Posts tagged politics

Did Income Inequality Cause the Financial Crisis?

Policymakers and academics have identified income inequality as a proximate cause for a number of society’s ills, from deteriorating social cohesion and unhappiness to high mortality rates. But could America’s widening income gap also be responsible for the 2008 financial crisis?

That’s the controversial conclusion reached by economists Michael Kunhof and Romain Rancière, whose 2011 report for the IMF explains how rising inequality incentivizes poorer households to over-leverage, eventually leading to financial crises. In their model, households are broken down into two groups—the richest 5 percent, representing capital; and the bottom 95 percent, representing labor. As in the real world, Kunhof and Rancière assume the capital group experiences large and persistent income gains over time, while wages for labor grow slowly or stagnate. But the top 5 percent cannot consume all of their disposable income (you can only buy so many cars), so they create financial wealth through loans to the bottom 95 percent, who need credit to maintain their accustomed level of consumption. As inequality grows, credit supply from the top and credit demand from the bottom expand simultaneously, increasing the probability of systemic default as risk and debt build.

If Kunhof and Rancière’s model sounds familiar, that’s because it is. In the United States, real average annual earnings for production and other non-supervisory workers peaked in 1972 at $40,884, while total consumer credit amounted to just $2,804 per person. By 2008, average annual earnings had fallen by $6,408 to $34,476, and households were making up the gap with an extra $4,940 in credit per person—more than triple the ratio of credit to earnings as in 1972.

As in Kunhof and Rancière’s model, U.S. politicians responded to growing income inequality and stagnating median wages in the years leading up to the financial crisis by promoting policies to prop up the living standards of the indebted lower and middle class. But instead of addressing the root causes of inequality (such as regressive tax policy and declining collective bargaining power), they cut the cost of borrowing even more, pouring gasoline on the already fiery housing market. Low income families were incentivized to take on second and third mortgages they could not afford, and the financial class pounced—diverting capital into financial gimmicks like mortgage-backed securities to obfuscate and distribute the underlying risk.

There is some disagreement within the economic community as to whether the relationship between higher levels of inequality and financial crises are causal or correlational. But consider this: when someone making $20,000 a year gets a raise, they spend it. When someone making $2,000,000 a year gets a raise, they invest it. And as an ever greater share of national income accumulates at the top (and discretionary income for the bottom 95 percent stagnates), the greater the demand for high-yield financial innovation independent of the faltering demand-side consumer economy. Until real median wages rise and the income gap begins to narrow, debtor nations such as ours will continue this disastrous boom-bust cycle.     

Graph of the Day: Going Over the “Fiscal Cliff” Would Cause Another Recession

Yesterday, the nonpartisan Congressional Budget Office released their analysis of the upcoming “fiscal cliff” (“taxmageddon,” for those more eschatologically inclined), and the results aren’t encouraging. Unless Congress finds a way to delay the $607 billion worth of tax increases and spending cuts that are scheduled to kick in automatically at the end of this year, the CBO expects the United States will fall briefly into another recession.

That presents policymakers with a dilemma. On the one hand, the expiration of the Bush tax cuts and the payroll tax holiday would generate over $300 billion in revenue next year. Deep cuts to the military budget and to safety net programs would save another $65 billion, shrinking the budget deficit by over 5 percent of GDP. But rapid debt reduction comes at a steep price (as Europe is well aware): the economy would take a sharp downturn, contracting 1.3 percent annualized in the first half of 2013, followed by 2.3 percent growth, for a measly 0.5 percent increase over all. Unemployment would rise above 9 percent, tax revenues would fall, and the government would be forced to increase spending on unemployment insurance, food stamps, and other social programs. 

However, if Congress delays these deficit reduction measures in the near-term, the CBO predicts real GDP will expand by a robust 4.4 percent in 2013, and that unemployment will continue its downward trend. Comparable fiscal constraint would still be needed in the medium term (federal debt held by the public is at its highest level since 1950; a matter of bipartisan concern), but policymakers would minimize damage to the economy (and to the individuals, families and businesses that make up economies) by agreeing to tackle deficit reduction only after a meaningful recovery is secured.

