The Battle for Income Equality

by Dan Lieberman / February 27th, 2024

Questioning the statistics in Thomas Piketty’s best-selling book, Capital in the Twenty-First Century, with intent to undermine his thesis, is futile. Even if Piketty’s alert that returns on investment have exceeded the real growth of wages and economic output, which means that the stock of capital is rising faster than overall economic output, is not exactly accurate, criticism has not upset the conclusions ─ severe income inequality and inequitable wealth distribution doom the capitalist system to collapse and a more narrow wealth distribution keeps it going.

Progressive economists connect meager wage growth to limited purchasing power ─ one cause of the 2008 crash ─ and increased concentration of wealth to cautious job growth in the post-crash years. Their conclusions have engineered debates on how to achieve equitable distributions in wages and wealth and raise middle-class wages, and the roles private industry, government, and labor unions play in achieving a more equitable society.

If private industry refuses to meet its obligations to readjust the divide, Thomas Piketty recommends increasing taxes on high earners and large estates and coupling them with a wealth tax. This method for resolving income inequality gives government a major role in correcting the unequal distributions of income and wealth.

In previous decades, unions had a larger membership, greater clout, and more strength to move management to meet wage demands. Government lacks a mechanism to force corporations to transfer productivity gains into wage gains. Only corporations can do the trick. Not likely. Corporations do not realize the social and economic benefits of decreasing income inequality and increasing middle-class purchasing power. Lowering remunerations to those in top pay brackets and increasing them for lower-income workers is more than a moral obligation; it has direct benefits to the economy for everyone. It is a requirement for achieving a stable economy.

Social costs due to less equitable income and wealth distributions

Rationalizing poorly distributed wealth by noting the American poor are wealthier than the middle class in many developed nations is deceiving. Poverty is defined as an absolute number but its effects are relative. The lower wage earners in the United States are unaware of what they earn in relation to foreigners; they are aware of what they do not earn in relation to others living close to them. The wide disparity in wealth creates resentment and tension and leads to psychological and emotional difficulties. Minimizing social problems means combining giving more to the lower classes and taking less by the upper classes.

The social problems and associated costs in developed nations that have wide distributions of income and wealth are well-documented — elevated mental illness, crime, infant mortality, and health problems. One statistical proof is that the United States, classified as the most unequal of the developed nations, except Singapore, had the highest index of social problems. The graph below from 2010-2011 and an earlier article, Health is a Socio-Economic Problem, describe the important relationships.

Every citizen suffers from and pays for the social problems derived from income inequality, an unfair condition in a democratic society. Private industry has an obligation and an opportunity to fix the problem it has caused. If not, Uncle Sam, whom they don’t want on their backs, will reach into their pockets, redistribute the wealth and resolve the situation.

Income inequality produces wealth concentration and political consequences. Wealthy individuals have increased control of the political debate, more influence in selection of candidates, tend to place their interests before national interests, and determine the direction of political campaigns. Skewing the electoral process distorts government and the decisions that guide social and economic legislation. Severe disparities in the concentration of wealth reduce democratic prerogatives, fair elections, and equality before the law.

The Sunlight Foundation, in an article, The Political 1% of the 1% in 2012 by Lee Dustman, June 2013, presents a fact-filled discussion of this topic.
Note: Although statistics are from ten years ago, they are interesting statistics and are relevant today.

More than a quarter of the nearly $6 billion in contributions from identifiable sources in the last campaign cycle came from just 31,385 individuals, a number equal to one ten-thousandth of the U.S. population.

Of the 1% of the 1%’s $1.68 billion in the 2012 cycle, $500.4 million entered the campaign through a super PAC (including almost $100 million from just one couple, Sheldon and Miriam Adelson). Four out of five 1% of the 1% donors were pure partisans, giving all of their money to one party or the other.

These concerns are likely even more acute for the two parties. In 2012, the National Republican Senatorial Committee raised more than half (54.2 percent) of its $105.8 million from the 1% of the 1%, and the National Republican Congressional Committee raised one third (33.0 percent) of its $140.6 million from the 1% of the 1%. Democratic party committees depend less on the 1% of the 1%. The Democratic Senatorial Campaign Committee raised 12.9 percent of its $128.9 million from these top donors, and the Democratic Congressional Committee raised 20.1 percent of its $143.9 million from 1% of the 1% donors.

To the many billionaires who are tilting election campaigns, add the political contributions by super-sized corporations and industries, and electoral control by the wealthy becomes complete. Campaign contributions from the financial sector, the same financial sector that increased its liabilities from 10 percent of GDP in 1970 to 120 percent of GDP in 2009, and shifted investment from manufacturing to rent-seeking ─ making money the new-fashioned way ─ leads the way.

The Sunlight Foundation article also states:

In 1990, 1,091 elite donors in the FIRE sector (finance, insurance, and real estate).contributed $15.4 million to campaigns ─ a substantial sum at the time. But that’s nothing compared to what they contributed later. In 2010, 5,510 elite donors from the sector contributed $178.2 million, more than 10 times the amount they contributed in 1990.

The Debt of each sector as a percentage of GDP tells the story of the financial sector.
Note: 2022 GDP = $25.4T
          2022 Q4 Debt at the following:
          Total = $89.5T, Household = $19.4T, Business = $20.8T, Finance = $19.3T, Government= $26.8
2022 Percent of GDP at the following:
Household = 72.4%, Business = 81.9%, Finance = 76.8%, Government= 105.5%

The graph shows that the FIRE sector increased its wealth by borrowing money, making the economy work for it rather than working for the economy. The credit enabled the financial industry to grow until it led the nation into the 2008 economic disaster.

