Back in May, former Reserve Bank of New Zealand advisor and multiple CEO, Terry “Macca” McFadgen, wrote a guest post on MacroBusiness entitled: Will Aussie housing go bust?. He then followed up in August with Big trouble ahead.
Now Terry is back with another serving of ‘Maccanomics’. In this installment, Terry provides a sobering assessment of the inequality that has been growing within the developed world and what it means for societies and economies. This is a must read article. Enjoy!
The developed countries suffer from two chronic conditions-too much debt relative to the amount of income available for debt servicing, and increasingly visible inequalities between “haves” and “have nots” which are putting social fabrics at risk. The first condition can only be solved by debt forgiveness, inflation or solid growth, and the second only by income redistribution or, once again, solid growth.
Solid growth figures loom large in both solutions. It is the magic elixir but sadly the prospect of a surging recovery is fading further and further from view as Europe digs itself into what will probably be a longish recession, the USA staggers along with an economy short of demand and much of Asia struggles with inflationary pressures. It is looking much more like a five year problem than a two year problem.
This new chart from Calculated Risk tells the story for the USA both in terms of the severity of this recession, and the likely timeline to full recovery:
(To put those projections in context, the USA is currently generating new jobs at the rate of approximately 80,000 per month. New jobs of 115,000 per month are needed just to keep pace with population growth).
The economic challenges are obvious, especially the need for sovereign balance sheet repair, and they are manageable within existing social and political frameworks given time and patience although the Eurozone may be the notable exception to that observation.
What is much less clear to Macca is whether the social pressures from the great financial meltdown are in the same category. They might not be.
Income Inequality
Cast your mind back to 1978 (if you weren’t born then don’t worry just keep reading). That was the year when Jimmy Carter was president of the USA, National Airways Corporation was merged with Air New Zealand to create a full national airline, US senate proceedings were broadcast on radio for the first time ever, and Carly Simon, Barry Manilow and the Sex Pistols were big on the airwaves.
The first Holden Commodore was released that year. Britain still had a car industry and Austin released the Marina (it was awful).
If I told you that American, male, blue collar wages had not improved one dime (in real terms) since 1978 you would be inclined to say I was kidding. But I am not-staggering though that statistic may be. In 1978 there were no personal computers, the internet did not exist, carbon paper as a copying device was finally being replaced by word processors (I remember it happening), China was a backward rural nation and the European Union had not been created!
Since then there has been no growth in male real wages in the USA, despite a massive lift in productivity. To be precise, the growth in labour productivity over the period 1980-2009 was 78%. Workers got zip and the entire benefit flowed to shareholders.
Over the last several decades the “lower middle” of the American workforce has been hung out to dry as manufacturing jobs have been lost to China and elsewhere, Unions have been broken, automation has captured what were once jobs for men, and those without College degrees have been consigned to the wages dustbin.
Whilst house prices were forging ahead in the early part of this century, home equity withdrawal (“my house is my ATM”) concealed the devastation of working class incomes. But when that game fell apart in 2008 it left those incomes-and the commensurate value transfer to the holders of capital or smart degrees- exposed to the cold light of day.
Take a look at these jaw droppers:
- In 2000, the average (median) American family earned $64,200 pa in today’s dollars. A decade later, in 2010, that had fallen to $60,400.
- Between 1979 and 2007 after tax incomes of the richest 1% of the American population grew by 275%.They rose by only 65% for the rest of the top 20% of Americans. For the 60% of Americans defined as middle class, after tax incomes grew by about 40%, and for the poorest 20% of the population incomes grew by only 18%. In other words the extremely rich grew fabulously richer, the middle class did just okay after adjusting for inflation, and the bottom rung did badly after inflation.
- The wealthiest 1% of the American population saw their share of the country’s income go from 10% in 1980, to 23.5% in 2007.In other words-nearly a quarter.
- Today, the richest 400 Americans have more wealth in aggregate than the entire bottom 150 million of the population.
Can any civil society survive very long-at peace with itself- with those disparities?
