-- Posted Friday, 9 December 2011 | | Disqus
By David Collett
Bottom 99%’s share of Income versus GDP growth
The Top 1%’s share of Income and GDP Growth
Total Income Growth versus Top 1%’s Income Growth
A Challenge to the Sceptics
A rising tide lifts all boats. This has become a popular cliché in explaining how lower taxes and relative steep rises in income for the top 1% of income earners help the economy in a broader sense. According to conventional wisdom; lower taxes, higher income and more wealth in the hands of the highest earners, lead to more investments causing the following trickle-down effect:
1. Higher job growth
2. Higher income growth
3. Higher economic growth, and
4. Higher living standard for all
US historical data proves this concept to be false, not because a rising tide does not lift all boats but because the tide is the bottom 99% of income earners not the top 1%. When the top 1% takes too big a slice from the income pie, the economy starts to falter and economic prosperity moves out with the tide.
Bottom 99%’s share of Income versus GDP growth
Chart G1 below shows the movement of the bottom 99%’s share in the total personal income pie of the United States over the past 100 years. The tide of an increasing share for the bottom 99% came in during the middle decades of the 20th century, lifting GDP growth, but since the eighties the tide is ominously moving out, dragging GDP growth down with it.
Although the above positive correlation between GDP and income distribution is by no means perfect, it’s strong enough to pursue the causal link between the two variables. Although the thirties-decade seems to buck the trend on the above chart, it’s only so because the GDP was calculated from the last day of 1929 to the end of 1939. The relative high growth of the twenties came to an end with the stock market crash late in 1929 and the subsequent fallout of this period of high income concentration is reflected in the GDP decline of -25.7% from 1930 to 1932. This negative GDP growth therefore negates the strong growth from 1932 to 1939 which was in excess of 40%.
The biggest decline in the 99%’s share came in the period from around 1923 to 1928 when their share drop from 85% to a record low of 80.4%. It remained low until the stock market crash of 1929 where after it increased slightly in the thirties. Chart G1/1 below gives a better perspective on the twenties and thirties over a 21-year period from 1918 to 1938. It compares three periods of seven years each. The average share for the 99% is calculated for every seven year period and charted with the corresponding GDP growth over the same 7-year period. The positive correlation between GDP growth and changes in the 99%’s share of income is obvious.
In analysing the trends in the chart G1 above, there are a number of other significant factors to keep in mind:
1. The United States became the main supplier of arms to the Allied Forces in the early forties. It is likely that the forties included a substantial GDP “war premium” that is not related to changes in income concentration.
2. The last decade (2000’s) also reflects some of the slow growth that followed in the immediate aftermath of the Dotcom bubble that was also preceded by a steep decline in the 99%’s share of income in the eighties and nineties.
3. External factors like the oil shock of the seventies (and to a lesser extent the early eighties) had a substantial impact on US GDP growth. The enormous jump in the price of oil decreased the real disposable income (after deducting fuel related expenses & its effect on inflation) for virtually all American consumers in the seventies, though it had a more negative effect on the lower income earners’ spending power. As the United States imported a substantial part of its oil, the high price also negatively impacted the trade balance which lowered GDP. In the subsequent decades however, oil and gasoline prices actually lagged the consumer price index giving the US economy the advantage of relatively low energy prices. When the oil and gasoline prices caught up with the consumer price index in 2008, it exerted further pressure on a struggling economy.
It is impossible to determine the exact impact of the above factors on GDP growth as reflected in Chart G1 above. We estimated the impact on GDP for each relevant decade on the following basis:
a. Excluded the negative growth for1930 and 1931 from the thirties and included it in the twenties’ net GDP growth.
b. Estimated the “war premium” at 80% of the amount that US GDP growth exceeded World GDP growth for the forties as shown in chart “G-1“ of Part VI of “The Dominant Causes of the Credit Crisis” and adjusted actual GDP growth for the forties accordingly.
c. Increased the seventies (5%) and eighties’ (2%) GDP growth with an “oil shock” premium.
d. Adjusted the nineties (-2%) and 2000-decade’s (+2%) GDP to compensate for the Dotcom bubble overflow from the nineties to 2000s.
The results of the above adjustments are reflected in Chart G1/2 below. Although the adjustments for GDP growth are estimates based on assumptions that are imprecise, the exercise is useful because it excludes some of the abovementioned background noises. Chart G1/2 therefore gives a more accurate picture of the relationship between changes in the 99%’s share of income and GDP growth.
