How the rich got richer and you got the shaft

The Great Recession and the Great Depression have many similarities.

Real estate comparison: $18.8M West Van waterfront vs $599,000 New West bungalow
VANCOUVER'S WIDENING GAP: A home currently offered at $18.8 million in West Van; a New Westminster bungalow listed at $599,000. (Images from Sotheby's, realtylink.org)

Economists have been scratching their heads for some time now, asking themselves why the economy has been so weak for so long. They've come up with all sorts of theories to explanation the situation: Automation, globalization, fiscal policy, secular stagnation, financialization, etc.

But what if the answer is much simpler than that? What if the biggest problem is income inequality?

Imagine you have a perfectly functioning economy. The working-class would make enough to generate sufficient consumer demand and keep the economy operating at 100 per cent. In addition, their incomes would grow along with the economy.

In this scenario, the wealthy would also make enough to provide sufficient investment capital to satisfy the needs of businesses, as well as the stock and bond markets. Again, in this ideal world, their incomes would grow along with the economy.

This describes the postwar period pretty well. Families were able to afford the standard lifestyle on one income and with relatively low levels of debt. Their incomes also grew with the economy, not just with inflation. At the same time, the wealthy did well, but weren't obscenely rich.

Now imagine the case where — over the course of several decades — the incomes of the working-class stop growing with the economy, while most economic growth ends up going to the wealthy. What would that economy look like?

First, you would expect the working-class to change their behaviour in order to adapt. Many families would no longer be able to maintain their living standards with only one income, so they would send their spouse to work. Then you would see households increase their debt in order to compensate for their lagging incomes.

 

Canada Debt To Disposable Income Ratio


Meanwhile, the wealthy would have more than enough investment capital to satisfy all of the needs of the business community. Therefore, they would begin to look for more creative ways to invest. They might fund internet startups like eToys or Pets.com. They might find new and innovative ways to give mortgages to people who really can't afford them. They might also start speculating in commodities, emerging markets, high-end real estate, etc.

This second scenario describes the last few decades pretty well. It also describes much of the situation that existed in the 1920s and 1930s. The Great Recession and the Great Depression have many similarities.

If this theory is correct, we should see a good distribution of income in the postwar period, and high income inequality in recent decades as well as the 1920s and 1930s.

 

Canada Top 1% Income Share

United States Top 1% Income Share

As is always the case when discussing the economy, the situation is complicated. Some of the other explanations listed earlier have merit, but most of them make many assumptions and conclude that something new and different is happening. The theory that income inequality is responsible for the current situation requires very few assumptions. And, of the many theories for recent economic weakness, income inequality is the only one that also applies to the Great Depression.

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