Inequality: A Market Test

February 3rd, 2014 at 6:12 pm

Finally have a moment to collect thoughts today, and wanted to reflect on some interesting inequality discussions in the papers this morning.

Two points, united by one academic study (and it’s one I’ve focused on before in these pages).

First, the NYT reports on evidence of higher inequality—more specifically, a squeezed middle class—in current consumer markets:

As politicians and pundits in Washington continue to spar over whether economic inequality is in fact deepening, in corporate America there really is no debate at all. The post-recession reality is that the customer base for businesses that appeal to the middle class is shrinking as the top tier pulls even further away.

As one consumer analyst puts it:

“As a retailer or restaurant chain, if you’re not at the really high level or the low level, that’s a tough place to be…You don’t want to be stuck in the middle.”

A figure accompanying the piece shows that the share of consumer spending by the top 5% has increased from 27% in 2002 to 38% in 2012; the top 20% now accounts for 61% of consumer spending, up from 53% in 1992.

I share this not because it’s surprising but because it’s a market test of the inequality problem.  In fact, I’m not sure it’s even correct that we’re sparring over whether inequality is “deepening.”  Both Obama and Rubio agree it’s a problem, and the debate has moved beyond “is it real” to “what should be done about it.”

Much of what the NYT piece is reporting on comes from the work of Cynamon and Fazzari (C&F), which I was onto a while ago and which I featured in my own analysis of the impact of inequality on growth.  As I summarized last summer:

C&F find that as the income shares of the top 5 percent soared relative to the bottom 95 percent, both the debt burden and the spending of the lower-income group grew quickly relative to that of the wealthiest households. The savings rates of the very wealthy increased over the 2000s expansion, while those of the bottom 95 percent fell sharply.

These dynamics drove much stronger consumer spending than one would have expected looking only at median income growth, inflated a huge housing bubble and ensured that once the bubble burst and the deleveraging cycle began, the United States was in for a deep and protracted recession.

So here we have two ways in which inequality is affecting growth.  First, through weaker consumer spending, though we shouldn’t assume that the top 20% can’t spend enough to make up for the weaker spending in the middle.  However, if you look at C&F’s figure 7, you do see weaker PCE growth (aggregate personal spending) in this relative to past recoveries.

Second, you’ve got the recipe for future bubbles that I described in my CAP piece linked above, where inequality simultaneously leads to cheap credit/underpriced risk and the demand for such credit by families facing stagnant incomes.

In the second piece citing C&F that I saw this AM, Robert Samuelson doesn’t buy that part of the story.  That is, he cites the excessive leverage but doesn’t see what inequality had to do with the debt bubble (“Just because households wanted to borrow didn’t mean lenders had to lend”).

It’s certainly true that we’ve had asset bubbles in periods of both low and high inequality.  But we haven’t had as many as we do now and there’s compelling theory and some evidence that wealth concentration is implicated as high levels of wealth concentration increases both the supply of (by the wealthy) and demand for (by the non-wealthy) loanable funds.

Moreover, as those funds inflate asset bubbles, the wealth effect juices consumer spending, setting the stage for a painful reversal of that effect when the bubble bursts.

Finally, you might wonder just how operative is all this in today’s economy.  After all, we are kinda growing out of the slump, no?

Well, I don’t want to make too much out of one year’s data, but I’ve shown lots of figures like the ones in here or here showing how profits have outpaced middle-incomes and wages in this recovery.  But if you look at the most recent year—2010, the first full year of the current recovery—of the very thorough CBO household income data, you clearly see highly skewed pattern of income gains.

Again, just one year but it certainly helps explain the retail results I started with at the top.  Now, of course if we could just inflate another asset bubble…



Source: CBO

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4 comments in reply to "Inequality: A Market Test"

  1. Tom in MN says:

    I thought it was rich (speaking of 4 of the top 10 — people not %) that Walmart had the nerve to complain that cuts to SNAP will hurt their sales. If they paid a living wage, they would have even more customers.

  2. Denis Drew says:

    A $15 an hour minimum wage would send about 3.5% of GDP the way of 45% of American workers — about $560 billion (much of it to bottom 20 percentile incomes who today take only 2% of overall income).

    Could raising the wages of 45% of the workforce actually raise demand for the goods and services they produce? Sounds sensible at some level; raising wages so much ought to add demand somewhere – but, is it all smoke and mirrors? Before the 45% — who would get a wage hike to $15 an hour — can raise demand anywhere, they would need to get the extra cash from somewhere else – meaning the 55%. (Bottom 45 percentile incomes – not wages – currently take 10% of overall income – so, at no time are we talking giant chunks of the economy here.)

