Income inequality and jobs

Once again it's been a few months since I last posted. As expected the macro-economic situation has changed very little in that time. At the outset of the financial crisis I predicted that the job recovery would be very slow and that an unemployment rate over 8% may last a decade.

Nothing has happened in the last four years to change my view on that. Yesterday we had the US jobs report for July. More jobs were added again but once again not enough. Unemployment went up a tick to 8.3%. Even if job growth rises to 250,000 jobs per month, the unemployment rate could still be 8% or more. There are plenty of sources that describe how the official unemployment rate is misleadingly low so I won't go into that here.

This post is about how income and wealth inequality eventually result in economic stagnation and unemployment. My primary source is The Great Financial Crisis: Causes and Consequences. Unlike many of the books written about the bubble and meltdown this book focused less on the proximate causes and much more on a long term view. 

Here's that view.

Over the long term capital (wealth) will become more and concentrated.  The growth of the middle class in the US after WWII and subsequently in the other industrialized nations was an aberration.  This historical anomaly lead to economic growth in all of these countries.  Starting around 1980 the situation began to revert to its historical norm - which is concentration of wealth which leads to stagnation.

The data is somewhat misleading because of the bubbles and one time conditions.  In the late 80's and early 90's there was a peace dividend as the cold was ended.  The dividend was physological as well as fiscal.  This was followed in the next 15 years by two bubbles in the US that temporarily produced unstainable GDP growth and unstainable employment levels. After the financial crisis and "recovery" we are back on our path to long term stagnation.

The reason that concentration of wealth and income leads to stagnation is straight-forward.  Wealthy individuals spend less of their income and save and invest more of it.  If there are no investment opportunities in industrial or commercial investments then capital flows to financial assets or even bubbles.  We know how that story ended last time.  Low and middle income workers on the other hand spend more of their income which leads to more economic activity and possibly more jobs.  Remember though that globalization and automation still play a drag on job formation.

The evidence that there is a surplus of capital is all around.  Investments in money market or savings accounts pay less interest than the currently modest inflation rate.  Capital in these asset classes are 100% guaranteed to lose purchasing power.  10 Year US Treasuries are yielding less than 1.5%.  Unless there is a deflationary cycle the massive investments in US Treasuries will also lose purchasing power over the life of the investment.

Why then has capital not flowed into commercial and industrial assets?  Businesses invest capital for only one reason - maintain or grow income.  Investments can do this in two ways, increase revenue or decrease costs.  In a slow growth and low inflationary cycle it is hard to increase revenue by simply raising prices. The other option is to sell more goods and services.  But once again we get back to low overall demand due to sluggish consumer spending.  The second investment opportunity is to lower costs.   These opportunities do not depend on demand; innovation, application of new technology, or simply moving production to lower labor costs are all effective ways to invest.  Unfortunately the cost-saving investments may lead to more unemployment not less.

Additionally the large US corporations have generated so much cash that many do not need outside capital for their investments.  Instead they are contributors to the excess capital conditions we have today.  They form part of the Giant Pool of Money and contribute to the concentration of capital into fewer hands.

So here we are and here we will stay.

As long as politicians, pundits and policy makers insist that higher taxes on high income individuals will cost jobs here we will stay.  As long as politicians, pundits and policy makers propose government austerity here we will stay.

I am not sure there is a solution.  The best try would be to significantly increase taxes on high income individuals, increase taxes on the upper middle class, eliminate tax loopholes, allow corporations to treat dividends as a business expense and at the some time tax personal interest and dividend as wages - including the payroll taxes of Social Security and Medicare.  The government then has to use that additional revenue to actually create jobs by the most direct and cost-effective means - hire people.

Right now we need more public sector jobs - teachers, fireman, librarians, construction and maintenance workers, and yes - regulators.