As the Rich Get Richer – Part I

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Part I – The Explosion of Income and Wealth Inequality

I have been studying inequality in America and the economics of inequality for the past two years, and in the course of researching and writing a book on the subject I have reached an epiphany that, I think, is worthy of a preview in this blog.  My understanding of the issue, and the underlying economics, have matured along the way, and I’m sorry to say that I find unfettered capitalism to be more unstable and destructive than I had imagined it could be, even two years ago.  In Part II you will find what I think are significant improvements in my perspective on the economics of inequality.

This two-part post summarizes what I’ve learned so far, and what I believe is most of what we need to understand to cope with the problem.  For the sake of brevity, this summary contains only a few graphs and only general references to the facts I have gathered.  This post is intended to make available an easily understandable perspective on the problem; the full  details and support will be provided with my book, which is now mostly written and hopefully will soon be finished.

The Inequality Problem in 2012

Income inequality and the concentration of wealth have been growing around the world over the last thirty years.  In the United States, especially, it has become an extremely serious threat.  The share of income going to the top 1% in America has increased from 8.9% in 1979 to about 23% in 2010 and has likely grown even higher over the last two years. Data of this nature making possible an understanding of what has been happening in the United States has only been available in the last few years. Soon, it will profoundly change both the way economists think about income and wealth distribution issues and our own expectations for the future of the United States.

The above graph, prepared by economists Thomas Piketty and Emmanuel Saez, shows the top 1% income share over the last century through 2008, both including and excluding capital gains.  It shows that income inequality by 2006 had grown to the level it was at in 1929 at the start of the Great Depression.  It shows the close inverse relationship between income share data and the marginal tax rates on top incomes and on capital gains. Lowering taxes on top incomes and corporate profits (not shown here) has enabled wealth transfers to the top which have increased the concentration of wealth at the top and led to higher income inequality.

Beyond the period covered by this graph, following the Crash of 2008, the stock market recovered fully to the benefit of the top 1%, but the collapsed housing market continued its damage to the bottom 99%, so by 2010 the 2006 level of income inequality was restored. Income inequality has almost certainly increased over the last two years.

The most recent data show that the United States has not only the highest level of income inequality among advanced, developed nations, but also the highest overall level of major social problems related to income inequality (such as poverty, unemployment, poor education, limited upward mobility, poor mental and physical health, etc.) as shown on the following diagram prepared by epidemiologists Kate Pickett and Richard Wilkinson:

The regression of income inequality among advanced nations against an index of their major social problems is statistically significant.  The status of the United States as the worst among these top nations in both respects is both disgraceful and alarming.

Income inequality is closely related to the unequal concentration of wealth, since higher inequality means greater wealth transfers from the bottom 99% to the top 1%.  The concentration of U.S. wealth in the top 1% was already very high thirty years ago, and it has since increased enormously.  More than one-third of total wealth and close to one-half of financial wealth has been held by the top 1% over most of this period, and it is difficult for the concentration of wealth at the top to increase much more in a viable economy.  It has been increasing, nonetheless, since the Crash of 2008.

At first blush, the income gap may not appear extreme.  However, with 25% of all income going to the top 1%, that leaves only 75% for everyone else.  This entails a serious decline in prosperity and living standards for the bottom 99%, and the sobering truth for members of the bottom 99% is that income inequality has been pushed very near the limit beyond which a viable economy cannot be sustained.

In 1980, at the beginning of the inequality growth trend, substantial income inequality already existed; nonetheless, there had  been a prosperous and growing middle class and a vibrant economy for most of the 35 years since World War II.  That situation has changed dramatically, however. Over the past thirty years since 1980:

1.  The incomes of the top 1%, adjusted for inflation, have gone up 400%, and the  higher income segments did even better with the richest 0.01% enjoying about a  650% gain;

2. Below  the top 2-3%, however, income growth has fallen off sharply, and the bottom four quintiles have experienced virtually no real income growth over thirty years;

3.  Over the past four years the median national income has fallen 10%;

4. The growth of the entire economy has been considerably lower than it was in the 35 years following World War II;

5. The growth of concentration of incomes in the top 1% has continued to accelerate; by 2010, a remarkable 93% of all new income was going to the top 1%;

6. With its income and wealth declining, the bottom 99% has gone from net saving to net borrowing since 2000; and according to Congressional Budget Office (CBO) data, nearly all of the middle class’s small business income has now shifted to the top 1%;

7.  The “tipping point” line above which incomes are growing faster than average and below which incomes are growing slower than average or declining has risen (by 2010) to near the dividing line between the top 1% and the bottom 99%;

8.  The bottom 99% has been unable to rebound from the Crash of 2008, and while the top 1% is doing well, the bottom 99% is functionally in a depression;

9.  Up to and including 2010, about $12 trillion of incremental wealth, beyond what it would have gained had income inequality not increased, has transferred from the bottom 99% to the top 1%; this computation, which is based on national net worth data, is of the same order of magnitude as estimates of lower income taxes paid by the top 1% as a result of the drastically reduced marginal income tax rates applicable throughout the period.

