The Great Divergence

Popular Economics Weekly

The so-called “minimalist” budget deal just reached by Congress is another illustration of the great divergence in wealth distribution of recent years that has eclipsed the middle class. The Great Divergence is not a term usually associated with inequality, but a term coined my historian Samuel Huntington to explain Europe’s explosive economic growth in the 19^th century that left the rest of the world behind. But today, it best explains what has reduced domestic economic growth and job formation over the past 30 years.

Until 1970 wealth had been fairly evenly distributed so that the rising tide of economic growth lifted most boats, but then something happened. The middle class began to disappear, with wealth flowing upward, so what was left was either the poorest or richest among us.

The results of such a ‘divergence’ of wealth from what was its distribution since World War II has not been well documented, and ultimately resulted in the Great Recession (which some have called the Lesser Depression). Middle class consumers in particular saw their accumulated wealth disappear with the busted housing bubble, and income growth that did not keep up with inflation. Both household and government revenues declined to record lows as a percentage of overall economic activity.

What happened since then is conservative economic policies begun under Presidents Carter and Reagan, have gradually shifted most of U.S. wealth created to the wealthiest individuals and corporations, resulting in money flowing to those who either hoard it (such as record corporate cash assets of more than $2.2 trillion), or play the financial markets, causing speculative bubbles that have resulted in 5 recessions since 1980.

There has also been a gradual reduction in economic growth since then, with GDP growth averaging 2.5 percent, whereas it averaged 3.5 percent up to 1980, including the Great Depression. It is even worse today, averaging 2 percent since the end of the Great Recession, with the unemployment rate stuck at 7 percent.

This is not new news. It has been well documented by such as Professors Thomas Piketty and Emmanuel Saez’s research on income inequality, and Robert Reich in his book and movie, Inequality for All. But we are now just beginning to understand its effects.

According to the Congressional Budget Office, between 1979 and 2007 incomes of the top 1 percent of Americans grew by an average of 275 percent. During the same time period, the 60 percent of Americans in the middle of the income scale saw their income rise by 40 percent. From 1992-2007 the top 400 income earners in the U.S. saw their income increase 392 percent and their average tax rate reduced by 37 percent. In 2009, the average income of the top 1 percent was $960,000 with a minimum income of $343,927

And now, the brutal cuts to federal spending known as the sequester have wreaked havoc on important programs for mostly the poor, cutting off hundreds of thousands from Head Start and low-income housing assistance, setting back scientific research and environmental protection, and costing more than a million jobs. Getting rid of the sequester for domestic programs was a high priority for Congressional Democrats, yet very little was achieved in a budget deal reached last Tuesday to right this great divergence of wealth from the have-nots to the haves.

Lowering the maximum income tax rates for the wealthiest to 36 percent from as high as 48 percent during the Reagan era, lowering capital gains, inheritance tax rates, as well as giving energy companies and major corporations huge tax loopholes to drive through, has transferred most of the wealth created since then to the top 1 percent, while corporations have amassed record amounts of cash reserves, much it held overseas where most growth has occurred for the multinational corporations.

And corporations have used their increased economic power and profits to cement their economic dominance; by suppressing collective bargaining, minority voting rights, and a great number of environmental regulations in state legislatures via ALEC, the American Legislative Exchange Council that actually writes the legislation for conservative state legislatures.

The result is that most of the productivity gains enabled by both technology and globalization (i.e., relaxed trading regulations and oversight) have gone to corporations and their investors, abetted by the reduced tax base.

This is while middle class incomes and retirement accounts have been depleted, and governments have been starved of funds to even keep up with outmoded infrastructure maintenance, while reducing educational spending, environmental enforcement that pay forward benefits for future generations.

The Great Divergence is once again a fact, but a fact that highlights the decline of western economies due to the increasing concentration of wealth. It should raise alarms in Europe as well, where austerity programs are at work impoverishing their middle class.

Harlan Green © 2013

Follow Harlan Green on Twitter: www.twitter.com/HarlanGreen

Fed Chairman Yellen Will Boost Economic Growth

Financial FAQs

If we need any more evidence that Janet Yellen should be the next Federal Reserve Chairperson, it was the decision by the Fed Governors to continue their easing at the conclusion of their September 18 FOMC meeting, just 3 days after Larry Summers withdrew his candidacy for Fed Chairman.  Their action was basically an endorsement of Yellen’s policies as the Fed’s current Vice Chairperson that confounded the pundits who were sure the Fed would begin it’s ‘taper’ of bond purchases in September. 

