Debt and Inequality Go Together: Rising Debt Is the Cause of Rising Inequality

As a German economist once pointed out, while any individual business can increase its profits (and thus executive pay, if shareholders are powerless) by paying its workers less, businesses in general must turn around and sell things to those same workers to make money.  As inequality rises what they gain in the labor market they lose in the consumer market, as they must cut prices to make sales or see their sales fall.  The same may be said of trade – country A can only sell goods and services to country B if country B has the money to pay for it, from selling to country A or someone else.  For these reasons, debt and inequality go together.  Debt allows businesses to pay workers less and yet sell them more, and countries with trade surpluses to sell to countries with trade deficits. And so it has been in the United States.

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The Federal Reserve released the latest data on U.S. debts, for 2013, last week.  More charts and related commentary may be found below.

The chart above shows the Gini coefficient, a measure of inequality, among full time workers, as measured by the U.S. Census Bureau.  The higher the Gini Coefficient, the greater the inequality.  The Gini Coefficient for total household income has risen even more, but that is due to an increase in the number of two-income families, and single parent families, divorce, and people simply choosing to live alone. These are social, not economic, issues.

The chart also shows the total debt – public and private – in the U.S. economy.  The Federal Reserve has just released an update of this information, known as the Z1 series, for 2013.  I wrote about this data last year in this post.

I’ve updated some of the data based on the latest Federal Reserve release, which updated the charts I did last year.  The spreadsheet is here.

Total Credit Market Debt Outstanding Stat Abst

The chart above combines both data series, debt and inequality, albeit on different axes.  It shows that both inequality and debt were relatively stable, the business cycle aside, through 1980.  Back then the share of national income going to labor, as opposed to investors, was thought to be relatively fixed.

In general inequality increases when the economy is up, as the better off capture more of the gains, and decreases when the economy is down, as the social safety net mitigates the losses for those at the bottom.  The lowest inequality in U.S. history?  During the Great Depression.  That was also a period of low debt, as the consumer, business and debt explosion of the 1920s was wiped out in a bonfire of bankruptcies.  The disappearing debt for some was the disappearing wealth of the wealthy.

Starting about 1980, however, both U.S. debt and U.S. inequality started rising in a long-term, non-cyclical sense.  Over the 1980 to 2010 period the two approximately match up, if one jiggers the scales of the two Y axes just right, but there is a big break – and a big increase in inequality – in the early 1990s.  That’s when the pattern of each generation earning less than the only before, which had started with high school dropouts and continued into high school graduates, finally reached college graduates.  Since then, it has no longer been possible to buck the tide of falling U.S. income by adding more schooling.  Although the conventional wisdom continues to push young people to desperately pursue that degree in a last ditch effort to join what used to be the middle class.

Note that when the Great Recession hit inequality went down at first, as the wealthy had their wealthy shrivel away with the stock market and their income shrink due to zero percent interest rates.  Pundits scoffed when some said the Great Recession hit the wealthy harder than the workers, but it was true and was not unexpected.  Although the wealthy (and the wealthiest generations, today’s seniors) were certainly in a better position to take a loss than those at the bottom and younger generations, their anger is probably responsible for the Tea Party, etc.

Of course since 2010 soaring federal debts and the Federal Reserves historically-loose monetary policy has caused asset prices to soar, pumping up the income and wealth of the wealthy.  Workers, meanwhile, continue to face decreases in real wages, high unemployment, delayed starts to careers, and ejection from the labor force before the planned date of retirement.  So inequality has likely risen again.

So if workers have less, to whom are businesses selling?  Where are people getting the money to buy things?  Well, Total Credit Market Debt, including the financial sector, stopped going down after 2011.

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And total debt excluding the financial sector started going up again in 2012.  Over the years since 1980, in fact, higher debts and GDP growth have pretty much gone together, with one the primary cause of the other.

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After soaring during the 2000s, household debt plunged during the Great Recession, as Americans defaulted on mortgages and credit card debt they had run up and couldn’t pay back.  But household debts are still high compared with the pre-2000 past.  Moreover, while mortgage debt continued to fall from 2011 to 2013, other consumer debts outstanding (credit cards, student loans) jumped 12.4% in just two years.  Basically, to the extent that the economy has recovered at all, it is because people are once again spending more than their employers are paying them.

