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Tuesday, November 26, 2019

Capitalism and America's Economic Heartland

Have you heard that wealth disparities are increasing in America? Those who say so should take a look at the numbers.


It is time to stop talking about "economic inequality". Not only is it a morally loaded term that makes differences in income and wealth look immoral, but it is also a pointless concept in terms of economic policy. 

Skipping for now the moral or ideological debate - although we will certainly return to it in the future - the most urgent part of the "inequality" debate is the suggestion that wealth ownership is becoming increasingly disparate. Ever since Thomas Piketty's fairy-tale book on the matter, the left has ramped up its campaign against the pursuit of prosperity. We see this in a Democrat presidential-candidate field that spans all shades of socialism, and in their heavily left-slanted caucus in Congress.

At no point does the left stop and actually explain their case to us. True to a 150-or-so year long habit, they simply presume that Marxist theory is axiomatically correct. The fact that their policies have destroyed country after country in the past century and ruined the lives of billions, is of no consequence when they reload and set their crosshairs on America.

To see how wrong they are, we don't even have to look very deep into available data - although the deeper we look the more their case is proven wrong. One of the most telling numbers on wealth distribution, and its trend, is the Distributional Finance Accounts series from the Federal Reserve. Reporting distribution of assets, liabilities and net worth by all sorts of socio-economic breakdowns, the DFA data is a formidable authority on the wealth side of the "inequality" debate. 

We can dig deep into the composition and distribution of wealth among the American people; for now, let us just review the most aggregate data and see what it tells us about economic differences. Figure 1 reports the distribution of assets and liabilities between two major income groups: those in the 50-percent lowest-earning half of the American people, and those who are in the 50th to 90th percentile. The numbers reported in Figure 1 show how many dollars worth of assets the upper-earning group has compared to the lower-earning group. For example, the number 5.00 means that the upper group has $5 worth of assets for every $1 the lower group owns.

The same construction is behind the liability number (reported on the right vertical axis). In other words, when the number rises the differences increase in ownership of, respectively, assets and liabilities; when the number declines, the differences decrease. In other words:

Figure 1
Source of raw data: Federal Reserve

There are three interesting take-aways from Figure 1. First, the ratio of asset ownership remains relatively stable over time. It varies cyclically, but the parity between assets owned by the upper-earning group and the lower-earning group is about the same today as it was 30 years ago. 

This is our first indicator that the rich are not getting richer relative the middle class. 

Liability ownership follows a similar cyclical pattern, but with a weak downward trend over time. The downward trend suggests that lower-income households have assumed more debt in the past 15 years compared to earlier, and that would be a matter of immediate concern were it not for the fact that the two ratios - assets and liabilities - follow the same cyclical pattern. In other words, the lower-earning households do not take on debt without getting something for the money. 

That does not mean their indebtedness is not a problem, but it means that we should not rush to some immediate conclusion that they are getting poorer. We need to take a closer look at what kind of debt is taken on by income group before we can draw any firm conclusions; for now, though, it is worth noting that when people make more money, they take on more debt.

More on that in a moment. The second take-away from Figure 1 is related to the first: the co-variation of the two functions. Debt is used to build equity; if the two diverged from each other it could suggest that consumers take on revolving debt to finance ongoing outlays. Under some circumstances, such as a deep recession, this does happen, but these numbers indicate that America's families overall are responsible debtors. They borrow money for the purchases of homes and cars; to the extent they use credit-card debt they handle it relatively well. 

To see the third take-away, let us put the numbers from Figure 1 in a macroeconomic context. Figure 2 compares the distribution of asset ownership to GDP growth and unemployment: 

Figure 2
Sources of raw data: Federal Reserve (assets), Bureau of Economic Analysis (GDP), Bureau of Labor Statistics (unemployment)

There is a compelling correlation between asset distribution on the one hand and GDP growth and unemployment on the other. Whenever the economy is doing well, the differences in asset ownership (and, by virtue of Figure 1, indebtedness) are reduced:

Period 1. This is the 1990s recession, caused in part by George Bush Sr.'s tax hikes (which cost him re-election in 1992). The GDP growth rate (dY in Figure 2) plummeted and unemployment increased. The asset distribution ratio held steady at 5.00.
Period 2. The Clinton economy was strong, with a fiscally responsible federal government and GDP growth even exceeding four percent. Unemployment fell steadily - and look what happened to the asset distribution ratio. It fell from 5+ under Bush Sr. to just over 4 in 1995. In the second half of the '90s it ticked up modestly again, but that was not because lower-income households saw their asset ownership plummet. It was almost entirely the result of substantial growth in the stock market. 
Period 3. Here comes the Millennium recession, where economic growth slowed down but never went negative. Unemployment rose rapidly but not to any excessive levels (as some on the left keep suggesting in an effort to pin a poor economy on Bush Jr). Immediately, we see a rise in the difference in asset ownership.
Period 4. One of Bush Jr.'s first missions as president was to cut taxes. In a two-step implementation that combined multiplier and accelerator effects, he and Congressional Republicans managed to get the U.S. economy back up to speed again after the Millennium Recession and the 9/11 attacks. GDP growth ticked above three percent and, in an isolated quarterly incident, exceeded four percent. Unemployment again trended down and the asset ownership ratio once again improved. The middle class was again making money and was therefore once again in the market for new homes, new cars and new investment opportunities. 
Period 5. The Great Recession came down on the U.S. economy like a ton of bricks. Unlike what conventional wisdom suggests,  it was not a financial crisis (for more on this, see my book The Rise of Big Government), but it did have negative effects on asset ownership - real and financial - for the middle class. With a contracting economy and skyrocketing unemployment, the bulk of America's families had to fight just to stay afloat economically. The wealth difference increased again.
Period 6. Obama presided over an embarrassingly slow growth episode in America's economic history. Thanks to two presidential terms without three percent growth in one year, Middle Class America had a hard time returning to asset ownership. Those wealthy enough to invest in the stock market pulled away, as shown by the blue asset distribution function. It was not until unemployment had fallen below six percent and GDP at least touched on three percent growth that the middle class began stabilizing their equity.
Period 7. Here comes Trump. Deregulation, tax cuts, growth in both jobs and GDP, and a reset on our trade relationships, and suddenly the middle class is once again gaining ground on the "wealthy". 

America's economic heartland, working families whose biggest investments are in their kids, their homes and their cars, does well when taxes are low, government is affordable and they can go about their lives without being poked in the side by the itchy finger of a government bureaucracy. America's economic heartland does well when people can start businesses, develop their careers and make money without having to cut through gobs of red tape and tax bills. 

America's economic heartland does well under free-market capitalism. President Trump has proven this in spades. Hopefully, his work will not be disrupted by 50 shades of socialism. 

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