The above chart shows a strong positive correlation between GDP growth and changes in the bottom 99%’s share of income. This is in accordance with the evidence and theory as discussed in Part VII and IV of “The Dominant Causes of the Credit Crisis”.
The close relationship between changes in income distribution and GDP growth makes economic sense. As explained in more detail in Part II and IV of “The Dominant Causes of the Credit Crisis” the balance between supply and demand are considerably influenced by significant changes in income distribution. In short - as the top 1% (or any other relevant percentage) takes more money from the economic income stream, demand slows relative to supply because the top 1% will tend to save increasingly more of each percentage point gained in income, whereas the bottom 99% would have spent a bigger portion of it if they were to receive it. The top 1% invests the additional income in financial assets which the relevant financial vehicles channel into either more capacity for the production of goods and services and/or lend to the bottom 99% to buy the extra goods and services produced by increased capacity. However, as the top 1% increasingly takes more out of the income stream, the credit expansion required to enable the bottom 99% to absorb increasing goods and services from additional investments, reaches unsustainable levels.
Although investments also create demand via salaries, wages and other outlays it cannot create sufficient demand to absorb the supply it created in an economy of increasing income concentration. The downward trend in capacity utilisation over the last four decades confirms this. That is one of the reasons why big corporations sit on $2trillion cash in 2011 which they are reluctant to invest in productive capacity. This reluctance is not surprising – there is not sufficient demand to justify more investments into capacity. Although fixed investments added very little to overall US industrial capacity in the last decade, there is still a lot of spare capacity in the economy. This is also true for China, the favourite investment destination. If investments over the last three to four decades created capacity that could produce more goods and services than what demand (created by the same investments) can absorb, why would further investment have a different result this time?
For the sake of clarity we wish to point out that the above charts exclude the effects of changes in taxation on income distribution. Both capital gains tax and top marginal tax rates on personal income came down significantly since the seventies. These tax rate reductions favoured the top 1% more than the bottom 99%. Contrary to the above reductions, payroll taxes increased significantly from the middle sixties onwards. Payroll taxes reduced the bottom 99%’s disposable (after tax) income substantially more than that of the top 1% and probably had a sizable negative impact on GDP growth over the last four decades. If one would therefore use the bottom 99%’s share in disposable income (after all taxes) instead of gross income, the decline in the bottom 99%’s share would be steeper than that shown on the above charts.
The effect of taxation on income distribution between various income groups for the period 1979 to 2006 can be observed in Part II of “The Dominant Causes of the Credit Crisis”. There are dynamics that work in favour of the bottom 99%, such as government transfers to the lower income groups. The above however, is more relevant to a debate about the fairness of total net income distribution which is not the focus here.
The Top 1%’s share of Income and GDP Growth
If we ignore three of the decades (thirties, forties and seventies) that were significantly affected by other factors besides changes in income distribution, the impact of changes in income distribution on GDP growth is considerable. Chart G2 below shows a trend of accelerating GDP growth (percentage wise) when the top 1%’s share of total income decreases and a declining growth trend when the top 1%’s share of income increases.
Note: Use adjusted GDP figure for twenties to reflect negative growth (1930 & 1931) caused by 1929 crash and prior income concentration
Let us compare the three decades (without any adjustments) where the top 1%’s share of income decelerated most with the three decades where it accelerated most and compare its effect on GDP growth. In chart G3 below we compare the decade (forties) with the fastest decrease in the top 1%’s share of income with the decade (eighties) with the fastest rise in the top 1%’s share of income; then the decade (fifties) with the second fastest decrease in the top 1%’s share with the decade (nineties) with second fastest increase in the top 1%’s share and the decade (sixties) with the third fastest decrease with the decade (2000s) with the third fastest increase in the top 1%’s share.
Irrespective of the use of adjusted or unadjusted GDP growth data, the results are the same. There is a strong negative (inverse) correlation between GDP growth and changes to the top 1%’s share of income. When the top 1% takes a lesser share of total income, the tide (top 99%’s share of income) comes in and lifts the GDP growth rate but when the top 1%’s share of total income increases, the tide goes out and GDP growth rate shrinks.
In each of the three comparisons, a decline in the top 1%’s share of income resulted in GDP growth that was substantially higher than the comparative decade where the top 1%’s share increased. In fact, you get the same result when you compare any of the decades (40’s, 50’s& 60’s) where the top 1%’share declined to any decade (80’s, 90’ & 2000’s) where the top 1%’s share of income increased.
In Chart G4, we compare the GDP growth (unadjusted) over a thirty year period (forties to sixties versus eighties to 2000’s). In the first thirty year period, the top 1%’s share of total income was in decline and in the second thirty year period, the top 1%’s share of total income rose sharply.
