Scottish-born economist - Angus Deaton - recently published his new book - An Immigrant Economist…
There was an Bloomberg Op Ed today (November 22, 2011) – Protesters Ignore American Love of Entrepreneurs – by Harvard economist Edward Glaeser. It is an attack on the OWS movement and an appeal to how great American entrepreneurship is. The ideas resonate with some recent work I have been doing on the impacts of national income redistribution under neo-liberalism on aggregate demand and the role of the financial sector. The link is that entrepreneurship in the US is not what it was and it is an illusion to think that the past two decades or so bears much similarity to the heyday of US entrepreneurship, whatever your view of the latter is. The entrepreneurs are disappearing in American and being replaced by rapacious wealth shufflers who add nothing to productive capacity or general prosperity.
I was talking to one of my PhD students about the way nomenclature is used in different ways. When an economist talks about “investment” – the term is being used to describe the flow of spending that is aimed at augmenting productive infrastructure – more equipment, buildings etc.
Buying a government bond or a share in a listed company is not investing to an economist. Entrepreneurs invest, hedge funds rarely invest. That distinction helps to understand why the Glaeser article misses the point.
Glaeser asserts that:
The Occupy Wall Street movement is fighting an almost unwinnable battle against the ghost of Steve Jobs.
America’s love affair with entrepreneurship complicates any attempt to mount an effective European-style war of have-nots against haves. To be successful, the new economic populists must connect their message with the American embrace of those, like Jobs, who become rich by improving our economy and the world.
While the OWS movement and the related general anger in the community might be, in part, a cry about income inequality and high incomes per se I consider it to be much broader than that.
I don’t just see the “Occupiers” as being “angry that President Barack Obama didn’t do more to eliminate the inequities of American life”. I see them angry about an elite that has hijacked the economic system and made it work less productively than before while redistributing more of what is working to themselves. So it is not just a distributional issue.
Glaeser seems to think that the OWS movement is pushing for a “far more expansive view of state intervention embraced in continental Europe” and are oblivious to the US sentiment that supports “America’s generally limited government”. He says that their “hopes ignore the profound historical forces that have limited social democracy and redistribution in the U.S.”
He then promotes a book he wrote with fellow free market (anti-government) academic (Alberto Alesina) which waxes lyrical about how wise the US founding fathers were to insulate the nation from as he says – “leftward tilts”.
He then quotes some survey results which tell us that:
1. “60 percent of Americans believe that the poor are lazy, a view shared by only 26 percent of Europeans”.
2. “30 percent of Americans believed that luck determines income, and 54 percent of Europeans had that opinion”.
3. “36 percent of Americans agree that “success in life is determined by forces outside our control,” and 62 percent disagree. By contrast, 72 percent of Germans and 57 percent of the French take the view that outside forces determine success”.
4. “58 percent of Americans, but only 36 percent of Germans, believe that “freedom to pursue life’s goals without state interference” is more important than that the “state guarantees nobody is in need.””
He considers that the differences reflect the “decades of left-wing political success in Europe that have led to promulgation of views that support the welfare state. Paradoxically, American children are taught that they live in a land of opportunity despite the fact that economic mobility is actually higher in Germany than in the U.S.”
Perhaps all of that is a sound representation of the state of the American psyche. But then when one starts eulogising about the “Entrepreneurial Model” the problems begin to run counter to the data.
He talks about the success of US entrepreneurs in comparison with the “dominance of the European aristocracy”, the latter who “do little to justify their luxuries”. The US success stories apparently “earned their billions with ingenuity and effort”.
He admits that entrepreneurship is threatened in the US but concludes that he fears that:
… a radically more redistributive state, resembling the one championed by the Occupy Wall Street movement, would damage the entrepreneurial spirit that has, for so long, been such an exceptional American strength.
The reality is that the state has already engaged in radical redistribution which has been associated with the decline in the “entrepreneurial spirit” and the success of the entrepreneurs.
I refer to the rise and now dominance of the neo-liberal era that has seen a dramatic redistribution of national and personal income in favour of profits and the rich but has also been associated with a dramatic decline in the performance of the US economy.
Perhaps, all that the OWS movement hankers after is the time – long past – when the US economy created wealth and opportunities for all Americans and didn’t produce to support a small enclave of extremely wealthy Americans who spend their time unproductively shuffling wealth.
Perhaps the OWS want is some guarantees that this cohort will in some way be held responsible for their behaviour and the spillovers which have undermined the wealth of millions and impoverished even more.