The Economic Consequences of Wealth Concentration

What has occurred with wealth concentration? A previous decade indicated a deflection of investment from dynamic industrial processes to static rent situations, from industries that employ workers to make goods to industries that employ money to make money. Graphs from the Bureau of Labor Statistics (BLS) record the trend.

Note: In 2023, Financial sector employment was 9.2M and manufacturing employment was 12.9M.

The graphs plot employment in the manufacturing and financial sectors, Manufacturing had a slow deterioration during the Reagan presidency, followed by stability during the Clinton administration and a sharp decline during the George Bush era. Some deterioration in manufacturing employment is understandable; administrative jobs (clerical, administration) have been displaced by information technologies and these fields have added jobs; factory floor work of consumer goods has been displaced by machines (robot, numerical control) that have their own factory floors; and labor has been transferred from highly labor-intensive manufacturing to service industries. However, the employment loss is excessive and bewildering when compared to the increase in financial employment. Can a healthy economy result from a steady growth in financial workers and a consistent decrease in industrial workers?

Beginning in the Reagan era, until economic collapse in 2008, employment in the financial sector monotonically increased, except for slight blips during the 1991 recession and a few years of the Clinton administration. From a ratio of 1/3 in 1986, financial sector employment rose to 2/3 that of manufacturing employment by 2014, and increased by more than the changes in their respective additions to the Gross Domestic Product. Since the 2009 mini-depression, employment in the financial industry has remained relatively static. The Bureau of Labor Statistics (BLS) shows the value added by each industry.

Manufacturing rose from $1390.1 billion in 1997 to $2079.5 billion in 2013, an increase of 50 percent.
Finance, insurance, real estate, rental, and leasing rose from $1623.1 billion in 1997 to $3293.2 billion in 2013, an increase of 100 percent.

A comparison between salaries of engineers, those who contribute directly to industrial growth, and financiers, those who drive active and passive investments, also reveals the importance given to those who make money from money.

One of the contributors to Capital, Thomas Philipson, in an article Wages and Human Capital in the U.S. Financial Industry: 1909-2006, NBER Working Paper No. 14644, January 2009, shows that wages for the financial sector started a steady growth during the Reagan administration, and eventually exceeded engineering wages, especially for those who had advanced degrees from the elite universities.

As the FIRE industry expands, the purchasing power contracts, one reason being that part of the rent-seeking covets higher returns and gets sidetracked into endless speculation; money rolling over and over and never available to purchase anything but pieces of paper. Millions of arbitrage transactions per second can earn thousands of dollars per second, which adds up to 3.6 million dollars per hour ─ no positive effect on the economy; only paper dollars continually created.

Stagnant labor wages and weak purchasing power force expansion of credit to increase demand, The wealthy respond to credit expansion with accelerated demand for larger houses, larger cars, and more luxury goods, spending that raises asset values and places middle-class earners at a disadvantage. The bottom ninety percent on the income scale desperately pursue debt to give themselves a temporary share of prosperity. Debt must eventually be repaid. Real wealth remains with a privileged few and others remain stagnant.

What is the Result?

Thomas Piketty has reshaped the thinking of the Capitalist system. Economics enables the understanding of how and when to increase demand, enable sufficient purchasing power, and the true meaning of profit.  A better understanding of economics may come from less regard for the conventional economics of modern theorists and more regard for the classical economics of the fathers of political economy ─ Adam Smith, David Ricardo, and Karl Marx. The latter provided a controversial concept ─ wages provide purchasing power, and beyond what is bought by that purchasing power is surplus, whose value allows profit.

Pledge your support

Piketty shows that profits are being sidetracked into passive investments that produce only more capital and not useful goods, into the accumulation of excessive personal wealth, and into financial speculation that features the constant churning of paper money, which removes dollars from the market and creates difficulties for manufacturing to grow. Accumulation of excessive wealth generates social problems, diminishes the quality of life, and burdens the middle class when taxes are used to seek relief.

Capturing the political system by those most responsible for the problems ─ the privileged wealthy who manipulate a portion of the electoral process for their advantage ─ hinders routes to ameliorating the deterrents to a fair and successful economy. Due to their financial and political clout, the wealthy have their voices more easily heard in Congress and before federal agencies.

Karl Marx claimed that Capitalism contains the seeds of its destruction. Those who foster severe income inequality and inequitable wealth distribution apparently want to prove his statement is correct.

Dan Lieberman publishes commentaries on foreign policy, economics, and politics at substack.com. He is author of the non-fiction books A Third Party Can Succeed in America, Not until They Were Gone, Think Tanks of DC, The Artistry of a Dog, and a novel: The Victory (under a pen name, David L. McWellan). Read other articles by Dan.

Let’s Set a Maximum Wage for the Rich

According to ‘Limitarianism,’ no one deserves to be a billionaire. Not even Taylor Swift.

Crawford Kilian 

26 Feb 2024

The Tyee

Imagine a world where Taylor Swift made just $1 million a year and saw most of her wealth taxed away to the benefit of people like the Swifties who splurge on tickets to see her perform. Would we have a more just society? 

Photo by Shanna Madison, Chicago Tribune, via ZUMA Press Wire Service.

Limitarianism: The Case Against Extreme Wealth
Ingrid Robeyns
Penguin Random House (2024)

“Eat the rich” may be an attractive idea to some, but let’s face it: the rich are just too few to go around. Their wealth, on the other hand, offers plenty for all.

Instead of fretting about a minimum wage for the poor, let’s set a maximum wage for the rich. Call it a million dollars a year, salary or investment income, with any excess income going straight into tax revenues.

