Barry Z. Cynamon, currently Visiting Scholar at the Federal Reserve Bank of St. Louis, and Steven M. Fazzari, Professor of Economics at Washington University in St. Louis, are researchers on consumer behavior and how it affects the economy. They wrote an op-ed for the St. Louis Post Dispatch in October 2007 in which they predicted that an end to the relentless trend of rising household debt and a subsequent crash in household spending could lead to a killer U.S. recession. Soon after, their prediction came true. Their current work, which examines how high and rising inequality is holding back the American economy, is part of the Institute for New Economic Thinking’s project on the Political Economy of Distribution. They explore how the massive debt which led to the Great Recession, the spending collapse that followed, and the stagnation that persists are all linked to income inequality. In the following interview, they discuss what their findings mean for America.
Lynn Parramore: Why have you decided to focus on inequality in your research?
Steven M. Fazzari: First, as Barry and I developed our research on household spending, debt, and big movements of the U.S. economy, it became clear that the overall trends before 2008 were unsustainable. Households were taking on debt at a rate that couldn’t continue indefinitely. But for each borrower, there is a lender. We got interested not just in the overall trends of debt and spending, but also who was doing the borrowing and lending; which part of the household sector was spending unsustainably? This question led us to think about inequality in a very general sense: the fact that some households borrow and others lend implies that households are different, that is, “unequal.”
Second, there has been a lot of attention on data that demonstrate rising inequality in the U.S. Thomas Piketty’s big book, Capital in the 21st Century, came out in English last spring, but some of the research that his book is based on appeared earlier. I’ve always had an interest in income inequality, perhaps mostly from the perspective of American values and social justice. So I was curious to look at these new data. It turns out that the rise of the income share of high-income households begins at almost the same time as the rise in debt that was the focus of our earlier research. It seemed likely that this correspondence was not a coincidence. I began to see a common thread between the dynamics of inequality and the macroeconomics of U.S. expenditure.
LP: An ordinary person on the street would probably say that if the rich have most of the money, that’s bad for the economy. She’d intuit that if the rest of us don’t have enough money in our pockets to spend on goods and services, the overall economy will suffer. Yet this has been minority view in the field of economics. In fact, many economists have long argued that economic inequality was good for economic growth. What explains the persistence of the conventional view?
SMF: The person on the street typically understands that consumer spending is the source of business sales, and if consumer spending falls then businesses will sell less, produce less, and support fewer jobs. As your question suggests, it is also intuitive that rich households will spend a smaller share of their income. So, the person on the street can appreciate that as more and more income flows into the hands of the rich, it will become more difficult for the economy to generate the sales it needs to support job creation.
But this rather simple intuition has been obscured in most practical discussions of macroeconomics. Most economists assume that the effect of inequality on spending is really only an issue in the short-term. The idea is that over the long run, the problem will fade because wages and prices will somehow adjust. Mainstream economists hold that even if most people end up with less money to spend because of inequality, that’s ok because other sources of spending, like business investment, will come to the rescue and we’ll end up with plenty of jobs.
Our works shows that this is not so. We find that high and rising inequality is now holding back the U.S. recovery from the Great Recession and the lack of purchasing power faced by most people is a job killer not just for a few quarters but also over a number of years. Unemployment may cause wages and prices to fall (or at least rise more slowly), but disinflation and, especially, deflation are not likely to raise total spending. Of course, consumers appreciate lower prices for the things they buy, but lower wages are bad for spending, especially if the household has a fixed mortgage or car payment to meet.
Another important problem is that falling interest rates will not be effective in pushing spending up, at least in a sustainable way. Short-term rates cannot fall much below the near-zero level where they are now. Also empirical evidence implies that low interest rates are not particularly effective at stimulating demand, outside of speculative bubbles like the one we saw in housing prior to the Great Recession.
When prices don’t adjust, and monetary policy doesn’t cure the demand problem caused by income inequality, we have the potential for persistent, or “secular,” demand stagnation — in plain English, a lackluster economy. We argue that this is the current situation in the U.S. Thus, the intuition you describe of the person on the street is mostly validated by the kind of work we are doing.
LP: You’ve noted that since about 1980, the bottom 95 percent of Americans have been losing income relative to the top 5 percent, and that to keep from losing ground, they’ve tended to go deeper into debt — a trend that ground to a halt in 2008 when the financial crisis resulted in a credit bust and they could no longer borrow to spend. At the same time, affluent people saw their incomes grow and were able to spend more and seek more investment opportunities, even after the crisis.
What factors led to the divergence and why is this situation dangerous?
SMF: Ultimately the “divergence” is about differences in income growth. From the 1950s to the late 1970s, real incomes per household grew at roughly the same rate, so demand growth was generated sustainably across the income distribution. Around 1980, the income growth rate for the top group increased when the growth rate for everyone else dropped. For a while, folks in the bottom group kept consumption at a higher than sustainable level by borrowing. But this behavior ran into a wall in 2007 and 2008 and the consumption of the bottom 95 percent has been forced down to correspond with their slower income growth.
