

The “Invisible Hand”

The sum and substance of the L1 mythology, finding no support in scientific economics, was eventually propped up by “the doctrine of the invisible hand,” a mythical and wholly false attribution of Friedman’s alleged “free market” philosophy to Adam Smith. (See my post “The Cult of the Invisible Hand,” December 22, 2013, here.)

Hang on to your hats: The fallacies behind the L2 myth (that distribution is macroeconomically insignificant) and the L1 myth (that an economy will always return to full employment “equilibrium” on its own) are virtually identical. L1 is like believing in the tooth fairy: the money needed for growth will magically appear under our pillow, as needed. L2 is the converse: growing income and wealth concentration does not have a negative impact on the active money supply, or put another way, the lottery winners can gather in money without restraint without hurting anyone else, without violating the so-called “Pareto Principle.” The latter idea has been stretched into the “trickle-down” argument, an idea that may have even pre-dated Adam Smith: This is the claim that the more money concentrates at the top, the better off those below will be; growth at the top causes growth at the bottom. 

In all these instances, when money is needed, it’s simply assumed to be there. That’s a fraud – the money supply is finite, so people really are hurt by inequality growth. Joseph Stiglitz recently weighed in on this point in his excellent discussion of the globalization of inequality (“On the Wrong Side of Globalization,” Opinionator, March 15, 2014, here):

In this series, I have repeatedly made two points: The first is that the high level of inequality in the United States today, and its enormous increase during the past 30 years, is the cumulative result of an array of policies, programs and laws. Given that the president himself has emphasized that inequality should be the country’s top priority, every new policy, program or law should be examined from the perspective of its impact on inequality. * * * And this brings me to the second point that I have repeatedly emphasized: Trickle-down economics is a myth. 

Here’s the real kicker: The impacts of redistribution on growth are vastly more significant than changes in Keynes’s propensity to save, the relatively minor trade-off between current and future consumption. Distribution of wealth and income  encompasses the entire money supply. We now know that since the Reagan Revolution began, the rate of growth was depressed in all five income quintiles, so growing inequality, while it was demolishing the bottom 80%, on a net basis even reduced the rate of growth of the top 20%. Worse, there has been no income growth, Thomas Piketty and Emmanuel Saez have demonstrated, outside of the top 5%. The problem has been consistently getting worse for decades, and now 95% of all income growth is going to the top 1%. The middle class and small businesses are evaporating. 

Needless to say, the “invisible hand” has been called into service to justify, and lend an appearance of inevitability to, the perpetuation of inequality. In fact, it was so used almost from the start, I have been surprised to learn, dooming Adam Smith to eternal misinterpretation just because he chose to use a religious metaphor once in Wealth of Nations, and once in The Theory of Moral Sentiments. 

Okun’s “Efficiency” Argument 

Here’s an important case in point: Back when Friedman and Feldstein were in their heyday forty years ago, another highly respected economist, Arthur Okun, who was Chairman of Lyndon Johnson’s CEA, floated the proposition that trying to correct inequality would likely reduce growth, not increase it, because it would decrease economic “efficiency,” or the ability of the economy to produce (Equality and Efficiency: The Big Tradeoff, The Brookings Institution, 1975). That could be rephrased: Trying to increase incomes of working people is likely to reduce total work. If that sounds absurd, don’t be alarmed: it is a real beauty. (In fact, the idea is apparently inconsistent, in a demand-side universe anyway, with his own more sensible “Okun’s Law,” the assertion he reportedly made of “a clear relationship between unemployment and national output, in which lowered unemployment results in higher national output.”)

According to Paul Krugman (“Liberty, Equality, Efficiency,” The New York Times, March 9, 2014, here) most economists have believed in “the big tradeoff” ever since:

Almost 40 years ago Arthur Okun, chief economic adviser to President Lyndon Johnson, published a classic book titled “Equality and Efficiency: The Big Tradeoff,” arguing that redistributing income from the rich to the poor takes a toll on economic growth. Okun’s book set the terms for almost all the debate that followed: liberals might argue that the efficiency costs of redistribution were small, while conservatives argued that they were large, but everybody knew that doing anything to reduce inequality would have at least some negative impact on G.D.P.

But it appears that what everyone knew isn’t true. Taking action to reduce the extreme inequality of 21st-century America would probably increase, not reduce, economic growth.

There’s no “probably” about it. We’re in a bottom 99% depression, not just a post-recession depression-like period as described by Krugman in his last book. 

Two Sides of the Same Coin

The relationship between inequality and growth is gradually sinking in with the economics profession, but understanding it requires jettisoning the supply-side world view that dominates the discipline. Both growth and inequality are statistics representing measures of income. The annual rate of growth is reflected in the amount of reported income accumulating over a year. Inequality is a measure of the distribution of that income. The factors that increase income and wealth concentration also reduce growth. So growth and distribution are literally two sides of the same coin.

It’s a bit more complicated than this, but here are the two main factors:

1. The demand-side factor: This one is easy for Keynesians, and both Reich and Stiglitz have emphasized it.  People with top incomes have a lower propensity to consume (percentage of income spent on consumption) than middle class people, or poorer people, who can save little or nothing and, at or near the bottom, are running up debt. So, as wages and jobs decline and income shifts to the top, the aggregate consumption (spending, GDP) is by definition declining. Two sides of the same coin by definition;

2. The supply-side factor: All profit is a form of economic rent, payment above and beyond the cost of production. As a career regulator of utility rates, I am intimately familiar with this one. The task of rate-setting is to prohibit the taking of monopoly rents by big corporations providing essential services. Most prices in the economy, even for essential products and services like health care, vehicle fuel, food, shelter, and clothing, are set under conditions of monopolistic control by huge corporations. Thus, these prices not only gradually reduce real incomes through inflation, they also attempt to maximize profit, which entails limiting supply below the point where the price would clear market demand. This too simultaneously compresses growth and increases inequality, compared to the result under competition.   

These two factors alone, together with the clear history of substantially reduced growth since the Reagan Revolution began, really should be dispositive of this issue.  Still, supply-siders don’t get it. Krugman’s article reported two recent studies by IMF economists trying by statistical correlation to test the relationship between growth and income inequality, both as against other social factors and across countries. (“Inequality and Unsustainable Growth: Two Sides of the Same Coin?,” by Andrew G. Berg and Jonathan D. Ostry, International Monetary Fund, IMF Staff Discussion Note, April 8, 2011 (here), and “Redistribution, Inequality, and Growth,” by Jonathan D. Ostry, Andrew Berg, and Charalambos G. Tsangarides, IMF Staff Discussion Note, February, 2014 (here).) 

Note that these researchers had an inkling of the true nature of their variables, as they revealed in the subtitle for their initial 2011 study. Nonetheless, their supply-side perspective cautioned timidity and restraint. In their first study, although they found inequality to be “one of the most robust and important factors associated with growth duration,” (pp. 13-14)  they timidly concluded: “The main contribution of this note may be to push slightly the balance of considerations towards the view that attention to inequality may serve both equity and growth at the same time.” (p. 18) The report on the second study led them to acknowledge a significant connection between inequality and growth. Still, they showed continued supply-side influence in a report that revealed more surprise than timidity:

First, inequality continues to be a robust and powerful determinant both of the pace of medium-term growth and of the duration of growth spells, even controlling for the size of redistributive transfers. Thus, the conclusions from Berg and Ostry (2011) would seem to be robust, even strengthened. It would still be a mistake to focus on growth and let inequality take care of itself, not only because inequality may be ethically undesirable but also because the resulting growth may be low and unsustainable.

And second, there is surprisingly little evidence for the growth-destroying effects of fiscal redistribution at a macroeconomic level. (pp. 25-26)

These two studies turned out to provide substantial corroboration of the fact that income inequality and growth are two sides of the same coin, despite a relatively poor potential correlation among the variables actually tested, yet the surprise these analysts professed was only that their results did not validate Okun’s big tradeoff.  

I checked to see what Okun himself had said: After extolling the virtues of capitalism as compared to state socialism (communism), he presented the source of his efficiency argument:

The case for the efficiency of capitalism rests on the theory of the “invisible hand,” which Adam Smith first set forth two centuries ago. Through the market, greed is harnessed to serve social purposes in an impersonal and seemingly automatic way. (p. 50)  

That was it: His “authority” was the falsely alleged viewpont of Adam Smith. Of course now we know for sure that trickle-down is a myth: Greed is not harnessed to serve social purposes; greed avoids social responsibility. In fact, greed has successfully avoided progressive taxation, which by definition is taxation that stops the further concentration of income and wealth.  The basic point of trickle-down, of course, is to avoid paying taxes. I’ll include again the Piketty/Saez graph charting the top 1% income share, along with capital gains, together with the top income tax and capital gains rates.

DP8675a

The wealthy classes today steadfastly avoid discussing the issue of increasing their taxes, occasionally advancing the Laffer curve argument that even attempting to increase taxes on top incomes would be counter-productive (disproved by Piketty/Saez/Stantcheva’s 2010 study of the income elasticity of the top income tax rate), while their spear-carriers in Congress continue to propose further reducing their already wholly inadequate tax contributions.  

We must now add Arthur Okun to the list of those who, like Milton Friedman and Martin Feldstein, wanted an economy that served only the rich. He was opposed to progressive taxation, but in 1975 he freely admitted, having no reason to try to deny it, that “[t]he progressive income tax is the center ring in the redistributive arena, as it has been for generations.” (p. 101) 

Coincidentally, in his latest Op-ed (“America’s Taxation Tradition,” New York Times, March, March 27, 2014, here), Paul Krugman has begun to develop this point, quoting Teddy Roosevelt’s famous 1910 “New Nationalism” speech, where Roosevelt argued that “[t]he absence of effective State, and, especially, national, restraint upon unfair money-getting has tended to create a small class of enormously wealthy and economically powerful men, whose chief object is to hold and increase their power” and called for “a graduated inheritance tax on big fortunes … increasing rapidly in amount with the size of the estate.” Krugman added:

The truth is that, in the early 20th century, many leading Americans warned about the dangers of extreme wealth concentration, and urged that tax policy be used to limit the growth of great fortunes.

Of course, estate taxation and income taxation are both crucially involved, because great wealth accumulates from excessive incomes. However, the larger point is that there is really no mystery here anymore: We’re facing the same old class warfare, and the entire “science” of “neoclassical” economics has sunk ever more deeply into an age-old mythology tailored only to serve the interests of wealth. 

The American economy will require much reform to survive, but first and foremost progressive taxation of incomes and wealth must be reinstated. Will that happen? I worry that corporations, because they are not really people, probably lack a survival instinct. Mankind has painted itself into a seriously dangerous corner.

JMH – 3/29/2014 (ed. 3/30/2014)   

  

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Amygdalas Economicus: Perspectives on Taxation

acivilamericandebate:

Paul Krugman is right that we are in the “dark ages” of economics. The wisdom of the ancients has been lost, but while mainstream economics operates under a presumed “law of supply and demand”, Krugman has acknowledged only that the wealthiest Americans do not live in a supply and demand world. Actually, Barry Lynn’s book, “Cornered: The New Monopoly Capitalism and the Economics of Destruction” (2010), demonstrates persuasively that no one does. How market economies work has been based on a fundamentally false perspective almost from the beginning. Today, monopoly profits rise rapidly to the top at everyone’s expense.

Inequality has risen rapidly because taxation of corporate profits and top incomes was severely reduced since our economy last prospered. This essay, originally posted over a year ago, explores the wildly divergent perspectives on taxation that result from the faulty mainstream, neoclassical perspective.

Originally posted on :

(Return to the Contents Topics page.)

economist mod econ theory

(Illustration by John Berkerly for The Economist, July 16, 2009)

To understand how the rich and powerful managed to replace the “invisible hand” of the open market with the invisible fist of their autocratic institutions, we have to look beyond their co-optation of the word “market.” We must also look at the word they appended to it: “free.”  It was the act of combining these two words into the term “free market” that transformed the market from a political tool that exists within  human society into something that exists over and around human society, something that acts upon human society like a sort of mechanical god. – Barry C. Lynn

Apologies for the title, but I chose it to remind me of the emotional, and often fearful, component of intellectual thought.

Barry C. Lynn’s fabulous book (Cornered: The New Monopoly Capitalism and the Economics of…

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Finding a New Macroeconomics: (10) Reinhart, Rogoff, and Redistribution

acivilamericandebate:

IMF studies (2011, 2014) of the relationship between growth and inequality, reported by Paul Krugman (“Liberty, Equality, Efficiency, New York Times, 3/10/14, here) surprised the researchers by showing that inequality is directly tied to growth. The corrected Reinhart/Rogoff Study (GITD) remarkably, albeit indirectly, confirmed the relationship, as this post shows: (1) Because the R/R correlation was between income (GDP) and the ratio of public debt (PD) to GDP, and (2) because of the interrelationships among income concentration, tax regressivity and public debt (PD effectively financed wealth concentration at the top), the R/R data surpisingly confirmed the enormity of the decrease in annual growth caused by the concentration of income and wealth in the U.S. The full effect of rising income and wealth inequality on growth, when compounded by an enormous national debt, is stunning.

Originally posted on :

An insistent question of our time is, how much government debt is too much. Is there some debt level that becomes crushing as opposed to merely costly? The controversy over research by economists Carmen Reinhart and Kenneth Rogoff shows how explosive the issue is. * * * 

One group of economists and policymakers argues that annual deficits must be cut because they’re creating — or have already created — dangerous debt levels. Another group contends that large deficits are needed to propel stronger recoveries and reduce huge unemployment. It’s “austerity” versus “stimulus.” If debt exceeding 90 percent of GDP is hazardous, then the case for austerity seems stronger. (Already many countries exceed or are approaching the 90 percent mark.) If not, deficit spending remains a possible temporary spur. Which is it? Although the newly discovered errors in Reinhart and Rogoff’s 2010 paper (“Growth in a Time of Debt”) are embarrassing…

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Pixie Dust

[Note - This is a re-posted article, originally posted here on 2/13/13.]

A_little_bit_of_pixie_dust_by_DawnyDawn

(Pixie by Dawny Dawn)

The “science” of economics today is not merely and institutionalized form of neo-feudal philosophy, nor is it merely an ideology of darkness that erects institutions to promote more darkness. It has become a form of madness, a dream of human imagination we mistake for a pattern of the world.  It is a path not merely to serfdom but to death.

We do have an alternative, though.  We can believe what we see with our own eyes.

(Barry C. Lynn, Cornered: The New Monopoly Capitalism and the Economics of Destruction, John Wiley & Sons, 2010, p.252)  

In recent months I have occasionally reflected on why, as a grad student at the University of Michigan, I decided to leave the PhD program in economics and to enroll in the law school. Mostly, I think, I was shying away from an academic career. But I had concerns about economics as well. Milton Friedman had just published Capitalism and Freedom the year before I entered college, and debates about the role of government in the economy were heating up in the late 1960s.  My professors at Oberlin had taken the Keynesian side, arguing that “supply-side” theory was unsupported and based on ideological opposition to government participation in economic affairs. I didn’t like wondering how a field like economics could be so political and still function objectively as a social “science.”

What I mostly recall today, however, are the troubling questions I had about the “microeconomic” supply and demand principles underlying most of the economics I was taught.  I remember feeling something like an Atlantic sockeye salmon, swimming upstream: The theories told me what “equilibrium” would look like, if I assumed “perfect knowledge” and “perfect competition” and a host of other assumptions, none of which were ever realized in the real world.  But I didn’t want to know what might happen in a hypothetical world; I wanted to know what actually happens in the real world.

A few years out of law school, as fate would have it, I was appointed to the position of Administrative Law Judge at New York’s Public Service Commission, a position I held for nearly thirty years. That job required me to decide cases involving a lot of – you guessed it – economic issues.  Instead of becoming a professional economist, ironically, I had become a practicing economics professional. My job required finding answers to sometimes difficult factual and policy issues, both legal and economic, from the bottom up. It was my job not to prejudge or speculate, but to try to find the truth, and I took that responsibility seriously, refusing to respond to political pressure. For a number of years, most of the big cases involving economic and antitrust issues, like the AT&T divestiture and the Bell Atlantic-NYNEX merger, came my way.  It was not clear to me that the Bell Atlantic-NYNEX merger was entirely in the public interest as proposed.  It was approved in New York and Washington, however, and the result was Verizon.

None of us can claim to be right about everything.  All of us may, from time to time, take comfort from some “pixie-dust” ideas, notions that are created through the application of top-down psychological preferences instead of through verifiable, bottom-up factual analyses.  This is mostly harmless when the ideas are reasonably inconsequential, and we do not firmly believe them to be true, like the wonderfully entertaining superstitions in “Silver Linings Playbook” about what it takes for the Philadelphia Eagles to win football games.

There is danger, however, when we form unfounded beliefs about important things.  Ironically, it is those ideas we hold by faith, without real-world factual support, that we are least willing to challenge or change in the face of contradictory evidence.  Alas, the “science” of economics is riddled with such ideas.

I have long believed that market economies are unstable, and have long suspected that unfettered market economies will eventually disintegrate, succumbing to the influence of growing stagnation. One recent morning I awoke, with a strong feeling of conviction, thinking this:

Unrestrained capitalist economies are virtual inequality machines, relentlessly creating and compounding dysfunctional distributions of wealth and incomes; and the rest is pretty much inconsequential window dressing.

It dawned on me, as I thought about it, exactly how I had arrived at that conclusion.  This “revelation” comes to me as I organize my materials and thoughts for a PowerPoint presentation on inequality, and consider theories on the mechanisms of economic decay.  I would have no basis, of course, to offer such a remarkable claim as a scientific one, without reference to the reports and studies on detailed income and wealth distribution data which have become available over the past two or three years.  Otherwise, how could I claim any more credibility for this idea than has been claimed for the economics Barry Lynn condemns as “neo-feudal philosophy”?

I told my sister about my epiphany.  “Do you think this is a new idea?” she asked, a bit impatiently.  “Read Barbara Tuchman’s A Distant Mirror.”

Okay, but what about modern economic theory?  You may react as my wife did when I told her about my revelation: “Have you been watching MSNBC?” she asked. “That’s what everybody’s been saying.” Well, no, not exactly: Certainly there has been much discussion recently, thanks to inputs from experts like Joseph Stiglitz and Robert Reich, about how dangerous inequality is and is how it is hurting our economy, but that’s about it.

This is not an issue upon which the economics profession has taken the lead. Eighteen months ago Americans in great numbers took to the streets to Occupy Wall Street and communities all over America, seeming implicitly to understand that the dividing line in the growing income inequality gap is almost exactly the line between the top 1% and the bottom 99%.  It was only six months ago, however, in July of 2012, that Stiglitz published The Price of Inequality: How Today’s Divided Society Endangers Our Future, and the likely implications of his observations are only now starting to emerge in media and professional discussions.  And just a few months earlier, in May of 2012, another distinguished American Keynesian, Paul Krugman, published End This Depression Now (May, 2012), in which he tentatively argued that income inequality may be essentially a “political” problem, presumably lacking material macroeconomic consequences.

Stiglitz’s book, to the best of my knowledge, is the first significant economic text since Henry George’s Progress and Poverty (1879) to describe what I now feel is capitalism’s basic flaw.  No, not even Keynes did that.  Almost no one, so far as I know, has looked at instability in modern economies quite that way – not even Joseph Stiglitz, even now.

I am inspired by the reasoning of Georgist economists Mason Gaffney and, recently, Mary Manning Cleveland, an environmental and inequality economist who is a supporter of the work of Barry C. Lynn (here).  This short list must also include Clifford Cobb and James Galbraith, who in a recent speech (here) skewered the notion of “normality,” and the associated belief that after each crisis “the economy will recover,” adding: “It was never made quite clear why.”

As someone whose interest and expertise comes not from academia, but from real-world experience, it is exciting to get a glimpse, in James Galbraith, of someone I might have been very much like had I gone down the academic road in life. Referring to the gap between Keynesians and supply-siders, Galbraith colorfully alludes to a “saltwater-freshwater pseudo-divide, maintaining an illusion of discourse, of conversation, yet always centered on the perfect competitive, perfect information, rational actor type,” which he calls “a form of scientific regress” and “a useless abstraction.”

What I have learned over the last two years, to my dismay, is that far too many Americans subscribe to beliefs about economics that are flat-out wrong, some of them absurdly so. Most people, including those with no economics background at all, would upon reflection likely reject ideas that are so ridiculous as to violate fundamental common sense.  But when perceived truth is inconsistent with their underlying interests, those in control of the media have been able to convince people of false ideas that are not so obviously wrong.

Here is my effort to summarize the major difficulties in one blog post.  This is essentially a view from a mile up, specifically designed to avoid the details over which so much debate and distraction leads to trouble.  Let’s try to see, in broad strokes, where economics has gone wrong.

The flawed “classical” paradigm of “equilibrium”:

The “neo-feudal philosophy” Barry Lynn speaks of so colorfully seems to me to be a regressive outgrowth of “classical” economic theory.   Galbraith reports in his wonderful lecture that ideas we think of as “classical” have been repackaged and recycled so much in different contexts that one loses sight of the original ideas.  So let’s go back to the beginning.

Influenced by Adam Smith (1723-1790), the French philosopher Jean-Baptist Say (1767-1832) popularized what has become known as “Say’s law,” the idea that “supply creates its own demand.”  Every sale is also a purchase, but that tautology in itself provides no useful information. The more useful idea was, and is, that aggregate supply creates aggregate  demand. Here, however, is where  the trouble begins: The idea that, through markets and the use of a viable medium of exchange,  aggregate demand will clear aggregate supply is not a tautology.  Here is a basic supply and demand curve:

image002

All it does is describe the idea that at higher prices lower quantities are demanded and greater quantities are provided.  The slopes and locations of these curves vary among circumstances.  The point of intersection of these curves is known as a point of “equilibrium.”  Inherent in any supply-demand analysis is the need to meet certain assumptions, like perfect knowledge and perfect competition, to actually “find” the hypothetical equilibrium point for a given product or a given market.  But supply-demand analysis offers, at best, a fleeting description of a market, as these curves change location and shape over time.

The basic problem is that “equilibrium” has never been more than just a hypothetical point, especially for an entire economy.  In what I conclude was Keynes’s main contribution to economic theory, his General Theory of Employment,  he showed that the achievement of a market-clearing aggregate supply and aggregate demand of goods and services for an entire economy cannot even theoretically be achieved by a continuous, linear, aggregation of individual supply-and-demand equilibria, pursuant to Say’s Law.

Keynes developed a simple model with three independent variables: (1) the interest rate; (2) the propensity to consume; and (3) the marginal efficiency of capital (cost of capital). He observed that output is divided between goods and services for current consumption, and investment in the means to provide for future consumption.  On the demand side, total income consists of total current consumption and total saving.  On the supply side, production consists of total current consumption and total investment.

These two amounts are equivalent (Say’s Law), but as Keynes explained this equivalence led to the erroneous “classical” assumption that savings always equals investment.  No law of economics, said Keynes,  requires monetary savings to be immediately applied to the provision of physical investment.  Savings can be hoarded.  So, if the aggregate propensity to consume declines for some reason (say, increased regressivity of the taxation system), and demand falls, investors would likely perceive from the decline in demand reasons to expect lower demand in the future.  Thus, Keynes famously reasoned, a decline in demand, instead of leading to more investment, would lead to higher unemployment!

In this observation, Keynes recognized the tendency of market economies to decay.  No reason has since been advanced to expect demand to grow again on its own, when an economy is left to its own devices. Not ever — not unless demand is revived extrinsically and abnormally, say, by warfare.  Household consumption requirements, which are spiraling down in response to declining investment and jobs, simply won’t recover on their own.  In a depression, moreover, the interest rate can fall all the way to zero without providing for a schedule of the marginal efficiency of capital sufficient to promote investment and growth.  And if demand is falling because of rising income inequality, as Mary Cleveland has suggested, the resulting “liquidity trap” becomes something even more debilitating, something we might call an “inequality trap” (here).

The presumption of normality:

The late James Tobin wrote in 1997 (“An Overview of the General Theory,” (here), Cowles Foundation Paper 947 ( here))  that the central economic questions of our generation are whether a market capitalist economy, left to itself, will fully employ its labor and other productive resources without government intervention, and whether it will return to full employment reasonably swiftly once displaced from it.  “The answer of the General Theory,” he said, “is ‘no,’” adding: “I argue that Keynes still has the better of the big debate.”

James Galbraith, as noted, discusses how mainstream economics is enthralled by the presumption of normality, which postulates that an economy will always recover from a slump; it may take a little longer, but economies will eventually bootstrap themselves back to “equilibrium.”  As Galbraith points out, no one has ever specified how that is supposed to happen.  It is a matter of faith, maintained with a liberal application of pixie dust.

Inequality in the spectrum of economic thought:

Here is a brief listing of four categories of economic thought I have identified, ranging  in my assessment from the craziest to the most accurate.  I assign each a “pixie dust rating” (PDR) on a scale from zero to ten:

1. Supply-side ideology: (PDR = 10)  

This is a collection of ideas that range from the preposterous to the simply wrong. These are ideological notions that dominate the tea party, the Republican Party, our national and many state governments.  No amount of pixie dust could make any of these ideas work:

- Tax reductions for the rich pay for themselves. (Even if lowering taxes on top incomes stimulated investment and growth, it couldn’t possibly stimulate enough growth to provide for the revenues lost.  And if it could, why would more tax reduction still be needed with taxes on top incomes and corporations already at their lowest point in about three generations?);

- Tax reductions for the rich stimulate growth. (No, they don’t.  From 1979 to 2007, these tax cuts made enough additional revenue available to the rich to accumulate about $14-15 trillion in net worth while the federal government ran up more than $12 trillion in debt.  Top 1% net worth increased nearly $12 trillion above the per capita allocation of wealth growth.  Meanwhile, the overall rate of GDP growth dropped by one-third, and income inequality skyrocketed.);

- Income inequality is the difference between what someone can make with a college education and what they can make without it. (This is according to the CATO Institute, Ben Bernanke, and even the 2012 Economic Report of the President. What can I say? “We can believe what we see with our own eyes.”)

2. Monetarism: I’ll use this broad term for want of a better one for this category. (PDR = 7)

- Milton Friedman, Frederick Hayek, and others argued that Keynesian fiscal policy would be self-defeating because, to the extent it  would increase the money supply, it would led to inflation.  (I don’t think there’s anything wrong with this logic, assuming there is a steady level of demand.  However,  over thirty years of federal borrowing from 1979-2007, during which some $14 trillion of national debt was incurred, there was no runaway inflation, no inflationary spiral; instead we got steadily declining demand, ending in a depression.);

- The interest rate can be lowered enough to induce jobs and investment in a downturn.  (Evidently not in a depression. – One virtue of this line of reasoning, though, is that it acknowledges the Keynesian point that the level of aggregate demand is important, flatly contradicting the supply-side ideology that asserts growth stems from rich people saving, not from everyone else earning and spending.);

- After a downturn, the economy will always return to full employment on its own, with no need for government help.  (Really?);

-  Inequality is not a problem; there’s plenty of opportunity, if people are willing to work.  (No – unemployment rose to extreme levels (10%) after the Crash, is still at about 8%, and is expected to stay there for several years, under mainstream assumptions.  Many working people in the lower middle class, often with college degrees, are living at or near the poverty level.  The decline in demand from inequality growth, in effect, ruled out any chance of runaway inflation.)

3. Mainstream Keynesianism: (PDR = 4)

- Government is a part of the economy, so its level of activity and spending affects the level of jobs and growth. (Yes) ;

- Austerity, that is reducing government spending, reduces demand, jobs, and growth. (Yes);

- Government deficit spending stimulates growth (It can, in some circumstances, but not if the countervailing force of inequality growth is depressing growth to a greater degree);

- There is no inequality or poverty problem at full employment. (Wrong – Keynes believed this, but the data show that reduced growth is accompanied by higher levels of income and wealth inequality; In a depression, high levels of inequality probably prevent a return to full employment.);

- The U.S. can stimulate the economy now through deficit spending, and pay off its huge debt once the economy is rolling again at full employment. (No – There has been constant deficit spending for more than 30 years, running up $16 trillion of debt by 2013; all of that “stimulus” merely landed the U.S. in a depression, and added commensurate levels of wealth transfers. The degree of continuous growth of inequality is now greater than any stimulus that might be gained by even well-placed federal spending and investment.);

- Inequality is a symptom of unemployment. (No. Inequality is the underlying problem, and regulating the distribution of wealth and income is government’s most important function.)  

4, Georgist-Keynesianism: (PDR= 0)

- Income and wealth distribution, not employment, is the fundamental driver of prosperity and decay;

- As Stiglitz argues, inequality growth has already gone way to far in America. The U.S. is the worst among industrial countries, and suffers the worst consequences. 93% of all new income goes to the top 1%, which holds nearly half of all financial wealth.  An estimated $300-500 billion of wealth (my estimate) is transferred up to the top 1% annually;

- Incomes of the top 0.01% tripled from 1979-2007, and the top 1% average income doubled, while the per capita real income of all categories in the bottom 80% declined;

- The middle class is drifting into poverty as poverty levels rise drastically; Almost all small business income left in the U.S. economy is now going to the top 1%, and wealth concentration has apparently nearly reached its practical limit;

 - The majority of income and wealth going to the top 1% is economic rent, that is, income received for no productive output.  Much of that, Galbraith asserts, is taken through financial transactions that are basically fraudulent;

- The economy is structured today in ways that keeps money flowing to the top (Lynn), and substantial economic regulation and re-regulation is essential to stop that process (Stiglitz, Galbraith). The economy is also threatened with potential collapse from the institutional failure of monopolistic structures (Lynn);

- Taxation must be revised to produce government revenues (as a percent of GDP) equivalent to those taking place in the 1970s. Land and resource rents, and income from non-productive activities, must be taxed more heavily and work and consumption less heavily. Government spending must be redirected into the kinds of investments for America’s future proposed by the President in the recent State of the Union Address;

There are billionaires like Warren Buffet and Howard Schultz, and the “Patriotic Millionaires,” who argue for progressive taxation and for federal budgets that preserve the middle class and promote growth, based on their understanding that their business success depends on the success of the entire economy. Such views, however, are poorly represented in Congress.  America is doomed to Great Depression II unless and until Republicans, and others not fully committed to preventing such an outcome, are excluded from the halls of Congress.

JMH – 2/13/13 (ed. 2/14/13)

(Republished – 3/7/14)

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Inequality and Taxation: The Krugman Conundrum

I’ll make this short: In today’s New York Times Paul Krugman once again revealed how his Keynesian thinking has been corrupted by opposing neoclassical, supply-side ideas. If you are losing patience with my continually “picking on” Paul Krugman, I am only focusing on his perceptions because our future, in many ways, depends upon our leading spokesman for populist economics getting the inequality issue right. After this short post, my plan is  to concentrate on writing up and refining my own analysis.

Krugman’s latest Op-ed (“Talking Troubled Turkey,” New York Times, 1/31/14, here) seems to clarify the dividing line between the Keynesian and neoclassical schools, that is between the demand-side and supply-side points of view, and helps explain why income and wealth redistribution has economic significance.

The macroeconomic problem with inequality boils down to this: The wealthy, who now own or control the large corporations, the capital stock (means of production), the associated real property, and most of the inputs of production, are making too much money. They charge too much for what they sell, and because they pay excessively low taxes, they are allowed to keep too much of that. They “save” their excess earnings, taking trillions of dollars out of circulation, shrinking the active economy.   

You will of course ask: How do we know that? And how much is too much?  My answers to those questions are enabled by an entire career spent determining how much income is enough for large corporations engaged in providing vital products and services, including electricity, natural gas, telecommunications, and water. The rates charged for these services have been determined by government because: (1) They are essential services; (2) they have been provided under conditions of monopolistic or near-monopolistic supply. Excess “profits” are windfalls to such companies, and excess retained earnings only create opportunities for cost escalation, or for excessive distributions to management and wealth concentration.

Much else in the marketplace, including, for example, food, transportation, fuel, clothing, and insurance, is essential to society as well. Only vibrant competition can provide efficiency, and prices based on efficient marginal costs; but that kind of competition is non-existent. In short, market power produces an endless accumulation of excess profits and wealth, and that drives inflation, and income and wealth concentration. Concentration continues until people who are not among those at the very top of the income ladder (the top 0.01%, roughly) are denied the fruits of growth and prosperity. Currently there is no growth below the top 1%. Growing unemployment and growing poverty, reduced education and reduced public health and safety, are all symptoms of this growing inequality. It is not the other way around.

Paul Krugman has seemed on the verge of articulating this reality, but he as yet has not. In today’s Op-ed, he said this:

Before I get to Turkey, a brief history of global financial crises. For a generation after World War II, the world financial system was, by modern standards, remarkably crisis-free — probably because most countries placed restrictions on cross-border capital flows, so that international borrowing and lending were limited. In the late 1970s, however, deregulation and rising banker aggressiveness led to a surge of funds into Latin America, followed by what’s known in the trade as a “sudden stop” in 1982 — and a crisis that led to a decade of economic stagnation.

The “world financial system” was “remarkably crisis free” for a generation after WW II, I submit, because the underlying economic conditions were crisis free. I’ve been over all of the details in previous posts: The basic point, seen most clearly in the case of the United States, is that up until 1980 there was broad prosperity and relatively robust growth. The active economy shrunk thereafter, however, with rising income and wealth concentration. Recessions (in terms of unemployment) were progressively deeper and longer-lasting. Now we’re in a depression.

