Imagine a world in which those who work — or try to work— are given mere scraps. Imagine an economy that is driven purely by speculation by the wealthy, the gains of which are then spent in high-end stores, the source of employment for those lucky enough to have a job. Imagine economic institutions that puzzle over the slow growth experienced in this economy, uncertain as to the cause.
Imagine no more, because this is the world we live in. Thankfully, however, two economists have finally pieced together the puzzle from disparate fragments of data to explain this malaise.
In a recent study (PDF), Steven Fazzari and Barry Cynamon start with what seems to be a paradox: Keynesian economic theory, together with common sense, tells us that higher-income groups should spend less in relation to their income than lower-income groups. However, since 1980, inequality in the United States has risen enormously, yet household spending has increased to historic highs.
According to the authors, the reason this occurred is that the debt-to-income ratio for the bottom 95 percent of the population rose enormously. Cynamon and Fazzari were then able to break down the rate of consumption among income groups. Looking at this graph (below), we can see that it tells us a great deal about the structure of the U.S. economy.
The authors explain the meekness of the recovery in the U.S. by pointing out that the consumption rate among the bottom 95 percent has failed to return to its prerecession level. This is due to the fact that households are unwilling — and probably unable — to take on more debt to fuel another substantial boom.
We should note, however, how the consumption rate of the top 5 percent of households soared after 2008. The recovery in the U.S., for what it is, is probably explained by this. While Cynamon and Fazzari’s data are for the United States, I am confident that similar trends are taking place across the developed world.
What fueled this consumption boom? While Cynamon and Fazzari do not provide an explanation, evidence points to the gains that the top 5 percent of households have made from rising stock prices thanks to the quantitative easing programs enacted by central banks in the U.S. and the U.K. after the financial crisis.
The way this works is that extremely low interest rates and the massive amounts of liquidity pumped into the banks cause investors to stake out positions in more risky assets, such as stocks. Add the fact that corporations have been using the record profits that they have been receiving since the start of the crisis to engage in share buybacks and dividends and you’ve got a recipe for a stock market boom detached from fundamentals. Economist Robert Shiller’s price-earnings ratio, a key measure of the confidence of stock market investors, rose from its recent low of 15.10 in 2009 to 25.72 in March of 2014 — almost as high as just before the crisis.
A booming stock market is endowing the top 5 percent of the population with money, which they then spend on consumption, while the rest of the country and the economy as a whole struggle. But is this rather weak recovery sustainable?
It just might be. Provided that the top 5 percent keep their animal spirits afloat and continue to recycle money into the stock market, gains in asset prices can buttress high levels of consumption among this group. This seems to provide just enough consumption that the economy recovers to a very limited extent. On the other hand, if investors ever get spooked, the market, followed by the whole economy, could come crashing down.
The massive disparities in income distribution — which have only worsened since the crisis — have given us an economy that is as prone to disequilibrium and collapse as a plate spinning on a stick. And if the animal spirits in the financial markets that are providing momentum ever recede, then we will be left with yet another mess to clean up.