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 million 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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