Many forces contributed to the escalation in income inequality but close to the top of the list were executive remuneration policies where rampant greed pushed common sense out the door-especially in investment banking:
- It is estimated that in 2007 the five best paid fund mangers earned more than all the chief executives of the USA’s 500 largest companies. The top three made over $9 billion!
- In 2008 Merrill Lynch lost $27.6 billion and had to be taken over by Bank of America assisted by $10 billion of taxpayer’s money. Yet its management approved bonuses of $3.6 billion that year.
Gorging on remuneration was not limited to the banking sector. Chinn and Frieden (see footnote 2) record that in 1980, the USA’s best paid executives made 100 times the national average wage but by 2007 this had risen to an extraordinary 770 times. By contrast, the ratio in Germany is currently about 40 times.
This madness eventually trickled down through a lot of the global economy. Remuneration committees could point to US trends, argue that their company had to be competitive in the quest for global talent, and pony up the crazy dollars. Even in Australia and New Zealand, CEO remuneration packages moved into the $5m range in quick time-about 100 times average wages and 10 times the amount paid to senior policy makers, medical specialists and senior judges.
It is easy to say that if shareholders want to pay their executives obscene amounts of money then that’s their business and no-one else’s. Macca begs to disagree. Income disparities not based on merit breed anger and incomprehension from those not blessed with largesse. The negative social consequences are shared by us all. Then consider the costs of diverting talent from the pressing issues of the real world including policymaking, academic leadership, medicine, the judiciary-and dare I say it politics. Chinn and Frieden also note that at the height of the Wall St boom in 2007 over 1000 physicists were employed in investment banks working on abstruse mathematical models to value or create financial instruments. Would any sane society allocate resources in that manner?
But stating the problem is easy – getting effective policy responses is not because big money owns Washington – it’s a simple as that. President Obama is reportedly targeting a re-election fund in excess of $100m. You can be sure that families on $60,000 a year are not the funders, and those that are contributing want their patch protected.
In fact, between 1990 and 2010 the financial services industry, including real estate, spent an incredible $2.3billion on federal campaign contributions. How could any politician resist?
The Club Med
Now please cast your eyes eastward to Spain and Italy. Greece captures the headlines but in truth it matters little in money terms representing only 2% of Eurozone GDP.
The larger Mediterranean economies matter a lot. Both economies are perilously poised in terms of their ability to fund themselves as their bond rates have escalated in recent months. In response they are drinking deeply from the cup of fiscal austerity. Further economic contraction seems guaranteed in a process that leads ultimately to self destruction. As each economy cuts deeper to achieve better fiscal balance in the short term, leaving core labour market and competitiveness issues untouched, the young and disaffected vote with their feet.
In Spain, unemployment overall sits at around 21.5%, but youth unemployment is close to 50% and there are 1.4m households where no-one has a job. Unemployment benefits are adequate, but a generation of Spaniards is growing up who have never experienced employment outside the black market and who are unlikely to any time soon. In the meantime, those with jobs are secure-put beyond the reach of normal market forces by laws which protect incumbents.
In May this year the “indignatos” protest movement took to the streets and since then around 7 million Spaniards have participated in protests in over 58 cities. The goals are largely indistinguishable from those espoused by the Occupy Wall Street movement. Indignatos aspire to” upgrade democracy and reduce the influence of economic powers in politics”. They share with OWS a strong antipathy to unemployment, the current two party political system in Spain, capitalism, banks and bankers. It’s all amorphous stuff-gut driven and vague- but compelling enough to get millions onto the street.
How the Spanish situation will resolve is unclear. New elections are scheduled for this month and we will then see the lie of the land.
Now take a look at Italy. This is not a peripheral economy by any means. It’s the 7th largest in the world and what happens there matters everywhere. It is burdened by substantial but not overwhelming public debt (net public debt is 100% of GDP), very low growth, and a political system which is at best”dysfunctional”. For a decade Italy has produced average annual growth close to zero(0.6%pa to be exact) whilst borrowing freely to support an economy marked by terrible productivity, patronage, closed shops, widespread corruption and a black economy thought to be as large as 20% of reported GDP.