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The deleveraging of households and the financial sector would have led to another Great Depression over the past six years, had not the federal government stepped in to stop it.  Note the soaring federal debt relative to GDP in the chart above.  That soaring debt was the result of plunging tax cuts revenues and soaring spending on various forms of assistance, which allowed people to keep spending – and businesses to keep selling – even as wage income plunged.  This prevented much suffering in the short run, but also preserved the high level of inequality and helped cement the tremendous shift in political power to those at the top.

And what will be the long-term result?  With that much higher debt looming, the richest generations in U.S. history, who comprise nearly all of the members of Congress and the state legislatures, now say that old age benefits will have to be drastically reduced to pay down the debt.  Not for their generation.  For the less well off generations coming after.  Or that taxes will have to be much higher to pay those benefits.  Not for their generation, but for the less well off generations coming after.  Or that let’s not deal with this now, let’s wait until all of us are grandfathered in, and pretend everything is fine.  Let those coming after us deal with it later.

So what happens to total consumer spending when the richest and most entitled generations have passed on, and poorer generations are retired into poverty?  Perhaps the Great Depression II wasn’t prevented.  Perhaps it was just spread out, so that the best off could be exempted from some of the fallout.

Let me repeat, each generation has been paid less than the one before starting with those who came of age in the 1970s.  Don’t take my word for it; read this paper, one of many like it over the years. The diminished income and wealth of younger cohorts (based on birth year) at each point in the lifecycle is summarized starting on the bottom of page 26 and shown graphically in figures 29 and 30 on pages 73 and 74.

Click to access Emmons-Noeth-Economic-and-Financial-Status-of-Older-Americans-4-Sept-2013.pdf

Until recently, however, though Americans were in reality becoming poorer, most didn’t live that way.  They actually spent more.  This was achieved in part by more family members (women) in the workforce, which allowed total household income (and spending) to increase even as individual workers earned less on average.  The share of U.S. adults in the labor force rose from 60.4% in 1970 to a peak of 67.1% over four yeas from 1997 to 2000.  And by lost income in retirement as employer-provided retirement benefits were cut back.  That would have led to a decrease in consumer spending if families saved enough to make up for it, but they did not.  Instead the personal savings rate plunged from around 8.0% in 1980 to around 2.0% in 2000.

Now, however, with the population aging the labor force participation rate has fallen from 67.1% in 2000 to 63.2% in 2013.  And the generations now approaching retirement, as opposed to those already there, mostly don’t have pensions (unless they are public employees, who got their pensions retroactively increased as private sector workers were losing theirs) and don’t have much savings.  That will also mean lower incomes, lower consumer spending, and diminished sales for businesses.

The last hurrah, or the last party, or the last adaptation to avoid facing the reality of diminished circumstances, was the soaring household debt of 2000 to 2007.  That allowed people to keep spending, and living the way the advertisers said was necessary to remain in the middle class.  Until they couldn’t borrow anymore, couldn’t pay back what they owed, and went under en masse.  And thus the era of rising inequality made possible by rising debt would have come to an end, had not the federal government and Federal Reserve intervened to prevent an economic collapse.  Otherwise, whom were they going to sell to?  Who was going to buy those cars, those overpriced houses the banks had foreclosed on, those imports?  And here we stand.

You don’t hear that has debt created inequality, and that one is not possible without the other.  No PhD economist, stuck within the paradigm they have been taught, has made the connection that what happens on the supply side (rising inequality) can only be detached from the demand side (the level of consumer demand and sales) by debts, and even then only in the short run.  Which is why the economic field is confused and in crisis.

So what are the common explanations of rising inequality one does hear today?

The first explanation for rising inequality is technology and automation.  With information technology and robots, it is possible to produce goods and services with fewer and fewer workers.  Therefore, those who control the investments in information technology and robots can earn massive amounts, even as the shrinking number of workers has their pay competed down by the rising number of unemployed.

But this ignores the other side of the economy, the sales side.  Who are these masters of technology going to sell to? The robots?  Either workers have to be paid enough to buy what the robots produce, or they have be given the money to buy what the robots produce.  Unless they borrow to buy what the robots produce, or the government borrows for them.

