Tuesday, September 14, 2010

Income distribution and economic growth

I was taken to task the other day by a reader for saying that the growing income inequality of the 1920s was the "overwhelming cause" of the Great Depression. I should have said "the fundamental cause" or the "single most important cause," but I otherwise stand by the point. The widening gap between what the economy could produce (as worker productivity soared) and what it could consume (as workers' wages stagnated) caused a cascading crash in demand when the crisis came to a head, signaled by the stock market crash of 1929.

The massive upward redistribution of wealth and income produced by the productivity–wage gap of the 1920s was further accelerated by tax policies that favored the rich. The marginal income tax rate on incomes of $1,000,000 or more was cut from 73% to 24%.

As Robert Reich notes in his new book Aftershock, too many of today's politicians have forgotten "the larger lesson of the 1930s: that when the distribution of income gets too far out of whack, the economy needs to be reorganized so the broad middle class has enough buying power to rejuvenate the economy over the longer term.” Fundamentally, that means ensuring that workers once again reap the benefits of growing productivity.

But tax policy matters, too: When wealth is increasingly shifted to the top brackets, the economy as a whole increasingly lacks the spending power needed to keep it on a healthy course. Middle class and poor earners always spend a much higher percentage of their incomes than do millionaires and billionaires. Taxing a higher proportion of top incomes to stimulate demand — through government purchases of goods and services (for example, infrastructure programs) and by increasing middle class purchasing power either directly by reducing taxes on lower brackets or indirectly through public goods that the middle classes could not otherwise afford to pay for themselves (universal education and health care, for example) — is one way to restore the balance in an increasingly unbalanced economy.

When the Great Depression hit in 1929, the Republican denizens and Wall Street leaders were unanimous both in pooh-poohing its seriousness and in insisting that the best policy was to "let nature take her course" (in the words of New York Stock Exchange President Richard Whitney). Treasury Secretary Andrew Mellon's prescription for recovery was, "Liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate." Mellon told Hoover that the depression "was not altogether a bad thing . . . people will work harder, live a more moral life . . . and enterprising people will pick up the wrecks from less competent people." Hoover steadfastly opposed an increase in government spending as a response to the Depression, insisting (in denouncing a relief bill as an "an unexampled raid on the public treasury") that "we cannot thus squander ourselves into prosperity."

It is scarcely short of the incredible that Republicans in the Congress of the year 2010 are oblivious to this history, as they call for retaining tax cuts on the wealthiest 2 percent, as they denounce emergency government spending in a recession as "bailouts," as they oppose unemployment relief extensions, as they have tried even to make "stimulus" a dirty word.

But as Robert Reich points out, even Democrats are forgetting the "larger lesson" of the 1920s, which is that gross income inequalities threaten the long-term stability of the economy. It is not a question of even "economic justice" or social fairness that drives this consideration; it is, as I said the other day, basic economic realities.

Here by the way is a chart of the percentage of total personal income earned by the top 1 percent, courtesy of economist Emmanuel Saez (much more detailed data available on his website). It is unlikely to be a coincidence that the last time we saw such inequality was the last time our country was plunged into a serious depression: