Lack of Confidence, Frustration and Alienation

The Congressional Budget Office just released a report Monday indicating that household income between 1979 and 2007 grew by 275% for the top 1% of earners and fell by 2 to 3% for middle class Americans. This disparity has risen even more since 2007.

There are many, many ramifications of this growing income disparity for public policy. One is the sense of unfairness that Americans feel both about the economy and our government. This sense of alienation has contributed to the volatility and polarization we are seeing in politics today. The lack of response by Democrats and Republicans alike has led to spontaneous movements like the Tea Party and Occupy Wall Street.

Secondly, if a higher proportion of the nation's income and wealth is going to the very richest, a segment that spends significantly less of their income than the middle class, could that be contributing a lack of consumer demand in the economy?

On top of this, recent BLS data indicates that the wages of college graduates has fallen steeply since 2000 as college tuition has increased and student debt has sky-rocketed. The estrangement and frustration felt by young people today does not forebode well for the future productivity of our country as college debt increases to record levels in response to sky-rocketing tuition.

The Animal Spirits of Capitalism Continued

I hope that most Americans have finally gotten the message that financial markets aren't necessarily rational and on the down and upside of the business cycle can be absolutely crazy and horribly damaging.

There does seem to be a fair amount of agreement that our economic troubles are caused by a "lack of confidence" in the future, The question is how do you calm these skittish wrecks and move the economy forward. I mean how do you restore confidence to our economy?

I think there are basically two competing paradigms on the restoration of confidence. A supply side approach and a demand side approach.

The supply side approach is the primary approach of the Republicans but also seems to be the dominant theme for Obama's economic advisers. The first step is to restore the confidence of Wall Street by demonstrating calm and moderation. Secondly, you make a commitment to keeping future interest rates and taxes down by cutting the size of government and closing the deficit. Finally, you create even more incentives for investment by lowering tax rates, simplifying the tax system and deregulating the economy. Add to that recipe free trade agreements and tax-free repatriation of foreign profits.

The demand siders assume that the problem is lack of effective demand in the economy. That businesses aren't investing because they are not confident anyone will buy their products. Furthermore, lower taxes or incentives will have little impact since firms are making huge profits and have even larger accumulations of cash which they are not investing. Furthermore, they would argue, that it is deregulation that got us here in the first place.

They would suggest restoring the confidence of consumes by quenching their desire for fairness and ensuring that the people who created the crisis are those who are paying for it. The public doesn't have any confidence in government to a large extent because they believe the government looks after the interest of big corporation and banks and does little to represent them. Perhaps, if there was an effort to create more fairness in the distribution in the costs of the recession and lay the blame where they think it belongs, then consumers may have more confidence, provide more political support for a bigger stimulus and perhaps be willing to go out and spend more. This approach incentivizes buying.

Supply siders respond by saying, nonsense, now you'll really scare them and they will never invest again and take all their money to Greece or China.

What is the answer for restoring confidence? I think a little of each perhaps. Signal to the public that you believe that the middle class and the poor have paid too much of the cost of the recession and that Wall Street and their owners need to pony up a larger share. But combine this with a thoughtful and certain long term deficit plan.

The Animal Spirits of Capitalism

The story of the economy today is a story about confidence. Investors and consumers alike are uncertain about the future and thus they tend to hold on to their money and spend less on big durable goods and investments. The fact that this crisis was precipitated by an over investment in housing making restoring confidence doubly hard.

John Maynard Keynes famously said, "Even apart from the instability due to speculation, there is the instability due to the characteristic of human nature that a large proportion of our positive activities depend on spontaneous optimism rather than mathematical expectations, whether moral or hedonistic or economic. Most, probably, of our decisions to do something positive, the full consequences of which will be drawn out over many days to come, can only be taken as the result of animal spirits - a spontaneous urge to action rather than inaction, and not as the outcome of a weighted average of quantitative benefits multiplied by quantitative probabilities.^[3]

Wall Street is the tale of the bulls and the bears. And the problem is they tend to run in herds. When things look good, investors run with the bulls and when things look bad, they run away with the bears. Rational thought has some bearing on this trend but not so much on either end of the spectrum. When things are going particularly well, irrational exuberance sets in leading to a chain of overinvestment in the latest thing, corruption and ultimately a crash of confidence.

