American Inequality

A Case for Economic Equity and Long-Term Growth (Draft)

Abstract

Macroeconomic policy issues, as well as the theoretical assumptions underpinning their conclusions, must be considered within a political Liberalism framework that ensures and upholds the democratic values of freedom and equality inherent to the constitution. The complexity of economic development requires a holistic empirical approach that accounts for the historical, political, sociological, and business factors contributing to the makeup of society when crafting and recommending economic policy.

For this paper we will assume that economic growth is the aim for society. Inequality is a product of increased bargaining power resulting from increasingly powerful institutions in the business, financial, and governmental sectors (Kumhof 2011; Barnhizer 2004; Argyres 1999). Research has repeatedly confirmed growing inequality globally and domestically (Hisnanick 2011). Inequality, manifested as widening income and wealth disparity, contributes to domestic and global account imbalances, consumer debt, and economic stagflation, i.e. inflation and unemployment (Kumhof 2012; Rajan 2012). In addition, inequality is linked to key social variables such as political stability, civil unrest, democratization, education attainment, health and longevity, and crime rates (Thorbecke 2002). Greater economic equality always results in greater long run economic prosperity for the whole. (Wilkinson 2009)

The thesis explored in this paper is that bargaining power inequalities causally contribute to economic and socioeconomic inequality due to path dependency, organizational inertia, and habit formation. Bargaining power inequalities increase proportionally with capital accumulation, concentration, and centralization. This paper will show that the restoration of equal bargaining power will rectify financial and labor market imperfections and spur economic growth. In addition, this paper argues that US economic growth over the past several decades has been vastly overestimated due to increases in financialization.

Executive Summary

In order to determine the best policy for rectifying inequality and spurring economic growth, this essay provides an overview of current economic and socioeconomic conditions within the US and abroad, identifies problems within those conditions, and details the contributing historical economic policies that shaped them. It then examines the systemic causal mechanisms contributing to current US economic conditions, present potential policy solutions that seek to address these underlying causal mechanisms, and lastly interpret and rank their theoretical effectiveness. This paper addresses the following areas:

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The Coming Collapse of the House of Cards: Tech, Education, Health

I just read the article titled Disruptions: With No Revenue, an Illusion of Value that discusses the overvaluation of tech companies. 

This article is so intuitive, yet so refreshing. It’s incredible that people aren’t discussing another eminent collapse.

Let’s talk about money and value.

Money represents a denominated value; it represents purchasing power. What does it mean to be worth something? It must possess utility, and that utility must be great enough, must possess enough value, that you would be willing to trade something else you value equally for it.  But what if the value of what money is representing is actually valueless?  What happens when the value attached to the dollar don’t reflect the value attached to the object? What happens when the dollar is worth significantly more than the object? You simply won’t exchange your money for the object, and suddenly it’s value decreases and disappears.

What if someone told you that a company was worth a billion dollars, but you actually believed it was worth nothing? I think of Instagram, Facebook, Twitter, Groupon. How do these companies generate revenues?  How much value are people willing to give up to use these services?

The problem is speculative valuation. The question of whether these tech companies will actually deliver the advertising dollars is still out. A valuation is only as good as its assumptions. Valuations based on discounted cash flows rest on some limited tentative assumptions, specifically: basing projections that the past will be like the future, variable discretionary capital expenditures, as well as the uncertainty of discount rates and growth rates. What if the market suddenly decides that companies like Instagram are no longer “cool” and stop using the product? What’s going to happen to that billion dollar valuation?

The tech industry is experiencing a speculative bubble, similar to the one witnessed preceding the real estate bust and the resulting financial crisis. What is the real value of information technology? I know it increases efficiency, it provides us with superficial pleasure as we peruse the internet, look at Facebook pictures, and the like, but what happens when we no longer derive value from these things? What happens when suddenly Instagram is no longer cool? The value will disappear along with everyone’s money.

I also believe that the education system, specifically higher education, is experiencing a boom and will eventually bust. What is the real value of going to college? You accrue massive debt that you can’t ever escape, your income is increased marginally, and there’s no guarantee you’ll get a job. What happens when people simply decide that the price tag isn’t worth it, they don’t want the loans, they don’t think college is worth it? The value disappears.

What other industries are suddenly thriving? Health care? Is health care an over valued industry?

