Submitted by Lance Roberts of STA Wealth Management,
Last night on "The Lance Roberts" show I was discussing the ongoing battle surrounding income inequality. The current Administration has taken on the "war on poverty" as its primary battle ground going into the mid-term elections later this year. I quoted Bill Dunkleberg recently in "NFIB/Gallup: Government Is The Problem" in regards to his very salient take on this issue.
"Since it is an election year, the main theme will be addressing the disparities in income and wealth (i.e. tax the rich and increase welfare programs) rather than promoting policies that would create jobs and raise incomes in a growing economy. This year, policy will be all about votes."
This isn't a new fight. As Robert Rector stated recently - that particular war has been less than successful.
"Fifty years and $20 trillion later, LBJ's goal to help the poor become self-supporting has failed."
However, while the Administration will use the argument to garner votes in an election year, the most interesting aspect about the income inequality debate is that it is the very policies of the current Administration that is fueling the income shift. My friend Shane Obata (@sobata416) recently studied the ongoing impact of the Federal Reserve's "quantitative easing" programs as a wealth transfer mechanism from the poor and middle class to the rich. The implications of this transfer effect, as shown in the chart below, on an economy that is nearly 70% driven by personal consumption expenditures suggests that the real "wealth effect" of the Fed's interventions has been a negative rather than a positive.
This wealth transfer is clearly seen in the rise in corporate profitability over the last decade. The drive to increase profits has become the focus of corporate executives and Wall Street which comprise the bulk of the top 1% and are largely compensated by rising asset prices. Chris Brightman from Research Affiliates recently published a piece on corporate profits stating:
"Profits are dangerously elevated by all reasonable measures. S&P 500 Index real earnings per share are far above their long-term historical trend. Industry profit margins are at or near all-time highs. Corporate profits, both as a percentage of GDP and relative to labor income, are at or near record levels. The dramatic rise in income inequality is a direct consequence of this spectacular reallocation of income to capital and away from labor."
The chart below shows corporate profits as both a function of employees and wages which illustrates Chris' point quite clearly.
Those two charts also suggest that, despite hopes of continued profit growth, the ability to increase profits from suppressing employment and wages is both finite and likely nearer its end than the beginning. In other words, what happens to corporate profit growth when there is an inability to extract profitability through cost cutting? Chris makes an interesting point in this regard:
"For nearly a quarter century, we have experienced profits growing at a faster clip than GDP. Extrapolating this trend into the future is speculative at best. Equilibrium real growth in earnings per share cannot exceed real growth in per capita GDP, real growth in wages, and real productivity growth, on a long-term basis, without violating our sense of social fairness: More rapid growth in profits than GDP means a rising share of income to capital. Capital's share cannot rise in perpetuity; social and political forces, if not economic developments, will cause it—sooner or later— to revert to a more usual level.
Many of today's investors uncritically assume that the conditions they have known over the course of their professional careers must be normal. The idea that we may soon experience a multi-decade period of zero or negative growth in real earnings per share, taking the level of profits down to a lower share of national income, seems preposterous. Yet economic history has seen many examples of such a turn, including the 1880–1890s, the World Wars, the 1930s, and the 1970–1980s. In fact, almost every decade except the 1990s and 2000s saw a protracted profits slump. Some declines in profitability lasted most of a decade; others, longer!"
His analysis has severe implications on both the future of the stock market and the inherent "wealth effect" created by the surge in asset prices. Furthermore, this also suggests that the "wealth gap" will be somewhat rectified as a reversion is asset prices negatively impacts the "rich" far more than the "poor." However, did the "leveling of the playing field" do anything to change the income inequality dynamics? Is anyone better off if the rich aren't as "rich?"
Asset price reversions do not fix the inherent problem that currently plagues the middle and lower income classes. While the war on income inequality is a noble one, the reality is that it will remain a losing battle as taking from "the rich" and "give to the poor" it is only a temporary solution. As Walter Williams recently wrote:
"Most of what's said about income inequality is stupid or, at best, ill-informed. Much to their disgrace, economists focusing on measures of income inequality bring little light to the issue.
Except in many instances when government rigs the game with crony capitalism, income is mostly a result of one's productivity and the value that people place on that productivity.
Far more important than income inequality is productivity inequality. That suggests that if there's anything to be done about income inequality, we should focus on how to give people greater capacity to serve their fellow man, namely raise their productivity."
In other words, fixing income inequality is about fixing the problem of productive inequality. As the old Chinese proverb states:
"Give a man a fish he eats for a day, teach a man to fish he eats for a lifetime."
Maybe that is the right place to start if you really want to fix inequality in America.