It’s a sign of our oligarchs’ power that such an idea is almost unthinkable. But Ingrid Robeyns, a philosopher and economist at Utrecht University in the Netherlands, explores in detail the idea of limiting private wealth. In her new book Limitarianism: The Case Against Extreme Wealth, she makes a persuasive case and raises some very serious moral, political and economic problems.

Philosopher and economist Ingrid Robeyns argues that no one needs or deserves more than enough income to live comfortably. 

Author photo by Keke Keukelaar.

The idea of limitarianism, as Robeyns defines it, is that no one needs or deserves more than enough income to live comfortably and securely. At present, she estimates, the local equivalent of a million dollars, pounds or euros should be plenty. Moreover, those making much less than a million would still live quite well thanks to social programs funded by taxing the super-rich.

In fact, such taxation would be simply retrieving the money the super-rich have stolen from us since the 1970s. “Trickle-down” economics actually pumped trillions of dollars out of the working and middle classes and up into the bank accounts of the 0.1 per cent.

Rich, thanks to dumb luck

The neoliberal takeover that began 50 years ago has now instilled in us the false idea that our personal success or failure should be measured in wealth, and derives from our own hard work or the lack of it. Robeyns argues that sheer luck determines wealth or poverty. Put Jeff Bezos and Elon Musk on a desert island, and they’ll be lucky just to survive. Put them in North America in the 1990s, when the taxpayer-funded internet has just gone commercial, and they’ll become billionaires.

Much great wealth has been dubiously acquired. Even under today’s laws, Robeyns says, much of the billionaires’ money is dirty — the proceeds of tax evasion, tax avoidance and plain crime. For example, an international tech corporation may make huge profits in Canada but pay nothing if it declares those profits in Bermuda, which has no corporate tax.

But it might be hard to find the line between dirty and clean money. Robeyns doesn’t mention the wealth gained by tobacco and alcohol corporations, or the makers of ultra-processed foods, or the fossil fuel corporations. She does mention the Sackler family, who gave the world OxyContin and the ensuing opioid disaster. Robeyns argues that the Sacklers should not have kept a single dollar made from such opioids.

Similarly, Robeyns says the bankers who caused the 2008 financial crash should not have been rescued by the taxpayers to the tune of $500 billion: “As the saying goes,” she observes, “‘socialism for the rich and capitalism for the poor.’”

“Capitalism for the poor” also means the poor pay far more than their fair share of taxes. And since the rich are taxed so lightly, governments find they must cut back on social services like health care, public education and environmental services... until they can be outsourced to the private sector, which can make easy profits from diverted tax revenues.


How to acquire $84 trillion without working

The situation is likely to get even worse. Robeyns cites an American financial advice service that predicts “that, among high-net-worth individuals (those with more than $5 million available for investments), a staggering $84 trillion will be transferred to the next generation by 2045. This massive transfer of assets from one generation to the next will see wealth inequality increase significantly in the decades to come.”

She then cites D.W. Haslett, a philosopher who said that if we have abolished the inheritance of political power, it makes sense to abolish the inheritance of economic power as well.

Ordinary people really have no concept of how rich the super-rich are. Robeyns cites Sir Leonard Blavatnik, who in 2021 was ranked the richest man in the United Kingdom thanks to his total wealth of £23 billion. Robeyns offers a thought experiment: “Suppose you work 50 hours a week, between the ages of 20 and 65 — week in, week out; year in, year out. How much would your hourly wage need to be so that, by the end, you’d have amassed £23 billion? The answer is £196,581 [C$334,056] for every working hour for 45 years.”

Robeyns offers a very useful explanation for the super-rich: the wealth defence industry. It was originally defined as a body of well-paid accountants and tax lawyers, dedicated to protecting and increasing the wealth of the top 0.1 per cent (and being very well paid for their efforts).

But the wealth defence industry also includes most political parties, media corporations, think tanks and even the justices of the U.S. Supreme Court who accept gifts and vacations from billionaires. Thanks to wealth defence, the ultra-rich can minimize their taxes (or pay none at all). Deprived of much of the tax revenue they should have, governments even lack the resources to go after tax cheats, much less provide good health care and education.

Wealth defence has effectively moved the Overton window of political discourse and economic policy far to the right. What was perfectly good politics in the 1960s, like Medicare or affordable post-secondary education, now looks politically impossible because the cost would fall on the long-suffering taxpayer — not on the super-rich.

It’s easy to dismiss limitarianism because the super-rich and their money are highly mobile, so they can avoid serious taxation. Elon Musk didn’t like a Delaware court ruling that cost him a $56-billion pay package, so he’s moving his companies to Texas and Nevada. He could move a lot farther, to Bermuda or the Cayman Islands or Liechtenstein, if such tax havens beckoned.

Robeyns is very aware of that, and offers no promises of sudden global transformation. Instead, she suggests reform would be a “patchwork” of steps where a particular country might boost taxes, bring in extra tax revenue and start building up social services. Even that would take careful preparation. “The first and perhaps most important action limitarianism requires,” she writes, “... is to dismantle neoliberal ideology, because it is at the heart of the problems we are facing.”

Many of the super-rich are already demanding to be taxed more, and those who fled to tax havens would be stigmatized (and boycotted) as tax dodgers. They could also suffer the kind of sanctions we now impose on Russian oligarchs, or even see their property nationalized by unsympathetic governments.

Born with a savings account

A universal basic income is one way we might redistribute taxes on the super-rich, but Robeyns points to other possibilities. If all Americans paid the taxes they should pay, she says, “it would mean that the government’s budget would increase by $470 billion. Or, with just above 74 million children currently under the age of 18, it would mean that the U.S. government could open a savings account for each child, and deposit $6,350 in it every year. Each American child would find about $115,000, plus interest, in their account on the day they turned 18.”