Note: For comparative purposes the increase or decline in the top 1%’s share is expressed as a percentage of the top 1%’s share at beginning of period
The results are compelling. In the first 30-year period real GDP grew by 285% while the top 1%’s share of total income decreased from 15.4% to 8%. In the second 30-year period GDP grew by a measly 118% while the top 1%’s share of total income increased from 8% to 18.3%. The connection between changes in income concentration and the rate of GDP growth is undeniable.
Total Personal Income Growth versus Top 1%’s Income Growth
Chart G5 shows that although growth of total US personal income relatively underperformed in the decades since the sixties, the growth in the top 1%’s personal income skyrocketed. One would normally equate such a steep rise in income in the hands of the top earner- entrepreneurs with an economy that performed substantially better than previous periods. The charts (below and above) clearly show that the economy underperformed against the previous decades in GDP growth as well as in real personal income growth.
Chart G6 below shows that if the US economy only repeated the personal income growth of the sixties over the next four decades, US personal income (and as a consequence its GDP growth) would have been twice the size it is today. The implications are huge. Based on the above evidence and theory that increasing income concentration impedes GDP growth and vice versa, the United States may have been robbed of nearly half its potential economy over the last three decades. The obvious question is - can the economy get back on track while income concentration increases or stays at its current high levels? No, it can’t.
If US real personal income and GDP growth kept track with the top 1%’s growth in personal income, the US economy would have grown even faster than the growth projected above in chart G6.
Chart G7 shows that the top 1%’s real personal income grew at a brisk rate of 405% (from $396bil to $2tril) over the last three decades while the nation’s income grew at 121%.
If one looks at the top 1%’s 1962 to 2010 balance sheets in Part III of “The Dominant Causes of the Credit Crisis”, you see an enormous increase of the wealth (owner’s equity) of the top 1% with relative little increases in debt. If the US economy grew as fast as the top 1%’s income and/or net wealth over the last three decades, the current debts and balance sheets of the US government and the average consumer would be in a much healthier state. Instead the United States is drowning in debt because budget deficits were used to stimulate growth over the last three decades and various financial institutions were assisted or bailed out. Credit to consumers simultaneously escalated at a fast pace. A major part of this money ultimately found its way into the pockets and balance sheets of the top 1%. They are the main creditors (indirectly through its financial assets) of the nation (public and private debt) and they took the biggest share from profits and income as their credit circulated through the economy. These profits were mostly saved and “stored” in financial assets. The financial asset’s values were further advanced by leveraging within the financial industry. These assets however, could lose a major portion of its value if all debts are not repaid by the debtors or the expected future revenue streams fail to materialise. Debt default is likely to happen because most of the ultimate debtors (government & lower income earners) are not able to pay the debts because of decreasing income, revenues and negative equity. The top income earners and wealth owners, who can pay the debts, will not do so – after all, they are the “creditors”. Although the financial authorities will kick the can down the road for as long as possible, debt defaults will eventually claw back some of the unrealised gains made in prior periods with devastating consequences for the economy.
The top 1% is promoted as the rainmakers and super entrepreneurs of the US economy. They were the captains of the US ship called “Private Enterprise”. Since the sixties and seventies they have been asking for lower taxes – they got it. They asked for deregulation – they got it. They asked for government subsidies, stimulus, bailouts and more open international trade – they got it. They asked for much higher compensation from the investment community – they got it. They demanded lower wages and higher productivity from employees – they got it. They prevailed over an era of great innovation, low interest rates, massive credit expansion and relative mild inflation.
However, when the economic scorecard is added up, the final mark shows they failed by some margin. The flagship, “Private Enterprise” is not only taking water on board but it is sailing recklessly close to the rocks in search of even bigger profits for the few. But the generation of entrepreneurs that prevailed over the US economy of the last three decades are convinced they are superstars, game breakers, beacons of light and mega achievers. To be honest, some were but many don’t deserve these accolades. They believe they took no more than they deserved – in fact many believed they were too conservative in remunerating themselves. According to some of them, the bottom 99% got much less because many of its members were just plain lazy or too scared to take risks, choosing to rather prowl around for handouts. Their excuse for the underperforming economy – bad government, too much regulation, too high taxes, too high minimum wages and creeping socialism. Their way forward – cut taxes, cut Medicare and Social Security, deregulate and get government “out of our way”. In short – they want more of the same. They usually get their way.