Paul Krugman focuses on what he calls a “sudden stop,” which is in effect a bursting bubble: 

Most recently, yet another version of the story has played out within Europe, with a rush of money into Greece, Spain and Portugal, followed by a sudden stop and immense economic pain.

As I said, although the outline of the story remains the same, the effects keep getting worse. Real output fell 4 percent during Mexico’s crisis of 1981-83; it fell 14 percent in Indonesia from 1997 to 1998; it has fallen more than 23 percent in Greece.

Money keeps flowing in, he notes, and yet output and employment falls. We need to ask: How can that be? How can that possibly happen unless inequality is growing and the demand  for output is declining? Here we see Krugman slipping into a supply-side frame of reference, and now we have reached the crux of the matter:

You may or may not have heard that there’s a big debate among economists about whether we face “secular stagnation.” What’s that? Well, one way to describe it is as a situation in which the amount people want to save exceeds the volume of investments worth making.

When that’s true, you have one of two outcomes. If investors are being cautious and prudent, we are collectively, in effect, trying to spend less than our income, and since my spending is your income and your spending is my income, the result is a persistent slump. 

Alternatively, flailing investors — frustrated by low returns and desperate for yield — can delude themselves, pouring money into ill-conceived projects, be they subprime lending or capital flows to emerging markets. This can boost the economy for a while, but eventually investors face reality, the money dries up and pain follows.

If this is a good description of our situation, and I believe it is, we now have a world economy destined to seesaw between bubbles and depression. And that’s not an encouraging thought as we watch what looks like an emerging-markets bubble burst.

The statement “we are collectively, in effect, trying to spend less than our income” is conceptually wrong: Investors are spending less than their income. Consumers, especially, in the last decade, students and home purchasers, want to spend more  than their income, so they run up enormous debt. This is the direct consequence of growing inequality. [1] 

“Secular” stagnation is an inherently supply-side concept typically used to describe stagnation caused by natural (catastrophic or demographic) phenomena, not Keynesian economic phenomena, as discussed in an earlier post addressing Krugman’s “mutilated economy” (here).  To regard stagnation as “secular” allows economists to ignore Keynesian stagnation and imagine that economies can and will rebound to full strength on their own, over time. When redistribution is taking place, as in the United States over the past 30-40 years, to characterize stagnation as secular — as Krugman and Summers did at the IMF conference in the fall — requires denying that redistribution has Keynesian economic effects. This leads to the notion that the world might “seesaw between bubbles and depression,” and ignores the existence of continuous, growing stagnation. 

What Krugman describes here, however, is the situation he has typically called the “liquidity trap,” where there is much excess savings piling up and little or no investment. Krugman is clear on the outcomes: When saving exceeds investment, we have a “persistent slump;” and if investors pour money into projects that will not produce returns, “this can boost the economy for a while,” but eventually “the money dries up and pain follows.” There can be only one explanation for such a depressed situation, and demand-side Keynesian economics provides that explanation — effective demand has shrunk.   

We need to stop and ask: What gave rise to the excess of saving over investment? I submit that can only be the result of excessive profits, that is, corporations making “too much” money, and making more money than you need to cover current costs is the definition of “too much.” Because that money has been taken from consumers, and redistributed to the top, their ability to purchase other things — output for which more investment would be needed — has been reduced. This impairs the ability (and expectation) of investors to earn enough return on investing in the production of such output, and investment and growth “dries up.”

This, as clearly as I am currently able to explain it, is the basic mechanism of how inequality growth through redistribution causes stagnation. This is why distribution is the underlying factor controlling whether prosperity or stagnation prevails in an economy. Because the process of excess profits accumulation is continuous, the cyclical, non-distributive influences on demand envisioned by Keynes only tell part of the story, a part of the story that pales by comparison.

Decline and decay will always be much more substantial than expected until the macroeconomic impacts of wealth and income concentration are acknowledged and factored into economic analysis. And the problem can never be resolved until the cause of income and wealth concentration — excessive profits — is corrected through price regulation or taxation. Of course, for a market economy, except in the case of a few crucial monopolistic industries where price regulation is feasible, the answer has to be taxation.    

JMH – 1/31/14 

[1] Added 2/18: It’s important to remember that no economic understanding of inequality, and its implications for taxation, is possible without differentiating between the “propensity to consume” of those whose income share is growing and that of those whose income share is declining.  To say that demand is declining is not the same as saying that everyone is “collectively” trying to increase saving; that ignores the decline in real income at the bottom.   

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Inequality, Money, and Taxation

The truth, both throughout the entire world as Oxfam International has now shown, and in the United States as my own statistics verify, is that the concentration of wealth in the hands of a very few individuals has gone way beyond even imaginable levels, and in both cases it is of a similar order of magnitude. What should have been clear all along is now becoming undeniable in the rational world: Inequality is fundamentally an economic problem; the distribution of wealth and incomes is all about money; and the distribution of money is the most important factor in determining prosperity, growth, and stagnation. 

It seems strange to have to re-emphasize that reality over and over again, but even today in 2014, the neoclassical, mainstream community continues to deny that inequality growth has any economic consequences. I frankly do not know how anyone — especially trained economists — can think of economics and economic change without at least conceptually including the role of money at every stage. The mainstream perspective does, however, benefit the rich, for it follows from the proposition that inequality growth has no economic consequences that taxing them also has no economic consequences.    

As discussed in previous posts (here, and here): David Brooks (1/16/14, here) outlined the propositions that wealth at the top is disconnected from poverty at the bottom, and that incomes, employment and social mobility at and near the bottom are determined by levels of training and education, social factors like single motherhood, and the declining availability of low-skill jobs. Raising the minimum wage, he said, would not help – money (evidently) is not a factor. Similarly, Harvard economics professor Martin Feldstein (1999, here) argued that inequality and poverty are stand-alone issues, that income inequality is not a problem, and that poverty is attributable to social factors such as inadequate training and education (which improves with private education). The amount of money available in an economy, its velocity and its distribution are (evidently) irrelevant, or at least not important enough to discuss.

What “Political” Problem?

Paul Krugman, the economics columnist for the New York Times and probably the best-known and most influential populist economist active today, has heretofore consistently taken the position that income inequality is a “political” problem (End this Depression Now! 5/12, Ch. 5), and he has resisted the conclusion of Joseph Stiglitz and Robert Reich that growing inequality depresses an economy because it depresses demand — an irrefutable and demonstrable consequence of Keynesian demand-side theory. 

Take another look at the famous chart of top 1% income share from the data compiled by Thomas Piketty and Emmanuel Saez:

top-1-share-of-income-usThe top 1% income share reached its first peak in 1928, just before the stock market crash that brought on the Great Depression. It then peaked again in 2007, just before the even bigger stock market crash that ushered in the Great Recession. Krugman, strangely for a self-styled Keynesian, argued in his last book that this could be just a “coincidence.”   

No, it cannot be a coincidence, not in demand-side theory: When the top 1% share reaches 24% of income, the bottom 99% is getting only 76%; for any given level of total income (GDP), bottom 99% income and purchasing power has substantially declined. This necessarily means reduced demand and slower growth. The facts since 1980, of course, bear out this reality, validating Keynesian demand-side economics. As this blog has frequently reported, not only has the economy shrunk, but the much larger top 1% share of the smaller pie turned out to be smaller than what the top 1% share would have been of the previous, much larger pie: Rising inequality has hurt everyone. 

Unfortunately, Krugman’s argument that inequality is just a “political” problem is in line with the neoclassical, supply-side perspective.  It would be one thing to take the position that the issue is political because of society’s failure to control income and wealth distribution, but that would add nothing of substance to the debate. It is quite another thing, however, to agree with the supply-side economic community that the issue only relates to social and institutional factors, while economic growth results solely from investment, which is stimulated only through monetary expansion and by reduced taxation of corporations and the wealthy. Calling inequality a “political” problem is therefore akin to arguing it is merely a collection of “social,” “behavioral,” “technological” or “institutional” problems. There are no other apparent senses in which inequality might be characterized as a “political” issue. 

Thus Krugman, as a champion of liberal, populist causes, with this stance must confront his adversaries in their own ballpark, effectively conceding their core argument that inequality growth is not an economic problem, and undermining as well his own case against the “austerity” doctrine.  

While his New York Times colleague David Brooks has been strenuously challenged on Keynesian grounds for arguing that inequality growth is not an economic problem, Krugman so far this year has been content to attack Pulitzer Prize winning columnist Bret Stephen’s year-end Wall Street Journal article (“Obama’s Envy Problem,” 12/31/13, here, and here). That exchange is informative: 

“The President thinks America has inequality issues,” Stephens began. “What he has — what it has — is an envy problem.” After a brief political attack on Obama, Stephens then quoted Alexis de Tocqueville (1805-1859):

“Democratic institutions strongly tend to promote the feeling of envy,” and “a depraved taste for equality, which impels the weak to attempt to lower the powerful to their own level…”

Then he introduced the “Pareto principle”:

Inequality is not a problem simply because the rich get richer faster than the poor get richer. It’s a problem only when the rich get richer at the expense of the poor.

“As it is,” Stephens asked, “to whom except the envious should it matter that the boss now makes a lot more, provided you, too, also make more?”

Finally, he challenged the numbers Obama cited in his speech related the widening gap between CEO compensation average worker pay and the record level of wealth concentration; and using quintile data (which averages in the huge gains in the top 1%), Stephens argued that growing income inequality is no big deal:  “The richer have outpaced the poorer in growing their incomes, just as runners will outpace joggers.”  

Krugman (“Disinformation on Inequality,” New York Times, 1/2/14, here): took Stephens to task for using nominal figures (falsely implying that incomes are growing at the bottom); criticized Stephens for using Census Bureau (top 20%) data obscuring the more relevant narrow band of top 1% data; confirmed the accuracy of Obama’s numbers; and cited CBO data to disprove Stephens’ suggestion that inequality hasn’t changed much since 1979:

The point here, as on so many other economic issues, is that we are not having anything resembling a good-faith debate.

We could have a debate about whether rising inequality is a problem, and whether measures intended to curb it would do more harm than good. But we can’t have that kind of debate if the anti-populist side won’t acknowledge basic facts – and it won’t. In his piece Stephens trashes Obama, accusing him of making a factual error when he did no such thing; then proceeds to commit just about every statistical sin you can imagine in an attempt to minimize the rise in inequality. In the process he leaves his readers more ignorant than they were before. When this is what passes for argument, how can we have any kind of rational discussion?

Krugman is correct that Stephens wrote a terrible piece, full of inaccuracies, but that was just low-hanging fruit. Krugman’s approach to the issue is troubling: The political right has been distorting the facts in this way for several years, so why should the populist side be content now with merely quibbling about the numbers? Stephens and supply-siders like him likely don’t care about merely being called out on their inaccuracies: It’s to their advantage to limit the inequality debate to discussions of data accuracy year after year. Meanwhile, others on the neoconservative team continue to hammer their argument that inequality growth is nothing more than the natural consequence of globalization and other social and technological developments (See, e.g., “What President Obama Doesn’t Get About Inequality,” by Peter Morici, Money News, 1/21/14, here), while inequality continues to grow. They are winning, so why wait for them to show “good faith” before engaging in a “rational discussion”?

It’s up to those of us who consider inequality growth to be a major economic problem, indeed a grave threat to the future of our economy and society, to make our case. We must identify the economic effects of inequality growth and explain how to counter them. Will Krugman join in this effort? In this article, he didn’t even challenge Stephens’ position that income inequality growth is no dig deal. Indeed, he voluntarily framed the issue for debate as whether “measures intended to curb [rising inequality] would do more harm than good,” implying at least partial agreement, potentially, with Stephens’ supply-side viewpoint.  

Krugman will not make a positive contribution on this topic until he unequivocally reverses his dangerous neoclassical posture. The point of attack on Stephens should have been on the Pareto principle, which Martin Feldstein also advanced (here). With increasing amounts of wealth continuously transferring into the top and the top 1% income share continuing to grow, people high up in the top 1% have simply been confiscating the money supply, badly harming everyone else.

[* Indeed, reflect on how the poor and rich might get richer at the same time: That would require a gain in productivity, so that there is more actual wealth per capita to distribute, and the actual distribution of a portion of that gain to the poor; not just rising pay for everyone. For any given level of tangible work product, more income for everyone means higher prices -- i.e.,  inflation. (added 2/6/14)]

Almost all new income today is going to the top. By the Pareto standard Stephens and Feldstein themselves cite, growing inequality is completely unacceptable. 

A Krugman Awakening?  

In two of his last three Op-eds, it appeared that Krugman might be gearing up to take on the economics of inequality. In “The Undeserving Rich,” (New York Times, 1/19/2014, here), he declared:

The reality of rising American inequality is stark. Since the late 1970s real wages for the bottom half of the work force have stagnated or fallen, while the incomes of the top 1 percent have nearly quadrupled (and the incomes of the top 0.1 percent have risen even more). While we can and should have a serious debate about what to do about this situation, the simple fact — American capitalism as currently constituted is undermining the foundations of middle-class society — shouldn’t be up for argument. 

We’re facing class warfare, Krugman said, “with the plutocrats on offense.” Then, however, he merely reviewed the strategies used for “crude obfuscation” — the falsification of numbers, blaming poverty on the poor themselves, and the mythology of the deserving rich. He referred again to Bret Stephens and his use of false numbers to support the conclusion that inequality is no big deal.  There is nothing new here, and no discussion of “what to do about this situation.” Still, for the first time (to the best of my knowledge) Krugman has acknowledged that inequality has real economic consequences.         

In “The Populist Imperative,” (New York Times, 1/23/14, here), Krugman extended that acknowledgment, making some important observations: (1) “jobs and inequality are closely linked if not identical issues”; (2) “There’s a pretty good although not ironclad case that soaring inequality helped set the stage for our economic crisis, and that the highly unequal distribution of income since the crisis has perpetuated the slump,” and (3) “There’s an even stronger case to be made that high unemployment — by destroying workers’ bargaining power — has become a major source of rising inequality and stagnating incomes even for those lucky enough to have jobs.” The upshot: “Beyond that, as a political matter, inequality and macroeconomic policy are already inseparably linked.”

But this is an economic, not a political, matter. It is fair to ask whether our leading populist spokesman is belatedly discovering, along with the rest of us, the immense macroeconomic power of income and wealth distribution, the reality the entire economics profession has ignored (or suppressed) for generations. Has his understanding of this issue grown since the IMF conference in the fall, with his recognition of the “mutilated economy”?    

In “Paranoia of the Plutocrats,” (New York Times, 1/26/14, here), Krugman seemed implicitly to acknowledge the role of taxation in controlling inequality, though that was not the subject of his post. He uncritically reported, however, a claim that requires close attention: “Between the partial rollback of the Bush tax cuts and the tax hike that partly pays for health reform, tax rates on the 1 percent have gone more or less back to pre-Reagan levels.” Because the Reagan tax cuts started this inequality spiral, that claim must be carefully reviewed. 

The Urgent Need for Progressive Taxation

This is a graph of data from the Piketty/Saez personal income data base (“Optimal Taxation of Top Labor Incomes: A Tale of Three Elasticities,” by ThomasPiketty, Emmanuel Saez and Stefanie Stantcheva, DP No. 8675, CEPR, November, 2011), revealing the very close relationship between income taxation and the top 1% income share.   

DP8675a

The graph shows the marginal (top) rates for income and capital gains over the past century, and the top 1% shares of personal income and capital gains. It shows that high marginal income tax rates have consistently produced effective taxation of the wealthiest among us sufficient to prevent the growth of inequality and the excessive concentration of wealth; and conversely, when the top rate is too low, inequality has grown. At least until very recently, effective tax rates have been highly correlated with the marginal rates applicable to each income category.

Piketty and Saez have properly defined a “progressive” tax structure as one that prevents further increases in income inequality. (“How Progressive is the U.S. Federal Tax System? A Historical and International Perspective,” by Thomas Piketty and Emmanuel Saez, Journal of Economic Perspectives, Winter, 2007, here.) A progressive tax structure is essential to curb the excessive wealth accumulation, in the first instance, within the top 1%. Without that, the bottom 99% economy will continue to shrink. This will nullify the promising gains from the President’s executive campaign to induce U.S. companies to increase employment, to raise wages, and to reduce the poverty at the bottom end of the inequality gap, initiatives he outlined in today’s State of the Union Address (here).  Beyond that, the inevitable result is a deeper depression. 

An initial take from this data is that a top rate on ordinary income of about 70% and a capital gains rate of 35% might be needed to reverse the inequality tide. The case is clearest for capital gains: We saw from the CBO data in the first of this series of posts that capital gains are the most highly concentrated of income sources, by far, and we see from this chart that the top 1% share of capital gains began a steep climb immediately upon reduction of the top capital gains rate from 35% to 28% to 20% in the early 1980s.