The National Debt

The substantial tax reductions enjoyed by the top 1% and its corporations over the past thirty years not only permitted the massive wealth transfers just mentioned, but reduced federal revenues commensurately.  Of the current national debt of nearly $16 trillion about $14 trillion (including interest) was raised during Republican administrations.  That portion of the national debt has served, in effect, to finance the wealth transfers to the top 1%. (By contrast, the Clinton administration borrowed only to pay interest on the Reagan/Bush debt, and the additional debt raised during the Obama administration has gone mainly for bailouts and stimulus to prevent the economy from crashing into a severe depression.)

Public Unawareness

The American people in general understand very little about economics, and for the most part they are unaware of the inequality problem.  In this election year, the Republicans hope to regain power by convincing voters that President Obama has aggravated the nation’s economic woes. Correspondent Michael Grunwald’s new book (The New New Deal) documents the refusal of Republicans in Congress over the last four years to cooperate in helping with economic recovery so that they would have ammunition against the president in 2012.  Unfortunately, this strategy works: election sound bites focus on isolated symptoms like the unemployment rate, and philosophical questions like whether people are entirely responsible for their own economic success (or lack thereof), entirely missing the crucial question of economic recovery and, beyond that, inequality growth.

In these circumstances, it is relatively easy to sell many voters on a proposed Republican “austerity” budget that works in exactly the wrong direction by reducing taxes on top incomes and corporations even more, and cutting government spending just when it must be increased to begin to stimulate the economy back to health.  Many people have apparently been taken in by the dominant supply-side, trickle-down argument that as taxes are reduced on top and corporate incomes, the economy recovers and everyone is better off. The wealthy have promoted this fantasy since the 1970s.

The State of the U.S. Economics Profession

When English economist John Maynard Keynes revealed his dynamic model of “macroeconomics” in 1935, during the Great Depression, his theory recognized that “effective demand” is required in an economy to achieve and maintain full employment.  The science of economics has fallen on hard times in America, however, with the triumph of the trickle-down ideology, and Keynes’s insightful knowledge has been all but forgotten here.

Compare the United States, for example, to Italy: In 2010 a letter to the Italian government was signed by 100 Italian economists encouraging it to abandon “austerity” government on these very Keynesian grounds, namely, that it would cause severe unemployment and stagnation.  Here in America, an equivalent letter (on a per capita basis) would require the signatures of 510 Keynesian economists.

In the last few years, however, I am aware of only three American Keynesians actively speaking out on the income inequality issue: Robert Reich (Aftershock; Outrage), Paul Krugman (The Return of Depression Economics; End This Depression Now!), and within the last month, most persuasively and substantively, Joseph Stiglitz (The Price of Inequality).  Only one economist that I am aware of, Edward Wolff (Top Heavy), has kept us informed of the details of wealth accumulation in America.

The sad state of Keynesian macroeconomics in America is not our only problem.  From the beginning of the development of scientific economics in the 17th  Century, the topic of wealth and income distribution has been marginalized everywhere.  Keynes himself set out to determine how to achieve “full employment,” and though he opined that his model explained “the paradox of poverty in the midst of plenty,” unemployment only explains part of the inequality problem.  A model designed for a fuller explanation would have been designed to determine optimal inequality, not full employment; and such a model would have included explanatory variables Keynes’s model excluded, such as the degree of market competition and tax rates.

Since Keynes, interest in distributional issues has remained low.  In his latest book (End This Depression Now!) Krugman listed a number of reasons why  American economists have until recently avoided analyzing the incomes and wealth of the rich and powerful, allegedly regarding the topic as unfit for scientific inquiry.  The subject of poverty has also long been neglected everywhere, perhaps because it too has been regarded as unfit for scientific inquiry. We should therefore not be surprised, I suppose, that Stiglitz’s latest book (The Price of Inequality) is the first major economics text focusing exclusively on the topic of income and wealth inequality since American economist Henry George published Progress and Poverty in 1875.

The development of econometrics, moreover, has been an important key to recent breakthroughs in this area.  The statistical analysis of income inequality in America got its start in the 1950s, a time when inequality was declining, with the pioneering econometrics work on this issue of Simon Kuznets.  Sadly, the topic was largely neglected thereafter until Piketty and Saez developed their database, released in 2001 (and since updated), from income tax returns.  Meanwhile, Reich and Stiglitz are the only American economists I am aware of who have described the macroeconomic dynamics of inequality, and Stiglitz is the first economist to begin discussing the economics of inequality in any detail.

Recently several other books have been published describing the inequality problem, identifying some of its proximate causes, and emphasizing the seriousness of the problem.  These books are invaluable, but they haven’t gone far enough in explaining the economic nature of the problem or identifying economic (as opposed to political) solutions.  While they propose approaches to fixing the problem, they don’t try to answer this question: What happens if we don’t fix the problem?

It’s time to identify a clear theory of the economics of inequality.  Part II sets forth in easily understandable terms the economics factors I find most pertinent to the rise of inequality. The evidence indicates, as we might expect from the history of the Great Depression, that the rise of stagnation and depression are closely related to the rise of income inequality and the concentration of wealth at the top.  Thus, I have returned to the basics of Keynes’s General Theory  for insights into the inequality problem.  My findings may surprise you.  They lead, I submit, to some straightforward, and inescapable, conclusions.

JHM – 8/28/12

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