An economics professor recently asked me a series of questions. So I went ahead and blogged my response.
1.) Grant, can inequality in income/wealth really affect economic growth?
2.) If Grant W. Huebner were to be the economic advisor for the President of the United States, what measures would you recommend to bring more equitable distribution of wealth?
Economic fairness is the defining issue of our time. Yes, there is income inequality in America. We've always had income inequality, and hopefully we always will have income inequality. The problem is keeping inequality in proportion. Income inequality is something I expect to hear from a third world country, not America. But is this really a problem?
Economic professors Saez (UC Berkeley) and Piketty (Paris School of Economics) showed that the percentage of wealth held by the richest 1% of Americans peaked in 1928 and 2007 — right before the Great Depression and Great Recession. At both of these times income inequality was at the highest it has ever been in our country’s history. Our income equality has only increased since the Great Recession, which makes this such a huge current issue.
First we need to ask; how did this become a problem today? As our economy has grown for the last couple decades, so has our economic spending. Wages since the late 1970s have remained stagnant. This divergence of wage and productivity, labelled as “The Gap,” has meant that many workers were not benefiting from the growth in productivity — the economy could afford higher pay but it has not been provided (Income Inequality). The common misconception with productivity growth is that it raises our living standard, but higher productivity only establishes the potential for higher living standards. If you want to achieve higher living standards, then wages need to complement productivity.
While wages remained stagnant, consumer spending was still rapidly increasing. McKinsey & Company recently said that our GDP grew at a compound rate of 3.8 over the last 50 years. But how is that possible??? How were families able to continue spending more and more money without higher compensations??? The less money you make, the less your going to spend, right??? Wrong! There were 3 reasons why spending was able to increase while wages stayed the same.
- ) A massive increase in women joining the work force. Ever seen ← this before? It became socially acceptable to see women working. The main reason why so many women started working was to increase family incomes that were dropping, because male wages weren't moving. BUT there was only a certain amount of women that could work. So we had to look elsewhere to gain capital.
2.) The next step to gaining capital was to work longer hours. Overtime, you know? People started working crazy hours. They picked up a 2nd job and even 3rd job. According to the ILO, “Americans work 137 more hours per year than Japanese workers, 260 more hours per year than British workers, and 499 more hours per year than French workers.” BUT a human being can only work so much. So again we looked else where to gain capital.
3.) The next coping mechanism was borrowing. Yes the dreaded word, borrowing. People would borrow money from their houses in order to fill the gap in their wages. In the early 2000s, people started investing like crazy in real estate as a way to gain capital. Financial advisers were motioning to anyone who owns a house to borrow as much money as they could against it. They would tell people take out every penny and invest it in real estate. This was a reasonable response because at the time you just couldn't lose. A thing that a lot of people didn't understand was that these homes were characterized in the asset market, and asset markets differs from goods markets. Now the key difference between an asset and a good is when you purchase a good you are going to use it, not resell it. But when you are buying an asset, it’s in the hope that you are going to be able to resell it later for a higher price. So when people see that the price of an asset is rising, they will often go purchase more of this asset in the hopes to gain more capital. So in the goods market as prices increase, demand often falls. But in the asset market as prices increase, demand will also increase. If an asset increases in price, this fuels demand for more purchases. It also fuels additional purchasing power because people can borrow more against the assets that they own that just rose in price. This vicious cycle caused a debt bubble. This is a big reason why we saw so much economic instability from the recently recession. The recession was caused by the crash of the housing market, but don’t you see the poor income distribution was the initial step that drove the debt crisis to the Great Recession. And just how bad was the Great Recession? Well let’s ask Jim Cramer from CNBC…
Make no mistake, we had Armageddon. If our Federal Reserve didn't make the moves at the time that they did, $5 trillion dollars would have been drawn out of the money market system in one day. This would have collapsed the entire economy of the United States, and in an addition 24 hours the world economy would have collapsed. Income inequality was holding our economy’s hand and leading her off a cliff into the abyss. It’s like playing dominoes with the economy, but your first piece is income inequality.
Now when the housing market crashed, this only added gasoline to a raging fire, and by fire I mean income inequality. Let me explain, the top 1% of Americans, who each have at least a net worth of more than $7.8 million, hold only 9% of their gross assets in principal residence (homes). While the middle class or middle 60% of Americans hold a whopping 63% of their gross assets in principle residence. So when the housing market crashed, the middle class who had so much of their wealth tied up in there homes took a big hit. This hit only further escalated our income inequality.
The last time our country’s income inequality was this extreme was right before the Great Depression, which again makes this such a huge current issue. So let’s take a look back at the Great Depression.
Now right before the Great Depression, there was a huge explosion of installment credit. Installment credit served as a way for the american people to gain capital by borrowing money. This explosion of installment credit led to a rapid increase in debt, to a point where our nation was too much in debt. Eventually the system collapsed resulting in the Great Depression. So the time right before the great depression can actually be seen as a precursor for our recent recession.
