A widening gap between rich and poor is reshaping the U.S. economy, leaving it more vulnerable to recurring financial crises and less likely to generate enduring expansions.
Left unchecked, the decades-long trend toward increasing inequality may condemn Wall Street to a generation of unimpressive returns and even shake social stability, economists and financial-industry executives say.
“Income inequality in this country is just getting worse and worse and worse,” James Chanos, president and founder of New York-based Kynikos Associates Ltd., told Bloomberg Radio this week. “And that is not a recipe for stable economic growth when the rich are getting richer and everybody else is being left behind.”
Since 1980, about 5 percent of annual national income has shifted from the middle class to the nation’s richest households. That means the wealthiest 5,934 households last year enjoyed an additional $650 billion -- about $109 million apiece -- beyond what they would have had if the economic pie had been divided as it was in 1980, according to Census Bureau data.
Disputes over what constitutes economic fairness are moving to center stage amid a near-stagnant U.S. economy saddled with 9.1 percent unemployment yet boasting record corporate profits. President Barack Obama last month targeted “the wealthiest taxpayers and biggest corporations” for higher taxes, saying they should pay “their fair share.” That drew charges of “class warfare” from House Speaker John Boehner of Ohio.
‘Occupy Wall Street’
The debate comes as demonstrations in New York by an amorphous group called “Occupy Wall Street” move into their 27th day. The rallies over what protesters call unbridled corporate power began in lower Manhattan’s Zuccotti Park, a few blocks from Wall Street, and have spawned copycats in several U.S. cities.
“We are the 99 percent that will no longer tolerate the greed and corruption of the 1 percent,” says the occupywallstreet.org web site.
The reference is to the fact that a sliver of U.S. households have enjoyed a disproportionate share of recent economic rewards. Between 1993 and 2008, the top 1 percent of families captured 52 percent of total income gains, according to a 2010 analysis of Internal Revenue Service tax data by economist Emmanuel Saez of the University of California, Berkeley.
Howard Buffett, the Berkshire Hathaway Inc. director and son of Chairman Warren Buffett, defended the Wall Street protesters in an interview with Bloomberg News yesterday.
“There has never been a larger gap between earnings in this country,” Buffett said. “There has never been a time in my lifetime when the government is going to cut an incredible amount of programs that support poor people and feed them.”
Such trends have left their mark on public sentiment. Though a majority of Americans reject the idea that the country is divided between “haves” and “have-nots,” those seeing such a divide rose to 45 percent from 35 percent in 2009, according to a Pew Research Center poll released Sept. 29. The sharpest increase occurred among self-described political independents.
Economists such as the late Arthur Okun, a chairman of the White House Council of Economic Advisers in the 1960s, traditionally believed that societies could emphasize equality or growth, not both. Now, in an age where the quality of human capital plays a larger role in determining economic outcomes, many economists -- including Federal Reserve Chairman Ben S. Bernanke -- say the two are linked.
“The large and growing gap between the haves and have-nots will tend to undermine growth, both directly and indirectly -- including by reducing the marginal propensity to consume and by amplifying the political polarization that has already contributed to poor economic policymaking,” says Mohamed El-Erian, chief executive officer of Pacific Investment Management Co. in Newport Beach, California.
Branko Milanovic, a World Bank economist, added in a September article: “Widespread education has become the secret to growth. And broadly accessible education is difficult to achieve unless a society has a relatively even income distribution.”
Since 1968, incomes in the U.S. have become steadily less equally distributed, according to the standard statistical measure of inequality known as the Gini coefficient. The U.S. Gini score rose from .39 in 1968 to .47 in 2010, meaning that incomes were becoming increasingly unequal.
Developed by the Italian statistician Corrado Gini in 1912, the scores represent a kind of distributional thermometer, ranging from 0 (each person enjoying equal shares of income) to 1 (one person has all income).
In the 30-nation Organization for Economic Cooperation and Development, only Turkey and Mexico have more unequal societies than the United States. In the U.S., the rich-poor gap widened by 20 percent since the mid-1980s, more than in most developed countries. “Nowhere has this trend been so stark as in the United States,” the OECD concluded in a 2008 study.
Economic gains in the U.S. have been spread less equally in recent years as a result of factors including globalization, technological change, the decline of labor unions, changing social norms, and government trade and tax policies, say economists such as the World Bank’s Milanovic.
“We have inequities,” David Plouffe, a senior White House adviser said on “Fox News Sunday” Sept. 25. “The American people are screaming out saying it’s unfair that the wealthiest, the largest corporations who can afford the best attorneys, the best accountants, take advantage of these special tax treatments.”
Not everyone shares that view. Economist Tyler Cowen, a professor at George Mason University in Fairfax, Virginia, says concerns over income inequality are exaggerated. “I don’t think it matters one way or another for macroeconomics,” he says.
Cowen, who also writes the “Marginal Revolution” blog, says only the most extreme manifestation of inequality involving the top 1 percent of the income distribution is worrisome. And that, he says, is almost entirely a function of distorted incentives in the financial industry. “Fix the financial sector and inequality will take care of itself,” he says.
In the aftermath of the 2007-2009 financial crisis, the fortunes of labor and capital have diverged. After plunging in the two years leading to December 2008, total corporate profits have roared back to a new high of $1.5 trillion, 6.5 percent above the previous peak reached in September 2006.
