Question: Which fuel best drives a nation's economy: wealth or consumption?
Answer: It depends, my friend . . . it depends.
"Depends on what?" I hear you ask.
To paraphrase a statement that is all the rage, "I am not an economist." However, I have, over the course of a half-century love affair with knowledge, read and tried to understand the writings of many economic writers and theorists, ranging from classical dudes like Ricardo, Malthus and Adam Smith to such thought-provokers as Marx, Maynard Keynes, Hayek, and Stigletz, and even the ole' monetarist himself, Milton Friedman.
So what have I learned?
That there has long been a basic and telling divergence between those -- returning to our original question about what best fuels an economy -- between those who side with wealth and those with consumption.
In other words, there isn't much agreement.
We see that lack of agreement in the different remedies prescribed by Democrats and Republicans.
In the main, most Democrats -- and liberal economists -- believe that consumption -- putting more money into the pockets of working people -- is the fuel that drives the economy. According to their understanding of the way things go, when working folk earn a buck, they spend it on such things as food, fuel and clothing, electronic devices and perhaps the occasional night out. In turn, increased consumer spending leads to increased manufacturing and increased employment, which in turn leads to more people who can spend; if you're selling more shoes, you're likely going to need to add another salesperson or two, thus adding another person or two who can earn a living and purchase consumer goods. This is called the multiplier effect. Additionally, most liberal economists believe that in times of recession, the government can play a positive role by increasing public spending, even if it means increasing deficits. Putting more spendable dollars into the hands of working class folks will, so the theory goes, stimulate our consumer-driven economy. This is pretty much what goes by the term "Keynesian Economics," named after the British economist Lord John Maynard Keynes.
On the other hand, Republicans, conservative economists and a whole lot of millionaires hold that wealth is the fuel that drives the economy. Higher taxes on the rich and their corporations, they argue, hurts economic growth, for it is the wealthy who are the job creators. Cut their taxes and they will use that extra capital to expand business, thus creating more employment, which will offset the decreased revenues caused by the tax cuts. This is classic "trickle-down" or "supply-side" economics. Its rallying cry is "A rising tide lifts all boats. The theory has many fathers; one of the latest is Reagan-era economist Arthur Laffer. As Nobel Prize winning economist Paul Krugman recently wrote, trickle down theorists "[insist] that the best policy is to cut taxes on the rich, slash aid to the poor and count on a rising tide to raise all boats."
For whatever reason, the perceived wisdom has long held that the nation's economy does far better under Republicans than Democrats -- that when it comes to "fuel," wealth outweighs consumption. Turns out, the perceived wisdom is wrong: according to a recent study published by the National Bureau of Economic Research (NBER), during the past 16 presidential terms, Republican presidents have presided over 41 quarters classified as recessions. And the Democrats? Only eight. According to the NBER report, under Democratic presidents, per capita Gross Domestic Product (GDP) has been higher; job creation has been stronger; decreases in unemployment have been greater; the S&P 500 stock index has been higher; corporate profits have been bigger; and real wages and labor productivity have increased. And yet, in poll after poll after poll, a majority of Americans believe that Republicans do a better job of handling the economy than Democrats. Go figure.
Income inequality has been growing at an unbelievably rapid pace over the past thirty years. In the latest-such reporting from the AFL-CIO, American CEOs earned an average of $11.7 million -- an eye-popping 331 times the average workers $35,293; the CEO-to-minimum-wage-worker pay ratio was a staggering 774:1 Compare that to 30 years ago, when an average CEO earned about 30 times more than a typical worker. Now without question, market economies do need a certain amount of inequality to function. However, if the proponents of supply-side, trickle-down economic theories were correct, all this increased wealth redounding to CEOS and the upper one or one-tenth-of-one percent should have helped foster an increasingly robust economy and narrowed the income inequality gap. But of course, it has not. And yet, despite demonstrable proof that trickle-down economic models do not -- and never have -- worked, American politicians continue to support them as if it were the Holy Grail.
It is possible -- just possible -- that this may be about to change. Just the other day, economists at Standard & Poor's Ratings Services issued a report with the straightforward title “How Increasing Inequality is Dampening U.S. Economic Growth, and Possible Ways to Change the Tide.” The fact that S.&P., an apolitical organization whose purpose is to produce reliable research for bond investors and others, is raising alarms about the risks that emerge from income inequality is a small but important sign of how a debate that has been largely confined to the academic world and left-of-center political circles is becoming more mainstream.
The S&P report notes that "Higher levels of income inequality increase political pressures, discouraging trade, investment, and hiring. [John Maynard] Keynes first showed that income inequality can lead affluent households (Americans included) to increase savings and decrease consumption, while those with less means increase consumer borrowing to sustain consumption…until those options run out. When these imbalances can no longer be sustained, we see a boom/bust cycle such as the one that culminated in the Great Recession."
It makes sense. If a multi-millionaires make a few more millions, what are they going to do with it? Buy another house or yacht or Rolex? How many is enough? But put a few extra dollars in the pay envelope of a worker and he or she will spend it as quick as you can say Jack Robinson.
Make no mistake about it: the authors of the S&P report are not liberal academics writing peer-reviewed articles that will only be read by their equally liberal academic colleagues. This is Standard & Poor's -- an organization everyone on Wall Street keeps on speed dial. Supply-siders cannot dismiss this report as the ivory-tower ranting of aging Marxist hippies. The folks at S&P have revealed a truth to Wall Street that many on Main Street have known -- at least viscerally -- for a long time: that massive income inequality is bad for the very poor, the very rich and everyone in between. Moreover, the S&P report speaks to the role played by education and notes that, ". . . if we added another year of education to the American workforce from 2014 to 2019, in line with education levels increasing at the rate of educational achievement seen from 1960 to 1965, U.S. potential GDP would likely be $525 billion, or 2.4% higher in five years."
To be certain, we are not the first generation to experience such radical income inequality; check out America in the last decade of the 19th century. But our level of inequality is far, far worse, because unlike our Victorian ancestors, we don't have an economy largely based on manufacturing. Ours is driven by consumption. And in order to consume, you have to be able to earn a living wage. And when workers earn a living wage, its good for the companies that pay that living wage. Even Henry Ford knew that; 100 years ago he doubled his assembly-line workers pay to $5 for an eight-hour day. The result? Worker productivity surged and the Ford Motor Company doubled its profits in less than two years.
And by the way, there's nothing new about trickle-down economics. Back in Gilded Age, they had something called The Horse-and-Sparrow Theory: namely, if you feed the horse enough oats, some will pass through to the road for the sparrows. Any way you slice it, what the sparrow -- and the rest of us who aren't hyper wealthy -- wind up eating is . . . horse . . . ah . . . oh, figure it out for yourself.
Which is the best fuel: wealth or consumption?
Let the debate continue!
©2014 Kurt F. Stone
(Many thanks to my old chum Alan Wald for an able assist in putting this essay together).