So equipped, young people could afford college or trade school, or start a business, or become artists. Employers would have to boost wages or otherwise improve the dull, low-paying jobs young people are now stuck with. (Robeyns says unions should be encouraged, and union-busting be made a criminal offence.)

Another option would be a year of paid national service for everyone, perhaps on high school graduation. It would enable young people to see new parts of the country and to mingle with people unlike themselves. The rich especially live sealed off from the rest of their fellow citizens, and it would do them good to meet some poor ones — at least until inheritance taxes and universal basic income end class segregation.

“In a limitarian society,” Robeyns says, “you would still have the opportunity to be CEO of a major international company, but you could no longer earn millions on a yearly basis.... But this is the price we pay for the massive opening up of opportunities for all other groups, and for making our societies more just.”


The Tyee Reader on Inequality

READ MORE

The rewards of such high-ranking positions would not be measured in income or amassed wealth, but in status: tech bros would brag about the vast sums they’d created for the public, not just for investors. Similarly, Taylor Swift, who currently earns $150 million a year and has a net worth of $1.1 billion, would make just a million a year and would see most of her wealth taxed away — much of it to the benefit of Swifties. Her artistic success would be measured by record sales and concert attendance, not by the $150 million worth of real estate she owns.

“The question we should be asking,” Robeyns writes, “is not whether we should have capitalism or socialism. It is, rather, which specific mix of markets, regulation, distribution, government ownership, private ownership and collective ownership should we have? Making the decision to move towards a new economic system means choosing a new set of rules and institutions. It is essentially a political decision. Choosing these rules and institutions can only be done once we have determined what our collective wants and needs will be.”

Seen through Ingrid Robeyns’ eyes, wealth is a public good, like clean water. In times of drought, we don’t let some people die of thirst so others can fill their swimming pools. Similarly, we could share out the money we make so everyone has enough, and no one goes without. Not even Elon Musk. 

Crawford Kilian is a contributing editor of The Tyee.

 

The Battle for Income Equality

by Dan Lieberman / February 27th, 2024

Questioning the statistics in Thomas Piketty’s best-selling book, Capital in the Twenty-First Century, with intent to undermine his thesis, is futile. Even if Piketty’s alert that returns on investment have exceeded the real growth of wages and economic output, which means that the stock of capital is rising faster than overall economic output, is not exactly accurate, criticism has not upset the conclusions ─ severe income inequality and inequitable wealth distribution doom the capitalist system to collapse and a more narrow wealth distribution keeps it going.

Progressive economists connect meager wage growth to limited purchasing power ─ one cause of the 2008 crash ─ and increased concentration of wealth to cautious job growth in the post-crash years. Their conclusions have engineered debates on how to achieve equitable distributions in wages and wealth and raise middle-class wages, and the roles private industry, government, and labor unions play in achieving a more equitable society.

If private industry refuses to meet its obligations to readjust the divide, Thomas Piketty recommends increasing taxes on high earners and large estates and coupling them with a wealth tax. This method for resolving income inequality gives government a major role in correcting the unequal distributions of income and wealth.

In previous decades, unions had a larger membership, greater clout, and more strength to move management to meet wage demands. Government lacks a mechanism to force corporations to transfer productivity gains into wage gains. Only corporations can do the trick. Not likely. Corporations do not realize the social and economic benefits of decreasing income inequality and increasing middle-class purchasing power. Lowering remunerations to those in top pay brackets and increasing them for lower-income workers is more than a moral obligation; it has direct benefits to the economy for everyone. It is a requirement for achieving a stable economy.

Social costs due to less equitable income and wealth distributions

Rationalizing poorly distributed wealth by noting the American poor are wealthier than the middle class in many developed nations is deceiving. Poverty is defined as an absolute number but its effects are relative. The lower wage earners in the United States are unaware of what they earn in relation to foreigners; they are aware of what they do not earn in relation to others living close to them. The wide disparity in wealth creates resentment and tension and leads to psychological and emotional difficulties. Minimizing social problems means combining giving more to the lower classes and taking less by the upper classes.

The social problems and associated costs in developed nations that have wide distributions of income and wealth are well-documented — elevated mental illness, crime, infant mortality, and health problems. One statistical proof is that the United States, classified as the most unequal of the developed nations, except Singapore, had the highest index of social problems. The graph below from 2010-2011 and an earlier article, Health is a Socio-Economic Problem, describe the important relationships.

Every citizen suffers from and pays for the social problems derived from income inequality, an unfair condition in a democratic society. Private industry has an obligation and an opportunity to fix the problem it has caused. If not, Uncle Sam, whom they don’t want on their backs, will reach into their pockets, redistribute the wealth and resolve the situation.

Income inequality produces wealth concentration and political consequences. Wealthy individuals have increased control of the political debate, more influence in selection of candidates, tend to place their interests before national interests, and determine the direction of political campaigns. Skewing the electoral process distorts government and the decisions that guide social and economic legislation. Severe disparities in the concentration of wealth reduce democratic prerogatives, fair elections, and equality before the law.

The Sunlight Foundation, in an article, The Political 1% of the 1% in 2012 by Lee Dustman, June 2013, presents a fact-filled discussion of this topic.
Note: Although statistics are from ten years ago, they are interesting statistics and are relevant today.

More than a quarter of the nearly $6 billion in contributions from identifiable sources in the last campaign cycle came from just 31,385 individuals, a number equal to one ten-thousandth of the U.S. population.