In a word, Dr. Yellen has always been pro-job creation, and that is the big change in economic policymaking that should make this economic recovery self-sustaining, as opposed to Republican Paul Ryan’s latest budget proposal that is in fact anti-jobs. Instead, he wants to focus on reducing the budget deficit by cutting entitlement benefits for the elderly in return for lifting some of the sequester (i.e., Budget Control Act) spending cuts. 

But that doesn’t reduce the current debt or boost hiring directly, although lifting spending cuts and ending the government shutdown will bring back all those furloughed workers.  Labor’s share of national income has been steadily falling, which reduces the buying power of consumers who power 70 percent of economic activity, and so the overall demand for goods and services.

Graph: Economix

           Economist Jared Bernstein said as much in a recent New York Times column, illustrated in the Economix graph from 1995 to Q3 2012:  “In fact, as many inequality watchers have noticed, profits as a share of income are at or near record highs while the compensation share is around a 50-year low.” And as Robert Samuelson also reported in the Washington Post, “…labor’s share has plunged in the past decade. In 2013, it’s 57 percent (vs. 63 percent in 2000). This shifts about $750 billion annually from labor to capital.” 

The so-called supply-side policies of smaller government and lower taxes that have favored producers over employees are out of touch with the real economic problems today.  It is mainly a lack of demand, rather than the supply of goods and services that has stunted this recovery.  We are in fact awash in cheap goods produced globally.

The best sign that we have a demand problem that no longer requires lowest taxes for the producers and corporations is almost no sign of inflation and record low worldwide interest rates.  These indicators signal the sluggish circulation of money and so reduced demand.  Most of it is being saved, or hoarded.  Banks have almost $1 trillion in excess reserves that would normally be loaned out or invested, while corporations have more than $2 trillion in cash and cash ready reserves not being invested.

Why?  Because labor has been left out of the recovery as almost everyone knows.  Thomas Piketty and Emmanuel Saez have documented that 95 percent of the wealth created since 2009 have gone to the top 1 percent, while household incomes have fallen.  That is why debt is even a problem.  Simply put, debt can’t be paid down unless tax revenues increase.  Paul Ryan and the Tea Party stalwarts have it all wrong.  Cutting back on government spending directly translates to fewer jobs and less tax revenues, as the current shutdown illustrates.

How to right the imbalance in order to boost growth?  Raise the minimum age for starters, as I’ve said in past columns, and raise some of the tax rates. Or, close those tax loopholes that have the wealthy such as Mitt Romney and Warren Buffet with lower tax rates than their employees. Our policymakers and politicians have enough choices, if they choose to act.

But until such happens, we have only the newly nominated Janet Yellen to rely on to keep interest rates low enough to create a sustainable recovery.

Harlan Green © 2013

Follow Harlan Green on Twitter: www.twitter.com/HarlanGreen

The Sequester Dilemma—How Much Is Too Much Austerity?

Financial FAQs

Come March 1, we will begin to see how much damage the sequester agreement causes. A recent CNBC column by Larry Kudlow illustrates both the misconceptions and reason for the gridlock on avoiding across-the-board spending cuts of some $85 Billion to the federal budget..

Kudlow says “Looking at the sequester in this light (only half of sequester cuts take place immediately), it's clear that it won't result in economic Armageddon. In fact, I'll make the case that any spending relief is actually pro-growth. That's right. When the government spending share of GDP declines, so does the true tax burden on the economy. As a result, more resources are left in the free-market private sector, which will promote real growth.”

In fact, GW Bush’s program of huge tax cuts that lessened the “true tax burden” while continuing government spending proved just the opposite. Pumping all that money into the private sector resulted in the slowest post-WWII growth in history, plus the Great Recession, the worst recession since the Great Depression.

Taxpayers paid for those tax cuts and wars, in other words, pushing corporations to record profits and the top 1 percent of income-earners to 121 percent of all income earned from 2009-2011. This is while incomes of the 99 percent that do most of the spending actually shrank 0.4 percent during that time, per economist Emmanuel Saez. So “real growth” wasn’t promoted, because the 1 percent hoarded their profits and paid themselves higher salaries, rather than reinvesting in the economy.