It will not be a simple matter of merely returning the top U.S. income tax rates to levels that were once progressive. Here are some complicating factors:

1) In an increasingly global world, American corporations are increasingly establishing foreign residences to avoid American taxes, and wealthy Americans along with the wealthiest people from other nations are increasingly depositing their personal incomes in off-shore accounts, to avoid taxation. Based on reports such as the one recently released by Oxfam International, I have reported that an estimate of total U.S. off-shore accounts of $5-8 trillion appears reasonable. International cooperation will be important to deal with this problem, and the U.S. will need to devise new methods for increasing the progressiveness of its tax structure;

2) The federal government will need to significantly revise its spending priorities. In 1980, according to the Piketty/Saez data, during 1960-1969, the period of peak growth of American prosperity and least unequal distribution of incomes, only 11% of all new income was going to the top 1%, while the next 9% got 24% and the bottom 90% got 65% of all growth. Income was unequally distributed, but gains were widely distributed throughout the economy. That gradually changed, however, and most recently Saez has reported that 95% of all new income has been going to the top 1%. The economy is structured to funnel nearly all income growth into the top 1%, so increased federal taxation of the top 1% will likely fail to stimulate the economy, and those revenues, when spent, will just end up back in the top 1%. New organizations and institutions that permit broader growth beneath the top 1% will have to be established.

It will not be easy to determine a level and design of taxation that will be sufficiently progressive, and Krugman’s suggestion that “[b]etween the partial rollback of the Bush tax cuts and the tax hike that partly pays for health reform, tax rates on the 1 percent have gone more or less back to pre-Reagan levels” must be carefully reviewed from that perspective:

(1) At first blush, it is difficult to see how that could even be true. The roll-back of the Bush tax cuts for the top 1% involved increasing the top rate from 35% back to 40%, a far cry from the 70% pre-Reagan level. My earlier efforts to determine the revenue impact of the rollbacks on top 1% tax revenues have not been completely successful, but it appears that every 5% increase in the top tax rate produces about $50-100 billion of additional revenue, so a tax increase effectively producing $300-600 billion of additional revenue is implied, and these changes don’t appear to come close to doing that. 

(2) It’s unclear how that claim, even if true, would impact inequality growth. Krugman did have a citation for his assertion, a source (“In 2013, the Top 1% Will Pay Their Highest Total Tax Rate Since 1979,” by Jordan Weissmann, 1/2/13, here) predicting that the average effective federal tax rate for the top 1% would exceed 35% in 2013, for the first time since the Clinton Administration and before that, 1979. I don’t know whether that prediction panned out. We do know, however, that when the top 1% rate peaked during the Clinton administration, as the chart above shows, it was a period during which income inequality, especially capital gains inequality, experienced its most rapid growth prior to the Crash of 2008. So an effective tax rate over 35% for the top 1% does not necessarily mean we have sufficient tax progressiveness to combat rampant inequality growth.

(3) As Krugman has I believe acknowledged, the inequality problem at the top is traceable mainly to extraordinary gains within the top 0.1% and 0.01%, and in these narrower bands of extremely high incomes, the history of effective taxation is much different:    

US_high-income_effective_tax_rates

Our inequality problems began, and grew, after the extremely wealthy highest-income class began to slash their contributions to federal taxation. The top 0.01% effective tax rate plummeted from 45% in 1980 to less than 25% in 2009. (“There’s Only One Way To Fix The Deficit — And Actually It’s Totally Painless,” by Joe Weisnethal, Business Insider, 12/28/12, here). 

Just as Stephens obscured the significance of the inequality gap by comparing averages of the top and bottom quintiles, the impact of reduced taxation on inequality is obscured by considering the top 1% rather than the top 0.1% and 0.01% effective tax rates. To say the least, the inference from Krugman’s comment that we can expect the current level of taxation of the top 1%, 0.1% and 0.01% to slow and stop the inequality cycle is improbable, and likely very wrong. There is an urgent need to further investigate the relationship of tax progressiveness to inequality, decline, and stagnation.    

A Statement of the Case:

The redistribution of wealth and incomes is a real, macroeconomic problem, and in the U.S. it involves the confiscation of extraordinary wealth, through an ever-broadening income gap, by those within the top 0.1% and the top 0.01% income categories. They have done this by cutting their own contributions of tax revenue to federal and state governments while, simultaneously, using taxpayer dollars and the national debt to greatly enhance their already excessive profits.

They have been supported in these efforts by a neoclassical economic ideology that asserts their actions don’t hurt anyone else and, further, that as they get wealthier the better off everyone else becomes. This neoclassical “pixie dust” fantasy, which in deference to the neoconservative Martin Feldstein I will call the “magic bird” school of economics, insists that all gains at the top are disconnected from all losses at the bottom; and since the gains of the most wealthy cannot not hurt anyone else, they likely believe, the decline at the bottom cannot really hurt them either. They must believe there is a limitless supply of money for them to skim out of the economy because, it seems, there always has been. 

But none of that is true. When they’ve finished their destruction of the market economies of the world, whenever that may be, they will eventually go down along with everyone else. 

JMH – 1/29/14

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Poverty, Inequality, and Real Macroeconomics

My last post (“Poverty, Inequality, and the ‘Conventional’ Cluelessness,” herefocused on the recent Op-ed by David Brooks, “The Inequality Problem” (1/16/14, here). Three rebuttals were discussed, along with my perspective on Keynesian and neoclassical economics set forth in two articles posted late in 2013 (“The Neoclassical Boondoggle and the ‘Mutilated Economy’ – Part 3,” hereand “Economics: The Lost Science,” here). Here’s a recap:

Brooks claimed that the focus on growing income inequality, or the gap between soaring incomes at the top and stagnating incomes at the bottom, confuses two unrelated sets of issues: People at the very top do better than their competitors through natural advantages and good fortune, while people at the very bottom are doing poorly primarily because they are not working full time or at all. The problem at the bottom is not economically attributable to an overall decline in real wages, and raising the minimum wage is not a valid solution: “The income inequality frame” is itself a simplification of “complex cultural, social, behavioral and economic problems into strictly economic problems.” Low income is the outcome of “social and cultural” problems and “low social mobility.” To argue that the problems of the poor relate to the growing wealth at the top improperly “introduces a class conflict element to this discussion.”

Critics raised a number of arguments: (1) Income inequality growth is closely related to declining social mobility; (2) Increasing the minimum wage has been shown to reduce poverty; (3) Growing income inequality is a macroeconomic problem, determined by “distributive institutions” (Bruenig) ; (4) Over the last three decades, returns to labor have fallen relative to returns to capital (Barro); (5) Growing income inequality is a cause, not a mere symptom, of declining wages, and it has led to a stagnating middle class as well as to increased poverty; (6) The shrinking of the middle class has reduced “the purchasing power necessary for buoyant growth” (Reich).       

I argued that the Brooks piece is a variation of the theme developed by neoclassical economics and advanced for over a century, namely, that capitalist market economies can support a limitless concentration of income and wealth at the top without causing overall decline. This argument implies that inequality growth has no macroeconomic consequences, i.e., no negative impact on growth and prosperity; thus, increasing the level of wealth at the top has no negative effect on the wealth and well-being of anyone else. Economic decline, therefore, is effectively self-correcting. 

That perspective is wrong, however, and the arguments of the critics are all demonstrably valid. As a consequence of Keynesian demand-side dynamics, continuous income and wealth concentration results in continuously declining demand and spending, and a continuous decline in overall income and growth. The result is a perpetual downward inequality spiral. Capitalist market economies are inherently unstable, not self-correcting.

Martin Feldstein’s version 

In 1999, an article entitled “Reducing poverty, not inequality” (here), by Harvard economist Martin Feldstein, President Emeritus of the National Bureau of Economic Research, was published in the right-wing journal National Affairs (here). The article, which surfaced near the top of a Google search of “poverty and inequality,” was previously published as NBER working paper #6770 in August of 1998. There, Feldstein presented an argument very similar to that developed by David Brooks, but couching the neoclassical theme in terms of economic theory.  Feldstein began:

According to official statistics, the distribution of income has become increasingly unequal during the past two decades. A common reaction in the popular press, in political debate, and in academic discussions, is to regard the increased inequality as a problem that demands new redistributive policies. I disagree.  I believe that inequality as such is not a problem and that it would be wrong to design policies to reduce it. What policy should address is not inequality but poverty.

The difference is not just semantics. It is about how we should think about the rise of incomes at the upper end of the income distribution.  Imagine the following: Later today, a small magic bird appears and gives each Public Interest [a neoconservative predecessor of National Affairs, here, and here] subscriber $1,000. We would all think that this is a good thing. And yet, since Public Interest subscribers undoubtedly have above average incomes, that would also increase inequality in the nation. I think it would be wrong to think of those $1,000 windfalls as morally suspect.

By any standard, for an article offering to demonstrate that the macroeconomic problem is one of poverty, not inequality, this one got off to a bad start. From the top, Feldstein cleverly transformed his essentially economic argument into a moral one, perhaps so that no one like me could come along later and argue that his economics are invalid. The important issue, though, is whether — as Brooks and right-wing economists today argue endlessly — his reasoning is economically valid.

It is revealing that his hypothetical example specified a “magic” bird because money, of course, never materializes out of nowhere. The magic bird reminds us, if only for the moment, that in reality money has to come from somewhere. And this reality highlights a core problem with the entire neoclassical ideology: it ignores the constraints of the money supply. In truth, it is this “magic bird” fantasy of a limitless supply of money that enables the false faith of neoclassical economists like Feldstein in a full employment “general equilibrium,” and allows them to overlook the unemployment, income decline, and poverty caused by income and wealth concentration. In my recent post “Economics: the lost science” I put it this way:

Metaphorically, therefore, believing in a full-scale general macroeconomic equilibrium is like believing in the tooth fairy. In fact, it is almost exactly like that. It effectively implies that new money appears from out of nowhere and ends up under our collective pillow, leading us to ignore where new money really comes from. Thus, it prevents recognition of the rational policies needed to correct the current, or any other, economic decline.

What if we changed the hypothetical, and specified that the magic bird gives each man woman and child in the top 1% of U.S. income earning households, a group of about 3.14 million people, a $3 million windfall? We would all have to wonder, would we not, where that money would come from. What if each person in the top 1% was to get a $30 million windfall? What genie could make that happen?

Feldstein then went on to agree with the “widely accepted foundation for the evaluation of economic policies” that “a change is good if it makes someone better off without making anyone else worse off” – the “Pareto principle.” So far, so good. But Feldstein’s analysis rapidly derailed beyond identification of the relevant principle. In effect, he presumed that the economy is in a perpetual state of Pareto optimality, no matter how much income concentrates at the top — the “magic bird” presumption. Having in this way switched the factual burden of showing that rising inequality is bad onto his opponents, he never revisited the question:

Some see inequality as so intolerable that they regard increasing the income of the wealthy as a “bad thing,” even if that income does not come at anyone else’s expense. Such an individual, whom I would describe as a “spiteful egalitarian,” might try to reconcile this with the Pareto principle by saying “It makes me worse off to see the rich getting richer. So if a rich man gets $1,000, he is better off and I am worse off. I don’t have fewer material goods, but I have the extra pain of living in a more unequal world.”

I’ll not belabor this further: Feldstein cannot show that any concentration of wealth or income  is Pareto optimal — i.e., that it does not come at someone else’s expense — so he chose a hypothetical trivial enough (in his view) to permit the argument that those who have to ante up the $1,000 windfalls have no change in their “material well-being.”

He then identified the “Gini” coefficient, which measures the concentration of income or wealth, and pointed out that a Gini coefficient would increase with a rise in income at the top even without a decline of income at the bottom. But there was no discussion of how high the Gini coefficients actually are, and how rapidly they are increasing, or any other factual aspect of inequality. His discussion, thereafter, quickly degenerated into a recounting of the kinds of arguments about social problems that Brooks made. 

The Feldstein article shows that adding the window-dressing of economic theory to this narrative contributes nothing of substance; it is, as they say, like putting lipstick on a pig: Because Feldstein could not show that rising income inequality between the top 1% and the bottom 99% doesn’t always leave the bottom 99% worse off, he had no way to support his presumption that the material well-being of the bottom 99% has not been reduced by all of the inequality growth experienced between 1979 and 1999. He made no case for ignoring inequality and focusing instead solely on treating poverty.

I have found that virtually all neoclassical and neoconservative writers beg the question this way: They must, for the facts are not on their side. Although inequality since 1999 has gotten much worse, Martin Feldstein has not revisited the topic or, so far as I am aware, retracted his dismissive approach to inequality.  

The Narrow Focus on Poverty

The facts belie Feldstein’s perspective, demonstrating that inequality is a much broader economic problem than one of growing poverty. Income and wealth concentration has mushroomed because virtually all consumer markets, and markets for infrastructure and public services as well, are not competitive in nature. Monopolistic and oligopolistic corporations collect too much money. They generate huge profits, and the owners and principals of these corporations are allowed through favorable taxation to keep too much of these corporate gains; and these gains come at the expense of all consumers, namely, everyone else in society. It is the middle class and lower classes above poverty — those with money to spend — that have contributed the most to these gains and have lost the most. 

Lorenz curves published by the Congressional Budget Office (“Trends in the Distribution of Household Income Between 1979 and 2007,” 10/11, here) show significant and similar concentration of capital (corporate) income and business (small business) income between 1979 and 2007. [1] The big shift in concentration is within the top 20-30%, and the gains are greatest within the top 1%. Stunningly, about 60% of small business income was distributed below the top 5% in 1979, but that declined to only about 30% in 2007. Even more notably, although 40% of small business income was realized within the top 5% in 1979, by 2007 nearly all of that was accruing to the top 1%. Small independent business income hes been literally swallowed up by the top 1% (think WalMart, Lowes, and Home Depot).   

Concentration of Capital Income Concentration of Business Income

So much for the Pareto principle: Obviously the top 1% has gained only at great cost to those below it, especially the middle class. These Lorenz curves also show that the biggest concentration of income throughout the entire three decades, by far, has been in capital gains. The wealthiest among us have been granted their huge gains at very low cost (an effective tax rate of about 14%). What is defined as “labor income” is less concentrated, and the increased concentration of labor income between 1979 and 2007 has been much lower than the increased concentration of business and corporate income. That is not to say labor income is less significant — most of the income of the entire bottom 80%, which has almost no income-earning wealth, is in this category. However, the biggest change in top 1% income has come from the eradication of the middle class.       

Concentration of Capital Gains Concentration of Labor Income

The accelerating concentration of U.S. income is becoming quite well-known. Reporting about the World Economic Forum in Davos in a recent Albany Times Union (1/25/14, here), Editor Rex Smith reported:

In the U.S.A., the income gap is widening. The richest 5 percent of Americans have seen their earnings grow by 19% over the past 25  years, as average Americans’ earnings have risen by just 0.6 percent. The trend has speeded up at the official end of the Great Recession: Since mid-2009, 95 percent of all income gains have flowed up to America’s wealthiest 1 percent. (emphasis added) 

Note that the CBO chart on labor income shows that there has been virtually no reduction in the level of income of the bottom 30%. Hence, Paul Krugman’s suggestion (“The War Over Poverty, New York Times, 1/9/14. here) that the war on poverty, initiated by Lyndon Johnson, has not been a complete failure. Still, with real wages declining, and some 40 million Americans now living at or below the poverty line, the poverty problem clearly needs attention. But to argue, as Feldstein did, that poverty is the only issue requiring our attention is to display a thorough misunderstanding, as fellow Harvard economist Raj Chetty put it (here), of “how the economy works and how to improve policy.” 

Growing Wealth Concentration

As reported in this blog, the growing wealth of the top 1% of wealth holders in the U.S. since 1980 has been huge, virtually unimaginable:

my graph 1952-1982 c

This chart shows my best estimate of the growth of top 1% net worth (assets minus liabilities) based on Census Bureau net worth data, and wealth distribution data published by economist Edward Wolff.  It is shown here together with total U.S. GDP (income) and the national debt, all in constant 2005 dollars. (The base year used for federal price indexing is 2005.) The chart shows top 1% wealth and the national debt increasing more rapidly than GDP since 1980, when income inequality began to grow.*

*Bear in mind that figures for GDP are not strictly comparable to the wealth and national debt figures. GDP is a cash flow record of the income side of a net income statement (income less expenditures), while the other two are balance sheet (assets minus liability) items. The former is a record of money in motion, and the latter is a snap-shot of money balances at some particular point in time. Some economists in recent years, as a controversial rule of thumb, have regarded GDP as a practical guideline for maximum desirable level of national debt.    

This makes perfect sense: With top 1% incomes growing much more substantially than bottom 99% income since 1980, it stands to reason that saving from income (wealth accumulation) had to have risen more rapidly for the top 1% of wealth holders than for the bottom 99%. What is remarkable is the extraordinary magnitude of the redistribution of wealth: The recorded net worth of the top 1% increased by about $18 trillion from 1980 to 2006. With the Crash of 2008, much of that gain was lost, but by 2012 the gain had rebounded to $16 trillion.