Of the 1% of the 1%’s $1.68 billion in the 2012 cycle, $500.4 million entered the campaign through a super PAC (including almost $100 million from just one couple, Sheldon and Miriam Adelson). Four out of five 1% of the 1% donors were pure partisans, giving all of their money to one party or the other.

These concerns are likely even more acute for the two parties. In 2012, the National Republican Senatorial Committee raised more than half (54.2 percent) of its $105.8 million from the 1% of the 1%, and the National Republican Congressional Committee raised one third (33.0 percent) of its $140.6 million from the 1% of the 1%. Democratic party committees depend less on the 1% of the 1%. The Democratic Senatorial Campaign Committee raised 12.9 percent of its $128.9 million from these top donors, and the Democratic Congressional Committee raised 20.1 percent of its $143.9 million from 1% of the 1% donors.

To the many billionaires who are tilting election campaigns, add the political contributions by super-sized corporations and industries, and electoral control by the wealthy becomes complete. Campaign contributions from the financial sector, the same financial sector that increased its liabilities from 10 percent of GDP in 1970 to 120 percent of GDP in 2009, and shifted investment from manufacturing to rent-seeking ─ making money the new-fashioned way ─ leads the way.

The Sunlight Foundation article also states:

In 1990, 1,091 elite donors in the FIRE sector (finance, insurance, and real estate).contributed $15.4 million to campaigns ─ a substantial sum at the time. But that’s nothing compared to what they contributed later. In 2010, 5,510 elite donors from the sector contributed $178.2 million, more than 10 times the amount they contributed in 1990.

The Debt of each sector as a percentage of GDP tells the story of the financial sector.
Note: 2022 GDP = $25.4T
          2022 Q4 Debt at the following:
          Total = $89.5T, Household = $19.4T, Business = $20.8T, Finance = $19.3T, Government= $26.8
2022 Percent of GDP at the following:
Household = 72.4%, Business = 81.9%, Finance = 76.8%, Government= 105.5%

The graph shows that the FIRE sector increased its wealth by borrowing money, making the economy work for it rather than working for the economy. The credit enabled the financial industry to grow until it led the nation into the 2008 economic disaster.

The Economic Consequences of Wealth Concentration

What has occurred with wealth concentration? A previous decade indicated a deflection of investment from dynamic industrial processes to static rent situations, from industries that employ workers to make goods to industries that employ money to make money. Graphs from the Bureau of Labor Statistics (BLS) record the trend.

Note: In 2023, Financial sector employment was 9.2M and manufacturing employment was 12.9M.

The graphs plot employment in the manufacturing and financial sectors, Manufacturing had a slow deterioration during the Reagan presidency, followed by stability during the Clinton administration and a sharp decline during the George Bush era. Some deterioration in manufacturing employment is understandable; administrative jobs (clerical, administration) have been displaced by information technologies and these fields have added jobs; factory floor work of consumer goods has been displaced by machines (robot, numerical control) that have their own factory floors; and labor has been transferred from highly labor-intensive manufacturing to service industries. However, the employment loss is excessive and bewildering when compared to the increase in financial employment. Can a healthy economy result from a steady growth in financial workers and a consistent decrease in industrial workers?

Beginning in the Reagan era, until economic collapse in 2008, employment in the financial sector monotonically increased, except for slight blips during the 1991 recession and a few years of the Clinton administration. From a ratio of 1/3 in 1986, financial sector employment rose to 2/3 that of manufacturing employment by 2014, and increased by more than the changes in their respective additions to the Gross Domestic Product. Since the 2009 mini-depression, employment in the financial industry has remained relatively static. The Bureau of Labor Statistics (BLS) shows the value added by each industry.

Manufacturing rose from $1390.1 billion in 1997 to $2079.5 billion in 2013, an increase of 50 percent.
Finance, insurance, real estate, rental, and leasing rose from $1623.1 billion in 1997 to $3293.2 billion in 2013, an increase of 100 percent.

A comparison between salaries of engineers, those who contribute directly to industrial growth, and financiers, those who drive active and passive investments, also reveals the importance given to those who make money from money.

One of the contributors to Capital, Thomas Philipson, in an article Wages and Human Capital in the U.S. Financial Industry: 1909-2006, NBER Working Paper No. 14644, January 2009, shows that wages for the financial sector started a steady growth during the Reagan administration, and eventually exceeded engineering wages, especially for those who had advanced degrees from the elite universities.

As the FIRE industry expands, the purchasing power contracts, one reason being that part of the rent-seeking covets higher returns and gets sidetracked into endless speculation; money rolling over and over and never available to purchase anything but pieces of paper. Millions of arbitrage transactions per second can earn thousands of dollars per second, which adds up to 3.6 million dollars per hour ─ no positive effect on the economy; only paper dollars continually created.

Stagnant labor wages and weak purchasing power force expansion of credit to increase demand, The wealthy respond to credit expansion with accelerated demand for larger houses, larger cars, and more luxury goods, spending that raises asset values and places middle-class earners at a disadvantage. The bottom ninety percent on the income scale desperately pursue debt to give themselves a temporary share of prosperity. Debt must eventually be repaid. Real wealth remains with a privileged few and others remain stagnant.

What is the Result?

Thomas Piketty has reshaped the thinking of the Capitalist system. Economics enables the understanding of how and when to increase demand, enable sufficient purchasing power, and the true meaning of profit.  A better understanding of economics may come from less regard for the conventional economics of modern theorists and more regard for the classical economics of the fathers of political economy ─ Adam Smith, David Ricardo, and Karl Marx. The latter provided a controversial concept ─ wages provide purchasing power, and beyond what is bought by that purchasing power is surplus, whose value allows profit.

