Financial FAQs
“With only about a month remaining before its recommendations are due, lawmakers on the congressional supercommittee charged with finding savings from the federal budget wrestled with cuts to defense, foreign aid and other programs on Wednesday”, said Bloomberg Marketwatch.
But the historical record tells us that finding “savings” in government spending will shrink, not expand economic growth. And so finding savings that aren’t spent elsewhere on stimulus programs won’t in fact reduce the federal deficit, which depends on increased growth. So once again as Paul Krugman has said, “And those who are determined to forget the past run a high risk of reliving it — which is why we’re in the state we’re in.”
At the risk of stealing the title from a New York Times Op-ed by economic historian and Rutger’s Professor James Livingston, “It’s Consumer Spending, Stupid”, we now have historical data verifying that consumers and government spending have driven economic growth over the past century, not corporate profits. This should not be surprising given that consumer spending now makes up 70 percent of economic activity.
Professor Livingston’s apostasy is letting us in on the “best kept secret of the last century: private investment—that is, using business profits to increase productivity and ouput—doesn’t actually drive economic growth. Consumer debt and government spending actually do”.
This is blasphemy to the classical orthodoxy, needless to say, but a truth that the #OccupyWallStreet protests recognize. Livingston says, in fact “…corporate profits are…just restless sums of surplus capital, ready to flood speculative markets at home and abroad. In the 1920s, they inflated the stock market bubble, and then caused the Great Crash. Since the Reagan revolution, these superfluous profits have fed corporate mergers and takeovers, driven the dot-com craze, financed the “shadow banking” system of hedge funds and securitized investment vehicles, fueled monetary meltdowns in every hemisphere and inflated the housing bubble.”
Graph: Congressional Budget Office
This also tells why this recovery has been so frustratingly anemic. It isn’t consumer debt, as much as the lack of income that has prevented consumers from spending enough to boost economic growth. There has been almost no household income growth above inflation since the 1970s, mainly because so much wealth was siphoned off to the wealthiest via tax loopholes and less progressive tax rates, according to the latest CBO study on income inequality.
It should no longer be a surprise to anyone that the share of income going to higher-income households rose, said the CBO study, while the share going to lower-income households fell. But it’s nice that the CBO is also providing more evidence, to whit:
- The top fifth of the population saw a 10-percentage-point increase in their share of after-tax income.
- Most of that growth went to the top 1 percent of the population.
- All other groups saw their shares decline by 2 to 3 percentage points.
How do we know that it isn’t corporations reinvesting their profits that spurs growth? After all, between 1900 and 2000, real gross domestic product per capita (the output of goods and services per person) grew more than 600 percent.
We know because net business investment declined 70 percent as a share of G.D.P. over that century, says Professor Livingston. In 1900 almost all investment came from the private sector — from companies, not from government — whereas in 2000, most investment was either from government spending (out of tax revenues) or “residential investment,” which means consumer spending on housing, rather than business expenditure on plants, equipment and labor.
In other words, over the course of the last century, net business investment atrophied while G.D.P. per capita increased spectacularly. In other words, corporations decided to spend their profits elsewhere. “The architects of the Reagan revolution tried to reverse these trends as a cure for the stagflation of the 1970s, but couldn’t, said Livingston. In fact, private or business investment kept declining in the ’80s and after. Peter G. Peterson, a former commerce secretary, complained that real growth after 1982 — after President Ronald Reagan cut corporate tax rates — coincided with “by far the weakest net investment effort in our postwar history.”
So even cutting corporate taxes, the cry of conservatives today, hasn’t encouraged corporations to invest in future growth. Professor Livingston has done a great service in what may be a first—actually exploding the myth that profits drive growth. It also explodes the myth that corporations have their customers’ best interests at heart. For their customers are consumers in the main, and consumers’ incomes have not even kept up with inflation. The huge jump in labor productivity has not been shared by their employees, in other words.