Economists Thomas Piketty and Emmanual Saez, who have reported the redistribution of income over the years, have noted that their data understate the total increase in top incomes, because of under-reporting. The same is true of wealth. My review of estimates of top 1% wealth deposited in off-shore and overseas accounts indicates that the top 1% likely possesses about $5-8 trillion additional wealth (in current dollars) not included in the Census Bureau’s net worth accounts. This means top 1% net worth has grown by about $22-25 trillion by 2012 (in current dollars). I stress that this area of wealth redistribution urgently needs more attention.

Let’s return to Martin Feldstein’s hypothetical, and ask his magic bird to distribute $23.5 trillion to every man woman and child in the top 1% of households.  One percent of the population is about 3.14 million people. Let’s assume that there are just 3 million people in these top 1% households. The magic bird will divide $23.5 trillion into 3 million gifts, and award $7.83 billion to each of them. 

Pick yourself up off the floor and ask: How is the Magic bird going to come up with that kind of money? How is it possible that (conservatively) this is exactly what has happened in the U.S. economy since 1980?

Part of the answer, certainly, is the national debt. Our national debt has grown to over $17 trillion, and it started to grow in 1980, just as Republican administrations began to reduce the federal taxation of top incomes and corporate earnings. Obviously, our national debt has financed those tax reductions, and therewith financed the massive increase in top 1% wealth.

Beyond that, the top 1% has raided the bottom 99% cookie jar, and scooped up an additional (estimated) $5-8 trillion. Hence the development of a housing bubble and its collapse in 2008; the development of a $1 trillion-plus student loan bubble and, with it, the serious decline of opportunities offered by higher education; the persistence of high long-term unemployment; the continuing decline of median incomes; the bankruptcy of Detroit and, imminently, other cities; the decline of infrastructure and local governments around the nation; and so on.  

There is great inequality even within the top 1%, with the concentration of incomes and wealth increasing exponentially up through the top 0.1% and 0.01%. The incredible degree of wealth and income concentration around the world is finally getting the attention it deserves. As Rex Smith (here) reported:

Oxfam (here), the leading anti-poverty charity, reported this week that the 85 richest people on earth hold as much wealth as those who are the poorest half of the planet’s inhabitants, 3.5 billion people. And this: eight percent of the human race draws half of its income.

The Oxfam International report “Working for the Few” was published 1/20/14 (here) , and in its press release (here), Oxfam International’s Executive Director Winnie Byanyima, hit the nail squarely on the head:

Without a concerted effort to tackle inequality, the cascade of privilege and of disadvantage will continue down the generations.

The underlying problem is not poverty, it is inequality, or as John Maynard Keynes put it “the arbitrary and inequitable distribution of wealth and incomes.” What Keynes did not understand, but we are quickly learning, is that inequality is the mechanism through which unbridled capitalism ultimately destroys itself. And it will not take generations as Byanyima and the rest of us have willed ourselves to believe; it is happening very quickly. What magical forces will slow the decline? Money is nothing but an accumulation of debt, after all, and what will happen when the U.S. government and other governments can no longer feed the voracious machine with more debt? When will that happen?  

In the U.S. and the rest of the world today, unbridled capitalism seems to have nearly reached the limit of its potential excesses. Perhaps things had to get this bad before the full inanity of the “conservative” notion that these are merely social, cultural, behavioral and psychological problems could become so clear. People cannot will themselves out of poverty. People cannot will themselves jobs or careers. This is about money, and if that does not make it an “economic” problem, then what is “economics”?

My next post will address the urgent need for the reestablishment of progressive taxation.

JMH – 1/26/14

____

 [1] A Lorenz curve shows the cumulative concentration of income by population segment from the lowest to the highest. If each segment has identical income, the Gini coefficient is zero, and the chart follows the diagonal line. If all income is located in one population unit, the chart follows the vertical axis, then moves up the horizontal axis at the 100% population point, and the Gini coefficient is 1.0. 

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Poverty, Inequality, and the “Conventional” Cluelessness

The well-being of society and the problems of poverty and inequality were among the principal concerns of the “political economy” of Adam Smith and most of the classical economists. With the development of “neoclassical” economics at the end of the 19th Century, however, these concerns became marginalized by mainstream economics, and they have been ignored by the economics profession for the last 30-40 years, the same period in which inequality and stagnation have grown in the U.S. and other developed nations. That ignorance is slowly starting to evaporate: The extent of poverty has always been greatest in times of stagnation and depression, and growing poverty in the U.S. has recently begun to gain more attention, along with the continuing growth of inequality, as the decline of the middle class and of the welfare of the entire bottom 99% have become more obvious. There has been a tendency to equate poverty and inequality, even though they are distinct phenomena: The amount of poverty is related to inequality, because it is a consequence of low incomes and high unemployment, but inequality, or the upward redistribution of income and wealth, is a much broader problem with much broader consequences.

Conventional “neoclassical” economics has, since the 1970s, become the dominant, mainstream economics in the U.S. In my last two posts of 2013, I presented a summary of the major fallacies of neoclassical ideology, and identified its rejection of the demand-side wisdom of John Maynard Keynes and its misrepresentation of important perspectives of the classical economists, in particular Adam Smith.  Recent coverage of the issues of “inequality” and “poverty” by major newspapers, notably the New York Times, indicates the media remain in the firm grip of neoclassical ideology. In fact, since President Obama announced last year that he intends to make alleviating inequality, poverty, and unemployment the top priorities of the rest of his administration, the push back from the political and ideological right has intensified. That push back has gotten prime exposure in the New York Times, and other more right-leaning publications.         

The conventional neoclassical perspective on the inequality growth of the last 3-4 decades, and on the distribution of income and wealth in general, is that they are merely narrow social and political problems, lacking macroeconomic significance. As a matter of economic theory, that perspective can be traced to a false belief that market economies are inherently stable, and a mythological faith in “general equilibrium” theory. As we enter 2014, the dominant print media has marginalized the inequality issue along these lines and, in the process, deceptively conflated the problems of growing poverty and inequality. The concentration of income and wealth is demonstrably the cause of decline, recessions, and depressions, and these discussions have harmfully obscured the enormous adverse consequences of income and wealth redistribution. This post reviews one of the most recent discussions of the increasingly conflated poverty and inequality issues, and the arguments offered in rebuttal. In the follow-up post, I offer a more expansive explanation of the neoclassical obfuscation, and a more comprehensive perspective on inequality economics.     

“The Inequality Problem,” by David Brooks

“Suddenly the whole world is talking about income inequality,” New York Times columnists David Brooks declared in a recent Op-ed column (1/16/14, here): “But, as this debate goes on, it is beginning to look as though the thing is being misconceived. The income inequality debate is confusing matters more than clarifying them, and it is leading us off in unhelpful directions.” Reading on, however, we find that rather than clearing up confusion, he provides his version of the standard neoclassical contention that has caused most of the confusion, namely, that income and wealth inequality are not economic problems. He advances three arguments:   

First, he says, “to frame the issue as income inequality is to lump together different issues that are not especially related.” (his emphasis) He sees two categories of such issues: (1) “At the top end” there is the growing wealth of the top 5 percent of “workers” (more accurately, income recipients), where the most successful benefit from perverse financial compensation schemes, and from good fortune (the “superstar” effect), and; (2) “At the bottom end there is a growing class of people stuck on the margins, generation after generation,” Which he attributes to “high dropout rates, the disappearance of low-skill jobs, breakdown in family structures and so on.” Then he makes this sweeping assertion:

If you have a primitive zero-sum mentality then you assume growing affluence for the rich must somehow be causing the immobility of the poor, but, in reality, the two sets of problems are different, and it does no good to lump them together and call them “inequality.” (my emphasis)

Secondhe continues, “it leads to ineffective policy responses” (his emphasis). Here, he shifts gears, arguing that raising the minimum wage may not be an effective solution to the inequality problem, because studies show there is “no evidence that such raises had any effect on the poverty rates.” Thus, after already suggesting the “bottom end” problem has to do with much more, he reduces it to the matter of “poverty rates,” then suggests only that raising the minimum wage cannot help because it does not reduce poverty levels. He then argues, without support, that the minimum wage is a poor policy tool, because:

The primary problem for the poor is not that they are getting paid too little for the hours they work. It is that they are not working full-time or at all. Raising the minimum wage is popular politics; it is not effective policy.

Thus, after raising the concept of “poverty rates,” he offers no discussion of the poverty threshold in terms of real dollars, or any comparison with median incomes or any other measure of bottom end incomes. 

Third, according to Brooks, “the income inequality frame contributes to our tendency to simplify complex cultural, social, behavioral and economic problems into strictly economic problems.” (his emphasis) We must resist the impulse to think there may be any “strictly” economic forces at work, he asserts, for to do so, somehow, oversimplifies the entire matter. In particular, the one inequality problem he perceives is low economic mobility, which he attributes to a fraying “social fabric,” rather than to economic factors. 

Fourth, Brooks boldly asserts, the income inequality frame needlessly polarizes the debate. (his emphasis) There should be broad agreement on inequality, he implies, because: “There is a growing consensus that government should be doing more to help increase social mobility for the less affluent. Even conservative Republicans are signing on to this.” Simply introducing “the income inequality language,” he avers, counter-productively “introduces a class conflict element” to the discussion. This he blames on Democrats:

Democrats often see low wages as both a human capital problem and a problem caused by unequal economic power. Republicans are more likely to see them just as a human capital problem. * * * Some on the left have always tried to introduce a more class-conscious style of politics. These efforts never pan out. America has always done better, liberals have always done better, when we are all focused on opportunity and mobility, not inequality, on individual and family aspiration, not class-consciousness.

This approach closely tracks the tactics of the Steve Forbes playbook (How Capitalism Will Save Us, by Steve Forbes and Elizabeth Ames, 2009, 2011) which simply denies that income concentration poses any problem at all, moral or economic, and claims that suggesting otherwise wrongfully foments class warfare.    

Rebuttals

Two or three years ago, such a discussion of “inequality” might not have generated much attention. As people awaken to the true economic nature of the inequality problem, however, articles like this are increasingly challenged. I have found three responses to the Brooks article, and all three took a combative tone (Matt Bruenig said that Brooks “is wrong as usual” and “has no idea what he is talking about;” Josh Barro said that “conservatives have no idea how to talk about inequality;” and Robert Reich said Brooks “displays profound ignorance”). I will argue that, however inadequate Brooks’ assessment may or may not be, the economic aspects of the Brooks thesis reflect the dominant mainstream, neoclassical ideology; his errors and misconceptions are, in large measure, those of the economics profession itself.

Matt Bruenig

Matt Bruenig at Policyshop (1/17/14, here) responded in some detail on the next day, in a post entitled “David Brooks’ Problem Understanding Inequality.” Bruenig focused on Brooks’ treatment of the “bottom end” issues, in particular his narrow identification of the inequality problem with social mobility. He objected that Brooks “mixes up social mobility and inequality as if the two are the same.” However, Bruenig argued, they are not: “Social mobility, at least as it is popularly measured, has nothing to do with overall inequality. We could have perfect social mobility and still have extreme inequality in theory.” However, he noted, they are related: “[I]t is also true, despite what Brooks suggests, that more unequal societies (in terms of outcomes) are also societies that feature less social mobility,” he argued, citing the “Great Gatsby Curve” of Miles Corak (here):     

gatsby curve

He argued further that, contrary to Brooks’ assertion, studies show that increasing the minimum wage does actually tend to reduce poverty.

More broadly, Bruenig rejected Brooks’ inference that income inequality is caused mainly by social factors, not economic factors:

High school drop out rates, the disappearance of low-skill jobs, the “superstar” effect, and anything else you might talk about is never sufficient to bring about the kind of rise in inequality we’ve seen in this country. Why? Because, if you are committed to avoiding such disequalization, you can always recalibrate your distributive institutions to do so, e.g. by increasing taxes and increasing transfers. For any of these phenomena to generate a specific distributive outcome, our complete set of distributive institutions have to be accommodating.

It is true “by definition,” Bruenig continued, that “gains flowing only to the rich is causing disequalization.” His fundamental point: “For any of these phenomena to generate a specific distributive outcome, our complete set of distributive institutions have to be accommodating.” Put another way: Inequality has macroeconomic consequences.

Josh Barro

In another following-day response in Business Insider (1/17/14,  here), “David Brooks Is Wrong About Inequality,” Josh Barro addressed Brooks’ claims about “top end” inequality:  

Brooks offers two theories of what sort of problem inequality might be: That people at the top are accruing too much money, and that people at the bottom are getting left behind. Like most conservatives, he wants to focus on the second problem. Regarding the first, he attacks the “primitive zero-sum mentality” that holds “growing affluence for the rich must somehow be causing the immobility of the poor.”

Barro then, at least for the most part, contested this argument:   

The thing is, while growing affluence for the rich isn’t causing low and moderate incomes to stagnate, they are to a large extent results of the same forces. There is a zero-sum tradeoff between the two, so a zero-sum mentality (primitive or otherwise) is called for.

He expressed his point in terms of relative returns to capital and labor:

Productive economic activity produces returns to both labor and capital. Over the last few decades, returns to labor have fallen relative to returns to capital. This has promoted sharp rises in wealth at the top and stagnating wage income for most of the public.

He then challenged the idea that increasing returns to capital has become necessary for economic growth, and argued that inflated profits resulting from intellectual property (IP) protections have actually inflated profits unnecessarily, contributing to inequality:

Governments could react to this by weakening protections for IP, since IP protections are supposed to be just strong enough to encourage the generation of good ideas. This would be a desirable and more or less zero-sum policy to combat inequality. Instead, industry lobbies have been pushing for strengthening of IP, which will tend to concentrate wealth in the hands of superstars, at the expense of everybody else (stronger IP means higher prices, and therefore lower real incomes.)

Finally, Barro argued that government policies to promote full employment and increase wages would reduce inequality, and promote overall growth.

Robert Reich

Robert Reich posted “David Brook’s Utter Ignorance About Inequality – OpEd” in the Albany Tribune, an independent on-line news magazine of Albany, Oregon (1/20/14, here). Reich said Brooks’ thesis — that the primary concern should be the “interrelated social problems of the poor,” and that these problems are fundamentally unrelated to inequality —  is “baloney”:

First, when almost all the gains from growth go to the top, as they have for the last thirty years, the middle class doesn’t have the purchasing power necessary for buoyant growth.    

Once the middle class has exhausted all its coping mechanisms – wives and mothers surging into paid work (as they did in the 1970s and 1980s), longer working hours (which characterized the 1990s), and deep indebtedness (2002 to 2008) – the inevitable result is fewer jobs and slow growth, as we continue to experience.

Few jobs and slow growth hit the poor especially hard because they’re the first to be fired, last to be hired, and most likely to bear the brunt of declining wages and benefits.

Reich added that the shrinking of the middle class has contributed to poverty and inequality. The middle class has an increasingly harder time being generous to those in need. Moreover:

America’s shrinking middle class also hobbles upward mobility. Not only is there less money for good schools, job training, and social services, but the poor face a more difficult challenge moving upward because the income ladder is far longer than it used to be, and its middle rungs have disappeared.  

Lastly, Reich vehemently rejected the idea that complaining about inequality is unreasonably provoking class warfare:

[A]s wealth has accumulated at the top, Washington has reduced taxes on the wealthy, expanded tax loopholes that disproportionately benefit the rich, deregulated Wall Street, and provided ever larger subsidies, bailouts, and tax breaks for large corporations. The only things that have trickled down to the middle and poor besides fewer jobs and smaller paychecks are public services that are increasingly inadequate because they’re starved for money. * * * 

Big money has now all but engulfed Washington and many state capitals — drowning out the voices of average Americans, filling the campaign chests of candidates who will do their bidding, financing attacks on organized labor, and bankrolling a vast empire of right-wing think-tanks and publicists that fill the airwaves with half-truths and distortions.

Discussion

Brooks specifically

In reading the Brooks article, or my summary, it rapidly becomes clear that Brooks has failed to eliminate any of the confusion about the inequality problem. In his framing of the inequality question, Brooks ignored core issues: At the top, the issue isn’t just about how the top 5% distribute their growing wealth among themselves; at the bottom, it isn’t just about how “a growing class of people” can’t get ahead because they dropped out of school, and low-skill jobs are disappearing; and he ignores the redistribution of income and wealth in the middle. Brooks doesn’t think or talk in terms of flows of money, and that is how he is able to conceive of inequality as nothing more than a collection of social issues.  

Bruenig properly points out that income inequality is about much more than specific social problems, and has real macroeconomic significance: As Bruenig puts it “distributive outcomes” are determined by “distributive institutions.” Importantly, he identifies increased taxes and increasing transfers as mechanisms for avoiding inequality growth, topics Brooks avoided entirely.