As this article mentions, and I believe and have said for a long time, that our economy’s worth is built on distorted valuations. The financial industry is over 21% of our economy. That’s right: twenty-one percent. What value are they actually producing? Financialization leads to decreased real asset investment, so I argue they produce no value. Instead, financialization increases speculation, risky investment, decreases private savings, and increases debt, among other things.

Our economy is a house of cards. Where is the real value?  What things possess real utility? When shit hits the fan and people have no more money, no more surplus income, no more savings: what will they be spending their money on? What good or services will people include to satisfy their necessary consumption for sustenance?  Will people prefer to spend their money on services or goods? I suspect real-asset goods. Is technology a good or service? It is intellectual capital, but does it possess any tangible value? No.  If people are broke, you think they’ll spend money to use Instagram? I bet not. And what if Instagram decided to use advertising? And what if those people are so broke that they don’t buy what they advertiser is offering? Why would a company advertise with Instagram, or Twitter, or Facebook, or similar companies?

Service industries are the result of past increases in productivity that lead to equal distributions of rising income which created a larger middle class; this middle class created a demand for services that were previously only available to the upper class; but as income distribution widens and wealth accumulates at the top while everyone else gets poorer, people will not be able to afford services. They won’t spend money on luxury goods. They won’t go out for dinner as much anymore.

But this will only occur when people can no longer borrow on credit. At present, debt is solely responsible for our sustained domestic demand and aggregate output over the years. Financial liberalization (cheaper borrowing through regulation) has allowed consumption to remain relatively stable as real wages stagnanted and inflation rose.

Only when lenders can no longer extend credit will our country experience massive stagflation (high inflation, high unemployment), eventually leading to a massive economic collapse.  We may be witnessing the beginning of such a stagflationary period.

How can someone prepare for a bubble collapse? Where should they invest their money? Commodities? How can someone bet against the market? Which goods will be in higher demand as incomes continue to drop and inequality worsens?

I’ll be posting a massive paper on inequality within the next few days and I’ll elaborate in depth on how  inefficiencies within various channels lead to economic inequalities that reduce socioeconomic equity and decrease economic growth.

A Case for Economic Equity and Long-Term Growth

Framework: Examine macroeconomic policy issues as well as the theoretical assumptions underpinning their conclusions within a political Liberalism framework that ensures and upholds the democratic values of liberty and equality inherent to the constitution. The complexity of economic development requires a holistic empirical approach that accounts for the historical, political, sociological, and business factors contributing to the makeup of society when crafting and recommending economic policy.

Overview: Economic growth is the aim for any society. Inequality is a product of increased bargaining power resulting from increasingly powerful institutions in the business, financial, and governmental sectors. Research has repeatedly confirmed growing inequality globally and domestically. Inequality, manifested as widening income and wealth disparity, contributes to domestic and global account imbalances, consumer debt, and economic stagflation, i.e. inflation and unemployment. In addition, inequality is linked to key social variables such as political stability, civil unrest, democratization, education attainment, health and longevity, and crime rates. Greater economic equality always results in greater long run economic prosperity for the whole.

Thesis: Bargaining power inequalities causally contribute to economic and socioeconomic inequality due to path dependency, organizational inertia, and habit formation. Bargaining power inequalities increase proportionally with capital accumulation, concentration, and centralization. Restoring bargaining power will rectify financial and labor market imperfections and spur economic growth.

The Problem

  1. Increasing debt, unequal capital accumulation, stagnating wages, and increasing inflation are responsible for the steadily rising economic inequalities experienced the past several decades. The habit formation of conspicuous consumption has compounded the impacts of income inequality.
  1. Inequality has deleterious effects on social well being and long term economic growth, and is the source of a host of cultural ills, affecting education, healthcare, political corruption, etc. It also affects entrepreneurship, creativity, and technological innovation in the long run.

The Cause

  1. Historical monetary policy, financialization, and financial liberalization (deregulation) have directly contributed to exacerbating economic inequality by negatively affecting business cycles through the misdirection of short term economic incentives and failing to consider the long-horizon. In addition, credit market imperfections, due to asymmetrical preferences and institutional constraints, causally contribute to inequality, in both physical and human capital accumulation.
  1. Bargaining power increases with capital accumulation, concentration, and centralization both domestically and globally, establishes organizational inertia in business and legal exchanges, and further compounds the effects of inequality. Avoiding full employment decreases labor demand, in turn decreasing wage bargaining power, leading to wage stagflation.