This is all very well and good but what do we do about it? How do we restore confidence, that is the question.

How Comfortable Will Americans be in our Newly Third World Country?

The gini index measures the degree of inequality in the distribution of family income in a country. Because it can have an effect on political stability, income inequality is one of the economic indicators tracked worldwide by the Central Intelligence Agency. Its current World Factbook puts the United States just inside the most unequal third among 184 nations, between Uruguay and Cameroon. Immediately below the USA and Cameroon in the rankings – that is more equal -- are Ivory Coast, Iran, Nigeria, Guyana, Nicaragua, and Cambodia. There are no developed countries with greater inequality. Stability and development tend to go hand in hand.

America has avoided much of the instability, violence and strife that has plagued much of the world largely because of the degree of equality of opportunity that our nation has treasured. This appears to be changing and changing very rapidly.

We have reached the greatest inequality of wealth since statistics have been kept. The top 1% of our wealthiest citizens controls a great percentage of our nation’s wealth than the time of the gilded age of Rockefellers, Carnegies and Mellons.

The financial collapse has hit the poor and the middle class the hardest. Accompanying the economic hit, governments, like the state of Washington, have slashed the safety net, housing, and health care assistance. While the rich have managed to dodge the bullet, Washington's tax system remains that most regressive in the nation. The poor and middle class pay 2 to 4 times the percentage of their income in taxes than the rich. Washington policy-makers have thwarted efforts to maintain some semblance of a safety net by imposing progressive taxes that more closely mirror those of our neighboring states.

One of the key predictors of prosperity is the level of education in a society (the other is union density). Sadly, investment in these arena have been slashed. Washington state has cut funding for higher education by nearly 50% over the past four years as citizens aged 25 to 34 are reported to have less education than those 34 and older.

Will all this lead to greater political and economic instability in the U.S.? Much of that depends on what we do next. How comfortable will middle-class Americans be as a newly third world country?

The gini index measures the degree of inequality in the distribution of family income in a country. The index is calculated from the Lorenz curve, in which cumulative family income is plotted against the number of families arranged from the poorest to the richest. The index is the ratio of (a) the area between a country's Lorenz curve and the 45 degree helping line to (b) the entire triangular area under the 45 degree line. The more nearly equal a country's income distribution, the closer its Lorenz curve to the 45 degree line and the lower its Gini index, e.g., a Scandinavian country with an index of 25. The more unequal a country's income distribution, the farther its Lorenz curve from the 45 degree line and the higher its Gini index, e.g., a Sub-Saharan country with an index of 50. If income were distributed with perfect equality, the Lorenz curve would coincide with the 45 degree line and the index would be zero; if income were distributed with perfect inequality, the Lorenz curve would coincide with the horizontal axis and the right vertical axis and the index would be 100.

A tragedy of our time – jobs go unfilled as the unemployed can’t find jobs

A few weeks ago on September 13, Dr. Douglas W. Elmendorf, director of the Government's official nonpartisan scorekeeper, the Congressional Budget Office testified in front of the newly formed Joint Select Committee on Deficit Reduction. Within the first few minutes of his testimony he said, "Weakness in the demand for goods and services is the principal restraint on hiring, but structural impediments in the labor market—such as a mismatch between the requirements of existing job openings and the characteristics of job seekers—appear to be hindering hiring as well."

The next day, the Wall Street Journal reported that the number of small businesses seeing a skills shortage has crept up this year. In August, 33% of small businesses reported having few or no qualified applicants for job openings, according to a National Federation of Independent Business survey. That was up from 21% in December 2009.

The State Workforce Training and Education Coordinating Board reported last week that key industries in Seattle including Business services, accounting, health care and manufacturing are all expecting major shortages of skilled workers within the next few years. Shortages are expected in occupations like accounting assistants and technicians, industrial machinery mechanics, telecommunications equipment installer and repairers, lab technician and registered nurses.

Is this really the time to make huge cutbacks in education and training? Is it actually costing us less to pay out unemployment benefits, foodstamps and emergency health care?