What’s Really Wrong with our Economy - page three
Rich vs. Poor
Outsourcing has been very good for some companies and their executives. Top executive pay has skyrocketed as executives pocket some of the cost savings from cheap Internet sales and cheap foreign manufacturing and service. Since income tax rates on the hyper-wealthy are the lowest they have ever been, this group in our society – the top-level executives of major corporations, just a tiny fraction of 1% of our population – has seen their income and their wealth shoot through the roof. In a very direct way they have been able to profit from the misery of millions of others.
This phenomenon explains much of the extreme polarization of incomes we have seen in the last two decades. The cost savings reaped by companies when they outsource jobs overseas has gone almost exclusively to upper level managers and to (to a lesser extent) shareholders; lower-level workers have seen their wages decline. In the years to come lower level workers will be compelled to reduce their wages still further in order to compete with foreign workers who can do the same job for less. The result will be an ever-greater gap between rich and poor in America, as more and more rank-and-file workers are let go in the United States and replaced with cheaper foreign workers. Eventually equilibrium will be reached, of course, as foreign wages climb and American wages decline, but the moment of parity is many years, perhaps many decades away. American can therefore look forward to declining wages in both manufacturing and services for years to come.
This situation is explosive. As more and more Americans become aware of what has been happening over the last 20 years, it seems inevitable that social unrest will erupt. We have too many unemployed and underemployed young people, and that spells trouble for any society. More than one sixth of all Americans between the ages of 20 and 30 are currently living in poverty. The unemployment rate for people aged 25-34 is now almost 10%, significantly higher than any other age group. And unemployment rates among teen-agers are double that rate, in some states triple.
Another consequence of the polarization of rich and poor in our country is that the feedback loop that used to exist between capital and labor has become completely dysfunctional. With so many middle-class workers unemployed or suffering from declining wages, fewer middle class people can save. More and more middle class people have been reduced to borrowing to sustain a standard of living they can no longer afford.
The hyper-wealthy, on the other hand, can live in luxury if they choose, but their excess pay creates an even worse problem for society. Few of them actually spend the vast incomes they extract from their corporate employers. When a CEO is making five or ten or a hundred million dollars a year, most of his salary is not spent on anything – it goes into savings and becomes part of a large investment pool in the hands of professional money managers.
This process in our society has gotten out of control and resulted in spectacular misallocation of investment capital. Safe and secure investments have become hard to find, and investors are forced to take more risk to get a decent return. The hyper-wealthy control too many dollars in the investment pool, and they tend to push their money into more speculative investments.
Thus the radical disparity between the rich and the poor has actually created a structural weakness in the economy. Because the poor and the middle class don’t earn enough to buy what they need, demand is slack across the economy. Because the rich have more money than they know what to do with, they chase speculative investments, and generate spectacular asset bubbles.
This bubble economy first appeared in the late 1990s, when the dot-com bubble blew up to gigantic proportions before it burst and collapsed. A few years later, vast amounts of cash poured into the housing sector, distorting incentives and creating the mother of all housing bubbles.
When the housing bubble burst in 2007 and 2008 the entire financial system came very close to collapse, as we all know. But for the rapid action of the Treasury, President Bush, and the Congress in creating the TARP program in October 2008, all the largest banks in the United States and Europe would have failed in the next few months. Trillions in deposits in those institutions could have been wiped out, and tens of millions of individuals, corporations, counties, states and agencies would have seen the cash in their accounts suddenly disappear. This large scale liquidity destruction would surely have resulted in a deflationary depression worse than anything in history – much, much worse than even the Great Depression.
Financial Armageddon was averted, but the underlying problem – the rich have too much money to invest and the poor and middle class have too little money to spend – has not been solved. It continues to cause a persistent structural imbalance in our economy.
This misallocation of rewards also explains why there has been no sustained inflation in the last three years, in spite of the fact that the Federal Reserve has created trillions in liquidity by buying bonds in the open market. All that new money is trapped in banks and financial institutions, looking for investments that will pay. Some of that money is lent to commodity speculators, who create wild swings in commodity prices with no underlying connection to real supply and demand. We saw this most vividly in 2008, when oil prices climbed as high as $140 per barrel, then crashed back down to $33 by February of 2009. Later analysis showed that virtually none of that change had anything to do with the real supply and demand for oil – it was all caused by extreme levels of speculation. This provides a very clear example of too much money in the hands of speculators and not enough money in the hands of people who really need to buy things.
In fact, very little of the cash created by the Federal Reserve has made its way into the hands of individuals. As a result, demand for real goods and services remains weak. Banks and brokerage houses are still swamped with too much cash and not enough productive investments for the cash. If all that cash ever flows into the hands of people who will actually spend it, the economy will revive very quickly. (And so will inflation.)
Government action can solve this problem. A dramatic increase in income tax rates for the hyper wealthy would go a long way towards tamping down the corrosive discontent that is festering in our country. It would also help solve the fundamental structural misallocation of cash in our economy by using the earnings of the hyper-wealthy to pay down the deficit. Raising income tax rates on the wealthy will not, by itself, do anything to provide jobs for our unemployed young people, but it will provide financing for the public spending that can help.
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