Piketty shows that profits are being sidetracked into passive investments that produce only more capital and not useful goods, into the accumulation of excessive personal wealth, and into financial speculation that features the constant churning of paper money, which removes dollars from the market and creates difficulties for manufacturing to grow. Accumulation of excessive wealth generates social problems, diminishes the quality of life, and burdens the middle class when taxes are used to seek relief.

Capturing the political system by those most responsible for the problems ─ the privileged wealthy who manipulate a portion of the electoral process for their advantage ─ hinders routes to ameliorating the deterrents to a fair and successful economy. Due to their financial and political clout, the wealthy have their voices more easily heard in Congress and before federal agencies.

Karl Marx claimed that Capitalism contains the seeds of its destruction. Those who foster severe income inequality and inequitable wealth distribution apparently want to prove his statement is correct.

Dan Lieberman publishes commentaries on foreign policy, economics, and politics at substack.com. He is author of the non-fiction books A Third Party Can Succeed in America, Not until They Were Gone, Think Tanks of DC, The Artistry of a Dog, and a novel: The Victory (under a pen name, David L. McWellan). Read other articles by Dan.

 

Entrepreneurs’ stock losses bruise their businesses

Company growth stalls when an owner’s personal portfolio takes a hit

Peer-Reviewed Publication

UNIVERSITY OF TEXAS AT AUSTIN

When a recession takes a bite out of an entrepreneur’s personal stock portfolio, does that person’s business suffer more than those of older and larger competitors? 

New research by Marius Ring, assistant professor of finance at Texas McCombs, finds a link between the wealth of small-business owners and the health of their companies during economic downturns. When their stock portfolios lose value, their businesses suffer ripple effects: less financing and curtailed hiring. 

“Entrepreneurial wealth follows the ups and downs of economic cycles,” Ring says. “I show that for entrepreneurs whose stock portfolios take a hit, their businesses are adversely affected to a greater extent than established businesses.”

Such business constrictions are concentrated among younger companies, he noted, because older companies have more financial options. 

Ring studied stock portfolios of entrepreneurs during the 2008-2009 financial crisis in Norway, where detailed income and investing data are available. He merged the data with information from education and employment registers to trace the crash’s impacts on investors, the businesses they own, and their employees.

He found that owners’ stock shortfalls hurt businesses in multiple ways, with fledgling companies faring worse.

Hiring Hiatuses. A stock loss of 10% reduced employment growth by an average 5 percentage points from 2007 to 2010. In younger companies, job levels still had not recovered five years after the crisis began.

Shrinking employment resulted not from firings, but from less hiring. Says Ring, “Investing in new employees is likely not a top priority in a recession.” 

Investment Lessened. A 10% drop in the owner’s wealth led to cutbacks in capital available for business growth. 

• It reduced injections of outside equity 22%.
• For younger companies, it meant an 84% decline in the two-year rate of investment in plants and property.

Why are younger businesses more sensitive to their owners’ investment setbacks? The answer, says Ring, is that “more mature firms seem to be able to substitute other sources of financing, such as banks.”

Mature companies, he found, took on more bank debt after an owner’s wealth shock. Younger ones, on the other hand, saw a decrease in bank debt.

An important policy question, says Ring, is whether reduced business activity is driven more by financial forces or by psychological ones, such as a decrease in entrepreneurs’ willingness to take risks. 

His results suggest that financial constraints are more likely at play. That means government interventions, such as small-business lending subsidies, might help counter those constraints and help small businesses weather recessions. 

“Small businesses are important in most economies, and most of these firms rely heavily on their owners for financing,” Ring says. “Owners can be a viable source of financing, but unfortunately, the owner’s personal wealth is likely to be hit at the same time as the firm is experiencing a downturn.” 

“Entrepreneurial Wealth and Employment: Tracing Out the Effects of a Stock Market Crash” is published inThe Journal of Finance.

 

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JOURNAL

The Journal of Finance

DOI

10.1111/jofi.13280 

METHOD OF RESEARCH

Observational study

SUBJECT OF RESEARCH

People

ARTICLE TITLE

Entrepreneurial Wealth and Employment: Tracing Out the Effects of a Stock Market Crash

Defusing the Derivatives Time Bomb: Some Proposed Solutions

by Ellen Brown / February 16th, 2024

The “protected class” is granted “safe harbor” only because their bets are so risky that to let them fail could crash the economy. But why let them bet at all?

This is a sequel to a January 15 article titled “Casino Capitalism and the Derivatives Market: Time for Another ‘Lehman Moment’?”, discussing the threat of a 2024 “black swan” event that could pop the derivatives bubble. That bubble is now over ten times the GDP of the world and is so interconnected and fragile that an unanticipated crisis could trigger the collapse not just of the bubble but of the economy. To avoid that result, in the event of the bankruptcy of a major financial institution, derivative claimants are put first in line to grab the assets — not just the deposits of customers but their stocks and bonds. This is made possible by the Uniform Commercial Code, under which all assets held by brokers, banks and “central clearing parties” have been “dematerialized” into fungible pools and are held in “street name.”

This article will consider several proposed alternatives for diffusing what Warren Buffett called a time bomb waiting to go off. That sort of bomb just detonated in the Chinese stock market, contributing to its fall; and the result could be much worse in the U.S., where the stock market plays a much larger role in the economy.

The Chinese Derivative Crisis

A January 30 article on Bloomberg News notes that “Chinese stocks’ brutal start to the year is being at least partly blamed on the impact of a relatively new financial derivative known as a snowball. The products are tied to indexes, and a key feature is that when the gauges fall below built-in levels, brokerages will sell their related futures positions.”

