On Inequality

I’ll try and keep this post short, as I really just want to express one economic principle that’s been roiling around in my gray matter for quite a long time now, but that I believe is worth mentioning.

Put simply, apart from any moral or ethical rationales why we, as a society, might desire to reduce the income and wealth inequality that plagues the United States these days, I believe there is an overriding functional principle that goes largely unremarked-upon, from my observation. 

But first, Brad DeLong, an economist at UC Berkeley who worked in the Clinton Administration, provides some context for why the middle class is ailing so much these days in his analysis of economic inequality:

The decline in our willingness to invest in education: a generation ago, we were the best-educated country among the rich nations of the North Atlantic; today we rank 14th. With fewer well-educated people than the trend would have predicted, supply and demand have raised the salaries of the educated relative to trend; with more poorly educated people than the trend would have predicted, supply and demand have lowered the wages of the less-educated not just relative to trend but absolutely. Add in more minor factors, such as the relative decline in the minimum wage and the coming of globalization, and the upshot is that the U.S. Bureau of Labor Statistics tells us that the typical white American male with just a high school diploma earns less today than his predecessor of the late-1970s, even though the country as a whole is 70 percent richer per capita. Thus the top fifth of America today outstrips the rest much more than it did a generation ago: their incomes are higher than their predecessors’ as they have kept up with the 70 percent tide of economic growth, while the statistics say that the rest are more-or-less treading water. (emphasis added)

Every person with some money in their pocket is an investor, of sorts.  Each person decides where they will invest their money based upon the value they place on what they expect to receive in return for their money.  Consumer spending makes up approximately 70% of US gross domestic product (GDP), meaning that, when individual consumers, in the aggregate, have less money to spend the economy necessarily takes a hit.  The function of unemployment benefits, food stamps, and other forms of aid to individuals in difficult circumstances (what are called “automatic stabilizers” in economics) not only keep families eating and housed, but also help to maintain at least a modicum of consumer demand in a weakened economy. 

Because each individual consumer decides where to invest/spend his or her money, that means that there are hundreds of millions of individual “pathways” let’s call them, for money to be injected into the economy.  Furthermore, these pathways are geographically spread all over the country, in cities, suburbs, and rural towns, every place that American consumers live, in fact. 

To me, the central conceit of “trickle-down economics,” and its central failing, is that by redistributing wealth upwards, you get fewer people with more of the money who are somehow supposed to continue to drive demand; who are to continue to provide a significant portion of the consumer spending that comprises 70% of our economy.  Would not such trickle-down policies lead to ever-increasing concentrations of wealth, particularly in those locales where the wealthy would tend to congregate?  Would not the spending habits of the top economic percentiles, and the fact that there are numerically fewer persons in those top percentiles, lead to less overall investment/spending in less wealthy sectors of the economy? 

As I sense that I am not making myself very clear, consider for an example a multi-billionaire hedge fund manager in New York City.  While his financial investments are surely global in scope, his spending habits may be relatively confined to the goods and services that specifically cater to the global elite in New York City – the high-priced housing, the waitstaff, the limo services, etc.  Thus, his spending may be concentrated in a relatively narrow slice of the economy, both in terms of the goods and services provided as well as the geographic spread of his spending. 

That billionaire is unlikely to, for instance, spend his money at a mom-and-pop grocery store in urban Detroit, or an agricultural supply shop in the Kansas farmland.  And yet, if the middle-class patrons of these other shops do not have as much purchasing power due to systemic and long-term wage stagnation, what is to happen to those shops, which are likely important to the social fabric of their neighborhoods?  What happens to the sales or property tax revenues that are lost in those communities, whose schools then become chronically underfunded? 

It turns out that FDR had some views on just this situation, and he addressed those views in a speech in Gainesville, Georgia in 1938:

FDR then went on to speak about how such attitudes affected the nation as a whole, of the consequences of economic inequality and the critical need to provide work and better wages for the "bottom third" of the U.S. population. He insisted it was vital to improve the "buying power" of the millions of unemployed and other workers "who are so under-employed or so underpaid that the burden of their poverty affects the little business man and the big business man and the millionaire himself." Moreover, he also reminded his listeners that better buying power meant not just greater purchases in hard-hit industries but also "many other...things -- better schools, better health and hospitals, better highways."

How much easier and more natural is it for wealth to “trickle upwards” from a base of consumers who have a moderate amount of discretionary income, rather than tenuously existing just above the poverty line?  Henry Ford understood this concept, which is why he famously paid his workers well enough ($5/day in 1914 compared to the industry average at the time of $11/week) that they would be able to afford the Ford cars they were producing. 

Not only was it a matter of social justice, Ford wrote, but paying high wages was also smart business. When wages are low, uncertainty dogs the marketplace and growth is weak. But when pay is high and steady, Ford asserted, business is more secure because workers earn enough to become good customers. They can afford to buy Model Ts.

This is not to suggest that Ford single-handedly created the American middle class. But he was one of the first business leaders to articulate what economists call “the virtuous circle of growth”: well-paid workers generating consumer demand that in turn promotes business expansion and hiring. Other executives bought his logic, and just as important, strong unions fought for rising pay and good benefits in contracts like the 1950 “Treaty of Detroit” between General Motors and the United Auto Workers. (emphasis added)

Of course, such a perspective requires that the executive making decisions regarding his or her employees’ compensation take a longer view, beyond simply the next quarterly earnings statement release date, and such management perspectives are sadly lacking in modern business culture on the whole. 

The point, is that each consumer has the ability, in miniature, to set off a “virtuous cycle of growth” in his or her community, depending on the spending choices we make.  Shopping at your local store, rather than online, for example, helps build up that store’s financial position, thus providing the managers more flexibility to someday hire more workers or expand product lines, both investments which cause positive ripple effects to occur further out in the economy. 

But again, if income and wealth becomes increasingly concentrated in fewer hands and in fewer geographic locales, then by nature, those many millions of small virtuous cycles of growth that individual consumers can help to set off all across the country will not be as likely to occur.  This dynamic makes our economy less resilient, as money circulation becomes increasingly driven by the spending decisions of fewer and fewer people, rather than by millions of individuals in many different places.

There is so much more to say on this topic, one blog post can barely scratch the surface.  The main takeaway, though, is that a rising tide truly does lift all boats, as the old saying goes.  And that rising tide operates everywhere, not just in the enclaves of the wealthiest, helping spread and multiply the benefits of a strong middle class in NYC, Detroit and Kansas.