    The 45% can get higher pay even as “numerical” (to coin a phrase?) demand for their output declines due to higher prices — as long as labor gets an bigger enough slice of the new price tags. This can be compared to a leveraged buyout or buying stocks on margin.

    Products produced by low-wage labor tend to be staples whose demand tends to be inelastic. Demand for food is inelastic – maybe even fast food. If the price of your Saturday family jaunt to McDonald’s rises from $24 to $30, are you really going to eat at home (the kiddies haven’t forgotten the fundamental theorem of economics: money grows on trees :-])? And fast food should be the most worrisome example: lowest wages to start with; even so, highest labor costs, 25%.

    Wal-Mart is the lowest price raising example (surprise) with 7% labor costs. Jump Wal-Mart pay 50% and its prices go up all of 3.5%.

    If low wage labor costs average 15% across the board and go up 50%, overall prices increase only 7.5% — and that is for low wage made products only; nobody’s car note, mortgage payment or health premium is affected. If demand drops just enough for price increases to maintain the same gross receipts (conservative, even without inelasticity), low wage income should improve appreciably.

    Allow me to cite: from a 1/ll/14, NYT article “The Vicious Circle of Income Inequality” by Professor Robert H. Frank of Cornell:
    “… higher incomes of top earners have been shifting consumer demand in favor of goods whose value stems from the talents of other top earners. … as the rich get richer, the talented people they patronize get richer, too. Their spending, in turn, increases the incomes of other elite practitioners, and so on.”

    The same species of wheels-within-wheels multiplier ought to work the at both ends of the income spectrum — and likely in the middle. A minimum wage raise to $15 an hour is not going to send most low-wage earners in pursuit of upper end autos, extra bedrooms or gold seal medical plans. Wal-Mart and Mickey D’s should do just fine, OTH – which in turn should keep Wal-Mart and Mickey D’s doing even better.

  3. PeonInChief says:

    What’s most interesting, though, is that if We The Great Unwashed aren’t spending, the economy can only muddle through. That’s not exactly a stirring defense of our present condition. More interesting, however, is that all that capital is searching for something to make into a bubble and not finding anything. The masses don’t have the money to try to play the stock market, and housing just ain’t an option, so perhaps capital can move into commodities, But how many people will be willing or able to take out a mortgage on milk?

  4. smith says:

    Two points
    I don’t think enough attention is paid as to how laws have changed recently (within three years before last bubble burst) that encouraged bubbles in important ways and protected those who profited win or lose.
    Example 1: 2005 bankruptcy law change that doesn’t let people get a fresh start anymore even if they get deeply in debt.
    Example 2: Same law also affected student debt which protected creditors. Many changes to laws that affect student debt passed over the last 25 years to protect creditors. A better way to address debt repudiation would have been to examine why it occurred, like exorbitant tuition hikes at public and private nonprofits, unscrupulous for profit operators preying on students who got easy loans, low interest rates that still add significantly to total costs (colleges are like the used car salesman, no money down).
    Example 3: 1978 court ruling that removed consumer credit protection on interest rates (Bernie Sanders tried to reinstate caps at 15% in 2009, only 20 something Senators voted yea)
    These and other measures (e.g. mortgage backed securities) remove the moral hazard of making bad loans which create bubbles. The lenders count on 30% interest rates, balloon mortgage rates, lack of bankruptcy protection, to absorb losses from risky loans that fuel growth (except it almost blew everyone up).
    Bottom line: Banks and financial firms are still raking in record profits, still too big to fail, people still have debt overhang. If you don’t want bubbles, you’d have to change those laws back to the way they were before bubbles.

    2) The reason (as Bill Maher wonders) people don’t riot in the streets is because we have a safety net (however inadequate), the standard of living has improved even for the poor (large screen TVs and cell phones, the new bread and circuses). Poor people don’t work in noisy factories, in mines, on the docks, they work inside at fast food joints, in Walmart, or call centers, or at the Mall. This is especially true for the squeezed middle class. Many are two wage earners families, and even though they fall behind, even the $50,000 median (with each making $25,000) buys a lot (especially outside very expensive northeast corridor or west coast). So you have the same problem communists and socialists faced in the 19th century. People do not rebel even though the left thinks they should and rising inequality also gives more power to upper tiers, and greater reason to protect their gains. Does anyone think the top 20% or even 10% don’t effectively run the country, set the agenda, have enormous incentive not to return to post New Deal levels of equality? Work on that political question first because the economics are simple, tax higher incomes, reduce costs of education, curb power over labor by reducing work hours as was done in 1938 and 1940, but cover non-manual labor.