Recently, I read a book entitled, “Aftershock, the Next Economy and America’s Future” by Robert B. Reich, 2011. The author discusses the linkage between income inequality and jobs, which I find so refreshing that I want to share with you.
The following table illustrates the degree of income inequality in the US as reflected by the income earnings of the top 1% as a percentage of national income:
1913 18% (top 1% income earners accounted for 18% of national income in 1913)
1929-1939 Stock market collapsed leading to the Great Depression
1939-1945 World War II
1973 First oil crisis
1979 Second oil crisis
1980-88 Reagan tax cuts, deregulation, deficit defense spending
1997 Dot-com boom began
2001 Dot-com bust
2002-2007 Bush tax cuts, deregulation, deficit Iraq war spending
2003 Mortgage boom began
2008-10 Mortgage bust, financial meltdown, causing the Great Recession
From the above table, several facts become evident:
Income inequality increased during the so-called roaring 1920s. This period is marked by unrestrained capitalism, the emergence of big corporations, and financial speculation. It reached a high point in 1928, where the top 1% of the population earned 24% of the national income. Then something bad happened.
The stock market bubble burst in 1929, bringing the Great Depression that lasted for a decade. The Depression hurt everybody including the rich, their income share falling to 16% by 1939. During this period, the US government incurred huge deficits (close to 50% of GDP) by actively investing heavily in infrastructure projects such as the Hoover Dam. The purpose was to provide more jobs and to stimulate the economy. This period was marked by heavy government intervention, including the 1935 enactment of the first social program now known as Social Security. These have proven to be good investments for a long prosperous period coming up.
World War II ushered in a war economy by creating massive demands for weapons and other war materials. This emergency external condition restored full employment, which continued for a long time even after the War. By War’s end, income of the top 1% came down to 13% of the national income in 1946.
After 1946, income inequality continued to decline until reaching the lowest level of 8% in 1978. This is known as the long prosperity period marked by full employment, rising wages, economic growth, and relatively low inflation. The US rose to become a superpower. The whole population generally became better off, both rich and poor. The US government could afford big expensive projects such as the Marshall Plan for Europe, building the national highway system, landing a man on the moon, enactment of Medicare insurance for seniors, an arms race with the Soviet Union, and even a war in Korea and in Vietnam. Because of large amounts of tax revenues coming in, the US national debt was minimal during this period.
From 1979 onward, income inequality worsened to 15% in 1988. It deteriorated to 22% in 1999 during the dot-com boom. Why? This period was marked by tax cuts, deregulation, deficit spending, and financial speculation. Does that sound familiar to the 1920s? The dot-com bust that ensued reduced the income inequality only briefly to 16% in 2002.
From 2002 onward, the income inequality worsened again to reach a high point of 24%, which coincidentally was the same level as in 1928. This period was also marked by tax cuts, deregulation, financial speculation, plus deficit spending for the Iraq war. Guess what followed? Financial meltdown and the Great Recession. We continue to feel the aftershocks today including a weak economy, high unemployment, stagnant wages, and huge federal deficits. The irony is that income inequality gets worse unlike the previous busts, because the big banks have received government bailouts, and most big corporations are earning good profits by outsourcing. They continue to shower large bonuses to their top executives. The rich have come out far ahead after a big bust in 2008, in contrast to previous times.
In conclusion, a clear pattern emerges as follows:
When the government relaxes the rules or refuses to regulate, private business goes wild especially big corporations. One consequence is the rich gets richer due to their inherent advantages. The other is speculation in many areas especially the stock market and mortgage finance. Speculation invariably produces a bubble that will eventually burst, dragging down the entire economy, resulting in job loss and continued high unemployment.
When the government gives a regressive tax cuts to the rich instead of a progressive one favoring the middle class, income inequality worsens. While the middle class spends most of its earnings to maintain a living, the rich spends only a small portion with the rest going to speculation such as the stock market, gold, currencies, commodities, even antiques that will multiply their investments much quicker. In other words, the middle class recycles their earnings back into the economy. The rich recycles their earnings into speculative ventures that will eventually lead to a bubble burst that drags down the economy.
When the government becomes active in the economy and does what it is supposed to do, income inequality will be reduced. The economy regenerates itself and grows. The middle class is strengthened. Their earnings are recycled back into the economy as massive demands due to their huge number. Increasing demands will entice business to invest more and hire more workers.
Reducing income inequality strengthens the middle class. It creates a virtuous circle of higher employment, higher wages, higher demands, and higher investments. On the other hand, worsening income inequality produces a vicious circle of high unemployment and stagnant wages like we are experiencing now.