So in order to solve this current inequality problem let’s look back at the time right after the Great Depression. The 3 decades after WWII from 1947–1977 was a time called the Great Prosperity. During the Great Prosperity our economy was booming. Now this is also a time when we had the least income inequality in our history, and I don’t think that was a coincidence. One thing that we know for sure is that education and income inequality are directly linked. At this time we made higher education a national priority. The Servicemen’s Readjustment Act of 1944, informally known as the G.I. Bill, paid college cost for returning World War II veterans. There was also an expansion of public universities, which led to lower education cost. These factors resulted in a massive increase of college graduates, and served as a huge catalyst for our economic boom. This was in large part because the US had the most educated work force of any other nation during the Great Prosperity. Theses education reforms led to the Great Prosperity, and lifted people out of poverty and into the middle-class.
So without a doubt, if you want your economy to boom and your income inequality to decrease, then let’s focus on higher education like we did during the Great Prosperity. And that is exactly what we are trying to do today. Obama has proposed making high education free or at least 2 year community colleges. It seems like he’s calling a play straight from LBJ’s playbook. But in The Great Prosperity we focused on 4 year education, not 2 year. Free community college is on a continuum with the GI Bill, but with one big caveat: While some fine community colleges are under-appreciated gateways to success, many are NOT. Their standards are so low that the diplomas they grant are often worthless in the marketplace. They outsource their instruction to poorly-paid adjuncts and offer too few courses connected to the needs of local employers. Most unforgivable, their average graduation rates are almost always below 50 percent (the average is around 30 percent), which means that more than half of their students are going into debt with little to show for it. I proposed we look more vigilantly at even higher education. Countries that focus on even higher education and skill building are able to really deal with globalization better. Financial upward mobility is key when you are trying to create a more equal wealth distribution, and education is the engine behind financial upward mobility. As income inequity rises, financial upward mobility is decreased. This also works in vice versa. If our goal is to have the most prosperous economy, then we have to have the most educated work force like we did in the Great Prosperity. Now commonsense tells me that the higher the passion of the individual, the higher the education they will pursue. I believe this passion is not as prevalent in community colleges as it is in our 4 year universities or masters programs. I am not trying to demean anyone's education from 2 year community colleges, but rather I want to see my fellow students take their education as far as possible. It’s true that pushing the poor toward community colleges risks worsening the problem of “undermatching” — poor students who are bright enough for four year colleges but don’t go. I’m scared that by solely focusing on 2 year community colleges, you will find a decrease in retention rates for further education. It’s like Dale Carnegie once said, “If you want to gather honey, don’t kick over the beehive.” If we’re going to do this, let’s do it right. I suggest we spread the wealth more across all public universities to accommodate this direct link, instead of just 2 year community colleges.
Another option would be touching taxes. Now taxes are a sticky topic. It seems impossible to say anything about taxes without stepping on politics. So I refuse to comment on this topic. Instead I will leave you with this video.
Now through historical evidence I have proven that too much income equality can and will affect the economy. Too much income inequality dismantles the middle class. Having a strong middle class is imperative to economic stability. The most important thing to understand is that consumer spending is 70% of the United States economy. Currently, our richest 400 individuals have the equivalent wealth of the bottom half of America or roughly 158 million people. In 2007, the top 10% earned 50% of of all US income, and the top 1% earned 24% of all US income. While the top 0.1% earned 12% of all US income, and the top 0.01% earned 6% of all US income. In other words, 15,000 Americans earned $700 billion, or half the GDP of Brazil. The top 1% invests most of their money into assets like unincorporated business equities and financial securities. These assets aren't as directly linked to economic growth as consumer spending is. The wealthier the individual the more they tend to save, and the less they tend to spend. Nick Hanauer, who is a venture capitalist, said; “the problem with rising inequality is that a person like me, who earns a 1000 times as much as the typical American person, doesn't buy 1000 pillows every year. Even the richest people only sleep on 1 or 2 pillows.” The middle class is at the heart of consumer spending. An economy just can’t substantially grow without a strong middle class. As I showed earlier, too much income inequality can have some serious repercussions.
2.) America survives on the concept of Capitalism. Without killing the entrepreneurship, how do you achieve better distribution of wealth?
Wow, pump the brakes! In order to achieve better wealth distribution, we want to ENCOURAGE entrepreneurs! I’m sure everyone is familiar with the company called, Amazon. Amazon uses a lot of technology to increase their production. They are currently even considering using drones for shipping their products. Amazon employs only 60,000 people and does roughly 80 billion in sales. BUT if small companies did that 80 billion in sales, they wouldn't have 60,000 employees, but rather 600,000 or maybe even a million employees. This is because small companies’ business models are so much less efficient than whales like Amazon’s. By increasing jobs, you decrease unemployment. If you’re decrease unemployment, then you are increasing financial upward mobility. Like I said before, financial upward mobility is key when you are trying to create a more equal wealth distribution.
3.) Is giving/increasing welfare payments a definite solution to improve the poverty level?
Not even close. People response to incentives, and in my opinion increasing welfare will just incentivize the unemployed to further procrastinate job seeking. This could serve as a quick shot in the arm, but I just can’t see increasing welfare payments really helping the unemployment rate in the long run. An increase in welfare is not a long term solution. This is putting a band-aid on a major problem. If you want to fix the problem, start by treating the wound. There are better ways to improve the poverty level. That old english proverb really resonates here. Give a man a fish and you feed him for a day; teach a man to fish and you feed him for a lifetime. If we want to improve the poverty level, let’s teach them how to fish instead of just giving them fish. Now teaching them how to fish translates to education. Can you see how education is so intimately intertwined with all of these issues?