On the other hand, it is the investor class that profited immensely from the myth that business investment creates jobs. Even though the historical record shows it merely bloated the financial sector from 8 percent to more than 20 percent of GDP over the past decade, which led to excessive speculation. It was excessive investments in new technology, for instance, that caused the dot-com bubble and market crash in 2000. Then came the housing bubble that resulted from overbuilding of housing, fuelled by too easy credit conditions.
“Consumer spending is not only the key to economic recovery in the short term; it’s also necessary for balanced growth in the long term,” says Professor Livingston. “If our goal is to repair our damaged economy, we should bank on consumer culture — and that entails a redistribution of income away from profits toward wages, enabled by tax policy and enforced by government spending. (The increased trade deficit that might result should not deter us, since a large portion of manufactured imports come from American-owned multinational corporations that operate overseas.)”.
We don’t need the traders and the C.E.O.’s and the analysts — the 1 percent — to collect and manage our savings. Instead, we consumers need to save less and spend more in the name of a better future. We don’t need to silence the ant, but we’d better start listening to the grasshopper, says Professor Livingston.
So when will consumers—you and I, that is—wake up to the fact that the future is ours for the taking?
Harlan Green © 2011
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Harlan Since I don’t see massive increases in wages in the near term I still insist that consumption will only grow if we return to the mountain of credit/debt we had up until 2007. I just took a loan at 3.5% to buy a new motorcycle.
A new motorcycle? I thought you economist guys were sane, sober, grumpy types. I’ll have to change my mental image.
David I’ve been riding for 53 years. Longest ride, Florida to Alaska and back, 9500 miles. Last year did Florida to California and back, 6500 miles. After a day in the saddle I am definitely grumpy.
Prof Livingston is just acknowledging reality, folks….It’s always been the 99% that grew economy, and 1% who mostly benefited. But there is a way to turn the tables, thanks to Facebook, Twitter, et. al. The young know how to outflank corporate owned public media that has been responsible for much of the supply-side propaganda that brought Reagan/Bush religious conservatives to power. Remember, Reagan was a fundamentalist, son of alcoholic father who believed in literal Bible, Medicare was socialism, etc., but would media expose this side of him?….no…Editor
The choice is stark. As I and many others have been saying for the last two years we must boost consumption to revive the economy. The choice lies in how to get the funds to boost consumption. One can follow Livingston and the Occupy Wall Street crowd to stripping the rich of their wealth and redistributing it to the new “poor,” the middle class or follow my suggestion of returning to borrowing the money from the rich to spend. I don’t see starting a revolution over a 3% interest rate.
I am not an economist. I remember all those graphs and get dizzy. However, I do believe in looking at history for its economic implications. This is my take:
The Depression, among other things, suppressed consumer demand because no one had any money. When WWII came, the federal government spent big time, but consumer demand was further suppressed. The wages made during the War went into savings, a lot into what were then called “War Bonds.” The economy benefits from the release of pent up consumer demand in the 50s and 60s.
After the war, Congress passed the G.I. Bill. This guaranteed that everyone who served had access to house without a down payment and could get a college education, courtesy of Uncle Sam. Those benefits were not limited to the GIs of WWII, but accrued to every man who served in the military, included the reluctant draftees.
Because of the low birth rate during the Depression, practically every able bodied man was drafted or volunteered for the military and thus earned the benefits of the GI Bill. Home ownership and a college degree built the middle class.
Medicare passed in 1965, also bolstered the middle class. It meant that retirees did not have to exhaust their savings to pay for medical care and were free to pass on an estate to their children. It also meant that the younger generations did not have to subsidize their parents medical care.
I love the idea of making credit costs tax deductible. But, I do not think that extending credit, alone, is the way back to consumer spending economic recovery.
The GI Bill simply extended a subsidized loan to buy a home. But it was still a loan and without it demand for housing would not have grown so fast. Medicare simply shifted what had been a heavy burden on state budgets to the Federal government. Old folk were formerly housed in state institutions. Now they are housed in senior care facilities paid for by Medicare and Medicaid.
My basic point is that the zenith of our economy reached in 2007 was based on a mountain of credit. No mountain means smaller economy. If you are a member of the “Small is beautiful” club then all is ok. But if you yearn for the higher level of employment and other benefits of our more robust economy, you must accept a new “mountain” of credit.