Political Dysfunction and the Filibuster

Republican brinkmanship over the raising of the debt ceiling nearly drove the United States to default last year, creating panic in financial markets and resulting in the first ever downgrade of the nation’s AAA credit rating. After failing to resolve the crisis, Congress was forced to accept a stopgap measure that was equally odious to both parties: the debt ceiling would be temporarily raised, but the budget for defense and social programs would both take a hit unless another compromise could be negotiated. The American people were not impressed: by the end of 2011, Congress’s approval rating had plummeted to 11 percent, with Republicans taking the brunt of public criticism. 

Sadly, last year’s debt ceiling debacle may pale in comparison to this year’s dysfunction. Once again, the debt ceiling needs to be raised, and already Republicans are doubling down on their 2011 hostage-taking tactics, threatening a default unless Democrats accept spending cuts greater than the size of the increase. At the same time, Congress also has to confront the expiration of the controversial Bush tax cuts (which would raise taxes on all Americans, especially the rich) and the end of Obama’s payroll tax holiday (which would hurt the working class), not to mention the across-the-board spending cuts that neither party wants to see happen. 

The intense partisanship surrounding these issues may be already taking a toll on the economic recovery. According to the Washington Post, businesses are slowing hiring and planning for layoffs in anticipation of a “taxmageddon” scenario, in which a deadlocked Congress fails to defuse the fiscal bomb of higher taxes, spending cuts and another market-roiling debt ceiling standoff. “How do you plan for chaos?” one industry lobbyist asked the Post, between meetings with lawmakers. “It’s almost a unique moment in government because there’s so much at stake. And there’s nothing that inspires confidence that this will get done.”

Congress hasn’t always been so polarized and dysfunctional. Filibusters, for instance, were rare until the 1960s, when they became a commonly-used tactic for delaying civil rights legislation. To end a filibuster, a three-fifths supermajority of Senators must vote to invoke cloture, bringing the debate to a close. Today, according to Senate Majority Leader Harry Reid, “60 votes are required for just about everything.” As a result, businesses have little certainty as to whether Congress will be able to move forward on legislation to mitigate the automatic tax hikes and spending cuts that will go into effect at the end of the year. And without a compromise of some kind, economists warn, the economy could easily head back into recession.  

Amending the filibuster would not by itself resolve the myriad dysfunctions that currently plague Congress—not least among them ideological polarization and the influence of lobbyists—but it would be a significant reform for a procedural rule that is more overused with each passing year. And, in the end, that may be the silver lining of the 112th Congress’s maddeningly partisan gridlock. Last week, Harry Reid indicated he was finally ready to move ahead with filibuster reform, which he has opposed in the past. “If there were anything that ever needed changing in this body, it’s the filibuster rule, because it’s been abused, abused, and abused.”

The One Percent’s Jobless Recovery

Something strange has happened in the U.S. economy. Nearly three years after the Great Recession officially ended in June 2009, unemployment remains stubbornly high at 8.1 percent and real wage growth is nonexistent, but corporate profits and GDP have never been higher. Six million workers have dropped out of the labor force in the last two years—twice the number of people who have found new jobs—but the Dow Jones and NASDAQ are trading above pre-recession levels as if nothing had ever happened. Economists like to call this incongruity a “jobless recovery,” but you might as well call it a recovery for the 1 percent: according to recent data, that small fraction of the nation’s wealthiest captured a stunning 93 percent of a income gains from 2009–10. Income growth for the bottom 99 percent was just 0.2 percent.

This unequal pattern of growth is highly unusual in recent history. For most of the post-war years, periods of economic recovery were defined by a rapid return to high employment and GDP growth. But for the past two decades, there has been an increasing disconnect between the strength of the economy and the health of the labor market. When the economy crashed in 2008, businesses aggressively laid off employees while demanding greater productivity from their remaining workforce. Without a union or effective labor laws to protect them—and with fierce competition for their jobs—many workers resigned themselves to more work for the same salary.