The Congressional Budget Office predicts that allowing the sequester cuts to kick in on March 1 will ultimately result in 750,000 lost jobs and subtract 0.6 percent from GDP growth. Why? Because when both the private sector and government cuts spending, there is no investment in future growth, period.

Graph: Calculated Risk

It’s actually worse than that, because unused production capacity will remain unused, which is the real casualty of a further cut in government spending. It has already been reduced some $2.35 trillion from existing legislation. Policymakers have enacted nearly $1.5 trillion in spending cuts for appropriated programs (mainly through the annual caps enacted in the 2011 Budget Control Act) and nearly $600 billion in revenue increases in ATRA, the American Tax Relief Act agreement reached in December.

The Congressional Budget Office expects the deficit to shrink from 8.7 percent of GDP in fiscal 2011 to 5.3 percent in fiscal 2013 if the sequester takes effect and to 5.5 percent if it doesn't. Either way, the two-year deficit reduction — equal to 3.4 percent of the economy if automatic budget cuts are triggered and 3.2 percent if not—would stand far above any other fiscal tightening since World War II, and could lead to another recession. For without rising household incomes, with private sector businesses that aren’t reinvesting, only the government can boost the demand for goods and services.

Harlan Green © 2013

Follow Harlan Green on Twitter: www.twitter.com/HarlanGreen

What Budget Problem?

Popular Economics Weekly

Does Congress know that our federal budget deficit has been shrinking steadily since 2009, the end of the 18-month Great Recession? Yes, that’s right. A combination of cuts in government spending and very low interest rates on the public debt have been bringing down what is really an apples and oranges problem. Annual deficits are decreasing, but they still add to the overall public/private debt, much of which is held by the Federal Reserve in bonds they can sell back to the public when the economy improves sufficiently.

In the depths of the most recent recession, the fiscal year that ended Sept. 30, 2009, the deficit was 10.1 percent of gross domestic product, the value of all the goods and services produced. Since then, the deficit has declined to 9 percent of GDP in 2010, 8.7 percent in 2011 and 7.0 percent in fiscal 2012. Private analysts predict the deficit will be between 5.5 percent and 6.0 percent of GDP in fiscal 2013, says Calculated Risk quoting Wall Street Journal’s David Wessel.

Graph: Calculated Risk

And bond investors must know this, since they keep buying Treasury Bonds, whose yields are hovering near all-time lows. The U.S. has no problem paying its bills, in other words. Inflation hawks have been crying inflation over the Federal Reserve’s bond buying program since the end of the recession. Yet interest rates, the best indicator of inflationary tendencies, continued to decline to their current lows.

That is why much of the outcry over the debt ceiling has been fabricated by those who want little or no government, who believe all government spending is for the 47 percent of ‘takers’, when in fact a large part of the government ‘largesse’ goes to the wealthiest to finance their tax breaks. Most of the federal debt comes from past spending, the spending run up since 2000 in fighting two wars, the Bush tax cuts, and recession. This is after 4 consecutive years of budget surpluses under President Clinton, as the graph shows.

Because debt held by the public flows through financial markets, it has more immediate relevance to the economy than intragovernmental debt, which is a matter of internal bookkeeping. As of the end of December 2012, debt held by the public (subject to the limit) totaled $11.563 trillion, says the Concord Coalition.

The rest of government debt for the most part is intragovernmental debt, consisting of trust fund accounts that are credited with dedicated revenue such as Social Security and Medicare payroll taxes (FICA). In theory, any surpluses in these accounts are “saved” for future benefit obligations. As of the end of December 2012, intragovernmental debt (subject to the limit) totaled $4.831 trillion. Hence the grand total of federal debt is $16.4 trillion.

But we know how to pay it down. The Clinton Presidency showed us how. It is important to reduce government spending, particularly on defense, which is being done as the wars wind down. Another part is fostering job formation programs that increase tax revenues, as happened during the 10-year growth cycle of the 1990s, the longest growth cycle in our history. Twenty one million jobs were created just during the 8-year Clinton term.