In 2009 each worker in Fiat’s Italian factories assembled an average of 30 cars per year, compared with nearly 100 per year in Poland, while being paid more than three times Polish wages. Hello…come in Italy…that just doesn’t work.
Interestingly the burden of Italy’s sick economy falls mainly on the young. The unemployment rate overall is a not very drastic 7.9% but the youth unemployment rate is 29.6%. Basically the young get locked out of the labour market to protect older incumbents in their jobs.
As a result, 40% of Italians in their 30s still live with their parents.
Italy’s economic fundamentals are not terrible but they are poor and the money men have moved against it. No-one has any confidence that a Berlusconi replacement will bring much change because he is (or was) a symptom not a cause.
The country has led a life of grandeur and delusion for well over a decade and has now ended up with a 30% plus productivity differential with the North of Europe. Short of a political and cultural transformation which is surely beyond them, fixing it will require IMF/Eurozone control of the economy for years. In fact that control is already being ceded as the attached copy letter from the European Commission to the Berlusconi government makes crystal clear!
The streets have been quiet so far because the disaffected young can vote with their feet- but for how long?
So What?
Jump into a helicopter and take a look at the developed economies from a decent height. What do you see? Extreme income inequality in the USA coupled with unemployment approaching 18%on the wider “U6” measure and no relief in sight. In the large Club Med economies you see terrible youth unemployment and the looming threat of IMF/ Brussels control. In England you would have seen vicious street riots over this summer before the Coalition’s austerity programme has even started to bite. Then add to this mix the prospect of five to ten years of very limited global growth.
To state the bleeding obvious, that is not a sanguine combination.
But what really makes it dangerous is the breakdown in social equity. The pain of the post financial crisis adjustment is not being borne fairly because the young and the under- skilled are being sacrificed everywhere to incumbents who want their jobs, tax rates, and asset values protected – and who carry the required political clout to get their way. And lest those of us in the commodity belt start feeling smug, have a think about the exclusion of many of our children from home ownership. Family (two bedroom) home ownership in convenient suburbs now starts at the $750,000 level and the required deposit is close to $150,000. This is a level most cannot afford without parental support. We are thus building an ugly two tier society comprising those who have parents wealthy enough to support them into decent home ownership and those who do not. Again, the incumbents are victorious. Property values are supported by supply-side constraints which benefit existing owners, local bodies via rates and development levies, and a host of parasites who feed on the current system. Do not bet on this lasting the next decade.
The past six months or so has been characterized by a remarkable number of spontaneous protest movements across the developed countries including Spain, England (more accurately perhaps riots rather than protests), Israel, and now the USA in the form of the Occupy Wall Street movement. OWS has spawned copycat movements in many places including, somewhat remarkably, Australia and New Zealand.
These movements are currently mostly leaderless, vague in purpose and lacking in credible policy initiatives. But they have deep foundations in perceived discrimination, inequalities and lack of opportunity. And in the USA an intellectual leadership is building quickly amongst academics disappointed by President Obama and sick of Wall Street’s influence in Washington.
Maybe these movements are just a rush of blood to the head and they will fade away. But personally I doubt it. In a recent poll in the USA, 59% of the respondents declared themselves to be “fully” or “strongly” sympathetic to the Occupy Wall Street movement. That sounds to me more like something reminiscent of the anti-apartheid movements of the 1980s or the American civil rights movement of the 1960s, than a passing fad.
Pessimists will say we have been here before of course – high unemployment, a decade of no growth, deep resentments regarding wealth distribution, austerity and currency pressures. It was the early 1930s and on that occasion a nasty little Austrian with no talent other than a superb feel for the mood on the streets came to the fore and wreaked global havoc.
Macca is no such pessimist but he is watching nervously in the hope rather than the conviction that equity will prevail over selfishness – and soon.