This may reflect a growing culture of unbridled greed and indifference to accountability. But it’s hard to criticize. Since when did entrepreneurs who created great wealth and good sources of income for themselves consider their actions and rewards as undeserving or bad for the economy as a whole? Yet they have the biggest say on how the country is run. This inability to restrain themselves in the pursuit of profit maximization is one of the reasons why many are of the opinion that the 99% must take effective control of the country– after all they are the majority “shareholders” in the United States of America Ltd.
The United States is not alone in this – many of the advanced economies experienced the same phenomena over the past few decades. According to a study by the Organisation for Economic Co-operation and Development, income inequality worsened substantially in developed countries over the last three decades. Countries like Italy and the United Kingdom are among the top ten with the biggest wealth gap as measured by the Gini coefficient. Income inequality increased for both of the abovementioned countries. The consequences for other countries with growing income inequality will not differ much from that of the USA.
There are a few countries in Asia, like China, that buck the trend. Wealth and income inequality in China have worsened faster than most over the last decade, yet its economy delivered even higher growth than the previous decades. This growth however, was depended on extraordinary high fixed investments, rising exports to the United States and Europe, massive bank lending and an undervalued currency. In a future article we will examine the sustainability of this growth in a world of increasing income and wealth concentration.
A Challenge to the Sceptics
High concentrations of personal income in the hands of the top 1% preceded both The Great Depression and The Great Recession; and periods of growing income concentration strongly correlates with periods of lower economic growth. In contrast to the above, higher economic growth strongly correlates with a more equal dispersion of income. Despite the evidence, many mainstream economists dismiss any causal link between changes in income concentration, economic growth and major recessions. According to them there can be no causal link because recessions also occurred during periods of relative low income inequality. That is akin to someone arguing that looking after your health is not important because healthy people get sick too from time to time.
The “pent-up demand” post-World War II, the start of the baby boomer era, rebuilding of Europe and the economic benefits from the Korean and Vietnam wars are considered by many economists as the main driving forces behind the exceptional economic growth rates of the fifties and sixties. For these reasons, they insist, the fifties and sixties cannot be used as a benchmark. Although some of the above factors might have impacted economic growth in the fifties and sixties to some extent, we have not seen any convincing evidence in the form of economic data that support such theories – at least nothing that trumps the data that shows the close relationship between changes in income concentration and economic growth. The last two decade had its own wars, its own construction and real estate boom and a world population that grew at a brisk pace, yet the US and world economy failed to produce growth that comes close to the growth of the fifties and sixties.
The questions that sceptics should answer are the following; when does income concentration become an impediment to growth – when the top 1% earns 20% of all personal income or 50% or 100%? If any of the above percentages is to be considered as a stumbling block, when and why do we reach such a limit?
There are economists who concur in principle that growing income inequality leads to slower economic growth and major recessions. Some however, seems baffled as to how and why these changes in income concentration occurred and are therefore often hesitant in proposing solutions to remedy the current situation. Many seem to consider it politically incorrect to criticize rising income inequality as a major cause of slow growth and major recessions. One should be sympathetic towards them. To mention the phrases “higher taxes” and/or “more equal distribution of income” in discussing possible solutions to our current economic problems is risky, because economic - McCarthyism seems to be on the rise and one can easily be branded as a delusional Marxist opposing capitalism. The irony of this is that the phrases “higher taxes” and “more equal distribution of income” encapsulate those conditions that prevailed in capitalism’s finest hour (fifties and sixties) when economic growth was at its highest and the 99% prospered in tandem with the 1%. Why should a much slower growing economy with lower taxes on high income earners and growing income inequality have more credentials in representing capitalism?
In Part IX of “The Dominant Causes of the Credit Crisis” we will look at economic data which gives support as to how and why specific economic policies may have influenced changes in income dispersion in the past and why it may do so again in future.
© Copyright David Collett 2011.
Whilst every effort was made to ensure the accuracy of this article, neither this document; nor its author, David Collett; nor any publisher of this article; offer any warranties (whether express, implied or otherwise) as to the reliability, accuracy or completeness of the information appearing in this article. Neither do any of the above parties assume any liability for the consequences of any reliance placed on opinions expressed or any other information contained in the above article, or any omissions from it. Its content is subject to change without notice. Any information offered, is intended to be general in nature and does not represent any investment or business advice of any nature whatsoever. If you choose to rely on such information you do so entirely at your own risk. Neither David Collett nor any third party involved in publishing this article, assume any responsibility or liability for the outcome of such reliance.
-- Posted Friday, 9 December 2011 | Digg This Article
| Source: GoldSeek.com