In fact, history shows growth remains mediocre without government revenues to support it. This is not just to finance social welfare and senior pension programs. There is so much public infrastructure repair and upgrades that need to be financed at the state and national levels which private industry cannot initiate.

For instance, building our national highway system in the 1950s was a huge boost to growth, and there is a multi-trillion dollar deterioration of current public infrastructure. Much more needs to be spent on schools just to keep up with rising worldwide educational standards. This is not to speak of environmental protection, renewable energy, and research and development that only governments can instigate.

Americans do know how to foster growth. But it has always been due to the partnership of private and public sectors, something our current Congress seems to have forgotten.

Harlan Green © 2012

Follow Harlan Green on Twitter: www.twitter.com/HarlanGreen

Happy New Year—A 2013 Recovery!

Popular Economics Weekly

Any doubts how dependent the rest of the world is on U.S. growth was dispelled on ratification of the ‘fiscal cliff’ bill by Congress. The world’s stock markets rallied on the news. The DOW was up + 2.35 percent, Europe’s FTSE + 2.19, Hong Kong’s Hang Seng + 2.98 percent, and so forth.

With the ‘fiscal cliff’ no longer a cliff (thanks to Congress finally listening to voters), 2013 might be the year of full recovery from the Great Recession. Real (after inflation) U.S. Gross Domestic Product is up 2.5 percent from its pre-recession highs, with only China’s growth rate higher since the Great Recession. This is in spite of various catastrophic events—such as Hurricane Sandy and the debt ceiling debate yet to come.

Graph: Econoday

Details are still vague on all details of the final fiscal cliff negotiations, but we know it preserves the tax rates prevailing at the end of 2012, except for those individuals earning more than $400,000 and households earning over $450,000. It also allows taxes on capital gains and dividends to go up, and extends benefits of the unemployed. Additionally, the Senate bill delays the onset of the "sequester" — the swift, automatic spending cuts — for two months.

The increased tax revenues will boost growth in 2013. Why? Northern Trust’s retired Chief Economist Paul Kasriel said in his blog what many economists are saying—that the additional revenues will boost private sector growth.

“The Treasury is going to collect higher taxes from me and either transfer them to you or buy something from you. In other words, an increase in tax revenues will not ‘suck’ spending power out of the economy, but rather redistribute that spending power.”

And this is just what is needed to stimulate higher growth. The additional revenues flow to US consumers who will spend it domestically, thus creating more jobs. US national and local governments spend directly to benefit constituents, in other words, whether in education, infrastructure, the social safety net, or research and development.

The fiscal cliff deal also extends the child tax credit and the college tuition credit for five years, individual and business tax extenders for two years, and the Medicare "doctor fix" for one year. The Alternative Minimum Tax will be permanently fixed. The agreement also extends the farm bill for one year.

Graph: Calculated Risk

So the additional tax revenues mean 2013 should be the year that our governments no longer act as a drag on growth. State and local governments have been a drag on GDP for twelve consecutive quarters. Although not as large a negative as the worst of the housing bust, this decline has been relentless and unprecedented. The good news is the drag appears to be ending.

Harlan Green © 2012

Follow Harlan Green on Twitter: www.twitter.com/HarlanGreen

Fourth Quarter Economic Growth Higher

Popular Economics Weekly

We are seeing a boost in Q4 economic growth, in spite of “fiscal cliff” worries. Service sector growth has increased significantly, job formation is accelerating, and real estate is coming back to life, thanks mostly to more jobs.

The service sector is our largest business sector and its ISM's non-manufacturing index rose five tenths to 54.7 with business activity over 60 for the first time since February. New orders are near 60 at 58.1 for a more than three point gain and the best reading since March. But employment is barely over 50, at 50.3 for a nearly five point monthly dip for the worst reading since July. Businesses are doing more with less as seen in this morning's productivity report and in the details of this report. But still, the gain in activity and orders is good news and other indicators show jobs increasing.

Graph: Econoday

The Non-Manufacturing Business Activity Index registered 61.2 percent, which is 5.8 percentage points higher than the 55.4 percent reported in October, reflecting growth for the 40th consecutive month. The New Orders Index increased by 3.3 percentage points to 58.1 percent. And overall growth is accelerating.