That’s not how it used to be. Research shows that until the mid-1980s, labor productivity tended to slow during recessions, as it was difficult for businesses to downsize effectively. But with the sharp decline of unions during the Reagan years, the correlation between productivity and employment turned negative. “These days,” writes economist Brad DeLong, “U.S. labor productivity looks to be countercyclical: firms take advantage of downturns in demand to rationalize operations and increase labor productivity, pleading business necessity in the face of the downturn to their workers.” Which explains why business sector productivity soared 5.3 percent in the depths of the Great Recession, driving corporate profits up 116 percent to a record $1.4 trillion. Although the stock market boom did little for the 70 percent of Americans who received less than 2 percent of their income from capital gains, the returns to the 1 percent were enormous. 

The divergence between productivity and labor (including wage compensation and employment) is the key to understanding rising income inequality, the stagnation of average wages, and the current state of our jobless, 1-percent-oriented recovery. “Productivity and the compensation of the typical worker grew in tandem over the early postwar period until the 1970s,” writes Lawrence Mishel, president of the Economic Policy Institute. “However, the experience of the vast majority of workers in recent decades has been that productivity growth actually provides only the potential for rising living standards.” In reality, average wage growth has stagnated, while the gap between productivity and compensation has accelerated.

According to Mishel’s research, this divergence can be explained primarily by growing income inequality and a recent shift in the allocation of compensation from labor to capital. Part of this story is the rise of the 1 percent, whose earnings grew 156 percent from 1979 to 2007. But Mishel differentiates between this divergence at the top—attributable to the extraordinary growth of executives’ compensation (especially in the financial sector)—and the wage stagnation of the middle class, who have suffered disproportionately from ”laissez-faire policies … including globalization, deregulation, privatization, eroded unionization, and weakened labor standards.” Wage inequality at the bottom is similarly a unique phenomenon, the result of continual high unemployment and the eroding value of the minimum wage.

Mishel’s research strongly suggests that improving labor standards—including a higher, inflation-indexed minimum wage and stronger protections for collective bargaining—must be central to any effort to reestablish the historical link between productivity growth and rising median wages. Here the experience of Europe, with its longstanding support for labor and milder income inequality, should be instructive. Another way to increase workers’ leverage would be to return to full employment, putting upwards pressure on wages. But most economists expect that could take years at current trend growth: businesses will continue to squeeze productivity gains from ever-smaller workforces until an increase in consumer demand requires them to begin hiring again. And consumer demand will not return to pre-recession levels until the jobs crisis is resolved. 

It sounds like a catch-22. (That is, until you remember the role of the U.S. government, which can borrow cheaply to stimulate the economy, creating outsize returns on investment.) Of course, in the long-term, the market will find equilibrium on its own—it just may not be the equilibrium we want or expect.

Graph of the Day: Public Sector Layoffs are Undermining the Recovery

April was another lackluster month for job growth, according to today’s official report. Only 115,000 new jobs were created last month—a not-unexpected but still disappointing slowdown from December to February, when job growth was averaging 252,000 a month. The unemployment rate fell a tenth of a point to 8.1 percent, primarily because discouraged workers continue to drop out of the labor force. And the number of Americans without a job was essentially unchanged at 12.5 million, nearly half of whom have been unemployed for over six months.

The takeaway, writes economist Jared Bernstein, is that fiscal austerity isn’t working. “It doesn’t work here, it doesn’t work in Europe, it doesn’t work for state and local governments. I’m tempted to ask how many data points we need to recognize this crucial economic truth, but I’m afraid data points don’t have much to do with it.”

And there are plenty of data points. The graph above, of net monthly job growth since 2008, shows how public sector layoffs have created a substantial drag on growth as the economy struggles to take off. While we’re finally back to a net positive number of private sector jobs since the start of 2009, state and local governments have shed over 600,000 workers—12,000 in the past month alone. Nine out of ten of those jobs were in local education, which is down over 200,000 since 2010.