What’s more, research has shown that income and wealth inequality breeds social problems, so inequality necessarily consists of much more than the mere existence of such social problems. In fact, research has surprisingly shown that many social problems are typically worsened by the growing level of inequality itself, regardless and independent of a country’s levels of prosperity, industrial development, or poverty. (See a summary of the “The Spirit Level: Why Equality Is Better for Everyone,” by Richard Wilkinson and Kate Pickett,  2009, here).

The greatest flaw in Brooks’ thesis is his denial that income levels at the top are related to income levels at the bottom. Brooks implies that the very idea of such a relationship is incredulous, a dubious product of “a primitive zero-sum mentality.” Barro explicitly, and Reich implicitly, reject that perspective, and they are right. In reality, the growth of real income at the top is intimately related to the decline of real income at the bottom, and both are related to the rapidly growing concentration of wealth in the hands of the top 1% (especially the top 0.1% and 0.01%) of households. To deny that reality is to adopt a “cookie-cutter mentality” (if I may call it that) that tends to treat any set of economic issues as if they originate independently, in a vacuum.

Both wealth and income concentration require sources of money, and given a fixed money supply, increasing income and wealth at the top could only come from below — from the middle and the bottom. The money supply is not fixed, of course — it is growing — but since 2009 new money has ended up almost entirely in the hands of the top 1%, as economists Thomas Piketty and Emmanuel Saez have documented (and as reported frequently in this blog). But distribution remains a zero-sum game, even as the “sum” keeps changing. 

As Reich’s comments explain, to ignore the incomes in the middle, and not consider what is happening to the middle class, is a glaring oversight. The neoclassical ideology must do that, however, for isolating the top from the bottom as “different issues that are not especially related” is a required component of the argument that inequality is nothing more than a collection of social issues. 

Two related points: (1) Raising the minimum wage is not merely intended to alleviate the poverty that inequality exacerbates — more importantly it would stimulate the economy, contributing to growth, and; (2) Once it is understood that the “inequality” problem is one of wealth and income concentration causing decline and stagnation throughout the entire bottom 99%, it becomes clear that the national response to inequality cannot be limited to addressing poverty, and that raising the minimum raise is an appropriate, albeit clearly inadequate, response.

The “neoclassical” paradigm

It is important, actually crucial, to appreciate why Brooks and other economic “conservatives” advance this unfounded perspective: Ever since class warfare began with the industrial revolution, the extremely wealthy have needed to suppress the true economics of inequality; hence the evolution of “neoclassical” supply-side theory, with its aggregation of “microeconomic” ideas, from Leon Walrus (1832-1910), Alfred Marshall (1842-1924), Arthur Cecil Pigou (1877-1959), among others, on down to Milton Friedman (1912-2006) and Paul Samuelson (1915-2009). Only by evading the implications of Keynesian dynamic, demand-side macroeconomics could they convince everyone (including themselves) that they could get very rich without harming anyone else. That meant that the issue must be framed as one of social problems, and the macroeconomic implications of redistribution must be overlooked.

Brooks is simply following this neoclassical playbook. As I have reported, outgoing Fed Chairman Ben Bernanke has similarly argued that income inequality is mainly the difference in the earning ability between people who have college and post-graduate degrees and those who do not (here); not surprisingly, indications are that the new Fed Chairman Janet Yellen has the same or a similar neoclassical mindset (here).

Inequality must not be regarded as an economic problem, or as Brooks put it, a simplification of “complex cultural, social, behavioral and economic problems into strictly economic problems.” A notable recent effort to marginalize income concentration on the basis of economic theory was recently made by Harvard economist Martin Feldstein, when he argued that public policy should be directed solely at treating poverty, not controlling inequality (here).  

Above all, people must not be allowed to suspect that when the rich get richer, the poor necessarily get poorer. This explains the subtitle to a year-end Wall Street Journal article by Bret Stephens entitled “Obama’s Envy Problem” (12/30/13, here) :

Inequality is a problem when the rich get richer at the expense of the poor. That’s not happening in America.

But it is happening in America, at a staggering pace and to an almost unimaginable degree, with the growth of income inequality over the past 30-40 years. This is why inequality growth leads market economies into depression, and how if it is not prevented from doing so capitalism will ultimately destroy itself.

In my follow-up post, I’ll discuss the bankruptcy of Feldstein’s arguments, Stephens’ inflamatory article, and Paul Krugman’s response to it. Then I’ll summarize the basics and the implications of the real macroeconomics of inequality.

JMH – 1/12/14  

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Provincetown: An Interloper’s Report

On January 12, Sunday, I attended the closing concert on the last day of the first annual Cape Cod Songwriters Retreat (CCSR) held January 10-12 in Provincetown. The retreat was organized by David Roth, and staffed by Cosy Sheridan, Reggie Harris, and Sloan Wainwright. All four are brilliant, internationally known singer-songwriters, very talented artists, and wonderful, generous people. I  have been privileged to know them for many years, through Penny Nichols’ SummerSongs, and Cosy’s Moab Folk Camp. 

I effectively crashed their party, deciding at the last minute to go. Today I summed up my experience in an e-mail I sent out to as many of my singer-songwriter friends as I could reach. Perhaps I can reach the rest of them through this post. What I learned, to borrow a phrase from Cosy, was “a bit of a surprise.” Here is my e-mail message:

Provincetown: An Interloper’s Report

Monday  a.m., shortly after deep sleep, I found myself at the Wired Puppy on Commercial St, one of the few coffee shops open in Provincetown on a January morning. Sitting on a window stool with a cranberry walnut muffin and a cup of the house blend (Sweet Puppy Love), I looked out at the nearly deserted street and the town library, drinking it all in and remembering the previous Sunday evening. I thought about my friends at the Land’s End, who would soon be debriefing and heading out.  After a few minutes and a few brief conversations, I walked back to the Moffett House Inn, got into my car, and drove down to Orleans before stopping in a filling station parking lot and sleeping for another hour.

I hadn’t been sure I could safely make the solo round trip from Albany to P-town Sunday, but a few of my closest friends encouraged me, reminding me that if I didn’t make the trip I would always regret it. They were right: It had been too long for me, and I could not pass up the chance to see David, Sloan, Cosy and Reggie at the Cape Cod Songwriters Retreat (CCSR), and the final show at the WOMR studios. What a surprise to find so many old friends there too – John and Luanne, Barbara and Graham, Barbara Shiller, Turner, and a few other SummerSongs veterans, some of whom I’d never met.   

This was new, arriving at camp’s end — as an interloper, an outsider — and it was quite an experience. The energy and the power I encountered was incredible. The word “amazing” doesn’t cut it anymore, so let me try this one: “transcendent.” Everyone was very good, and every performance special. What’s more, I sensed a deepening spirituality within the entire community. I know I am given to hyperbole, but I kid you not: Without exception, each song spoke calmly and confidently about the rejection of conflict, both in personal relationships and in the world. Everyone in this group is connected and courageous, and each song provided a piece of the puzzle, of the limitless potential power in music.   

When I started writing songs and parodies 20 years ago, I wrote for the fun of it. These four heroes of mine, Dave, Reggie, Cosy and Sloan, along with Penny and others, have proved to me over the years that no matter what I thought I was doing, I was writing about myself and about my life.  This Sunday, that perception changed slightly from “about my life,” to “about my life.” Sloan brought that home in her powerful song “Live Out the Best of Your Life.”  Two decades ago I regarded songwriting as the “retreat,” sort of a hobby; and the idea of a songwriting “community” seemed a bit eccentric. But I have long known, for sure, that it is the perversity of the “real” world that is the retreat, much of it now exactly upside down; for 20 years, it seems, I have been slowly going sane. 

All of this is more important, I think, than we can know: I’ve been sensing that 2014 may bring a higher level of spiritual awareness to all of the creative communities in the arts and sciences, and throughout the population. For the first time in years, I’m beginning to think we just might succeed! (fn: For heaven’s sake, do not fail to get Sloan’s new CD! It’s a clear roadmap to the future. Congrats, Sloan!) 

Congratulations to David, Cosy, Reggie and Sloan for a complete CCSR success. It was so good to see you again! And congratulations to all involved for what you accomplished.  Don’t any of you stop what you’re doing. Turn up the heat: Now is the time, and you are a big part of the answer.

Love you all,

Mike

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2013 – Flowers and Dust

Here’s my contribution to the year in review. Searching for images reflecting the contrasting, paradoxical feelings I’ve lived with this year, these two words leaped to mind immediately. They may seem obvious, or trite, but they were the first two words that came to mind. I checked, and the phrase is the name of a song by Museum I’d never heard: Listening, I found it has a heavy refrain that oddly resonates:

        A lifetime happily spent is not hard to pretend.                                                               I’m not myself at all, I’m not myself at all.

The draft of Skip’s offering, “The Ugly, the Bad and the Good,” also resonates for me, along similar lines. This is indeed a world, as he says, where people learn little and remember less, and so it’s easy to see how the true significance of major social changes like Obamacare can go largely unnoticed; but the extreme negative reaction that such attempts to improve the human condition provoke from large segments of our population disturbs me more and more every year. That goes beyond the place of not knowing, to the place of not wanting to know. What is it — what is going on that makes us so collectively, and helplessly, numb to the realities of the world we’re living in, and so seemingly uncaring about the fates of other people? After living through a half-century of adulthood, I find it hard to understand what has changed more — we, or our world. Certainly our world is changing, but we no longer seem to be ourselves at all.

Here are some of my biggest disappointments with the trends of 2013: First, after the horror of Sandy Hook, we might have hoped for a more urgent call for a more lawful society. Yes, there have been some valiant efforts to make our everyday world safer from the dangers of firearms. Gabby Giffords and her husband, astronaut Mark Kelly, came to the annual gun show in Saratoga Springs this October, and their visit received tepid, almost indifferent media coverage.  That’s understandable: The voices of sanity are rarely loud, and the loudest voices since Sandy Hook seem to have been those of fear. Hence, society’s response, it seems, has been to increasingly inhibit the sensible restriction and control of killing machines that, demonstrably, have no place on civilized streets or in our homes or places of business.

How ironic and unfortunate it is to watch evil prevail. The attempt on Gabby’s life moved us to create this website, and the death a year ago at Sandy Hook of a good friend’s sister, Ann Marie Murphy, continues to touch the lives of many of us here in upstate New York. A song of my youth, Pete Seeger’s “Where Have All the Flowers Gone,” has come to mind often this past year, and I wonder: Are real inroads being made toward a more peaceful society, and a more peaceful world? It does not seem so. Americans routinely demonize the other guy, the foreigner, and we seem still unable to see ourselves the way the rest of the world sees us. Happily, in 2013, we have avoided going to war in Syria, Iran, and North Korea. But what will happen in 2014?

Second, the apparent erosion of our personal liberty continues to trouble me. Indefinite detention of suspected wrongdoers without trial has for centuries been recognized in western law to be contrary to basic freedom. When “national security” is deemed at risk, these basic human rights have too often been entirely compromised, along with other requirements of due process of law. In these circumstances, the elaborate, comprehensive electronic spying on nearly everyone by NSA, regardless of any actual suspicions, seems especially dangerous, and subject to substantial potential abuse.

Edward Snowden is regarded by many as a traitor because he released information about the extent of NSA activities. The editorial board of the New York Times opined on New Year’s Day, however, that the documents Snowden released show that much of the information gathering and spying has itself been illegal. The Times argued:  “When someone reveals that government officials have routinely and deliberately broken the law, that person should not face life in prison at the hands of the same government.” That very idea has a bad Stalinist or fascist feel to it. I am not confident about the preservation of our Constitution and our Bill of Rights (the personal freedoms our Constitution attempted to protect from government interference), and I hope that 2014 will bring us reassurances on that score.

I heartily agree with Skip that “2013 seems like a year during which we got dumber.” My guess is that people are retreating more and more into their daily lives and their favorite entertainments to avoid confronting what, objectively, is an increasingly perilous existence for themselves, and for the rest of the human race. It’s not just our culture and our economy that are in peril, but the ecological future of the entire planet. It’s having that kind of effect on me, for sure, as I become more enveloped by my own pessimism and resignation.

Frequently in 2013 I found myself humming the epic Kansas classic “Dust in the Wind.” Seriously, that is true: For me, the year 2013 seems to have actually been the year of “flowers and dust.”

My own approach to coping with it all includes escaping into my favorite TV series, shows like HBO’s “Boardwalk Empire,” “Game of Thrones,” and “Newsroom.” A lot of skill goes into the writing, producing, filming and acting of these series, and they are improving all the time. I’m looking forward in 2014 to “True Detective,” a series featuring two of my favorite actors, Woody Harrelson and Matthew McConaughey.

Such escape has its dangers, however. If it becomes a crutch, we can retreat dangerously far into the fantasy worlds these programs present; and that, it seems to me, may actually be one of the main themes of the series “Once Upon a Time.” No matter how much we enjoy such diversions, we must never lose touch with the real world, and I have always agreed with Skip that religious ideas and the belief in magic and magical fantasies nullify the progress of civilization. The “science” of economics has been lost in ideology for over a century, and thus fails us today, and environmental sciences are far too dis-empowered by denial. I’m looking for a return to a more courageous society in 2014, for people to begin to grasp the extent of their power to improve the world.

I also find at least mildly disturbing the emergence, or reemergence, of profane, coarse language in everyday communication, or at any rate such a representation of everyday conversational speech in many TV shows. It may just be me, but shows like “Deadwood,” “Sons of Anarchy,” “Breaking Bad” and “Boardwalk Empire” seem to me to include so much profanity associated with violence that they may well affect the way people communicate in real life. These are excellent, well-produced shows, but what are we learning from them about violence, and the language of violence?

For whatever reasons, civility and decorum, in my view, are in a major retreat. We have seen the loss of civility recently in discussions involving racism and sexual preference on TV news programs, and such discussions have cost people their jobs.  I suspect that part of “dumbing down” involves retreating from traditional standards of civility and decorum in our daily lives in ways that ultimately affect socialization, potentially to the point of damaging our sense of fairness, and ultimately even destroying our understanding of the difference between right and wrong.

So I remain deeply concerned about our future. Those concerns, I suspect, will loom larger before they begin to wane. But we know what we have to do — and all we can do is the best we can.

JMH – 1/2/2014

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2013 — The Ugly, The Bad and The Good

It’s late morning of the last day of 2013 as I make my contribution to the year’s summary. I’m doing Sergio Leone’s iconic title backwards because I want to end on an up note.  Not an optimist by nature, I nevertheless understand our aversion to pessimistic assessments.

The Ugly

Has to be the roll-out of The Patient Protection and Affordable Care Act, the PPACA, “Obamacare”.  Whether you consider Obamacare to be a Good thing, as I do, or a Bad thing, as apparently almost all Republicans and most Americans do, it is difficult for any of us to assert with a straight face that its roll-out hasn’t been Ugly.  And we’re not talking John C. Reilly lovable-ugly.  We’re talking 1986-remake-of-The-Fly, late-stage-Brundlefly ugly.

This roll-out has been ugly in the truest sense of the term: a pastiche of mismatched elements, an agglomeration of discordant bits and pieces, a whole that is not merely less than the sum of its parts, but essentially different.  For those of us who see Obamacare as the bare minimum that a civilized nation ought to do for its people, the roll-out has been particularly ugly for its exacerbation of the already-ugly segment of our society.  It has empowered anti-care elements in Congress and elsewhere.  It has allowed anti-government factions to point and say, “See.  We told you government doesn’t work.”

I don’t have the expertise to understand why the roll-out was so ugly or how it could have, should have, been made less so, or even made beautiful.  But I do know that its likely visage should have anticipated the anti-government reaction.  Its midwives should have been more clearly aware of the world into which Obamacare would be born, a world in which people learn little and remember less.

Which brings us to . . .

The Bad

To my admittedly jaundiced eye, 2013 seems like a year during which we got dumber.  I use “dumber” here in an idiosyncratic sense:  more faith/feeling-based, less fact-based.  In retrospect, it seems that there was at least one well-publicized, powerfully fact-deprived “factual” statement made every day.  A typical example is the October 8 Fox News report that President Obama had “offered to pay out of his own pocket” to keep a Muslim museum open during the government shutdown.  This was merely one of the year’s spoof stories generated by a satirical website and then reported by Fox as “news” and it is a typical example because it derives from a pervasive, generalized ignorance in our culture and instantiates the divisive effect of the absence of any common ground of fact that we share as a society.

It almost doesn’t matter whether the Fox News producers believed the story and published it as apparent truth or were indifferent to its truth but attracted to its Obama-as-Other quality or knew it was false but knew also that their target audience will eagerly consume anything anti-Obama.  While only a few short years ago “My strong belief trumps your indisputable fact” was a cute, if snarky, punchline, in 2013 that statement is an unignorable cultural truth.  Assertions are no longer judged against any factual/logical standard, but by their source.  If the source of an assertion is apparently affiliated with your belief tribe, it will probably be received as true.  This probability increases markedly if the subject assertion disparages/denigrates/devalues an opposing belief tribe or any of its members.

