The middle class’s missing $1.6 trillion
The United States was the world‚Äôs first middle-class nation, which was a big factor in its rapid growth.¬† Mid-19th-century British travelers marveled at American workers‚Äô ‚Äúductility of mind and the readiness‚Ä¶for a new thing‚ÄĚ and admired how hard and willingly they labored. Abraham Lincoln attributed it the knowledge that ‚Äúhumblest man [had] an equal chance to get rich with everyone else.‚ÄĚ
Most Americans still think of themselves as middle class. ¬†But the marketing experts at the big consumer goods companies are giving their bosses the unsentimental advice that the middle class is an endangered species. Restaurants, appliance makers, grocery chains, hotels are learning that they either have to go completely up-scale, or focus on bargains for the struggling and budget-conscious.
Current income surveys, for statistical reasons, usually segment families by broad categories, which obscure the recent radical shift of income to a thin stratum of the super-rich. Well-to-do people may buy $100 coffee pots, but the lion‚Äôs share of the income growth has been going to folks with five houses and staff to make the coffee.
For the last 15 years, an international consortium of economists has been building data bases on the income shares of the richest people in the developed countries, based on pre-tax market income including capital gains and tax-exempt income, and excluding government transfers. The American data reveals the greatest inequality by far, followed by Great Britain.
The stunning income distribution has a remarkable symmetry.¬† In 2012, the top 10 percent captured half of all reported income. But the top 1 percent got almost half of that — 22.5 percent — while the top 10th of 1 percent (0.1 percent) captured half of that. All three are within a few decimal places of the previous highs — which occurred in 1928, just before the market crash that ushered in the Great Depression.
The percentages don‚Äôt quite capture the violence of the skew.¬† The stock market implosion of the 1930s followed by World War II‚Äôs strict price controls and high marginal taxes brought the top 1 percent‚Äôs income share down to about 9 percent by the end of the war.¬† Executive and financial sector pay was quite restrained, even through the good times of the 1950s and 1960s, and the 1 percent‚Äôs income share did not start to rise until the late 1970s. It took off for the stratosphere then — amid the oceans of cash sloshing around Wall Street during the 1980s leveraged buyout boom.
The sums involved are enormous. The difference between the 1 percent‚Äôs income share in 1975 (8.9 percent) and today‚Äôs 22.5 percent is 13.6 percent.¬† That additional share of personal income is worth $1.6 trillion.¬† Each year.
What can you buy with $1.6 trillion?¬† Well, it‚Äôs more than the annual outlays for Social Security payments, and about twice as large as Defense Department appropriations.¬† It‚Äôs enough to pay off the federal debt held by the public in about seven years.
To amass that incremental $1.6 trillion, the 1 percent took 68 percent of all personal income growth between 1993 and 2012. To be fair, those same folks lost a great deal of income during the 2008 financial collapse, because much of their income comes from financial assets. But during the recovery of 2009-2012, they took a whopping 95 percent of the income growth — so their relative income and wealth positions are nearly all the way back to their pre-2008 high.
The canonical retort to such musings is that all segments of society benefit from a well-fed and contented super-rich. They are the ones, the argument goes, who supply the high-octane financial fuel to maintain America‚Äôs advantage in high technology, keep its job-creation machinery humming, and lay the foundation for solid long-term growth.
Unfortunately, that is not proved true in recent experience. Since financial markets were liberalized in the 1980s, the finance sector‚Äôs income and debt has soared, income inequality has skyrocketed, and the world economy has flopped from crisis to crisis ‚Äď the Savings and Loan fiasco, the petrodollar debacle, and the leveraged buyout ¬†circuses of the 1980s; the ‚Äúhot-money‚ÄĚ driven currency crises and hedge-fund collapses of the 1990s, and the hallucinatory mortgage games of the 2000s.
The dangers of runaway finance have been getting some academic attention of late, as scholars have begun connecting the dots between the super-rich and financial instability.
The very rich do invest productively, of course, and are also interested in capital preservation — so large segments of their portfolios are invested in safe, AAA-rated assets. As their income soared, however, their appetite for safe assets greatly outstripped the available supply. so the financial industry dutifully set about creating allegedly top-quality assets out of whatever lower-quality paper was at hand.
Adair Turner, the former head of the British financial regulatory authority, has outlined the ‚Äúcomplexification‚ÄĚ of finance that gave rise to the insane derivative structures and synthetic portfolios that unraveled so dramatically in 2008.
Stephen Cecchetti and Enisse Kharroubi, two senior economists at the Bank for International Settlements, have documented the ‚Äúinverse U-shaped curve‚ÄĚ of finance‚Äôs contribution to the economy. The history of all developed countries shows that as finance employment rises, economic growth and productivity increases. But only up to a point. After that, continued growth of the finance sector often triggers falling growth and declining productivity.
The two authors also worked out a model of why this happens. As the financial sector grows more sophisticated, it competes with technology and manufacturing industries for the smartest and most ingenious engineers and mathematicians. At the same time, however, broad-gaged finance needs highly ‚Äúpledgeable‚ÄĚ assets that can be readily leveraged, like residential and commercial mortgages. (High-technology investing has a very high risk of failure, and so is the preserve of specialist venture-capital firms.)
The best and the brightest, they found, instead of creating new technology breakthroughs, become the servants of the super-rich — because they pay the most.¬† The¬† engineers devote themselves to increasing low-productivity, easily understandable assets in order to transmute them into new, highly complex, instruments that look super-safe, but often aren‚Äôt. How to wreck an economy in three easy steps.
Reversing these realities, unfortunately, will take at least as much time as it did to create them. But we have to start somewhere and keep at it for a couple of decades.
The first step should be to continue to rein in the financial sector. Turner of the British financial authority, points out that a key founder of the ‚ÄúUniversity of Chicago School‚ÄĚ of free-market economists, Henry Simon, opposed almost all government regulation, except for the financial sector. Simon understood that very smart people applying high leverage to other people‚Äôs money is an invitation to disaster, and so required tight regulation. The most important step today might be breaking up the mega-banks that emerged from the crash. Then they would be easier to police — and easier to indict.
Second should be to start rolling back the income shares of the very richest people by targeted taxation and other strategies, including radical tax simplification to reduce the legal cubbyholes for sheltering income. The economist Brad DeLong wonders why the middle classes haven‚Äôt risen up and demanded fairer income distribution.
Reducing the top 1 percent‚Äôs income share to, say, 14 or 15 percent, still much higher than the pre-1980 norm, would free up about $1 trillion for middle-class tax relief; higher minimum wages; pension, healthcare, and educational subsidies, or job-creating infrastructure construction.
That wouldn‚Äôt solve all of our problems. But it would help put America back on course to realizing its original promise.
ILLUSTRATION (TOP): Matt Mahurin
PHOTO (INSERT 1): At least 20 private jet aircraft sit parked at the Friedman Memorial Airport during the Allen & Co Media Conference in Sun Valley, Idaho July 13, 2012. REUTERS/Jim Urquhart
PHOTO (INSERT 2): A model presents a creation from the Oscar De La Renta Autumn/Winter 2013 collection during New York Fashion Week, February 12, 2013.
PHOTO (INSERT 3): A couple walk with Hermes shopping bags as they leave an Hermes store in Paris March 21, 2013. REUTERS/Philippe Wojazer