One of our consistent messages over the past few years has been that the benefits of the economic recovery have largely accrued to the wealthy and that a more balanced distribution of recovery benefits will be necessary to achieve a stronger (and healthier) economic recovery. In late January we received fresh evidence of the problem in the form of a new study by Barry Z. Cynamon and Steven M. Fazzari. This study does an outstanding job of explaining why the current economic recovery has been so anemic relative to past recoveries.
The new study begins with the familiar refrain that income inequality between the top 5% and bottom 95% of the income distribution has been rising since the early 1980s. This is not a revelation as Thomas Piketty and Emmanuel Saez and others have been tracking this trend for many years. The more interesting points in the new study have to do with the trends since the beginning of the Great Recession. But first some background. Cynamon and Fazzari show that the disparity in consumption growth since the early 1980s has not been nearly as pronounced as the disparity in income growth. Faced with slower income growth relative to the top 5% beginning in the early 80s, the bottom 95% began to spend increasing amounts of their income by lowering their savings rates and increasing their borrowing. Greater borrowing power was made possible by a long, slow deterioration in lending standards. The increase in debt among the bottom 95% was a major contributing factor to the financial crisis. Cynamon and Fazzari: “This crisis was preceded by a falling personal savings rate, starting in the mid-1980s, and a household spending boom financed to a large extent by rising household debt.”
With the advent of the Great Recession in 2007, the trend of lower savings rates and higher consumer debt levels (among the bottom 95%) stopped in its tracks. All but the most creditworthy consumers lost their ability to borrow freely as the banks worked to minimize credit exposure and fortify their balance sheets. Compounding the issue was the seizure of the securitization markets, which were a major source of increased loan supply. As a result of tightening credit, the consumption-income ratio for the bottom 95% contracted dramatically. Cynamon and Fazzari: ” …the cutoff of credit flows to the bottom 95 percent forced their spending down to trigger the Great Recession.” Further, the authors go on to suggest that this reduction in the consumption-income ratio (triggered by tighter credit) during the Great Recession was unprecedented over the period studied. During other recessions, the consumption-income ratio had risen in a process referred to as “consumption smoothing.” This time around, a rising consumption-income ratio did not occur to cushion the economic hit as well as hasten the economic recovery.
What can be gleaned from this new study? Most important, the study provides validation for those (us included) calling for a protracted period of sub-par growth in the US. If 70% of our economy is tied to consumer spending, and 95% of the consumers in the country are faced with scant income growth and much more limited access to loans, then it is relatively difficult to envision a scenario whereby growth accelerates to and sustains at levels seen in prior recoveries. Yes, the top 5% have been doing extraordinarily well, but they cannot continue to pull the sled for the rest of us indefinitely.
In my opinion, we are at an important crossroads. Americans spent the better part of 30 years borrowing against future growth by spending beyond their means and trying to “keep up with the Joneses.” The result has been a deterioration in the aggregate balance sheet of the bottom 95% in the income distribution. As a response to the Great Recession, policymakers have succeeded mostly in widening the income and wealth gaps that had been expanding since 25 years prior to the recession. Those fortunate enough to own assets (read: stocks and houses) have benefited greatly during the recovery, and the wealthiest Americans have indeed driven the income and spending gains since the recession started. At this stage in the game, though, we need to see more evenly distributed spending power. And the answer is not to encourage more irresponsible borrowing through the suppression of interest rates.
Please find the Cynamon and Fazzari study in the link below.