Sunday, July 20, 2014
ECONOMICS 101 Why the U.S. is in such an economic mess
by Allen Laudenslager and Bryan Neva
How are the current economic policies working out for you? Salaries and buying power for the vast majority of Americans have been declining for decades. In 1972, the average hourly earnings was $20 per hour; in 2008 it was $18 per hour (in constant 2008 dollars). And over that same period, the cost of life’s essentials have risen a staggering 176%! Despite the official unemployment rate of around 6%, a staggering number of Americans have dropped out of the workforce entirely. The middle class is shrinking as more Americans than ever are receiving some sort of government assistance while at the same time corporations are recording record profits. The rich are literally getting richer and the poor are literally getting poorer.
We believe there are several reasons for the current economic mess the United States currently faces, but the the biggest single element is the decision makers fundamental failure to understand how the economy really works. This lack of understanding stems from accepting some wrongheaded, common wisdom that is represented by these three adages:
1. Wealth trickles down from the top;
2. A rising tide lifts all boats;
3. Nothing happens till somebody sells something.
Far too many people who should know better (including trained economists, politicians, and most of all the pundits) have heard these economic adages for so long and so often that they have come to believe them as the gospel truth. In fact, these statements are misstatements, if not outright perversions, of how the economy really works. Trying to formulate economic policy while believing these falsehoods results in government policies and corporate decisions that actually make things worse and not better. These three adages illustrate the huge gap between what many believe and the truth. So let’s look at these one at a time:
Myth 1: Wealth trickles down from the top.
Fact 1: Wealth does not “trickle down” rather it “trickles up!”
We talk about the really rich as the 1%? Why that number? Because as of 2007 the top 1% owned over 33% of the wealth in America. Moreover, the top 10% owned over 71% of the wealth. The bottom 90% of Americans owned the remaining 29% of the wealth. And get this, the bottom 50% of Americans owned only a measly 2.5% of the wealth in America.
If we could magically keep inflation constant, what would happen if we confiscated every single dime of the top 10% of people and gave an equal share to everyone else? Over the course of time the distribution of wealth would end up about the same as when we first started. Why is that? Because the bottom 90% of the population would actually put the bulk of that money back into circulation and the money would “trickle back up” to the corporations, banks, and eventually back into the hands of the wealthy. See, trickle up and not trickle down!
The bottom 90% of the population that just received their windfall from the top 10% would, individually, go out and buy new cars, homes, appliances, etcetera and deposit the rest in a bank. All this money spent would be collected by businesses and be deposited into banks or paid out in dividends to shareholders. Banks are just resource aggregators: a place to collect all those small sums into one big pot so it can be put back out as car, home, or business loans. At some point it gets turned into interest payments to people with large savings or as dividends to people with stocks or bonds. And most of those rich people (that notorious top 10%) don’t spend their entire income, they store their “excess” money in stocks, bonds, and savings accounts.
By understanding that the system only works when the bottom 90% of people have money to spend, you also understand that any injection of money into the system has to be at the bottom and not the top. Giving money to banks as low interest loans is easy for the government but ineffective in priming the economic pump. Similarly, giving tax breaks to large corporations or the rich in hopes they’ll spend their surplus is also ineffective. Injecting that same amount of money in smaller chunks to lots of people is very hard for the government to manage but much more effective in getting that money to circulate.
So why doesn’t the government or their trained economists recommend priming the pump at the bottom rather than the top of the well? Because figuring out how to get the money out to the 90% and then get it back again is a big complicated job; it’s much easier to give big blocks of money to a few large corporations even though it has proven less effective.
Myth 2: A rising tide lifts all boats.
Fact 2: A rising tide can swamp any boat that’s tightly anchored to the bottom.
This one seems to make a lot of sense until you include a couple of inconvenient but essential elements.
The idea is that each of us is one of those boats floating on the surface of the economy and when the economy does well (rises) each of us floats up on that surface. The idea is that more money circulating in the economy is the rising tide. The rising tide also represents inflation and inflation swamps the boats.
The first mistake is not understanding that our economy is like a harbor where lots of boats congregate and boats don’t just float around loose in a harbor, they are tied tightly to the dock or tightly anchored to the bottom (otherwise they’ll drift off and collide with each other). Either way if those ropes are too short when the tide rises those boats gets swamped!
Metaphors can be dangerous when pushed too far, so in this one what are the ropes? The ropes to the dock or to the anchor represent savings and income. The wealthy have enough extra savings and large enough incomes that when the tide of inflation goes up they can let out more rope; the 90% who have much smaller savings and incomes get swamped. For the top 10%, their income and savings are large enough to permit them to “let out some rope” and absorb significant price hikes while the 90% get swamped.
(In real life, a large yacht or ship actually use a heavy anchor and chain. When the anchor is dropped, a large length of chain is also dropped to the bottom. When the tide rises, there’s enough excess chain at the bottom to allow the yacht or ship to rise with the tide. Smaller boats are incapable of carrying a heavy anchor and chain. They must use a smaller anchor and a light marine rope. Any excess rope would allow the small boat to drift in the harbor and collide with other boats.)
What this means for the bottom 90% is that their salaries must increase at least at the same rate as inflation or they must spend less, and that huge number of people spending less (because their money buys fewer things than before) slows the whole economy.
If we accept this metaphor, then the only way a rising tide lifts all boats is if salaries (that metaphorical anchor rope) go up at the same rate as the tide. This tiny but critical adjustment to the “rising tide” theory makes all the difference but gets overlooked because it puts the responsibility squarely on the shoulders of the top 10% to ensure that the wealth gets spread around and not collected by too few people or companies.
Myth 3: Nothing happens till somebody sells something!
Fact 3: Nothing happens till somebody buys something!
While it is true that someone does have to sell something to keep production moving, a lot of product, sold to a wholesaler or on a store shelf doesn’t do much for the economy, it is a superficial viewpoint. The fuller truth is that nothing happens until someone buys something!
You can be the best salesperson in the world but unless your potential customer has money to spend, you’ll never sell a single thing. To buy things, people must have income and income comes from two sources: interest on savings (in whatever form) and salaries. That means that people must first have large enough salaries to afford whatever you’re selling.
What happens to the economic system when food, clothing and shelter take up the majority of the 90%’s income? Why they stop buying luxuries of course and the vast majority of what we produce and sell are not the basics of food, clothing and shelter they are the luxuries of new cars, bigger TV and a smart phone.
Companies operate on the same basic principles as your own family. If you don’t have enough money then you have to cut back on the “nice to have” in order to pay for the “got to have.” Remember when a lot of American companies asked their employees to take pay freezes if not outright pay cuts? And remember when they stopped giving automatic cost-of-living raises? Remember when they began cutting benefits and pensions because they were losing money?
Well, employees accepted those cuts and still were some of the most productive (if not the most productive) in the world. Those cuts by the employees constituted an investment by the employee in the long-term success of the business. Now, when many of those same companies are posting record profits, the employees have every right to expect those same companies to honor the unwritten and unenforceable social contract to return their investment.
In fact it just makes good business sense! Since more people with money to spend means that you have more people to sell to because people with money buy stuff and people without money don’t.
By accepting the truth instead of these fatally flawed adages we can clear our vision of the economic world and use that correct vision to begin fixing our current problems and creating a system to avoid the same kinds of devastating crises in the future.
While changing these three simple beliefs won’t by themselves fix the economy correcting the decision maker’s concepts will go a long way to helping them formulate better policy.
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