Graph: Econoday

Even more important was the upward revision in Q3 Gross Domestic Product growth to 2.7 percent, which will boost fourth quarter growth as well. Real GDP growth for the third quarter was revised up significantly because of a large inventory buildup, rather than increased sales.  But the Commerce Department raised the second estimate to 2.7 percent annualized, from the advance estimate of 2.0 and second quarter rate of 1.3 percent.

And we know that real estate activity has picked up, because housing prices are rising. The Case-Shiller Index has been rising since January. Improvement was really evident in the year-on-year rate which is up to plus 3.0 percent from plus 2.2 and plus 1.1 percent in the prior two months. Gains were in nearly all 20 cities, with Phoenix and San Diego prices rising the most.

Graph: Econoday

And the Conference Board’s consumer confidence index in November was steady and firm with buying plans for homes a special positive. The consumer confidence index rose to a new recovery high of 73.7 in November from an upwardly revised 73.1 in October. Strength was centered in the expectations component which is up 1.1 points to 85.1.

Graph: Econoday

Lastly, the most positive indicator of future sales is pending home sales up a very strong 5.2 percent even with the impact of Hurricane Sandy.  This is based on only a fractional decline in the Northeast, at least in the October report. The Midwest showed a very strong gain as did the South. The NAR’s October pending home sales index is at a five-year high.

Graph: Econoday

Real estate has seen falling foreclosure inventories, as well. And Hurricane Sandy will give a big boost to reconstruction of much of the Atlantic seacoast, boosting construction employment. So 2013 could be a very good year for economic growth, if as I believe any fiscal cliff issues will be resolved sometime early next year.

Harlan Green © 2012

Falling Households Incomes—The Real ‘Fiscal Cliff’

Popular Economics Weekly

It is household income that is falling off a cliff. This is partly due to the busted housing bubble and subsequent Great Recession that shaved 40 percent from household wealth. But household incomes haven’t been rising as fast as inflation since the 1970s, either. So we should be worrying about the drastic decline in buying power, rather than Congress’s inability to agree on a federal budget, if we want to cure the looming ‘fiscal cliff’.

If we don’t find a way to improve average household finances, Americans could plunge into decades of slow growth and the continued deterioration in their standard of living. Why? We are a consumer society, so that 70 percent of U.S. economic growth is powered by consumer spending. That is why government has to be part of the solution.

Three-fifths of all jobs lost during the Great Recession paid middle-income wages, while those created during the economic recovery pay low wages, according to a new study by the National Employment Law Project. Both economic forces and government budget cuts are causing this deficit of good jobs, according to the study.

For instance, many of the losses in well-paying jobs came from state and local governments, which have cut 485,000 jobs since February 2010, NELP found. Many mid-wage government workers that have been laid off during the economic recovery include teachers and police officers.

There is an easy way to reverse the downward spiral in wages—begin to upgrade our aging public services. In what New York Times Nicholas Kristof has labeled A Failed Experiment, the World Economic Forum ranks American infrastructure 25^th in the world, down from 8^th in 2003-4.

One would think with the ongoing drought, Tsumanis, and Hurricane Sandy that we would know how important government is to the solution of our many problems. New Jersey Governor Chris Christy certainly thought so in lauding President Obama for his help during Sandy. So the most obvious place to start is a national program to repair our crumbling infrastructure that the American Society of Civil Engineers estimates needs at least $2.2 Trillion in repairs and upgrades over the next 5 years just to keep it safe.

The wealthy have always had an answer to the ongoing decrepitude of public services, said Kristof. “Public playgrounds and tennis courts decrepit? Never mind—just join a private tennis club. I’m used to seeing this mind-set in developing countries like Chad or Pakistan, where the feudal rich make do behind high walls topped with shards of glass; increasingly, I see it in our country.”

The ASCE has launched a new series of reports that take a closer look at the economic impacts of America’s deteriorating infrastructure. These economic studies look forward to 2020 and 2040 to predict impacts on GDP, personal income, and jobs if current infrastructure investment trends continue. 

The first report was released in July 2011 and focused on surface transportation. The landmark study, Failure to Act: The Economic Impact of Current Investment Trends in Surface Transportation Infrastructure, found the nation’s deteriorating surface transportation infrastructure will cost the American economy more than 870,000 jobs, and suppress the growth of the country’s Gross Domestic Product by $897 billion by 2020. Commissioned by ASCE and conducted by the Economic Development Research Group of Boston, the report shows that the nation is facing a funding gap of about $94 billion a year compared with our current spending levels.