The typical American household, meanwhile, has yet to regain the ground it lost during the recession. The median income of $49,445 at the end of 2010 remained below the level reached in 1997.
The widening chasm between haves and have-nots has tangible consequences. Societies with a narrower gap between rich and poor enjoy longer economic expansions, according to research published this year by the International Monetary Fund. Income trends in the U.S., where the wealthy over time have pulled away from the rest of society, mean that future U.S. expansions could last just one-third as long as in the late 1960s, before the income divide began widening, said economist Jonathan Ostry of the IMF.
Expansions -- or what Ostry and coauthor Andrew Berg label “growth spells” -- fizzle sooner in less equal societies because they are more vulnerable to both financial crises and political instability. When such countries are hit by external shocks, they often stumble into gridlock rather than agree to tough policies needed to keep growth alive.
“Increased inequality is likely to diminish the duration of expansions,” Ostry said in an interview.
The average postwar economic expansion lasted 4.8 years, according to the National Bureau of Economic Research. The current expansion, which is just 27 months old, may already be petering out. Goldman Sachs Group Inc. said Oct. 3 that the U.S. would be “on the edge of recession” by early 2012, adding that the firm now expects first-quarter growth to be 0.5 percent.
Some say the wider rich-poor gap is an additional impediment to recovery. “Very high levels of inequality seem to be associated with slower economic growth,” said Michael Feroli, chief U.S. economist for JPMorgan Chase & Co.
Raghuram Rajan, the IMF’s former chief economist, says countries with high levels of inequality tend to produce ineffective economic policies. Political systems in economically divided countries grow polarized and immobilized by the sort of zero-sum politics now gripping Washington, he said.
“It makes the politics more difficult, and that makes it more difficult to grow,” said Rajan, now a finance professor at the University of Chicago’s Booth School of Business. “There is no consensus on any of the solutions that are proposed.”
As rich and poor drift apart, the constituency for redistributive tax and spending policies grows. The 30.5 million American households that earned less than $25,000 in 2010 were almost seven times the number making more than $200,000, according to new Census Bureau figures. In 2000, the ratio was 5.6-to-1.
“The guys who are falling behind don’t see much hope of getting ahead and therefore are more focused on redistribution,” Rajan said.
Ultimately, unbridled inequality threatens social stability as rich and poor separately nurse their mirror-image resentments. Bernanke last year told CBS’s “60 Minutes” that rising inequality was leading to “a society which doesn’t have the cohesion that we’d like to see.”
In the U.S. and Europe, austerity policies may be exacerbating the trend. Already, European capitals, including London, Madrid and Athens, have witnessed street protests in response to reduced government spending and subsidies.
New York Mayor Michael Bloomberg -- speaking in September before the confrontations between police and “Occupy Wall Street” demonstrators -- alluded to the danger that persistent unemployment could spark social unrest.
“You have a lot of kids graduating college, can’t find jobs,” he told WOR radio, before mentioning protests that topped Egyptian President Hosni Mubarak and Spanish anti-austerity demonstrations.
“You don’t want those kinds of riots here,” said Bloomberg, the founder and majority owner of Bloomberg LP, the parent of Bloomberg News.
On the surface, inequality might appear to be a problem of the have-nots. Yet the haves will suffer, too. Barry Ritholtz, CEO of the investment research firm Fusion IQ, says millions of potential investors may conclude, as they did following the Great Depression, that the stock market is a rigged game for insiders.
Such seismic shifts in popular sentiment can have lasting effects. The Dow Jones Industrial Average didn’t regain its September 1929 peak of 355.95 until the same month in 1954.
“You’re going to lose an entire generation of investors,” says Ritholtz. “And that’s how you end up with a 25-year bear market. That’s the risk if people start to think there is no economic justice.”
Rising inequality contributed to the onset of previous financial crises and may already be laying the groundwork for the next one, some economists say.
During both the 1920s and the most recent decade, the rich enjoyed large income gains, much of which were made available to the working poor and middle class via credit channels. Politicians encouraged the resort to credit as a way to bridge the gap for those struggling to sustain living standards amid flatlining wage income, according to Rajan’s 2010 book “Fault Lines.”
As a result, household debt nearly doubled in both periods, setting the stage for the Great Depression and the most recent financial crisis, says a December 2010 paper by economists Michael Kumhof and Romain Ranciere of the IMF. That increasing debt burden left the economy exposed to widespread defaults when a financial shock hit.
For many consumers, easy access to credit today is a thing of the past. Government fiscal policy -- in the form of payroll tax cuts and transfer payments -- is filling the gap between income and consumption the way easy credit did during the boom years.
“The missing credit temporarily is being filled in by fiscal measures,” said Feroli. “But we have yet to understand or see how a post-leverage, post-fiscal support household sector will behave.”
The government’s response to the financial crisis may also have exacerbated the rich-poor gap by shifting liabilities from private banks to taxpayers. Households and businesses have trimmed their debts since the 2008 peak while government borrowing -- to recapitalize the nation’s banks and battle the recession -- has exploded.
As a result, total domestic nonfinancial sector debt topped $36.5 trillion at mid-year, compared with $32.4 trillion in mid-2008. And that massive load leaves the economy vulnerable to future shocks.
“In the current climate, if nothing is done about income inequality there may be recurring crises,” says Kumhof, adding: “Leverage has not significantly improved. In terms of the danger of another crisis, we’re right back where we started.”