The sector with the most technology and automation?  Agriculture.  Farming required half of all U.S. workers to produce the food we needed a century ago, compared with just a percent or two today.  Does that mean that every farmer is a $billionaire, and everyone else still spending half their income on food?  No.  The gains to farmers of no longer having to pay as many farm workers were lost in the food marketplace, as food prices fell relative to the overall economy.  Because farmers had to have someone to sell to.  Today many farmers do well, but only because the government intervened to keep their prices from going even lower, and subsidized them.

A second explanation for rising inequality is globalization and trade.  With the rise of free trade, businesses have been able to in effect replace their U.S. workers with lower paid workers from poor countries, keeping the difference as profit.  The result has been a shift in economic power from the U.S. to China.  But where did the U.S. get the money needed to buy all that stuff from China (and oil from the Middle East), and to run a current account deficit for all these years?  We, collectively, borrowed it.  Had we not borrowed, we would only have been able to buy as much from other countries as we sold to other countries, and the effect of trade on employment and equality would have been negligible.  We don’t have a trade problem. We have a trade deficit problem that is really a debt problem.

In what part of the economy has trade wiped out the most jobs?  How about clothing, which is almost 100 percent imported today.  So does that mean everyone who works in the clothing industry earns $millions every year while ordinary people still spend as much for clothes as they did 50 years ago?  No.  I remember when my middle class mother had to patch our blue jeans, and it was still cheaper to make clothes than to buy them.  Now new clothing is so cheap that no one wants hand-me-downs anymore, unless they are college-educated “hipsters.”  In the clothing industry lower wages have just meant lower prices, benefitting all workers and not investors and executives.

A third explanation for rising inequality is political:  having captured the U.S. federal government, the rich have managed to beat down the unions which allowed labor to bargain with capital and ordinary workers to bargain with those at the top.  Once the Reagan Administration made union-busting respectable, everyone but the executives at the top became worse off.

There are two problems with this.  First, after some successes on the social justice front in the first half of the 20th century, I’m not sure unions made workers in general better off at the expense of investors and executives.  They just made some politically powerful workers better off at the expense of others.  The heyday of American unionism was also the heyday or white male wages, but women and racial minorities were confined to lower-paid economic ghettos at the time.  More recently the public employee unions used their clout to have their pensions retroactively increased, even as active and retired public employees “voted” for lower wages and benefits for other workers by seeking the best deal possible every time they went shopping.  It is only because government is something you are forced to pay for, whether you think it is a good deal or not, that members of public employee unions have been able to force other workers to accept less and pay more.  They are out of solidarity with the rest of the American workforce.

Second, even if the ascendance of the Koch Brothers and the absence of unions leads to a minimum wage of $2.50 per hour, and enough desperate competition for jobs to avoid starvation that most Americans earn no more than that, business would run head-long into the same problem.  Who are they going to sell to?  The Chinese and Arabs?  They have more inequality than we do.  And though rising wages and spending by ordinary Chinese is widely considered necessary for us to get out of our global economic imbalances, the Chinese economy is starting to slow and American sales there are weakening?  Why?  Because the biggest customer of the Chinese economy – the U.S. – is now broke.

Perhaps the only federal policy that the wealthy can use to increase inequality is rising debt.  It was only two years ago that the Republican Party, in the person of Presidential candidate Mitt Romney, identified the working poor (former middle class) who had their wages topped off by federal programs such as food stamps and the Earned Income Tax Credit (EITC) as a bunch of parasitic freeloaders.

Now, however, with the business class taking back power from the Tea Party the Republicans have a new idea.  Don’t increase the minimum wages, which might increase our sales but won’t increase our profits because we will be paying workers what we sell to them.  Increase the EITC instead!  Let’s keep wages falling, but have the federal government borrow money and give more of it those workers so we can keep selling things to them.  And reward ourselves with bonuses for the greater gap between wages and sales.  And when the federal government goes broke?  No need for those at the top to worry about that.  They’ll just cash in their winnings and move to Bermuda or someplace like it.

Worse, after having Reagan teach the Republicans that deficits don’t matter, we have people like Paul Krugman trying to do the same for the Democrats.  Because we need to borrow to do something about inequality.  But guess what, it is in fact rising debts that have cause rising inequality, and it’s about time people understood this.  Worried about inequality?  Fight it as a consumer not a worker.  Don’t pay them what they don’t pay you.