Further details are in a January 23rd  article titled “’Snowball’ Derivatives Feed China’s Stock Market Avalanche.” It states, “China’s plunging stock market is leading to losses on billions of dollars worth of derivatives linked to the country’s equity indexes, fuelling further selling as retail investors offload their positions…. Snowball products are similar to the index-linked products sold in the 2008 financial crisis, with investors betting that U.S. equities would not fall more than 25% or 30%,” which they did.

Chinese shares rose on February 6, as officials took measures to prop up the ailing market, including imposing new “zero tolerance” curbs for malicious short selling.

The Greater U.S. Threat

The Chinese stock market is much younger and smaller than that in the U.S., with a much smaller role in the economy. Thus China’s economy remains relatively protected from disruptive ups and downs in the stock market. Not so in the U.S., where speculating in the derivatives casino brought down international insurer AIG and investment bank Lehman Brothers in 2008, triggering the global financial crisis of 2008-09. AIG had to be bailed out by the taxpayers to prevent collapse of the too-big-to-fail derivative banks, and Lehman Brothers went through a messy bankruptcy that took years to resolve.

In a December 2010 article on Seeking Alpha titled “Derivatives: The Big Banks’ Quadrillion-Dollar Financial Casino,” attorney Michael Snyder wrote, “derivatives were at the heart of the financial crisis of 2007 and 2008, and whenever the next financial crisis happens, derivatives will undoubtedly play a huge role once again…. Today, the world financial system has been turned into a giant casino where bets are made on just about anything you can possibly imagine, and the major Wall Street banks make a ton of money from it. The system … is totally dominated by the big international banks.”

The Speculators Dominate the Regulators

In a 2009 Cornell Law Faculty publication titled How Deregulating Derivatives Led to Disaster, and Why Re-Regulating Them Can Prevent Another, Prof. Lynn Stout proposed stabilizing the market by returning to 20th century derivative rules. She noted that derivatives are basically wagers or bets, and that before 2000, the U.S. and U.K. regulated derivatives primarily by a common‐law rule known as the “rule against difference contracts.” She explained:

The rule against difference contracts did not stop you from wagering on anything you liked: sporting contests, wheat prices, interest rates. But if you wanted to go to a court to have your wager enforced, you had to demonstrate to a judge’s satisfaction that at least one of the parties to the wager had a real economic interest in the underlying and was using the derivative contract to hedge against a risk to that interest.… Using derivatives this way is truly hedging, and it serves a useful social purpose by reducing risk.

… Under the rule against difference contracts and its sister doctrine in insurance law (the requirement of “insurable interest”), derivative contracts that couldn’t be proved to hedge an economic interest in the underlying were deemed nothing more than legally unenforceable wagers.

… Hedge funds, for example, should really call themselves “speculation funds,” as it is quite clear they are using derivatives to try to reap profits at the other traders’ expense.

The rule against difference contracts died in 2000, when the US embraced wholesale deregulation with the passage of the Commodity Futures Modernization Act (CFMA):

The CFMA not only declared financial derivatives exempt from CFTC or SEC oversight, it also declared all financial derivatives legally enforceable. The CFMA thus eliminated, in one fell swoop, a legal constraint on derivatives speculation that dated back not just decades, but centuries. It was this change in the law—not some flash of genius on Wall Street—that created today’s $600 trillion financial derivatives market.

The Casino Gets Special Privileges

Not only are speculative derivatives now legally enforceable, but under the Bankruptcy Act of 2005, derivative securities enjoy special protections. Most creditors are “stayed” from enforcing their rights while a firm is in bankruptcy, but many derivative contracts are exempt from these stays. Similarly, under the Dodd Frank Act of 2010, derivative claimants have “super-priority” in the bankruptcy of a financial institution. They are privileged to claim collateral immediately without judicial review, before bankruptcy proceedings even begin. Depositors become “unsecured creditors” who can recover their funds only after derivative, repo and other secured claims, assuming there is anything left to recover, which in the event of a major derivative crisis would be unlikely.

That’s true not only of the deposits in a bankrupt bank but of stocks, bonds and money market funds held by a broker/dealer that goes bankrupt. Under the Bankruptcy Act of 2005 and Sections 8 and 9 of the Uniform Commercial Code (UCC), “safe harbor” is provided to entities described in court documents as “the protected class.” The customers who purchased the assets have only a “security entitlement,” a weak contractual claim to a pro rata share of a residual pool of fungible assets all held in the name of Cede & Co., the proxy of the Depository Trust and Clearing Corp. (DTCC). As Wall Street financial analyst John Rubino put it in a January 27 podcast:

What we used to think of as a bank bail-in where they take your deposit in order to support a failing bank, that is now spread across the entire financial economy where whatever you have in an account anywhere can just disappear, because they’re going to transfer ownership of it to these big dominant entities out there in the financial system that need those assets in order to keep from blowing up.

Derivative speculators are considered “secured” because they post a portion of what they could wind up owing as “margin,” but why that partial security is superior to the 100% security posted by the depositor or purchaser is not explained. The “protected class” is granted “safe harbor” only because their bets are so risky that to let them fail could crash the economy. But why let them bet at all?

The Solution of the Regulators

The fix of the G20 leaders following the global financial crisis, however, was to force banks to clear over-the-counter derivatives through central counterparties (CCPs), which stand between buyer and seller and protect either party if the other blows up. By March 2020, 60% of credit default swaps and 80% of interest rate swaps were centrally cleared. The problem, as noted in a December 2023 publication by the Bank for International Settlements, is that these measures taken to protect the system can actually amplify risk.

