The Fix We’re In


THE FIX WE’RE IN….Via Tim Fernholz, Rutgers history professor James Livingston offers his take on the core cause of our current financial meltdown. Naturally I like it, since it confirms many of my existing prejudices about the matter, so maybe you’ll like it too:

The Great Depression was the consequence of a massive shift of income shares to profits, away from wages and thus consumption, at the very moment — the 1920s — that expanded production of consumer durables became the crucial condition of economic growth as such. This shift produced a tidal wave of surplus capital that, in the absence of any need for increased investment in productive capacity (net investment declined steadily through the 1920s even as industrial productivity and output increased spectacularly), flowed inevitably into speculative channels, particularly the stock market bubble of the late 20s.

….[Likewise], a shift of income shares away from wages and consumption, toward profits, has characterized the pattern of economic growth and development over the last twenty-five years….The offset to this massive shift of income shares came in the form of increasing transfer payments — government spending on social programs — since the 1960s; these payments were the fastest growing component of labor income (10 percent per annum) from 1959 to 1999. The moment of truth reached in 1929 was accordingly postponed. But then George Bush’s tax cuts produced a new tidal wave of surplus capital with no place to go except into real estate, where the boom in lending against assets that kept appreciating allowed the “securitization” of mortgages — that is, the conversion of consumer debt into promising investment vehicles.

….And while consumers were going deeper into debt to service the current account deficit and finance economic growth, corporations were abstaining from investment: “The recent household deficit more than offset the persistent financial surplus in the business sector. For a period of six years — the longest since the second world war — US business invested less than its retained earnings.” (FT 8/22/07, p. 13)

….So the Bush tax cuts merely fueled the housing bubble — they did not, and could not, lead to increased productive investment. And that is the consistent lesson to be drawn from fiscal policy that corroborates the larger shift to profits, away from wages and consumption.

I’ll leave it to economists to argue over whether Livingston is right in detail. But the confluence of stagnant middle class wages; the resultingly vast pools of idle money looking for places to go; a rising federal deficit and a skyrocketing current account deficit; and then a series of tax cuts to make it all even worse — that’s the big-picture core of what’s wrong with our economy. It won’t get fixed overnight, but the sooner we start the better.

POSTSCRIPT: And on a similar note, how about that capital gains tax cut in 1997, passed just in time to direct even vaster streams of cash into the dotcom bubble? Not such a good idea in retrospect, was it?

UPDATE: See Tyler Cowen here and Daniel Davies here for related thoughts. Though, really, I’m not sure “related” is quite the right word. But beneath the surface there’s a sort of family resemblance.

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