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Why Income Inequality Will Likely Keep Getting Worse

Thomas Piketty has just published a massive new book tackling the explosive growth in income inequality.  Here’s what it looked like in Europe and the United States in 2010 (source):
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A New York Times review of the book, Capital in the Twenty-First Centurybegins as follows:

What if inequality were to continue growing years or decades into the future? Say the richest 1 percent of the population amassed a quarter of the nation’s income, up from about a fifth today. What about half?

To believe Thomas Piketty of the Paris School of Economics, this future is not just possible. It is likely…

His most startling news is that the belief that inequality will eventually stabilize and subside on its own, a long-held tenet of free market capitalism, is wrong. Rather, the economic forces concentrating more and more wealth into the hands of the fortunate few are almost sure to prevail for a very long time.

Piketty’s pessimistic view is based on his argument that income generated from capital normally grows faster than the economy or income from wages.  This means that the private owners of capital benefit disproportionately from growth, which makes it easier for them to increase their asset holdings and by extension future income.  And, since wealth and income translate into political power, we face a self-reinforcing dynamic leading to ever growing inequality.

This suggests that embracing a system based on maximizing the returns to private owners of capital is a mistake for the great majority of working people. A recent study by the investment bank Credit Suisse provides more evidence for this conclusion.  As Michael Burke explains,

The study… shows that long-term growth rates of GDP in selected industrialized economies are negatively correlated with financial returns to shareholders.

That is, the best returns for shareholders are from countries where GDP growth has been slowest, and vice versa. Where growth has been strongest, shareholder returns are weakest…

The negative correlation [seen in the chart below] does not prove negative causality. But it does support the theory which suggests that the interests of shareholders are contrary to the interests of economic growth and the well-being of the population.

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All this information is worth keeping in mind the next time business and political leaders tell us that the key to our well-being is boosting business confidence, the market, or private returns on investment.

Cross-posted at Reports from the Economic Front.

Martin Hart-Landsberg is a professor of economics at Lewis and Clark College. You can follow him at Reports from the Economic Front.

“Businesses are Swimming in Money”: More Profit Protection Will Not End the Recession

One conventional explanation for our economic problems seems to be that our businesses are strapped for funds.  Greater business earnings, it is said, will translate into needed investment, employment, consumption and, finally, sustained economic recovery.  Thus, the preferred policy response: provide business with greater regulatory freedom and relief from high taxes and wages.

It is this view that underpins current business and government support for new corporate tax cuts and trade agreements designed to reduce government regulation of business activity, attacks on unions, and opposition to extending unemployment benefits and increasing the minimum wage.

One problem with this story is that businesses are already swimming in money and they haven’t shown the slightest inclination to use their funds for investment or employment.

The first chart below highlights the trend in free cash flow as a percentage of GDP.  Free cash flow is one way to represent business profits.  More specifically, it is a pretax measure of the money firms have after spending on wages and salaries, depreciation charges, amortization of past loans, and new investment.  As you can see that ratio remains at historic highs.  In short, business is certainly not short of money.

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So what are businesses doing with their funds?  The next chart looks at the ratio of net private nonresidential fixed investment to net domestic product (I use “net” rather than “gross” variables in order to focus on investment that goes beyond simply replacing worn out plant and equipment).  The ratio makes clear that one reason for the large cash flow is that businesses are not committed to new investment.  Indeed quite the opposite is true.

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Rather than invest in plant and equipment, businesses are primarily using their funds to repurchase their own stocks in order to boost management earnings and ward off hostile take-overs, pay dividends to stockholders, and accumulate large cash and bond holdings.

Cutting taxes, deregulation, attacking unions and slashing social programs will only intensify these very trends.  Time for a new understanding of our problems and a very new response to them.

Cross-posted at Reports from the Economic Front.

Martin Hart-Landsberg is a professor of economics at Lewis and Clark College. You can follow him at Reports from the Economic Front.

Whose Economic Recovery Is It?

Officially our most recent recession began December 2007 and ended June 2009.  The following chart provides an important perspective on the recovery period.

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Stocks and profits have enjoyed a remarkable recovery.  While income is slightly up over the period, it is critical to remember that this is average income and the increase largely reflects gains for those at the very top of the income distribution.  Jobs and housing have yet to recover.

So, with returns to capital booming, it is easy to understand why business leaders are relatively content with current policies and, by extension, political leaders are reluctant to rock the boat.

