Wealth Inequality Erodes Economic Growth

Friday, 03 Jan 2014 06:56 AM

By Barry Elias

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Wealth inequality in the United States has reached an unprecedented level. Greater wealth in fewer hands causes a decrease in consumption and investment. As a result, employment, income and tax revenue stagnate while debt rises. Eventually, the products produced by the wealthy become less affordable to the masses, leading to further economic collapse.

This dynamic has been occurring at an accelerating pace during the past several decades in the United States.

The Gini index measures the degree of wealth inequality in an economic system. From 1947 through 1980, this index was in a relatively narrow range, between 0.35 and 0.38. Since then, it has increased to a record 46-year high of 0.45, one of the highest among developed nations, according to the U.S. Census Bureau and the CIA Factbook.

The disparity has widened since the recovery began in mid-2009. The top 1 percent captured 95 percent of the gains in incomes in the first three years of the recovery, according to an analysis of tax returns by Emmanuel Saez, an economist at the University of California, Berkeley. The richest 10 percent of Americans earned a larger share of income last year than at any time since 1917, earning 12 times their counterparts in the poorest decile, according Saez and data from the Census Bureau.

"Wall Street is roaring and Main Street is struggling," Rep. Kevin Brady, R-Texas, chairman of the Joint Economic Committee, said in an interview. "Quantitative easing has really exacerbated income inequality."

The S&P 500 index rose 29.6 percent in 2013. The richest third of U.S. households account for 89 percent of all equities ownership, according to the Center for Retirement Research at Boston College.

As wealth becomes more concentrated, the propensity for consumption declines. While savings rise, an insufficient quantity is invested in real goods and services that promote employment and income growth. Much of the savings is invested in financial assets, such as equities and bonds, as speculative demand for short-term arbitrage (profit-taking) opportunities rises. This activity increases trading revenue and profits, but much of these returns are filtered to the wealthy, not employment and income for the lower and middle class. This further undermines a long-term sustainable economic ecosystem.

From 1980 through 2008, consumption as a share of the economy rose from 61 percent to 68 percent, while the share due to gross private domestic investment fell to 12 percent from 20 percent, according to the Federal Reserve.

From 1987 through 2008, U.S. research and development rose a mere 0.3 percent per annum, compared with 4.9 percent annually from 1953 through 1987, according to Information Technology & Innovation Foundation, a non-partisan research and educational institute.

The ratio of financial assets to GDP was consistently 4 between 1950 and 1980. However, from 1980 through 2008 this ratio exploded to 10, a 150 percent increase. During this period, gross private domestic investment as a percentage of GDP fell 40 percent, resulting in a 60 percent decline in the turnover of money (monetary velocity), according to the Federal Reserve.

Employment and income stagnated for the masses, while the share of wealth for the top 1 percent grew to 35 percent from 20 percent, a 75 percent rise, according to a study performed by the University of California, Santa Cruz.

In 1980, $1 in money supply generated $3.50 of income. Today, that same dollar only generates $1.40 in income, based on data from the Fed. The primary reason for this decline has been lower levels of investment relative to GDP.

Investment has a greater economic multiplier than consumption does. It generates more income per dollar of expenditure, since the spending occurs at the beginning of the production process, not at the end, as with consumption. Expenditures at the beginning create collateral expenditures to support the production process of cost-effective, high-quality, value-added goods and services for the masses.

The recommended policy changes to promote investment in real goods and services include lowering corporate tax rates well below personal rates and increasing capital gains tax rates, since much of the investment in financial assets does not translate into increases in employment and income.

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