The Solution

  1. Increasing economic equity yields the highest long term economic growth, improves social well-being, facilitates creativity and innovation, and empowers society to resolve its cultural ills.
  1. Economic equity can be achieved by restoring bargaining power, regulating financial investment activities, incentivizing real-asset investment, and implementing a single structured tax policy on the wealthiest.

Monetary Policy and Inequality: Target Inflation, Wages, and Unemployment

I should describe the human race
as a strange species of bipeds
who cannot run fast enough
to collect the money
which they owe themselves
—Don Marquis

So I was in class listening to a discussion regarding the natural rate of unemployment this week and I had some serious issues I needed to think through. I wanted to question the methodology for determining unemployment’s so called “natural rate”, specifically the use of the Non-accelerating Inflation Rate of Unemployment (NAIRU) analysis for the natural rate of unemployment and the actual accuracy of the Phillips curve, which states  pi = pi_e - b(U-U_n) + v , . In this model π and πe are the inflation and expected inflation, respectively; b is a positive constant; U is unemployment, and Un is the natural rate of unemployment, or NAIRU; v is unexpected exogenous shocks to the world supply. (*See the end of the post for a note on the old model)

Without going into all the details, there are two crucial assumptions built into the concept of NAIRU: first, that inflation is self-perpetuating; second, that unemployment is inversely related to inflation , so that as unemployment goes down, inflation goes up, and vice versa.

The basic NAIRU analysis assumes that when inflation increases workers and employers account for expectations of higher inflation and create contracts that matches the expected level of price inflation to maintain constant real wages. That is, they expect high inflation and counter up their wages to maintain a constant level of real wages. Thus, to prevent ever increasing wages through contract bargaining due to higher labor demand, the analysis requires accelerating inflation to maintain a targeted unemployment level (hence the central bank target inflation rate).

The implicit assumption is that workers and employers cannot contract to incorporate accelerating inflation into wage expectations. However, there is no explicit justification for assuming that expectations or contract structures are limited in this way, aside from the fact that these wage arrangements are not commonly observed. Given a scenario with low unemployment, i.e. a higher demand for labor, why wouldn’t they adjust their wage expectations to reflect accelerating inflation? Why must the wage contracts lead to runaway wage increases and thus self-perpetuating inflation?

I want to challenge these fundamental assumptions. Why is inflation necessarily self-perpetuating? Why does low unemployment necessitate runaway inflation? Why couldn’t inflation rise initially and level off after these increases in inflation are incorporated into expectations?

My greater question is how the use of the Phillips curve (and the Taylor rule) negatively impacts monetary policy decisions. What is the consequence of a target rate of inflation? What is the impact of high employment on real rages? Does increasing globalization and world competition limit the ability of American firms to raise prices, and prevent workers from pushing for higher wages? Maybe this makes up more competitive globally, but what of the real-wage’s impact on domestic aggregate demand? How can we sustain growth if we can’t afford to buy domestic goods?

When I asked my professor about these questions, specifically regarding the relationship between inflation and unemployment, his answer was less than satisfactory. He responded that, yes, inflation is artificially created by the federal reserve, but the major increases of inflation are due to money supply shocks, such as those created by oil shocks. I continued imploring: If unemployment and inflation are linked, how is it that real-wages have not increased in more than three decades? How is this possible that inflation has persisted, that goods have continued rising in price, and that GDP has continued to grow and increase, yet no one has seen a rise in earnings? What’s happening here that I don’t understand?

More plainly, how the hell does our economy continue growing if prices are increasing, yet peoples wages, their buying power, has not?? How are we buying increasingly expensive goods if we don’t have any more money to buy them with? What is fueling our GDP growth for Christs sake?

But my professor wavered, he went on and on about money supply shocks and what not. I actually don’t think he could see the connection I was making, and given that class had been over for ten minutes and his next class was filing in to fill the seats, I could only express my appreciation to him for entertaining and clarifying my confusion which, in the latter case, he did not.