In fact Nobel Economist Joseph Stiglitz asserts in a recent Project Syndicate blog that “Spending, especially on investments in education, technology, and infrastructure, can actually lead to lower long-term deficits.”

Most of the federal ‘fiscal cliff’ was created by borrowing to finance serial tax cuts and increased military spending that benefited the few at the expense of the many, instead of shoring up social security and Medicare reserves, as Bush Treasury Secretary Paul O’Neill advocated.

In fact, those tax revenues were diverted to the real ‘takers’, the wealthiest Wall Street financiers and corporate CEOs who have managed to capture most of the created wealth over the last decades. Just in 2009, it’s well documented that 93 percent of the income increase went to the top 1 percent of income earners through lower dividend and capital gains taxes, as well as record corporate profits.

But that means taking political power back from the elites who would rather starve government programs that could boost middle class incomes and consumers, asserts Chrystia Freeland in Plutocrats, The Rise of the New Global Super-Rich and the Fall of Everyone Else. Plutocrats are putting the wealth accumulated from deregulation of the U.S. economy into developing the middle classes of developing countries such as India, China, and Brazil, rather than the U.S.

Need we say more? Should we continue to allow the private good to trump public good? Not unless we enjoy reverting back to conditions like those in the developing world.

Harlan Green © 2012

Next 4 Years—Back to the Future

Financial FAQs

President Obama’s victory means it’s Back to the Future for economic as well as social policies. It means he now has the mandate to implement what the electorate chose him for—a functioning government to not only fix disasters such as Hurricane Sandy, but the economy; to lead the United States of America into the future rather than backward with Republican economic policies of the 1920s, as Obama said in the third debate.

Yes, that does mean government creates jobs, contrary to the Bain Capital ethos—whether in Detroit, or with clean energy investments, infrastructure building, better regulations that prevent economic disasters, and lower cost student loans that enable a better educated workforce.

That is, if he doesn’t give in to Boehner’s House Republicans who aren’t budging on returning tax rates to the Clinton era, when 23 million jobs were created and there was greater prosperity for all.

Paul Krugman has called it economic blackmail. “Because Republicans are trying, for the third time since he took office, to use economic blackmail to achieve a goal they lack the votes to achieve through the normal legislative process. In particular, they want to extend the Bush tax cuts for the wealthy... So they are, in effect, threatening to tank the economy unless their demands are met.”

The fiscal cliff is not the real problem, or large budget deficits at a time when the economy still needs a boost. It is not really a cliff, according to most analysts. The Center for Budget and Policy Priorities is one of many that say it is more of a slope, in that the effects of letting the Bush tax cuts lapse and the sequester agreement to cut government spending only begin to take effect in 2013.

“In fact, the slope would likely be relatively modest at first (and then much steeper if 2013 unfolds without a fiscal resolution). This means that if there is no agreement by January 1, policymakers will still have some (although limited) time to take steps to avoid the serious adverse economic consequences that the Congressional Budget Office (CBO) outlines in its recent analysis of what will happen if the expiring tax cuts and new spending cuts take effect on a permanent basis.”

Exit polls showed voters tended to blame Bush for the Great Recession, rather than Obama, and so have given President Obama the opportunity to lead us back to fiscal sanity. It turns out Republicans tried to label Democrats as the tax and spend party, but voters decided Republicans have been the real tax-cut and spend party; which is true. Presidents Reagan and GW Bush were responsible for both the largest tax cuts and largest budget deficits since WWII, in their decision not to follow the pay-as-you-go budget rules that said tax cuts had to be matched by spending cuts.

It really boils down to how much to tax which U.S. taxpayers. Conservatives have called for lower taxes in the name of greater freedom from government controls. But Obama’s victory is a victory for the right to choose—the freedom to choose union representation and negotiate wages via collective bargaining, or women’s control of their health, family planning, or even a cooler climate.

The future belongs to those who have recognized that the richest have been helping themselves, rather than the country. It belongs to those who see that government is for the common good, rather than the few. This is the direction, however halting, that government has been marching ever since the New Deal began to cure the flaws and real damage that unrestrained capitalism can cause—back to the future.

Harlan Green © 2012