This cultural condition is Bad because at a deep level it prevents effective beneficial collective action.  Representations about our shared world are believed or disbelieved according to this tribal assessment rather than upon any analysis of effect, either personal or national.  The existence and danger of anthropogenic climate change (ACC), for example, are accepted or rejected based upon tribal identification, not upon the burgeoning scientific evidence.  And a tribal rejection of ACC, being fact-independent, is also largely fact-impervious.  Thus, additional facts that challenge this rejection are either ignored or themselves rejected.

An obvious effect of this cultural condition is the difficulty it imposes on collective action for the benefit of the nation as a whole.  If you participate in a tribal rejection of ACC , you are unlikely to authorize any cost of responding to ACC.  If your tribe denies the benefits of a national healthcare scheme, you will likely oppose such a scheme without analyzing how that scheme would affect you personally.  If your tribe holds sexual orientation to be “a lifestyle choice” rather than an effect of brain organization, you may happily stigmatize those of homosexual orientation without confronting the essential anti-humanness of such a posture and the extent to which that posture toxifies the wider culture in which your tribe exists.

This continuing dumbing-down now appears to me to have a clear political component.  For our 2012 50th high school reunion, a classmate and I created and administered a rather comprehensive survey seeking, among other things, information on attitudes, beliefs and values held by class members.  An analysis of the results revealed that a classmate’s anti-science beliefs, which I interpret as a bias against the fact-based and toward the faith-based, correlated not with any level or variety of religiosity, but with a specific political party identification:  Republicanism.

This 2012 finding, from our small and self-selected sample, was supported in the spring of this year, 2013, by a Pew survey of adults in all 50 U.S. states and the District of Columbia. Analysis of the Pew survey revealed that the percentage of Democrats who accept that humans have evolved over time, as opposed to believing that we’ve existed in our present form since the beginning of time, increased from 64% in 2009 to 67% in 2013, but the percentage of Republicans who accept the truth of that evolution decreased during that time from 54% to 43%.

It is bad enough that we seem to be growing more ignorant about the world.  It is worse, truly The Bad, when one of our two national political parties is increasingly identified with that ignorance, whether by enabling, validation or outright championing.

The Good

At the dinner event during that high school reunion, on Labor Day 2012, I gave a brief oral summary of parts of the survey results to the assembled classmates and their spouses. During that talk I railed against the Defense of Marriage Act (DOMA) and happily, perhaps even triumphantly, noted the extent to which the survey revealed that even in our “old” demographic, people who graduated high school 50 years earlier, there was substantial acceptance of non-standard gender expressions and relationships, including gay marriage. I closed that part of the talk with this conclusion:  “In technical terms, folks, the Queer Train has left the station.”

But even I am surprised by how prescient that comment was, how rapidly that Train accelerated during the following year, 2013:  among other stations on the Train’s route during this year, the Supreme Court found DOMA to be unconstitutional in June,  the number of marriage-equality U.S. states more than doubled and  the percentage of people living in states that recognize gay marriage increased from c. 14% to more than 38%. While the Train still has a long way to go to reach the LGBT Promised Land of Full Equality, and while there will undoubtedly be increasingly frantic attempts to block the Train and reverse its course, it now seems to me that its momentum is too great to disrupt.

So that’s my Good for 2013 — not my somewhat tortured metaphor, but the clear humanistic turn in this nation toward LGBT equality.  In my more hopeful moments, I see the Good in 2014 as a contagion of that humanism, a spreading of that sense of our human commonality, an emphasis on our similarities rather than our differences during these few brief years we share.

ARC – 12/31/2013

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The Cult of the Invisible Hand

The triumph of bizarre ideologies in economics, some (such as “trickle-down” and “austerity”) so clearly wrong it is hard to see how anyone can actually believe them after due reflection, and others (like “stability” and “equilibrium”) equally, though perhaps less obviously, dependent on large doses of pixie dust, is perplexing. I am not fond of conspiracy theories, because they often lack proof and depend entirely on inference. As noted in my previous post, John Maynard Keynes at the very end of his magnum opus, while discussing the development of bad theory, rejected the idea of a conspiracy of the wealthy: “I am sure that the power of vested interests is vastly exaggerated compared with the gradual encroachment of ideas.” [1] 

But that was nearly eighty years ago, and current economic discourse takes place almost as if his book had never been published. The field of economics is ruled today by the “supply-side” system of thinking that has overwhelmed the heart of Keynesian dynamic theory — namely, his observation that “effective demand” underlies virtually all economic activity. When we speak of “stimulus” we are speaking in Keynesian terms, yet conventional ideology does not think in such terms. In fact, it denies the obvious nature of economic reality: Real, tangible wealth — which consists of the  products we buy and sell and the infrastructure we use — exists as a result of demand for it; and the money offered for it is merely a medium of exchange, an accumulation of debt. It is not the other way around. 

Therefore, unless Keynesian theory was intentionally undermined by “vested interests” seeking to destroy its effective implementation, it is hard to imagine how its basis in this reality could have vanished from the “conventional wisdom.” There must have been at least a virtual conspiracy, if not an actual one, to misconceive the market system for the benefit of “vested interests.”         

Admittedly, the logical infirmity of “supply-side” thinking is not immediately intuitive to everyone. It may not become obvious until one thinks through the implications of “Say’s Law,” which transforms the truisms that every transaction is both a sale and a purchase, and that the aggregate of all sales therefore equals the aggregate of all purchases, into the inference, as Keynes put it, that “supply creates its own demand.” That supposition takes demand out of consideration by the simple device of assuming that there is always enough demand to clear every market. But we know that isn’t true. Recessions, depressions, even unemployment, wouldn’t exist if that were true.

You can see where this is going: Any doubt that a market economy is always at or near optimum performance of its own accord forces consideration of measures to stimulate consumer demand, reallocating income and wealth back into the hands of consumers to increase their demand  for goods and services, which naturally means a reduced share of the pie for the sellers; that is the implication of Keynesian economics. So the suppliers must fight that conclusion if they are to keep the reallocation of income and wealth working in their favor. 

The supply-side perspective, with all of the assumptions of optimum efficiency and performance upon which it depends taken for granted, has provided the ownership class with scholarly ammunition for the battle. It sets the stage for the coup de gras, the assertion that the economy does fine all by itself, thank you very much, without government interference or constraint. Thus, as surprising as it may seem, Milton Friedman’s “Capitalism and Freedom” and the entire economic philosophy of the Chicago School depend in this way upon a tortured system of inverted logic traceable directly back to the fallacy of “Say’s Law.”   

Of course, an ideology this fundamentally wrong cannot survive without an all-out propaganda effort, and perhaps the most blatant and extensive propaganda effort on behalf of laissez-faire capitalism to be found is what I call “The Cult of the Invisible Hand.” It consists of the assertion, or inference, that the father of political economy himself, Adam Smith, understood and taught that market economies automatically achieve optimal outcomes when people are allowed complete freedom to act in their own self-interest. This fanciful proposition is itself virtually nonsensical, and cannot withstand scrutiny. Worse, however, the claim that Adam Smith ever subscribed to such an idea is patently false.

The claim has been made so frequently by people with academic standing, in open defiance of the facts to the contrary, as to raise the possibility of at least a tacit, or virtual, conspiracy. I prefer to look at it this way: If the supply-side perspective was correct, and Keynesian demand-side theory could be directly refuted on its own merits, resort to “The Cult of the Invisible Hand” would be entirely pointless and unnecessary.              

Adam Smith

Wealth of Nations was published in 1776, the year the American Colonies declared their independence from British rule. Despite the great changes that have taken place since then, Adam Smith’s pioneering work in political economy contains fundamental insights still relevant today. 

Smith’s political, social and economic views were comparable to those of today’s progressives. He divided the European societies of his day into three classes – the productive class (laborers), the unproductive class (landlords), and proprietors (capitalists), and in his view “freedom” was maximized by maintaining equality among these classes:

It can never be the interest of the unproductive class to oppress the other two classes. It is the surplus produce of the land, or what remains after deducting the maintenance, first, of the cultivators, and afterwards of the proprietors, that maintains and employs the unproductive class. * * * The maintenance of perfect justice, of perfect liberty, and of perfect equality, is the very simple secret which most effectually secures the highest degree of prosperity to all three classes. [2]

This is among the earliest definitive statements of a guiding principle of distribution on record: Smith argued that equality will optimize prosperity. The influence of Smith’s perspectives on how market economies repress labor and contribute to inequality were shared by his successors Say, Mill, Marx, and George, and resemble the views of contemporary economists like James Galbraith, Robert Reich, and Joseph Stiglitz.

In our modern capitalist society, in fact, most of us would likely reject Smith’s ultimate goal of “perfect” equality in favor of Keynes’s position that some inequality is both inevitable and desirable in market economies. Neither Smith nor, so far as I am aware, any other economist ever observed or claimed to believe that “perfect equality,” or even imperfect equality, develops naturally in an economy of its own accord.

Although he was an advocate of free international trade, for the benefit of home industry, Smith was opposed to unrestrained corporate freedom. Similarly, the original meaning of laissez-faire – opposition to 18th Century mercantilist policies – has been replaced by The Free Dictionary with this definition: “An economic doctrine that opposes governmental regulation of or interference in commerce beyond the minimum necessary for a free-enterprise system to operate according to its own economic laws.” [3] That was not, however, the view of Adam Smith.

The “Invisible Hand” 

The false mythology about Adam Smith is that he fully supported laissez-faire capitalism.  [4]  Wikipedia, for example, wrongly describes the invisible hand as Smith’s reference to “the self-regulating behavior of the marketplace.” Likewise, Investopedia wrongly asserts that “the invisible hand is essentially a natural phenomenon that guides free markets and capitalism through competition for scarce resources.” [5]

The most egregious misrepresentation of Smith’s views I have found appears on the back cover of my paperback edition of Smith’s own book, Wealth of Nations.  There, an unidentified author wrote:

What sets this book apart is its statement of natural liberty. Smith believed that “man’s self-interest is God’s providence” – that [if] the government abstained from interfering with free competition, the invisible hand of capitalism would emerge from the competing claims of individual self-interest. Industrial problems would be resolved and maximum efficiency reached. After more than two centuries, Smith still stands as the best statement and defense of the fundamental principles of capitalism. (Emphasis added.) [6]

This cleverly crafted attribution cannot survive even a cursory review of Smith’s actual perspectives. I have found no instance in Wealth of Nations where he attacked governments for over-regulating markets, or “capitalism” as that term might have been applied to the agrarian/mercantile markets of his day. He scarcely mentioned constraints on the operation of markets at all until Chapter 8 and Chapter 10 of Book I.  In Chapter 10 he specified three harmful forms of interference with “perfect liberty,” but allowing markets to resolve “competing claims of individual self-interest” of their own accord was not among his objectives:

[T]he policy of Europe, by not leaving things at perfect liberty, occasions other inequalities [beyond the “inequalities arising from the nature of the employments themselves”] of much greater importance. It does this chiefly in the three following ways. First, by restraining the competition in some employments to a smaller number than would otherwise be disposed to enter into them; secondly, by increasing it in others beyond what it would be; and, thirdly, by obstructing the free circulation of labour and stock [capital], both from employment to employment and from place to place. [7]

None of these were constraints by government on commerce: The first consists of constraints on labor and trade through the “exclusive privileges of corporations;” the second is due to institutional tendencies in his time for over-education in un-prosperous lines of work; and the third is due to “the obstruction which corporation laws give to the free circulation of labour.” [8] Those were different times and societies, but Smith’s views on restraint of economic activity were quite the opposite of those alleged on the book cover: It was restraint and control of the markets for labor and capital stock (tools and machinery) by corporations of which he complained. And, clearly, Smith chose to write about inefficiency in the allocation of labor, not to argue that markets are naturally “self-regulating” or achieve “maximum efficiency.”     

Beyond these specific concerns, Smith was generally critical of the corporate influence on laws affecting trade and commerce: “It is to prevent this reduction of price, and consequently of wages and profit, by restraining that free competition that would most certainly occasion it, that all corporations and the greater part of corporation laws, have been established,” he wrote, and “[t]he pretense that corporations are necessary for the better government of the trade, is without any foundation.” [9] In short, Smith opposed corporate monopoly power, not government restraint of it.

What Smith Actually Said

With respect to “the invisible hand,” there is no alternative to reading what Smith actually said and understanding the points he was making. Smith used the metaphor only once in Wealth of Nations, and that was in opposition to policies that he regarded as creating artificial monopolies in restraint of trade. The discussion took place in Book IV (“Of Systems of Political Economy”), Chapter II (“Of Restraints Upon the Importation From Foreign Countries of Such Goods as Can be Produced at Home”). Here is that (regrettably lengthy) reference, including the essential portions of the context in which it was used:

By restraining, either by high duties, or by absolute prohibitions, the importation of such goods from foreign countries as can be produced at home, the monopoly of the home market is more or less secured to the domestic industry employed in producing them. * * *

That this monopoly of the home market frequently gives great encouragement to that particular species of industry which enjoys it, and frequently turns toward that employment a greater share of both the labour and stock of the society than would otherwise have gone to it, cannot be doubted. But whether it tends either to increase the general industry of the society, or to give it the most advantageous direction, is not, perhaps, altogether so evident. * * *

The general industry of the society never can exceed what the capital of the society can employ. … [T]he number of workmen that can be continually employed by all the members of a great society must bear a certain proportion to the whole capital of that society, and never can exceed that proportion. No regulation of commerce can increase the quantity of industry in any society beyond what its capital can maintain. It can only divert a part of it, and it is by no means certain that this artificial direction is likely to be more advantageous to the society than that into which it would have gone of its own accord. [10]

[NOTE – Thus far, Smith has argued that protection of a home industry by tariffs or prohibition against foreign competition will tend to divert a part of the home country’s labor and capital in directions they would not otherwise have taken. Political Economy at that time was not yet able to account for changes over time in productivity, labor/capital ratios, and other factors that would affect production, but under the assumption that everything else remains constant (ceteris paribus), his reasoning is unexceptionable.]

Every Individual is continually exerting himself to find out the most advantageous employment for whatever capital he can command. It is his own advantage, indeed, and not that of the society, which he has in view.  But the study of his own advantage naturally, or rather necessarily leads him to prefer that employment which is most advantageous to the society.

First, every individual endeavors to employ his capital as near home as he can, and consequently as much as he can in support of domestic industry; provided always he can thereby obtain the ordinary, or not a great deal less than the ordinary profits from stock.

Thus, upon equal or nearly equal profits, every wholesale merchant naturally prefers the home-trade to the foreign trade of consumption, and the foreign trade of consumption to the carrying trade. * * * Upon equal, or nearly equal profits …, every individual naturally inclines to employ his capital in the manner in the manner in which it is likely to afford the greatest support to domestic industry, and give revenue and employment to the greatest number of people in his own country.  [11]

[NOTE – Smith continued, presenting reasons why protectionist policies designed to benefit the home society would be unlikely to do so.  Protectionist legislation is entirely unneeded, he implied, because even though individuals do not consciously act in society’s interest, acting in their own self-interest leads them to act as if they were, because they prefer to employ their capital for home consumption, at ordinary profit levels, over the riskier endeavors of exporting their merchandise or engaging in the merchant trade.]

Secondly, every individual who employs his capital in the support of domestic industry, necessarily endeavors so to direct that industry, that its produce may be of the greatest possible value. * * *

The produce of industry is what it adds to the subject or materials upon which it is employed. In proportion as the value of this produce is great or small, so will likewise be the profits of the employer. But it is only for the sake of profit that any man employs a capital in the support of industry; * * * As every individual, therefore, endeavors as much as he can both to employ his capital in the support of domestic industry, and so to direct that industry that its produce may be of the greatest value; every individual necessarily labors to render the annual revenue of the society as great as he can. He generally, indeed, neither intends to promote the public interest, nor knows how much he is promoting it. By preferring the support of domestic to that of foreign industry, he intends only his own security; and by directing that industry in such a manner as its produce may be of the greatest value, he intends only his own gain, and he is, in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention. Nor is it always the worse for society that it was no part of it. * * *

To give the monopoly of the home market to the produce of domestic industry, in any particular art or manufacture, is in some measure to direct private people in what manner they ought to employ their capitals, and must, in almost all cases, be either a useless or a hurtful regulation. (Emphasis added.) [12]

[NOTE – Individuals acting in their own self-interest, Smith said, amounts to attempting to maximize their profit (value), which was to him the obvious point of “employing capital,” with a natural preference for supporting domestic rather than foreign industry. Thus, he concluded, giving a monopoly of the home market to the produce of domestic industry, because it improperly encourages potentially excess domestic investment and production in the preferred industries, “must, in almost all cases be either a useless or a hurtful regulation.”]

This is a precise, sophisticated argument. Recall that the book cover alleged Smith believed “competing claims of individual self-interest” will “resolve industrial problems” and achieve “maximum efficiency.” However, there is nothing in the actual text pertaining to his mention of “an invisible hand” that supports such a broad interpretation.