Of course, my convicted intuition is that debt is how, that people have been living on less and less, that necessary consumption has increased and surplus or luxury consumption has decreased. If you look at inflation, debt, and savings rate data, this is clear as day. In my mind, increasing debt and over leveraging have been sustaining domestic consumption for the past several decades. This is the only explanation for how an economy can maintain rising inflation and stagnating wages, yet increase its GDP. This is ALSO why I suspect we’re struggling as an economy right now, why our unemployment is so high and our demand is so low: after the recent recession there was a collapse in the debt market, specifically involving the housing market, and people experienced a massive shock to their balance sheets when the value of their net assets, like tied up in their homes, essentially dried up overnight. The hardest hit were those with large debt balances. Many people were forced to cut back consumption to pay off the massive debt they accrued for a house that’s significantly less valued than when they bought it. In order to get their finances in order and repair their impaired balance sheets households had to cut back consumption. This resulted in the drop in consumer demand we’re experiencing today. Though it’s all interrelated, this may be a little beside the point.

My main contention is this: monetary policy is ruining our country. The federal reserve is operating on behalf of corporate interests rather than in terms of the well being of the citizens at large.

What is the consequences of a target inflation rate of 2-3% in order to keep unemployment at 4-5%? The higher the unemployment, the lower demand for labor, and the lower the wage bargaining power. People can’t demand higher wages if there’s a surplus of workers desperately pandering for the same job: High supply means low demand. If we never allow for low unemployment, never experience a high demand for labor, wages will not increase because workers possess no wage bargaining power; that is, there’s no demand for hiring additional workers, especially at the wages they request to live on. The result? Wage stagnation (WSJ). Familiar?

I have much more to say, and perhaps I didn’t even say my intuitions too clearly here.

I’ll end by saying that I think financial liberalization, inflationary targets, and institutional bargaining power are the cause of wage inequality, debt, and unemployment. Basically all our problems.

I know there’s the whole international competition thing, but I don’t like the assumptions built into the NAIRU and the Phillips curve. I believe they are plain wrong.

*I’ll elaborate and expand on why is this significant later, specifically regarding the use of coefficients: The older Phillips curve, as the long run expectation equilibrium, states [ gP = [1/(1 − λ)]·(−f(U − U*) + gUMC) ] In this model: gp is the price inflation rate; f() function is assumed to be monotonically increasing; U is unemployment; U* is the NAIRU;  λ represents the degree to which employees can gain money wage increases to keep up with expected inflation, preventing a fall in expected real wage, and is presumed constant during any time periods; gPex is the expected inflation rate).

 

A Prediction

To pay off our $15.5 trillion national debt the government will continue monetary expansion and quantitative easing, i.e. printing money. Inflation will rise. Prices Increase. Income/ real wages will stagnate and unemployment will increase as businesses look for ways to cut costs. Since businesses possess bargaining power, wage labor markets will suffer. The cost of living will be so great that people will be forced to reign in consumption and cut spending. If you have debt (financed by wealthy private domestic lenders), you will have difficulty paying it off because cost of living has left you with less money to live on. If you can’t pay it off and file for bankruptcy, they will not only repossess your assets, you’ll still be in debt, thanks to recent revisions in Chapter 7 and 13 Bankruptcy laws. What’s left of the middle class will continue getting squeezed until the income disparity is so large that poverty will be the norm. Meanwhile the wealthy will get richer as they continue cashing in on your debt.

A word of advice: get out of debt, fast.

Now, I have to ask myself: if income drops and consumption decreases, and if credit and loans are more difficult to obtain, what will sustain the domestic demand that drives economic growth? Simplified: if 90% of the country has no money, how will they buy things, and how will businesses make money?

Data indicates that our GDP has continued increasing and is back to pre-recession rates.

What if I said GDP is a worthless measure of the economy? What about exponential growth in inequality? What if I said real wages were a better determinant of economic prosperity and success?

Domestic and Global Inequality

Just read the paper Unequal = Indebted by Michael Kumof of the IMF.

It’s a short paper highlighting some of inequality’s effects. Take specific look at the commentary on China’s growing current account surplus. Contrary to popular belief, inequality has been rising just as quickly over there. The reason they aren’t in debt is because of their inefficient financial markets, in contrast to the US hyper efficient financial markets. They save more, despite making less and less, because there aren’t developed financial markets that provide banking services. This excess surplus travels to the US and fuels the debt investment driving our consumption and domestic demand. This type of behavior is driving global current account imbalances.