Boosting state and local government employment—especially of public school teachers, whose job it is to educate our children—should be a nonpartisan priority for legislators. But somewhere along the way, collective action became controversial and civic duty became politicized. Many conservative commentators now encourage public sector layoffs in the belief that smaller government is preferable to creating or maintaining government jobs. As if thousands of unemployed teachers will find more socially productive work now that they’re off the taxpayers’ dole.

Sadly, this is the state of the debate. We have the tools to stimulate the economy and get America back on track towards full employment, but half the political establishment is ideologically bound to tax cuts for the rich and dismantling the social safety net. For now, it looks like the economy will have to recover on its own.      

The Right Wing Radicalism of Paul Ryan

Representative Paul Ryan (R-Wis.), current chairman of the House Budget Committee and the eponymous author of the Republican’s 2013 budget proposal, wants to lower taxes on the rich, eliminate assistance for the poor, uninsure millions of Americans and increase military spending. His plan would cost $4.6 trillion in lost tax revenue over the next decade (not including the $5.4 trillion loss from the Bush tax cuts) and save $5.3 trillion in nondefense budget cuts. Two-thirds of those tax breaks would go to households earning over $200,000, and two-thirds of the “savings” would come from gutting programs that benefit the poor—a radical redistribution of wealth from the bottom to the top. So how has Ryan become “the most popular guy in Washington,” asks Jonathan Chait, “revered as much by the mainstream media as by the tea party”?

The answer, according to Chait, has everything to do with the moderate image that Ryan has cultivated over the years—as a humble, self-sacrificing policy wonk and courageous fiscal austerian. “The Paul Ryan that has been introduced to America is a figure of cinematic rectitude—a Jimmy Stewart character, but brainier,” Chait writes. “He is America’s neighborhood accountant, a man devoted to the task of restoring our fiscal health, whatever slings and arrows may come his way.” As a result, the right wing radicalism of Ryan’s budget proposal has gotten an unusual pass from media figures like the New York Times‘ James Stewart, who insist that Ryan “seems very genuine.” This despite the fact that the Ryan Plan “would likely produce the largest redistribution of income from the bottom to the top in modern U.S. history,” according to CBPP president Robert Greenstein, “and likely increase poverty and inequality more than any other budget in recent times.”

Conservative commentators like former Bush advisor Michael Gerson are presently trying very hard to advance the notion that Ryan’s approach—which Gerson brands “Reform Conservatism” in a recentWashington Post column—is a ”modern, market-oriented way” to fix a broken system. This is preferable, he suggests, to the Tea Party’s “Rejectionist” strain of conservatism, which seeks to “fundamentally reorder the role of the federal government.” It’s a straw man argument that allows Gerson and other Establishment conservatives to distance themselves from their party’s fringe element while praising the “disproportionate creativity and influence” of Republicans like Ryan.  

Yet one glance at Ryan’s actual proposals reveals a startlingly radical agenda. According to TCF budget analyst Andrew Fieldhouse, the Ryan Plan consists of four component parts: 

    1. New tax cuts (49.7% of benefits go to households making over $500,000 a year)

• Individual income tax rates consolidated to 25 percent and 10 percent brackets
• Alternative minimum tax (AMT) repealed
• Taxes included in the Affordable Care Act repealed
• Corporate tax rate cut to 25 percent 
• Corporations no longer taxed on foreign income

                    Total cost: $4.6 trillion in lost revenue

    2. The extension of the Bush tax cuts  

                    Total cost: $5.4 trillion in lost revenue

Which would be funded by

    3. Non-defense spending cuts (62% of cuts come from programs that assist low-income households, like Medicaid and food stamps)

                    Total savings: $5.3 trillion

    4. Trillions of dollars in unspecified offsets 

                    Total savings: ???

Altogether, that amounts to an additional $4.7 trillion deficit over the next decade, which Ryan suggests will be offset by reductions in tax expenditures in the future. Republicans like Gerson want to sell this budget as an honest effort at reform, the brainchild of a moderate policy wonk reaching across the aisle in good faith. But it only takes one look at the numbers to grasp how radical such a “reform” would be. Without specifying which loopholes and deductions he would eliminate, the Ryan plan is revealed for what it is: the end of the social safety net as we know it and a trillion dollar windfall for the rich.