Unfortunately, current policies are unlikely to do much to improve the job prospects or income of most workers.  In fact, the rise in business profits owes much to our depressed labor conditions.  Unless something dramatic happens, we can expect the next few years to look very much like the past few years.

Cross-posted at Reports from the Economic Front and Pacific Standard.

Martin Hart-Landsberg is a professor of economics at Lewis and Clark College. You can follow him at Reports from the Economic Front.

$22.62/Hr: The Minimum Wage if it had Risen Like the Incomes of the 1%

The federal minimum wage is $7.25 an hour.  Several states mandate a higher minimum wage; the state of Washington has the highest, at $9.19.

President Obama recently voiced his support for efforts to increase the minimum wage to $10.10.  The federal minimum wage was last raised in 2009 and certainly needs to be increased again.  The fact is that the federal minimum wage has not kept up with inflation.  As the New York Times graphic below shows, the current minimum wage is, when adjusted for inflation, 32% below what it was in 1968.  It is 8% below what it was in 2010.  In other words, those earning the minimum wage are suffering a real decline in income.

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As for the appropriate value, why not $22.62?  That, as the graphic illustrates, is what the minimum wage would be if it grew at the same rate as the income of the top 1%. Alan Pyke explains:

[Such a large increase] may seem outlandish, but previous research indicates American workers have just about earned it. Worker productivity has more than doubled since 1968, and if the minimum wage had kept pace with productivity gains it would have been $21.72 last year. From 2000 to 2012 alone workers boosted their productivity by 25 percent yet saw their earnings fall rather than rise, leading some economists to label the early 21st century a lost decade for American workers.

Looked at from that perspective the current movement for a $15 hourly wage at fast food restaurants sounds reasonable.  

Martin Hart-Landsberg is a professor of economics at Lewis and Clark College. You can follow him at Reports from the Economic Front.

Does Rising Inequality Threaten Future Economic Stability?

According to an article at the Wall Street Journal,  the average income for the bottom 90% of families fell by over 10% from 2002 – 2012 while the average income for families in all the top income groups grew.  The top 0.01% of families actually saw their average yearly income grow from a bit over $12 million to over $21 million over the same period.  And that is adjusted for inflation and without including capital gains.

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What was most interesting about the article was its discussion of the dangers of this trend and the costs of reversing it.  In brief, the article noted that many financial analysts now worry that inequality has gotten big enough to threaten the future economic and political stability of the country.  At the same time, it also pointed out that doing anything about it will likely threaten profits.  As the article notes:

But if inequality has risen to a point in which investors need to be worried, any reversal might also hurt.

One reason U.S. corporate profit margins are at records is the share of revenue going to wages is so low. Another is companies are paying a smaller share of profits on taxes. An economy where income and wealth disparities are smaller might be healthier. It would also leave less money flowing to the bottom line, something that will grab fund managers’ attention.

Any bets how those in the financial community will evaluate future policy choices?

Martin Hart-Landsberg is a professor of economics at Lewis and Clark College. You can follow him at Reports from the Economic Front.

The Weakest Economic Recovery Since World War II

The current economic recovery officially began June 2009 and is one of the weakest in the post-World War II period.  This is true by almost every indicator, except growth in profits.

One reason it has offered working people so little is the contraction of government spending and employment.  This may sound strange given the steady drumbeat of articles and speeches demanding a further retrenchment of government involvement in the economy, but the fact is that this drumbeat is masking the reality of the situation.

The figure shows the growth in real spending by federal, state, and local governments in the years before and after recessions.  The black line shows the average change in public spending over the six business cycles between 1948 and 1980.  Each blue line shows government spending for a different recent business cycle and the red line does the same for our current cycle.  As you can see, this expansionary period stands out for having the slowest growth in public spending.  In fact, in contrast to other recovery periods, public spending is actually declining.

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According to Josh Bivens:

…public spending following the Great Recession is the slowest on record, and as of the second quarter of 2013 stood roughly 15 percent below what it would have been had it simply matched historical averages… if public spending since 2009 had matched typical business cycles, this spending would be roughly $550 billion higher today, and more than 5 million additional people would have jobs (and most of these would be in the private sector).

The basic stagnation in government spending has actually translated into a significant contraction in public employment.  This figure highlights just how serious the trend is by comparing public sector job growth in the current recovery to the three prior recovery periods.