CCPs tend to ask for more collateral than banks did in the pre-crisis world; and when a CCP hikes its initial margin requirement to cover the risk of default, this applies to everyone in the market, meaning cash calls are synchronized. As explained in a May 2022 Reuters article:

It’s logical that CCPs ask for more collateral during a panic: that’s when defaults are most likely. The problem is that margin calls seem to have made things worse. In March 2020, for example, a so-called “dash for cash” saw investors liquidate even prime money-market funds and U.S. Treasury securities.

… [R]ampant margin calls have intensified a financial panic twice in as many years, with central banks effectively bailing out markets in 2020. That’s better than in 2008, when taxpayers had to step in. But the problem of margin calls remains unsolved.

… Central counterparty (CCP) clearing houses should consider asking clients for more collateral during good times to reduce the risk of destabilising margin calls during a financial panic, a Bank of England official said on May 19.

Yet all this, as Michael Snyder observes, is to allow the big international banks to run the largest derivatives casino that the world has ever seen. Why not just shut down the casino? Prof. Stout’s suggested solution is for Congress to return to the pre-2000 rule under which speculative derivative bets were not enforceable in court. That would include reversing the “superpriority” privileges in the Bankruptcy Act of 2005 and the Dodd-Frank Act. But it won’t be a quick fix, as Wall Street and our divided Congress can be expected to put up a protracted fight.

What If the DTCC Goes Bankrupt?

In a 2015 law review article titled “Failure of the Clearinghouse: Dodd-Frank’s Fatal Flaw?,” Prof. Stephen Lubben points to a more ominous risk from pushing all derivatives onto exchanges; and that concern is shared by former hedge fund manager David Rogers Webb in his 2024 book “The Great Taking.” The exchanges are supposed to be safer than private over-the-counter trades because the exchange steps in as market maker, accepting the risk for both sides of the trade. But in a general economic depression, the exchanges themselves could go bankrupt. No provision for that is made in the Dodd-Frank Act, which purports to decree “no more bailouts.” Still, reasons Prof. Lubben, the government would undoubtedly step in to save the market from collapse.

His proposed solution is for Congress to make legislative provision for nationalizing any bankrupt exchange, brokerage or Central Clearing Counterparty before it fails. This is something to which our gridlocked Congress might agree, since under current circumstances it would not involve any major changes, wealth confiscation or new tax burdens; and it could protect their own fortunes from confiscation if the DTCC were to go bankrupt.

Other Possible Federal Solutions

Another alternative that not only could work but could fix Congress’s budget problems at the same time is to impose a 0.1% tax on all financial transactions. See Scott Smith, A Tale of Two Economies: A New Financial Operating System, showing that U.S. financial transactions (the financialized economy) are over $7.6 quadrillion, more than 350 times the U.S. national income (the productive economy). See my earlier article summarizing all that here. On a financial transaction tax curbing speculation in derivatives, see also here, here and here.

There are other possible solutions to customer title concerns. There is no longer a need for the archaic practice of holding all securitized assets in the street name of Cede & Co. The digitization of stocks and bonds was a reasonable and efficient step in the 1970s, but today digital cryptography has gotten so sophisticated that “smart contracts” can be attached by blockchain-like distributed ledger technology (DLT) to digital assets, tracking participants, dates, terms and other contractual details. The states of Delaware and Wyoming have explored maintaining corporate lists of stockholders on a state-run blockchain; but predictably, the measures were opposed. The practice of holding assets in street name has proven very lucrative for the DTCC’s member brokers and banks, as it facilitates short selling and the “rehypothecation” of collateral.

In October 2023, the DTCC reported that it has been exploring adopting DLT; but the goal seems only to be speedier and safer trades. No mention was made of returning registered title to the purchasers of the traded assets, which could be done with distributed ledger technology.

South Dakota’s Innovative Solution

The most readily achievable solution is probably that in a South Dakota bill filed on Jan. 29.  The bill is detailed in a Feb. 2 article titled “You Could Lose Your Retirement Savings in the Next Financial Crash Unless Others Follow This State’s Lead”, which observes:

… [I]f your broker … were to go bankrupt, the broker’s secured creditors (the people to whom the broker owes money) would be empowered to take the investments that you paid for in order to settle outstanding debts….

To avoid a catastrophe in the future, a nationwide movement is desperately needed to alter the existing Uniform Commercial Code. Of course, that won’t be easy to accomplish, especially because bank lobbyists and other powerful financial interests will almost certainly fight kicking and screaming to stop policymakers from taking away their advantage over consumers.

The good news is, this “great taking” can be stopped at the state level. Americans don’t need to count on a divided Congress to get the job done. Because the UCC is state law, state lawmakers can take concrete steps to restore the property rights of their constituents and protect them in the event of a financial crisis.

On Monday, South Dakota legislators introduced a bill that would do just that. The legislation would ensure that individual investors have priority over securities held by brokerage firms and other intermediaries.

It would also alter jurisdictional provisions so that cases are determined in the state of the individual investor, rather than the state of the broker, custodian or clearing corporation. This would ensure that individual investors are able to rely on the laws of their local state.

Hopefully, other states will follow South Dakota’s lead. Tennessee, for one, is reported to have such a bill in the works.

• This article was first posted on ScheerPost.

Ellen Brown is an attorney, founder of the Public Banking Institute, and author of twelve books, including the best-selling Web of Debt, The Public Bank Solution, and Banking on the People: Democratizing Money in the Digital Age. She also co-hosts a radio program on PRN.FM called “It’s Our Money.” Her 400+ blog articles are posted at EllenBrown.com. This article was first published in Scheer Post. Read other articles by Ellen.