In this post I’m going to weave together a number of threads that have been common themes here. To understand it you’ve got to cast your mind back to 1970. 4% of the U. S. population were immigrants, most of whom had lived in the United States for more than ten years. Imports comprised 5% of GDP. 90% of the wealth and income were held by 90% of the people. The rich were still rich—the top 1% of income earners received about 10% of income with the top .5% receiving about half of that.
Now fast forward to today. 14% of the U. S. population are immigrants, many of whom have been here less than 10 years. Imports are 15% of the U. S. economy. The top 1% of income earners receive about 20% of total income with the top .5% receiving most of it.
What in the heck happened? It is the thesis of this post that the changes can be attributed to changes in the following:
- Federal Reserve policy
By “financialization” I mean the increasing importance of the financial sector to the economy. Since 1970 the percentage of income attributable to the financial sector has grown from 5% to nearly 10% today. That is the largest single factor in the increase in income inequality over the period.
One of the major factors in increasing financialization was interstate branch banking. Interstate branch banking had been made illegal by the McFadden Act of 1927, reinforced by the Bank Holding Company Act of 1956. These were effectively repealed by the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994. The Gramm–Leach–Bliley Act increased the scope of activities in which commercial banks were allowed to operate, culminating in the financial crisis of 2007-2008.
I don’t believe that the Reagan era banking reforms had as much impact as some do. 1994 was a watershed year for financialization and, not coincidentally, for increasing income inequality.
Just as financialization had many causes it had many effects. One of these effects was a drastic change in how businesses invested. In 1970 28% of business investment was in the financial sector. By 2000 half was and, in some cases, as much as 78%. There has been a transmogrification in the idea of the firm from managerial investment in innovation and production to a financial model. Said another way today’s large businesses are less interested in producing more goods more efficiently than in realizing more revenue at less risk.
Since the enactment of the Immigration and Nationality Act of 1965, the percentage of immigrants in the United States has skyrocketed, most of them from Mexico and Central America with limited skills or command of English. That this would promote income inequality should be obvious. Not only has the slack labor market created by immigration held wages down for working class Americans, it has further predisposed American businesses to utilize minimum wage (or sub-minimum wage) labor rather than investing in increased productivity for their workers.
Although globalization began with Japan’s trade policy, subsidizing exports and discouraging imports, it has not ended there. Japan’s model has been successfully emulated, first by South Korea and then by China.
It was one thing when entire supply chains moved from the United States to Japan or South Korea, countries that are, if not actually friendly towards us are at least not actually hostile but another when they extended into China and even moved there wholesale. The enormous loss of American manufacturing jobs in the early Aughts was not a consequence of the operation of the markets. That’s fatuous. It was a direct consequence of policy, first granting China Most Favored Nation trading status and then its admission to the WTO. If it had been a consequence of markets, the job loss would have preceded the policies. It did not.
Federal Reserve Policy
Since the financial crisis of 2007-2008, Federal Reserve policy, specifically its policy of quantitative easing, has explicitly fostered financialization, consolidation of the financial sector, and income inequality. With its track record I do not think it is too extreme to wonder why we have a Federal Reserve at all?
Imagine for a moment that the Federal Reserve had seen its job as one of fostering increased productivity and production rather than ensuring that the DJIA always rose. I don’t know what policies it would have adopted but the U. S. economy would certainly be different.
The factors listed above have worked synergistically to create the economy we have today. They are not the result of market forces in operation or at least not merely the result of market forces in operation but the consequences of policy decisions. That economy is one of increased income inequality with the rich becoming extremely rich while young people don’t see a lot of hope for the future. That is reflected in reduced rates of home ownership, reduced marriage rates, reduced birth rates, and increasing rates of suicide and substance abuse by working age people.
We didn’t arrive at this point because of tax policy and changes in tax policy won’t solve the problems that created our present situation. Neither will giving people “free stuff” for the same reason.
If we don’t solve these problems, things will only go from bad to worse. The divide between the ultra-rich and the rest of us will only get greater. Political dysfunction will become more exaggerated. The professional class will see their incomes increasingly dependent on the federal government. The U. S. economy will become larger but weaker.