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The rise in income inequality is closely linked to the financialization of U.S. economic activity that began during the 1980s. Prior to that time, during the "Golden Age of Capitalism" (1945-1970), the economic system was doing a pretty good job at generating rising wages, productivity and economic growth, based on a robust partnership between labor, business and government. This framework also sharply reduced income inequality.
This unraveled at the end of the Golden Age, as the Bretton Woods monetary accords collapsed, inflation surged and the dollar fell, compelling then-Fed Chair Paul A. Volcker to hike short-term rates to stratospheric levels. This bold move was accompanied by the adoption of neoliberal policies during the 1980s that demonized labor, eviscerating its bargaining power.
Real wages have been stagnant for several decades. In recent years, corporate profits have hit record levels, benefiting investors. However, the combination of stagnant wages and high profits ignores a key driver of economic growth: people must be able to purchase the goods and services that companies produce. In the Golden Age, rising labor incomes were sufficient – more recently, not so much, requiring ever-increasing levels of indebtedness. And this trend, as we learned in the global financial crisis, is not sustainable. We are trapped in an economy with 2% real growth.
From 1980 to 2007, rising debt-to-income ratios offset the slowdown in wage growth. Increasing debts also fueled serial asset-price boom-bust cycles in property, equities and other asset classes. Most (nearly all) of the benefits from rising asset prices went to the top 20% of households. Their share of total wealth in the U.S. rose from 81% in 1983 to nearly 90% in 2013. Whenever those booms threatened to unwind, the Fed would step into the breach (the “Greenspan put”), reigniting the financial cycle.
Also during this time, non-financial corporations focused on "maximizing shareholder value," via stock buybacks, LBOs, M&A, etc., that pushed up share prices at the expense of labor and other stake holders. Finally, when this debt-driven edifice threatened to collapse in 2007-2008, the government stepped in and protected the financial system from a depression, but once again did little to assist the bottom 80% of households.
Finance-driven economic activity fueled asset price bubbles, financial fragility, income inequality and financial instability, while pulling resources that might otherwise have been used to support productive activity. Other factors, notably globalization and the integration of China, Russia and other economies, also placed downward pressure on wages. However, in a 2013 report entitled "Why Have Wage Shares Fallen?" Engelbert Stockhammer determined that financialization was the primary contributor, with more than twice the weight of globalization.
Why is income inequality important to economic growth? Economic justice concerns aside, if the bottom 80% are not generating sufficient income and are unable to spend, aggregate demand and economic growth will suffer. These households, in general, consume more of their income than the top 20%, so they make a central contribution to growth. As Henry Ford recognized a century ago, it was in his own self-interest to pay his workers reasonable wages – his reason – if he did not, who would purchase his cars? If the bottom 80% of households are unable to consume, where will the engine to economic growth reside?
Most people have never heard of financialization and instead view finance as just another sector in the economy. However, in a liberalized financial system, positive feedbacks between credit growth and asset prices drive financial cycles. Ultimately, these cycles are based on unsustainable dynamics that lead to financial instability and ultimately, as would have occurred in 2008 had the Fed not stepped in, to a depression. It is well past time to correct the distortions that a financialized economy has inflicted on productive activities.
Quantitative easing (QE) exacerbated conditions, by once again skewing benefits toward the wealthy and contributing to heightened uncertainty about how to properly unwind these policies. Here is a truly disturbing statistic: The top 0.1% of U.S. households now own as much as the bottom 90%.
Is it any wonder that populism has returned with such vengeance?
Tax legislation: Another nail?
Sadly, the U.S. Congress and the administration are considering tax legislation that goes in precisely the opposite direction of what is needed. The tax plan that passed the House of Representatives last week provides huge givebacks to U.S. corporations and the top 20% of households under the guise of a “tax break for the middle class.” The purpose behind this legislation is naïve, ideological and disingenuous. The speaker of the House, Paul Ryan, says that the objective is to encourage corporations to invest in job creation.
We have seen how that works – in recent years, corporations have borrowed to buy back their own stock, instead of investing in productive activity. Why should handing them still more money change that behavior? Gary Cohn, head of the national economic council at the White House, in a speech to CEOs last week, asked by a show of hands how many would invest the tax savings in job creation – reportedly, virtually no one raised their hands. This policy, once again, ignores the fact that the bottom 80% of households are key components that are needed to help drive economic growth.
This tax legislation, or anything like it, will not help the bottom 80% of households, who hold the key to our economic future. According to one estimate, 10% of the total benefits in the Senate version will go to the middle quintile (40%-60% of the distribution), with an average cut in taxes of $630. More than 50% will go to the top 5%. Alternative practical solutions must be developed to address these issues.
Policies that deserve consideration include restoring public-private partnerships, beginning with an infrastructure bank. A job guarantee program that targets rebuilding deteriorating infrastructure also may prove worthy of consideration. Infrastructure policies will offer a far more appealing approach when compared with the tax giveaways to the top 20% of households.
One final thought – wouldn’t it be terrific to see members of the top 0.1% or the top 1% or the top 5% (you get the idea)... voluntarily provide both expertise and finance to these partnerships? Action is needed today!
John Balder’s experience combines more than 25 years of work building innovative investment strategies at firms that include GMO and SSgA. He previously worked with the US Treasury and Federal Reserve Bank of New York after beginning his career with the House Banking Committee on Capitol Hill. His research has focused on the topic of financial stability and the real world relationship between economics and finance.
Read more articles by John M. Balder