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As Josh Bivens and Heidi Shierholz explain:

…the public sector has shed 737,000 jobs since June 2009. However, this raw job-loss figure radically understates the drag of public-sector employment relative to how this sector has normally performed during economic recoveries… [P]ublic-sector employment should naturally grow as the overall population grows. Between 1989 and 2007, for example, the ratio of public employment to overall population was remarkably stable at roughly 7.3 public sector workers for each 100 members of the population. Today’s ratio is 6.9, and if it stood at the historic average of 7.3 instead, we would have 1.3 million more public sector jobs today.

In short, the challenge we face is not deciding between alternative ways to further shrink the public sector but rather of designing and building support for well financed public programs to restructure our economy and generate living wage jobs.

Martin Hart-Landsberg is a professor of economics at Lewis and Clark College. You can follow him at Reports from the Economic Front.

U.S. Corporations are Hoarding Wealth at Highest Rate Since 1971

The dominant firms in the U.S. and other major capitalist counties are happily making profits, but they aren’t interested in investing them in new plants and equipment that increase productivity and create jobs.  Rather they prefer to use their earnings to acquire other firms, reward their managers and shareholders, or increase their holdings of cash and other financial assets.

The chart below, taken from a Michael Burke post in the Irish Left Review, shows trends in both U.S profits and investment .

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As you can see the increase in profits (in orange) has swamped the increase in investment (in blue) over the relevant time period; in fact, investment in current dollars has actually been falling.

Looking at the ratio between these two variables helps us see even more clearly the growth in firm reluctance to channel profits into investment.  The investment ratio (investment/profits) was 62% in 1971, peaked at 69% in 1979, fell to 61% in 2000 and 56% in 2008, and dropped to an even lower 46% in 2012.

According to Burke,  if U.S. firms were simply to invest at the level they did in 1979, not even the peak, the increase in investment in the American economy would exceed $1.5 trillion, close to 10% of GDP.

The same dynamic is observable in the other main capitalist economies:

In 1995 the investment ratio in the Euro Area was 51.7% and by 2008 it was 53.2%. It fell to 47.1% in 2012. In Britain the investment ratio peaked at 76% in 1975 but by 2008 had fallen to 53%. In 2012 it was just 42.9% (OECD data).

So what are firms doing with their money? As Burke explains:

The uninvested portion of firms’ surplus essentially has only two destinations, either as a return to the holders of capital (both bondholders and shareholders), or is hoarded in the form of financial assets. In the case of the U.S. and other leading capitalist economies both phenomena have been observed. The nominal returns to capital have risen (even while the investment ratio has fallen) and financial assets including cash balances have also risen.

So, with firms seeing no privately profitable outlet for their funds, despite great societal needs, their owners appear content to reward themselves and sock away the rest in the financial system.  In many ways this turns out to be a self-reinforcing dynamic.  No wonder things are so bad for so many.

Cross-posted at Reports from the Economic Front.

Martin Hart-Landsberg is a professor of economics at Lewis and Clark College. You can follow him at Reports from the Economic Front.

The Striking Rise in “Missing Workers”

The Federal Reserve Bank has said it will maintain its stimulus policy as long as the economy remains weak. One of its key indicators for the strength of the economy is the unemployment rate, which has been steadily falling for several years, from 10% in October 2009 to 7.3% in August 2013.  However, this decline in the official unemployment rate gives a misleading picture of economic conditions, at least as far as the labor market is concerned.

The reason, as the Economy Policy Institute explains, is because of the large number of “missing workers.”  These missing workers are…

…potential workers who, because of weak job opportunities, are neither employed nor actively seeking a job. In other words, these are people who would be either working or looking for work if job opportunities were significantly stronger. Because jobless workers are only counted as unemployed if they are actively seeking work, these “missing workers” are not reflected in the unemployment rate.

We are seeing many more missing workers now than in recent history.  The chart below shows the Economic Policy Institute estimate for the number of missing workers.

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 The next chart compares the estimated unemployment rate including missing workers (in orange) with the official unemployment rate (in blue).

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As you can see, while the official unemployment rate continues to decline, the corrected unemployment rate remains stuck at a rate above 10%. In other words labor market conditions remain dismal. And here we are only talking about employment.  If we consider the quality of the jobs being created, things are even worse.

Martin Hart-Landsberg is a professor of economics at Lewis and Clark College. You can follow him at Reports from the Economic Front.