No, Leo, I disagree. The states were not taking care of the elderly prior to Medicare. That is a gross misunderstanding. I speak from my experience working in “welfare” in the sixties. Most elderly poor did not receive medical care and died early, or their children were required to pay for their care. Of course the VA benefit for homes were a loan, but it made it possible for families to get into homes and begin to build equity.
Your solution is no solution because it presumes that credit will create employment sufficient to pay the interest on the credit, in perpetuity. It is a scheme that mirrors what happened in 2008. I certainly do not have to accept a “mountain” of credit. Nor will I allow my ideas to be dismissed as being part of the “small is beautiful” crowd.
I agree with Joey, Leo; That “mountain of debt” only occurred under Dubya because so much wealth had been shifted to the top 1%. See Krugman’s latest blog…It has to be shifted back to the middle class mainly’ via more progressive taxation, and better regulation that doesn’t allow such a concentration of wealth in the financial sector. Incomes for the 99% have to begin to rise again, in other words. Harlan
To Joey and Harlan, good luck in your campaign to redistribute weatlh via a more “progressive” tax. I prefer recreating our “mountain” of credit, especially when interest payments are as low as 3%. And that “mountain” of credit/debt has been with us since long before “W” was elected.
Again, I don’t think we should have a revolution over a 3% interest rate. Your comments are precisely why I now write that taxation wil be the key issue next year’s election. I hope the tax “wars” will be confined to the ballot box.
Joey
My home town, Washington DC, still has a publicly funded “old folks” home and has had one since before the day I was born. I understood that this was common in all states. However, I guess such has not been the case,
Harlan
I believe we agree that we need to boost consumption to revive the economy. We disagree on how to fund that boost. You want it via taxation to redistribute wealth. I prefer to borrow the funds.
Leo,
One “old folks” home can not begin to replace the support provided to senior citizens via medicare/medicaid. I am sure you know that.
I believe that the “mountain of credit” you describe carries with it the seeds of its own collapse and that is what contributed to the economic crisis of 2008.
The Bush tax cuts were established in 2001, prior to 9/11, because the Clinton administration had left a budget surplus. It was an issue during the 2000 election. Gore wanted “lock box” the budget surplus for social security. Bush wanted to return the surplus to the taxpayers. He won and that was done in the form of the Bush tax cuts, that were limited to ten years.
The surplus quickly disappeared after 9/11. Two wars and the Prescription Drug Benefit were federal expenses that were not paid for. These facts are independent of the economic collapse of 2008. i think it fair to restore the pre Bush tax rates to those segments of the population who have faired well despite the economic problems of the past decade.
Were we are all in agreement is that demand generates economic growth. I believe it is the federal government’s responsibility to help stimulate demand by spending money to create the government jobs that will invest in infrastructure and also put money in those job holders who can then “consume.”
I think we need a short term solution to the current crisis and then address the systematic economic problems. The latter include
aging population, technology replacing the need for workers, and global competition in the form of cheap labor resulting in cheap goods.
Joey
I do not believe it was just “one old folks” home but many. All with whom I have discussed the question have stated that in their particular states there were old folks homes. The largest cost for Medicaid is “old folks” homes now called assisted living and other more poltically correct names. Believe me, this is a “hot” topic down here in “God’s Waiting Room.”
The “locked box” is the Social Security Systems surplus as you state. By law the surplus must be invested in US Treasury Bonds. President Bush wanted to diversify this surplus as one would do with any smart pension fund.
I am amazed at how people attack the Prescription Drug Benefit of Medicare put in place by Bush but say nothing about the rest of Medicare. Is this because a Republican created this benefit while Democrats crafted the rest of Medicare? As for the statement that the drug benefit was “not paid for” I submit that we all know that Medicare will run short of funds in the not too distant future. So none of it has been “paid for.”
Your solution for reviving the economy, Federal Government spending, is precisely what President Obama did in 2009 when we spent the equivalent of 7% of our national GDP to “stimulate” the economy. While it did “stabilize” the economy, it did not “stimulate” the economy. We need another solution, not more of the same.