These are the supportable conclusions:

(1) The “invisible hand” is merely a metaphor for the profit motive, not, as the image implies, some force with mystical problem-solving powers. Smith did not suggest otherwise;

(2) Smith’s narrow use of the metaphor was limited to his discussion of the effects of restraint of international trade on domestic investment and production; 

(3) Even if Smith accurately identified the influences of trade on labor and capital in agrarian England in 1776, things have drastically changed since then: Today’s U.S. multinational corporations can profit from exporting both their capital and their jobs from the “home” society, so today there is no happy coincidence of their self-interest with domestic social benefits;

(4) Smith did not say or imply that pursuit of the profit motive would achieve “maximum efficiency,” and his discussion (e.g., “every individual … endeavors as much as he can”) shows skepticism in that regard. Market efficiency, a core presumption of Milton Friedman’s free market ideology, was never presumed by Adam Smith; and

(5) The enemy of optimal production by a society, Smith frequently asserted, is monopoly, which he consistently opposed in all contexts, not just this one. 

William D. Grampp of the University of Chicago underscored this straightforward reading of Smith’s meaning in his article “What Did Smith Mean by the Invisible Hand?” (2000):

The invisible hand is not a power that makes the good of one the good of all, and it is not any of a number of other things it is said to be. It is simply the inducement a merchant has to keep his capital at home, thereby increasing the domestic capital stock and enhancing military power, both of which are in the public interest and neither of which he intended. * * *

In my interpretation, the invisible hand is more interesting than it is important.  It is part of an argument for free trade. … [I]t has become a rhetorical device in the polemics over economic policy, … * * *

Does what he said matter? It should. If what he meant by the invisible hand is misunderstood, then what it is mistakenly said to mean may be misunderstood also.  [13]

The transformation of this obscure reference to an invisible hand into a symbol for laissez- faire economics may have begun shortly after Wealth of Nations was published. T. R. Malthus, apparently concerned that anti-government sentiments might be pushed too far, took issue with such an idea in the introduction to his Principles of Political Economy (1820), where he made the case for enlightened government:

It may perhaps be thought that, if the great principle so ably maintained by Adam Smith be true, namely, that the best way of advancing a people towards wealth and prosperity is not to interfere with them, the business of government, in matters relating to political economy, must be most simple and easy.

But it is to be recollected, in the first place, that there is a class of duties connected with these subjects, which, it is universally acknowledged, belongs to the Sovereign; … doubts may arise, and certainly in many instances have arisen, as to the subjects to be included in this classification. To what extent education and the support of the poor should be public concerns? What share the Government should take in the construction and maintenance of roads, canals, public docks? * * *

Secondly, every actual government has to administer a body of laws relating to agriculture, manufactures, and commerce, which was formed at a period comparatively unenlightened … To remain inactive in such a state of things, can only be justified by a conviction, founded on the best grounds, that in any specific change contemplated, taken in all its consequences, the balance of evil will preponderate; while to proceed straight forward in the rigid application of general principles … might plunge it into such complicated distress, as not only to excite the public indignation against the authors of such measures, but to bring permanent discredit upon the principles which had prompted them. [14]

These cautionary sentiments were hardly necessary, in light of a fuller reflection on Smith’s views. Smith and Malthus were in agreement on that point.

To fully understand how far the ideology of the invisible hand truly strays from Smith’s actual perspectives, we must examine his reference to an invisible hand in The Theory of Moral Sentiments (1790). Smith had no empathy with or sympathy for the wealthy classes. He made no effort to hide his distaste for the landlord class, and he abhorred greed. When he used the invisible hand metaphor in The Theory of Moral Sentiments, he was virtually gloating about the landlord’s inability to consume more food than his laborers:

It is to no purpose, that the proud and unfeeling landlord views his extensive fields, and without a thought for the wants of his brethren, in imagination consumes himself the whole harvest that grows upon them. The homely and vulgar proverb, that the eye is larger than the belly, never was more fully verified than with regard to him. The capacity of his stomach bears no proportion to the immensity of his desires, and will receive no more than that of the meanest peasant. The rest he is obliged to distribute among those, who prepare, in the nicest manner, that little which he himself makes use of, among those who fit up the palace in which this little is to be consumed, among those who provide and keep in order all the different baubles and trinkets, which are employed in the economy of greatness; all of whom thus derive from his luxury and caprice, that share of the necessaries of life, which they would in vain have expected from his humanity and justice. * * * The rich . . . consume little more than the poor, and in spite of their natural selfishness and rapacity, though they mean only their own conveniency, though the sole end which they propose from the labours of all the thousands whom they employ, be the gratification of their own vain and insatiable desires, they divide with the poor the produce of all their improvements. They are led by an invisible hand to make nearly the same distribution of the necessaries of life, which would have been made, had the earth been divided into equal portions among all of its inhabitants, and thus without intending it, without knowing it, advance the interest of the society, and afford the means to the multiplication of the species.  [15]

This long-winded rant should be more than enough to inform anyone of Adam Smith’s actual views. In his day, the wealthy classes employed thousands in the task of growing and harvesting crops, and were obliged to feed them. It was not with kindness that he observed their contribution to the survival of the species: He described the landlords’ self-interest as “vain and insatiable desires.” Circumstances are much different in today’s modern industrial societies and Smith, we can reasonably assume, would have been appalled by the handling of poverty in the United States today. He certainly would not have advocated leaving such matters to the “generosity” of the wealthy classes and their corporations, whom he said lacked “humanity and justice.”

Smith would have regarded as absurd the claim that corporations, acting in their own self-interest by suppressing wages to poverty levels, or by manipulating government budgets to obtain subsidies at the expense of food stamps or unemployment compensation, are somehow advancing the interests of society.

A Carnival of Ideology

The “invisible hand” is fundamentally a religious idea. It certainly is not an economic idea, although it has been repeatedly treated as one. Mark Thorton, of the Ludwig von Mises Institute, wrote in 2006 that:

A veritable cottage industry has sprung up in recent years to define the true meaning of Smith’s phrase and to capitalize on its widespread recognition and use. For example, Spenser Pack found that the invisible hand leads to increased destitution among the poor and slaves while benefiting the wealthy.  Syed Ahmad offers us four “invisible hands” and William Grampp reviews ten different possibilities.  We are told that the invisible hand derives from Smith’s theology, that it is an important secular device, and that it is an ironic, but useful joke.

Whatever its true meaning, the issue is important enough that the American Economic Review (AER), Journal of Economic Perspectives (JEP), and Journal of Political Economy (JPE) have all recently published articles on the meaning of the invisible hand. Add to that the numerous articles and book-length treatments of the subject—including an entire book of entries from the New Palgraves published under the title The Invisible Hand and you have not only a major debate, but a puzzle regarding the true importance of it all. (Citations omitted.) [16]

The “widespread effort to discover the ‘true’ meaning of the invisible hand,” he suggested, “appears to have muddied the conceptual waters almost beyond recognition.”  [17]       Three years later, however, Thorton opened an article appearing in an Austrian Journal with this:

The invisible hand remains an important foundation of economic analysis, continues to be a source of new analytical and explanatory devices, and is the conceptual basis of a whole class of scientific models throughout the sciences. [18]

He added, though, that “the phrase is an obvious reference to the supernatural powers of God” (p.2) and “the obvious problem here is that the concept remains at least partly mystical and normative and therefore unreliable in a scientific sense.” [19]

How such a scientifically unreliable idea can be “an important foundation for economic analysis,” or have any implications at all beyond its mystical meaning, simply escapes me. Consider the well-publicized response to Grampp’s article, published in Econ Journal Watch, by political philosopher Peter Minowitz. [20] In this article, Minowitz presented a series of disorganized, disconnected arguments, the truth of which he ultimately assumed on the basis of inference and innuendo. This is an excellent demonstration of the anecdotal, non-logical process through which mythology is created. [21]

Thorton, as well, simply assumed his own “trickle-down” conclusion, regardless of scientific analysis, or even of anything Smith wrote:

Cantillon’s model of the isolated estate … takes the reader from the very visible hand of the feudal economy to the invisible hand of the market economy. His model demonstrates that production is maximized and follows the dictates of consumer demand as a result of entrepreneurs following the dictates of the price system and profit and loss. It also demonstrates that while the distribution of wealth on the isolated estate may be completely skewed, i.e. one person owns everything in the world, the distribution of income and consumption will be reasonably equal and the standard of living will improve over time if the estate owner simply follows his self-interest. [22]

Beyond the cult of the invisible hand itself, this dangerous argument simply ignores the relationship between income and wealth. It also implies some sort of natural, automatic “trickle-down,” an idea that has elsewhere infiltrated the modern academic curriculum on the study of classical economics. [23] 

Thorton had, in fact, already assumed his result from the very beginning of his article, with a nifty bit of léger-de-main:

To be fair to Smith, many scholars . . .  have recognized that he invoked this terminology as a rhetorical device meant to convince readers of the merits of the market economy. Despite this understanding of Smith’s purpose, we still require a scientific understanding of the invisible hand. [24]

This clumsily sets up a false issue: Smith meant no such thing, of course, and no “scientific” understanding of “the invisible hand,” or for that matter any other metaphor or rhetorical device, is even logically possible.  Again, such a semantic approach to explaining Smith’s meaning is “required” only where the intent is to subvert the plain meaning of what he actually said.

The Broader Ideological Context

Any further review of the many interpretations of Smith’s use of the invisible hand metaphor would be superfluous. [25] There is, however, one more point that must not be overlooked: Even if Smith had shared Milton Friedman’s ideological faith in the efficiency of markets, or for that matter Richard Cantillon’s alleged faith in some sort of magical trickle-down redistribution, these faulty ideas would have been no more correct in Smith’s day than they are in recent times. We cannot, in the face of overwhelming evidence to the contrary, accept Friedman’s faith in perfect market efficiency, and the notion that capitalism promotes equality is demonstrably wrong.

What makes the invisible hand metaphor especially pernicious, of course, is the elephant in the room, its locus at ground zero in the class warfare between rich and poor.  For anyone interested in promoting the ideas that corporations are good and governments bad – always, and for everybody – no Madison Avenue advertising firm could have come up with a better slogan than “the invisible hand.” It is memorable, it evokes serenity and comfort, and it has appealing religious overtones. Best of all, it is associated with the “father of economics” himself, Adam Smith, a man who can be profusely adulated with little fear that very many people will actually read his books.

In a 2001 article in Journal of Economic Perspectives entitled “No History of Ideas, Please, We’re Economists,” Mark Blaug discussed the value to economists of reviewing the history of economic thought. Here, Blaug identified two important reasons for studying the history of economic ideas:

If we teach the ideas of the great economists of the past with due attention to their intellectual background, their philosophical preconceptions and the institutional context in which they wrote, we end up fulfilling the third of Schumpeter’s reasons for studying history of economic thought: “insights into the ways of the human mind.” But more pertinently, we end up with insights into the ways economics got to where it now is. [26]

The persistent reinvention of the views of early “classical” economists like Adam Smith, and the demonizing of other important economists like J.M. Keynes, Karl Marx, and Henry George, suggest that ideological forays into the history of political economy  like “The Cult of the Invisible Hand” may serve to teach us even more about the “philosophical preconceptions and the institutional contexts” of today’s economists than about the minds of those who got us here.  

JMH – 12/27/2013

_____

[1] John Maynard Keynes, The General Theory of Employment, Interest and Money, 1936, Ch. 24.

[2] Adam Smith, Wealth of Nations, 1776, Prometheus Books, Great Minds Series, Amherst, N.Y., 1991, pp. 448, 454. 

[3] Definition of “laissez faire,” The Free Dictionary by Farlex (here).

[4] The term “laissez-faire” is credited to François Quesnay, a physician and favorite at the court of Louis XV and an early contributor to economic theory. His “Tableau économique” (1758) provided the basis for the theories of the “Physiocrats,” a.k.a. “The Economists” or “the Agricultural School.” Physiocrats maintained that “the wealth of a community was increased not by money, but by an abundant produce from its own soil. Quesnay argued that the right of property included the right to dispose of it freely at home or abroad, unrestricted by the state. This doctrine was formulated in the familiar expression, ‘laissez faire, laissez passer.’” J. Laurence Laughlin, from the introduction to his abridged version of John Stuart Mill’s Principles of Political Economy, 1885 (1848), p. 16.    

[5] “Invisible hand,”Wikipedia (here) “Definition of ‘invisible Hand,’” Investopedia (here).

[6] A very similar statement is found at “Introductory Note, Bartleby.com (here), par. 3; Whether Adam Smith intended to convey, with the idea that “man’s self-interest” is “God’s providence,” a belief in a divine invisible planner, or whether his three references to “an” invisible hand were merely metaphorical, is a trivial question. Smith’s economic ideas were based on observation and reason, so speculation on what his views might have been on divine intervention is clearly beside the point. Further discussion of this trivial issue can be found at “God and the Economists,” by Jerry Bowyer, Forbes, August 17, 2011 (here); see also, “On the Metaphorical Origins of Adam Smith’s Idea of the Invisible Hand?,” Dr. Jan Garrett, rev. March 22, 2013 (here). (I have located only one Dr. Jan Garrett, an orthopedic surgeon from Tyler, Texas; if this is not the same individual, I must attribute the site to anonymous authorship, with apologies to the surgeon.)

[7] Wealth of Nations, supra, p. 126.

[8] Id. at 126, 145. Today, constraints on the size of the qualified workforce available for specific occupations are shared among employers (job requirements for educational and training experience), government (licensing requirements) and labor organizations (required union membership).

[9] Id. at 131, 138.

[10] Id. at 348-349.

[11] Id. at 349, 351.              

[12] Id. at 351-352.

[13] “What Did Smith Mean by the Invisible Hand?,” by William D. Grampp (here), Chicago Journals, Vol. 108, No. 3, June 2000 (here), Journal of Political Economy, 2000, vol. 108, no. 3, pp. 441-2.

[14] Thomas R. Malthus, Principles of Political Economy: Considered with a View to Their Practical Application, 1820 (here), pp. 14-15.

[15] Adam Smith, The Theory of Moral Sentiments, Sixth Edition, 1790, p. 165 (here).

[16] “The Mystery of Adam Smith’s Invisible Hand Resolved,” by Mark Thorton,  Ludwig von Mises Institute, May 15, 2006 (here), reprint (here), pp. 3-4.

[17] Id. at 1.

[18] “Cantillon and the Invisible Hand,” by Mark Thorton, Quarterly Journal of Austrian Economics, Summer 2009; Vol. 12, Issue 2, June 2009, p. 27, reprint  (here), p. 1.

[19] Id.at 3.

[20] “Adam Smith’s Invisible Hands,” by Peter Minowitz, Econ Journal Watch, December 2004, pp. 381-4 12 (here).

[21] For example, at p. 385 Minowitz argues that “a few pages earlier the chapter seems to anticipate the invisible hand with a paragraph that ignores the distinction between domestic and foreign investment;” but Smith’s argument was that self-interest favors domestic to foreign investment, so a discussion that fails to distinguish between the two is irrelevant, and inapplicable.

At p. 454, he argues: “In the paragraph that immediately follows the invisible hand, Smith provides another strongly worded claim that reinforces his commitment to economic liberty;” but the argument that Smith is expressing a general commitment to “economic liberty” in this chapter simply extrapolates from the argument Smith actually makes against a protectionist trade policy to a broader principle, assuming its own result.

And at p. 392, he maintains Smith argues “that mankind has consistently survived and progressed despite pronounced inequality”; the fact that individuals who did not perish from starvation and disease “survived” is obvious, but it glosses over Smith’s expectation of continuing survival at the bare subsistence level for the lower classes; the idea that mankind had “progressed” from that state of affairs by 1776 is Minowitz’s, not Smith’s.

[22] “Cantillon and the Invisible Hand,”supra, p. 4.

[23] In this on-line lecture on Smith’s Book I, Chapter 8, of Wealth of Nations, “Of the Wages of Labour,” (here); in the video (here) a major argument of the lecturer is that Smith believed the “increase in capital stock and wealth is what boosts wages of labor.” Smith did not say that, however, nor to my knowledge did any of the other classical economists. They believed that improved capital stock can increase labor’s productivity, making a higher return to labor possible, but they never contended that higher productivity would likely increase labor’s wages: On the contrary, instead of rising to reflect workers’ higher productivity, they expected wages to tend to sink to the subsistence level wage floor. Incidentally, this tendency is in evidence today in the rapid growth of income inequality since 1980.

[24] “Cantillon and the Invisible Hand,”supra, p. 3.

[25] See, e.g., Craig Smith, Adam Smith’s Political Philosophy: The invisible hand and spontaneous order, Rutledge, London and New York,  (here); “The Treatment of Smith’s Invisible Hand,” by Jonathan B. Wight, Virginia Tech (here).

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