The US Congressional Budget Office provided very interesting data Additional Data on Sources of Income and High-Income Households, 1979-2005 – which reveals that in 2005, the top 1 per cent of Households on average earned $US24,286,300 (post tax) while the bottom quintile earned $US15,300 on average. The second quintile earned $US33,700, the third $US50,200; the fourth $US 70,300, and even the second last percentile earned on average $US3,191,600.
The following graph shows the ratio of the average household income for the top percentile to the lowest quintile between 1979 and 2005 for pre-tax and after-tax income.
In 1979, families in the top quintile received 467 times the income received by families in the bottom 20 per cent of the distribution (291 times after tax).
By 2005, the ratio had risen to 2231 (and 1587 after tax), a staggering shift.
Further, consider the following Table that I assembled which bears on the performance of the entrepreneurs in the US over the last 60 odd years.
Real GDP growth rates have been significantly lower over the last two decades relative to the more “Keynesian” years 1950s and 1960s when entrepreneurship was more concerned with building productive capacity and putting workers to making things.
It is clear from the Table that the growth in real wages has lagged (increasingly) behind the growth in productivity. It is also clear that hours worked and persons employed in the “productive” sector has been in decline over the last few decades.
Prior to the 1970s, when neo-liberal ideas started to gain prominence, real wages growth largely tracked productivity growth which meant that as the productive capacity of the system expanded, the capacity of the workers to maintain consumption standards out of wages also grew in proportion
There were high incomes produced but these typically came from success in building things and spreading the gains (somewhat to workers).
Now high incomes come from the financial sector capturing an increasing share of national income and using it to shuffling financial assets in the financial markets casino which adds about zero to productive output.
And when these gamblers stuff up – after cheating, lying, double-dealing and whatever else was involved – they plead for bailout support from the state. All private gains, all socialised losses.
The discontent associated with the from the general public, is, in part, what I think the OWS movement is trying to articulate. They might not yet have enough conceptual ammunition to present an alternative but with millions unemployed and bank bonuses still being paid the contrast is rather stark.
If we think back in history – the “left” (as it is) in the US were in control of America during and after the Great Depression for more than 3 decades. The economy boomed (with cycles) and real wages kept pace with productivity.
By contrast, the neo-liberal years have resulted in fairly poor outcomes and have culminated in the worst economic disaster since the Great Depression.
I think Edward Glaeser is writing in a time warp. Entrepreneurship in the US is now swamped by the financial market gamblers.
There is an interesting Bureau of Labor Statistics paper in the January 2011 edition of the Monthly Labor Review – The compensation-productivity gap: a visual essay – by BLS staff Susan Fleck, John Glaser, and Shawn Sprague.
They examine what they term to be the “compensation-productivity gap” in the US which is the difference between the growth in real wages and labour productivity. They argue that (Page 1):
Productivity and compensation measures yield information on the extent to which the employed benefit from economic growth. Productivity growth provides the basis for rising living standards; real hourly compensation is a measure of workers’ purchasing power … Employers’ ability to raise wages and other compensation is tied to increases in labor productivity. Since the 1970s, growth in inflation-adjusted, or real, hourly compensation has lagged behind labor productivity growth.
The following graph is taken from a paper I have just completed with Joan Muysken (available in working paper form soon) and shows the movement in productivity (output per hour worked) and real hourly compensation in the US from the first-quarter 1947 to the third-quarter 2011. The data is sourced from the US Bureau of Labour Statistics Major Sector Productivity and Cost database.
Labour productivity is real non-farm business output divided by the total hours worked and real wages are the total real hourly wages, salaries, and benefits paid to workers in the non-farm business sector. The data is seasonally adjusted. The time series are indexed to 100 at the start of the sample and the indexes are expressed in log format to “ensure constant proportionality of the growth of each index across time” (see Fleck et al., 2011: 2).
There are both cyclical and trend factors evident in the evolution of the time series. Labour productivity tends to be pro-cyclical (as a result of hoarding).
The shading is based on the business cycle data provided by the US National Bureau of Economic Research and denotes the peak to trough which define the recessionary period. The NBER shading is included to highlight the cyclical behaviour of each series.
In addition, it is clear that while both series have been trending upwards over the sample, the divergence between productivity and real wages has widened since the mid 1970s. The widening productivity-compensation gap evident in the graph is a common feature of many advanced economies.
The widening compensation-productivity gap means that the wage share – “the share of output accounted by employee’s compensation” (Fleck et al, 2011: 1) – has been falling.
Fleck et al. (2011: 1) say that the wage share is:
… a measure of how much of the economic pie goes to all workers. When labor share is constant or rising, workers benefit from economic growth. When labor share falls, the compensation-productivity gap widens. Concurrently, nonlabor costs-which include intermediate inputs into production and returns to investments, or profits-represent a greater share of output.
