By Karen Shaw Petrou
In prior blog posts, we’ve looked at recent data on income and wealth to assess U.S. economic equality and the policies that drive it. Depressed that we are, we soldier on and here turn to a new Federal Reserve staff study that puts these two critical indicators together with a third – consumption – in an impressive effort to judge economic equality not just by separate distribution tables, but also by a “multi-dimensional” approach. This looks not only at who has how much income or wealth, but also at who has the most of each along with the greatest amount of consumption. Combining all three measures of prosperity turns out to show that a small group of people who have the most income and wealth control a lot more economic resources than even prior measures of inequality revealed.
Economic equality is fired by an engine in which income and wealth power each other up unless something – a financial crisis, regressive taxation, etc. – chokes it off. Labor income (wages) is the equality engine’s ignition switch. Income is of course used for consumption, but when there’s more than enough for subsistence, it also goes into savings and investments. These generate valuable assets and a return on capital that creates wealth. Wealth creates “capital” income (i.e., interest, dividends, asset-sale proceeds) supporting both more consumption and investment. The more wealth, the more investment, the more capital income and retained wealth. A prudent income/wealth generator that does not divert his or her lucre into consumption (and most wealthy households consume proportionally less than lower wealth ones) then passes on this wealth. With it, the next generation enjoys both capital income and more wealth absent an inheritance tax that forces what would have been theirs to fire up their own labor-income machine.
When this engine works well, there is still inequality – wages will never be the same absent a dictatorship. However, growth, productivity, and fiscal and financial policy give lower-income and -wealth households a fair chance to gain enough labor income and keep enough wealth to ensure inter-generational mobility. This was in fact the situation in the U.S. from about 1938 to 1980, as a comprehensive new world-inequality report makes clear.
The equality engine has only recently been well understood with regard to the interplay between labor and wealth. The consumption dimension is more controversial, in part because the richer a household, the less it consumes as a percentage of income. Assuming that more consumption equals more economic equality – as some conservative economists are prone to do – causes the engine analytics to misfire in many ways. This new Fed study is thus a useful contribution because it goes beyond approaches that equate consumption with wealth.
Instead, the Fed staff study captures consumption data because, as it rightly says, consumption contributes to personal well-being. Most of us aren’t misers – we like stuff. Moreover, as the Fed paper says, we need consumption capacity to secure not just big-screen TVs, but also health care, higher education, personal mobility, and other goods and services critical to security and inter-generational wealth transfer when our day is done.
So, what does the Fed study tell us about U.S. economic equality when looked at from the multi-dimensional “well-being” perspective? Unsurprisingly when four Fed economists fire up their laptops, it’s complicated. But, the paper’s key finding is that:
[U.S.]Inequality in two dimensions and three dimensions increased. The percent of households in the top 5% of two resource measures [income and wealth]and all three measures [adding in consumption]increased between 1989 and 2016, with 44 percent of households in the top 5% of income also in the top 5% of both consumption and wealth in 2016. The share of resources going to the top 5% increased faster in two and three dimensions than in one dimension. These patterns persist when looking at multi-dimensional inequality by quintiles. Only the top quintile gained shares while the four lower quintiles lost shares. …
The values at the top of the distributions dwarf the middle and bottom. The top of the distribution has 4.2 times as much income, 3.1 times as much consumption, and 24.5 times as much wealth as the middle of the distribution. These ratios rose considerably since 1989, with wealth headlining the increase. The ratio of wealth at the 95th percentile to the median increased by 67 percent since 1989. The level and trend in the ratios for income and consumption seem reasonable only in comparison to wealth.
An additional and important contribution of this work are data series run through 2016. With these, we can look not only at these longer-term, distressing trends, but also at what happened before and after the great financial crisis and the post-crisis policies that then redefined the U.S. financial system. As we’ve shown in other work, economic equality was in bad shape before the crisis but gets far worse fast after its shock began to wear off in 2010 and all the new monetary and regulatory policies were put in place.
From a multi-dimensional perspective, the Fed study demonstrates that the post-crisis period shows a bit of a slow-down in the rapid inequality march for income and consumption, but not for wealth. Still more problematic, the bottom fifth of the U.S. population “only had 4.0 percent, 7.6 percent, and -.5 percent of income, consumption, and wealth in 2016.”
For millions of Americans, the economic-equality engine is on the garage floor under a vehicle going nowhere anytime soon. Even a bit of income-share loss leaves them farther behind in terms of wealth because the debt needed to maintain a bit of consumption robs them of any ability to save, let alone invest.
Financial policy isn’t the only problem – low post-tax wages and problematic labor participation derive from many factors. But, the ability to put income into savings is also destroyed by ultra-low interest rates for the few wealth-generating assets for which lower-income households can hope even as unconventional monetary policy distorts asset valuations to make the rich far richer far faster. We’ve shown this before, here and here, but the Fed’s new data show us that it’s even worse than we thought.