I fully agree that while we need a short term kick for the economy. But we should make this integral to our efforts to address the systematic problems you describe so well.
Leo,
I am not sure what it is you are suggesting in regard to us “old folks.” If you are saying that medicaid should stop paying for nursing home care when a senior has depleted all resources and instead each state should establish a series of state run nursing homes, then you have to specific how that will save money. It is the care that seriously ill and demented citizens need that is so costly, regardless of where the funding comes from. If you are talking about boarding homes with minimal supervisions, they already exist. But, they can not provide adequate care for the seriously ill and demented. So, you need to get real specific about cost and where you think the states and municipalities will get the money.
There is no Social Security “lock box.” Social security taxes are invested in Treasury Bonds that are virtually an IOU from the government. Gore wanted to put the then budget surplus in a special fund for Social Security that the the government could not “borrow.”
Bush wanted to return the surplus to taxpayers in the form of tax cuts which is what happened.
Bush also wanted to privatize part of Social Security and put the money into the stock market….or as Frank Lutz might put it, “diversify.” It had nothing to do with the budge surplus.
The drug benefit was not “paid for” for an increase in the Medicare tax. There is a real funding problem with Medicare. We are talking right now about where the ongoing debt crisis, today, came from. One source of this problem was a new entitlement benefit that was not “paid for.”
Federal spending did stabilize the economy. Now, that the economy is “stabilized,” federal spending should be used stimulate demand by creating jobs and also federal spending should be used to invest in public infrastructure.
Joey
I made no comment about shedding “old folk” from Medicare or Medicaid. I simply said that Medicare and Medicaid shifted the responsibility for taking care of us “old folk” from the states to the Federal Government. And in fact, Medicaid is funded largely from the Feds, but implemented by the states who usually contract with private copmpanies to handle the program.
Al Gore insisted that the surplus Social Security funds continue to be held in US Treasury Bonds and not be invested in other assets.
The Federal Government borrows from Social Security by selling T Bills to SS and SS, not the Chinese, is the largest holder of the US national debt. If we had diversified investment of the surplus we could have extended the life of Social Security as it is for many more years. T Bonds pay much less than almost any other asset.
I believe all agree, including President Obama, that jobs are created by the private sector, not the public sector. Evidence of this is that for several months now the public sector has been shedding jobs while the private sector has been adding jobs.
Leo, we can’t create a larger ‘mountain of debt’, as you should know. And, we can redistribute wealth by goosing infrastructure, R&E, and other productivity enhancing spending. It has to be done at present by bringing back Clinton era tax rates that takes money away from the nonproductive sector–i.e., the wealthiest who mostly speculate on risky investments–although going back to Eisenhower-era taxation rates would do it faster. Prof. Livingston’s point is that private investment hasn’t done this for the past century, so then who?…Editor
Harlan
“…takes money away from the nonproductive sector …” pretty much sums up the battle lines. The wealthy got wealthy by being productive, if they had not been productive they would have been the poor. As for speculatiing in “risky investments” we have the pesent debacle of the solar panel company that got half a billion dollars, repeat, half a billion dollars from the Feds and then went belly up. At best it was a poor investment decision, at worse a scam.
The “mountain” is, as you have repeatedly stated, the money being “horded” by banks and corporations that could be leant out to consumers to spur consumption. The money is there. You can wrest it from those who hold some of it by higher taxes, although I would like to know how you would get it from the pension funds and insurance funds that hold most of it. Alternatively you can get it for 3% interest a year. I still insist that the latter is an easier path to follow than is the former.
From Leo: “I believe we agree that we need to boost consumption to revive the economy. We disagree on how to fund that boost. You want it via taxation to redistribute wealth. I prefer to borrow the funds.”…
But Leo, you forget it was too much debt that caused the market crash. Consumer’s incomes and corporate profits have to return to 1970 levels as percentage of GDP/total income, which means all the wealthy tax breaks, loopholes, and anti-union, collective bargaining laws must be removed.