Graph of the Day: “The Great Divergence”

Yesterday morning, The Century Foundation hosted New Republic senior editor Timothy Noah for the first public discussion of his new book, The Great Divergence: America’s Growing Inequality Crisis and What We Can Do About It, which examines the economic and political policies that have widened the income gap between the richest and poorest citizens in our society over the last thirty years. (Click here for video of the event, featuring panelists Dan Alpert, Robert Hockett and Dorian Warren.)

According to Noah, the “Great Divergence”—a term originally introduced by Paul Krugman—describes the dramatic reemergence of income inequality after 1979, following several decades of wage compression and increasing equality that economists sometimes call the “Great Compression.” Before the stock market crashed in 1929, the richest 1% received nearly a quarter of all wage and capital income—until today, the most unequal time in American history. But thanks to New Deal-era policies like progressive taxation, strong labor laws and the GI Bill, the poor and working class were able to share in the benefits of America’s incredible postwar boom in productivity. Wages rose throughout the mid-2oth century, creating a large and dynamic middle class. By 1970, the income share for the top 1% had shrunk to just 9 percent. 

The Great Divergence, Noah writes, “has coincided with a dramatic decline in the power of organized labor;” the result of conservative policies that have weakened unions and allowed wealth from productivity gains to be diverted from labor to capital. Congressional support for labor faltered in the late 1970s, and the Reagan administration was notoriously hostile towards the movement. After peaking in 1954 at about 40 percent of the private sector workforce, union density today stands around 7 percent—the same level as in 1933. “It’s as if the New Deal never happened.”

By 2007, the income share for the top 1% had returned to its 1928 peak of 24 percent—a figure thatresearch suggests may be even higher now, despite the 2007-2009 recession. And the decline of organized labor is just one piece of the puzzle. In his book, Noah explores a whole range of reasons for inequality’s rise, taking time to refute the supposed impact of race, gender (women entering the workforce) and immigration. Better explanations include a rising college wage premium, an increase in corporate lobbying in Washington, regressive tax policies and competition from low-wage labor markets in China and the developing world (Noah estimates trade with low-wage nations is responsible for 12 to 13 percent of the Great Divergence, “and perhaps more”). 

As a result, the United States has one of the highest levels of income inequality in the developed world, and is now one of the least socially mobile as well. Such a society, Noah concludes, is less reflective of our democratic ideals with each passing day. We can, and should, do better.

Video: Timothy Noah on America’s Growing Inequality Crisis

This morning I had the pleasure of helping host New Republic senior editor Timothy Noah for the first discussion of his newly released book, “The Great Divergence: America’s Growing Inequality Crisis and What We Can Do About It,” at The Century Foundation in New York City.

Joining Tim were four excellent panelists (from left to right in the photo  above): Greg Anrig, vice president for policy at The Century Foundation; Timothy Noah; Daniel Alpert, Century Foundation fellow and founding managing partner of Westwood Capital; Robert Hockett, Century Foundation fellow and professor at Cornell Law School; and Dorian Warren, assistant professor of International and Public Affairs at Columbia University.

I’ll be posting more about Tim’s presentation and his new book later this afternoon, but in the meantime, check out the video recording of the event below.

Video streaming by Ustream

“A Strict and Arbitrary Document”

Ronald Dworkin, “Why the Mandate Is Constitutional: The Real Argument,” New York Review of Books:

If the Court does declare the act unconstitutional, it would have ruled that Congress lacks the power to adopt what it thought the most effective, efficient, fair, and politically workable remedy—not because that national remedy would violate anyone’s rights, or limit anyone’s liberty in ways a state government could not, or be otherwise unfair, but for the sole reason that in the Court’s opinion our constitution is a strict and arbitrary document that denies our national legislature the power to enact the only politically possible national program. If that opinion were right, we would have to accept that our eighteenth- century constitution is not the enduring marvel of statesmanship we suppose but an anachronistic, crippling burden we cannot escape, a straitjacket that makes it impossible for us to achieve a just national society.

Food for thought on a rainy Monday morning.