The following graph shows the share of US wages in gross national output for the period 1960 to 2011. Once again the cyclical movements (wage share tends to rise in a recession as productivity growth declines faster than the growth in real wages) are evident as is the trend decline.
The declining wage share over the last three decades or so is a common feature of most advanced economies. Prior to the mid-1970s, the constancy of the wage share in national income, as a result of the close relationship between labour productivity and real wages growth, was one of six stylised facts of capitalist economic growth identified by Cambridge University (UK) economist Nicholas Kaldor in 1957.
I also superimposed the share of Personal Consumption in GDP (per cent) from 1960 to 2010 onto the wage share. About the time, the wage share started to decline (early 1980s) the share of consumption in GDP grew rapidly.
The data makes it clear that the declining wage share was not associated with a higher investment ratio. The question that arises, given these trends, is how did the consumption share rise so significantly at the same time as real wages growth was largely flat and the share of wages in national income was falling?
A further question is also suggested from the data. As noted above, the growing gap between the “two shares” violated the traditional relationship between real wages and consumption. So, if the output per unit of labour input (labour productivity) is rising strongly yet the capacity to purchase (the real wage) is lagging badly behind – how does economic growth which relies on growth in spending sustain itself?
The two questions are clearly related. Marx identified the “realisation problem”, which he considered to be intrinsic to capitalism. In the past, maintaining a constant wage share helped offset this problem.
In the recent period, a new way was found to accomplish this which allowed real wages growth to be suppressed while an increasing share of national income was distributed to profits. The “realisation problem” was solved by the rise “financial engineering” which oversaw a significant escalation in debt being borne by the private sector, particularly consumers.
The rising debt underpinned the creation of a range of securitised (derivative) financial products that were deployed by the fast-growing financial sector to expand their profitability.
The following graph shows the evolution of private credit in the US from 1985 onwards using data available from the US Federal Reserve Bank. The data covers corporate, consumer and real estate credit from all finance companies and is available monthly from June 1985 ($US billions, seasonally adjusted).
All components of private debt grew significantly in the decade leading up to the financial crisis which consumer debt leading the way.
The household sector, in particular, already squeezed for liquidity by the move to build increasing federal surpluses during the Clinton era, were enticed by lower interest rates and the vehement marketing strategies of the financial engineers to borrow increasing amounts.
Part of the real income that was redistributed to profits was also the source of the dramatic escalation of executive pay and financial market bonuses that have been documented over the last few decades in most advanced economies.
The following graph shows the Household Debt Service Ratio (DSR) published by the US Federal Reserve.
The DSR “is an estimate of the ratio of debt payments to disposable personal income. Debt payments consist of the estimated required payments on outstanding mortgage and consumer debt”.
The DSR peaked at 13.96 per cent in the third quarter 2007, just before the crisis emerged.
The related series – the Financial Obligations Ratio (FOR) – which “adds automobile lease payments, rental payments on tenant-occupied property, homeowners’ insurance, and property tax payments to the debt service ratio” follows the same sort of pattern and also peaked at 18.85 per cent in the third quarter 2007.
While this strategy sustained consumption growth for a time it was unsustainable because it relied on the private sector becoming increasingly indebted. The strategy relied on the financial sector broadening the debt base and so riskier loans were created and eventually the relationship between capacity to pay and the size of the loan was stretched beyond any reasonable limit.
With growth being maintained by increasing credit the balance sheets of private households and firms became increasingly precarious and it was only a matter of time before households and firms realised they had to restore some semblance of security by resuming saving.
At the margin, small changes in interest rates and/or labour market status (for example, the loss of a job) pushed debtors into insolvency. Once defaults started then the triggers for global recession fired and the malaise spread quickly throughout the world.
In our paper we argue that aggregate consumption demand is sensitive to the distribution of national income (factor shares) and that the US economy was able to continue growing in the period leading up to the financial crisis despite a major erosion of the wage share because of the expansion of credit.
We also argue that these dynamics were directly responsible for the financial and then real crisis that emerged in 2007.
I will provide more discussion about our econometric and mathematical model in another blog.
The neo-liberal redistribution of national income instigated by the financial market lobbying of the US Congress has served to undermine US entrepreneurship.
The OWS movement intrinsically knows that that the America of old is defunct and an elite of bankers has taken over the economy and use it to gamble – often winning spectacular amounts but, equally sometimes losing.
The gambling elites have arranged things so that the losses are all borne by the masses while the gains have been increasingly privatised. More US economic activity is now described in this way rather than the “glory” days of classic US entrepreneurship in the 1950s and 1960s.
That is enough for today!