What are the dangers going forward? I would identify two big problems. First, as we emphasize in our work, the economy needed the high consumption of the bottom 95 percent to keep job growth acceptable. The economy wasn’t really booming in 2005 and 2006 even with a lot of debt-financed consumption from the bottom 95 percent. But a lot of this demand was lost when the borrowing of this group collapsed. The top group may be moving along just fine, probably roughly along the trend it was following prior to the Great Recession. But it has not picked up the slack from the debt-financed spending of the bottom 95 percent that we lost, which we identify as a primary reason that the recovery has been so disappointing.
Second, as incomes grow faster at the top and the earnings of most household stagnate, more and more of the production in the society is being generated to serve high-end consumers. We are becoming less of a “middle-class” or “mass-market” society. Some of our recent work suggests that by 2012 the top 5 percent was consuming almost as much, in total, as the bottom 80 percent! As these trends continue, we are moving more and more to a society in which the work of the middle class (if they are lucky enough to have jobs at all) goes to serve the consumption of the affluent. This trend is inconsistent with norms of shared prosperity that are part of the American Dream. It may ultimately lead to social tension and a growing sense of injustice in our economy.
LP: How does our sense of fairness and justice evolve in view of this growing inequality; this sense that the hard work of the many is supporting the luxury spending habits of the few?
Barry Z. Cynamon: Humans have achieved incredible things on this planet not just through our use of tools but through cooperation. E.O. Wilson tells us that humans are one of roughly 20 species known to be “eusocial” — that means we live in multigenerational communities, practice division of labor, and show willingness to sacrifice some of our personal interests to that of the group. Regardless of the debate about kin selection versus group selection, it is widely agreed that we have conquered the planet by cooperating with one another in spite of universally present instincts toward survival and self-interest. Our elaborate, interlocking systems of social norms, laws, and concepts of fairness and justice collectively bolster that underlying trait of eusociality so that what once enabled survival and propagation of small bands of humans has also enabled vast civilizations—including the unprecedented global human civilization of which we are all part today.
Fairness is central to this incredible history of cooperation. If we lose our trust in the legal system and the legitimacy of the market, then we will lose trust and cooperation. When that happens, it is not good. Societies that lose their trust end up looking more like Somalia, Iraq, or Sudan than like Sweden, Canada, or Australia. The point is not that the U.S. is one election or financial crisis or a few percentage points of income concentration away from becoming an ungovernable state. Rather, the point is that social infrastructure makes a huge difference, and it is not something that we seem to understand well enough to reliably manipulate it for good.
LP: Let’s say you’re Joe the banker. You’ve made a lot of money in the stock market since the financial crisis and you’ve got plenty of money for consumption and speculation. Why should you be worried about the 95 percent and their ability to spend? What’s going to happen to you down the road if inequality continues to increase?
BZC: If the 95 percent do not have rising incomes, then their spending won’t rise. Without the increase in spending, eventually the sales of the companies you own will stop growing. Setting aside the possibility of revolution or other violent scenarios, there is a very real possibility of another financial crisis and a crash in the values of assets that simply cannot justify their valuations in a world that is too unequal. Worse—no single rich person can move the dial by voluntarily paying extra taxes any more than any of us can stop climate change by diligently recycling. It is only by massive coordinated action that we can operate on the level of the massive coordinated system of which we are all part.
LP: Capitalism today appears to be a mechanism that creates and exacerbates inequality. What does your research point to in terms of the necessary factors for creating a more equitable economy?
SMF: The part of this big question that is most relevant to our work relates to how we can generate strong and sustainable demand growth that is necessary to keep the economy moving forward and approaching, at least, full employment. Broadly, I think we need to work toward a goal of shared prosperity, wage growth that keeps up with productivity growth across the income distribution. In the U.S., this goal was largely met in the decades after World War II, but it has failed since the early 1980s.
How can this objective be reached? It’s far from obvious. Higher minimum wages, along with indexing of the minimum wage for inflation (perhaps even for productivity growth) will help on the bottom of the distribution. But it is not enough. We need faster growth in middle-income wages and salaries as well. Perhaps the most obvious policy to encourage this outcome is to get the economy back closer to full employment to improve the bargaining power of workers.
There is a “chicken-and-egg” problem here because we need faster wage growth to get the demand necessary to get back toward full employment, but we need full employment to get faster wage growth. One possible way out of this Catch-22 could be aggressive fiscal policy. These actions could include a push on infrastructure, both traditional projects and “green” activities such as smart electric grids. Another proposal would be a substantial middle-class tax cut or rebate designed to restore some of the consumption spending lost when the bottom 95 percent had to curtail its borrowing.
I also see the need for institutional change that improves the bargaining power of labor. In the past, labor unions played this role to some extent. I don’t think it is a coincidence that the era of shared prosperity after WWII was also a time of strong unions. In the modern globalized world, however, meeting this objective is likely more of a challenge. The social perception of unions has changed, as has their feasibility in a world where out-sourcing threats almost certainly constrain wage bargaining. We need to think creatively about why top incomes are pulling so quickly away from the rest of the economy and what can be done about this trend.