Issue Number 03-3, October 2003
Income Disparity: Another Piece of the Puzzle
We are now familiar with top picks in the National Football League draft becoming instant millionaires before they play a single season of professional football. This development is symptomatic of a distinct widening of income disparity in the 1990s as depicted in the following table:
As this table shows rather dramatically, all of the change in shares of aggregate income in the nineties came at the expense of the first four fifths of income recipients and accrued to the top one fifth. Within the top fifth a greater share accrued to the top five percent than to the next highest five percent.
To obtain a dollar value for the shares shown above we will refer to the data for total personal income, which in 2001 equaled $8,685.3 billion. Ten percent, therefore, is $868.5 billion and one percent is $86.9 billion. As the table shows, 3.5 percent more of aggregate income was received by the highest firth in 2001 than in 1990. This, then, is equivalent to a transfer of $304.2 billion from the first four-fifths of income recipients to the top one fifth. 200l also had the dubious distinction of being the first year in which more than 50 percent of aggregate income was received by the highest fifth of households.
Sources of Personal Income
Personal income is broken down into the same categories as national income. The following table shows data for these categories for the years 1990 and 2001.
As the table shows, some income sources advanced considerably more than others during the period covered.
Wage and salary disbursements. These categories constituted 57 percent of total personal income in 2001 and included most of the labor force. Within this category, a breakdown of wage and salary accruals per full-time equivalent employee by industry is available ad follows:
The average person may well question the accuracy of this data. Surely the average full-time employee in 2001 did not earn $39,784. One way to test this is by comparing average weekly earnings, which are also available, with average full time equivalent earnings in the table. Weekly earnings in manufacturing were $603.58 in 2001, which equates to $31,386 per year. This contrasts with the $45,580 shown in the table. Likewise, weekly earnings in retail trade of $282.35 equate to $14,682 whereas the table shows $23,009. These discrepancies no doubt reflect the fact that industry averages in the table include every one from the CEO down to the lowest paid member of the industry. Averaging them is highly misleading.
The average person will also be struck by the variations across industry groups. The highest paid industry is Finance, insurance, and real estate at $63,738. But within this group, the highest paid are Security and commodity brokers at $161,879 while the lowest paid are Real estate at $41,364. Likewise, in Mining, the highest paid are Oil and gas extraction at $68,142 while the lowest are Non metallic metals except fuels at $44,282.
In Services, the largest category by number of employees, there are similar wide disparities. The highest paid are Legal services at $71,019 while the lowest paid are Social services at $22,071 and Private households at $14,975 (the lowest paid group in the table).
Thus, we see that there is a wide disparity from one industry to another, but also wide disparity within industry groupings.
Proprietors' income. Net farm income rose from $44.6 bn in 1990 to only $45.7 bn in 2001, which explains the dismal comparative return to farm proprietors. Other proprietors income, however, grew faster than wage earners'.
Rental, dividend, and interest income. These three categories represent earnings on capital, and together constituted 18.9 percent of total personal income in 2001. Rentals and dividends grew much faster than wages and salaries in the nineties, but interest income lagged due to the historic decline in rates.Transfer payments also grew faster than wages and salaries due to a larger percentage of the population entering this category. Deductions for social insurance rose less, about the same as overall labor income.
Thus far we have shown that aggregate income is greatly concentrated with the top fifth of recipients receiving as much as the other four fifths combined. We have also found that personal income varies widely across broad industry groups and within individual industry groups. We have found that some sources of income such as non farm proprietors, rental, dividend, and transfer grew faster than others from 1990 to 2001 as well. Some additional evidence will now be examined.
The January 2003 Federal Reserve Bulletin published results of the 2001 Survey of Consumer Finances. Following are quotes from this survey.
[These comments underscore the hollowness of the Bush program to cut taxes on dividend income. This income is concentrated in the richest 10 percent of U.S. households, and the tax cut will accentuate the existing disparity. It will not stimulate investment because there is already a surplus of funds available for investment. The net result will be higher and higher Federal deficits and more cuts in social programs. Yet even this absurd proposal has been sold to the American public!]
"Another piece of the puzzle"
The puzzle we refer to is the nature of the current downturn in the U.S. and world economies. We have, simultaneously, excess consumption, excess capacity, and an excess of money. This has led to an absence of inflation in commodities and most manufacturing along with ongoing inflation in asset prices and certain parts of the services sector (health, education, finance, legal, etc.) The challenge is to explain these divergent trends.
One obvious change in the economy is a downturn in investment, but why has this happened at this particular time? There seems to be a twofold answer to this question. First, the long postwar boom in electronics has passed its peak. It began with television and then led to computers and communication, which transformed much of industry and services. The internet was the culminating stage of this phenomenon, but growth now is more like that of older industries, not the explosive growth of the nineties. All of this change absorbed a great deal of capital for decades, resulting in wild excesses that led to the collapse beginning in 2000. Today there is little prospect that these high tech enterprises will offer the perceived investment opportunities they did in the past. And there are no other areas in view that can replace them. In a sense we might say that the pace of technological innovation has slowed, despite all the change that is going on around us.
The second part of the answer to the investment problem has to do with finance. We have seen that there was a pronounced shift of income from the lower four-fifths of families to the top one-fifth. This has notable implications for saving/investment as shown in the following FRB table (Jan. 2003)
The message of the table is that saving is even more concentrated in the upper income brackets than income. More people within a bracket save as you move up the income scale and, with more income, the larger amount they save.
As we discussed in the last Pulse, all income must be recycled into either consumption or saving/investment. As affluence increases, a larger share of income tends to be directed to saving over consumption. Thus, we have a situation where opportunity for profitable investment of saving is shrinking while savings seeking such opportunities are growing. This, in a nutshell, is why we now have short-term Treasury rates of 1.10%, negative after inflation, and dividend yields on the S&P 500 of 1.85% (April 5).
These twin developments have profound implications for public policy and the future of the economy. The proposals now being considered to revive economic growth are aimed at maintaining consumption through growth of government and household debt. They do nothing to address the problem of inadequate investment demand combined with an excess of income seeking investment. These conditions led to the historic inflation of stock and bond prices of the past decade and are today still inflating real estate prices. We need to recycle the excess income now flowing to the top income recipients into sound public investment and into some of the low income groups who are now stressed. But only time and more adversity will force us to face those issues.
The GDP data from the Economist compares the second quarter 2003 with the same quarter a year earlier. All of the countries except Japan declined on this basis. Industrial production rose in Germany and Japan while falling in Canada, the U.K. and the U.S. Retail sales volume increased in the U.S. and Canada but fell in the U.K. Germany and Japan again had negative growth.
Consumer prices (Economic Indicators) rose more strongly in the first half than in 2002 in Canada, the U.K., and the U.S.; in Germany the increase was less, and Japan's prices again declined. Unemployment rates rose in Canada, Germany, and the U.S. with little or no change in Japan and the U.K.
Interest rates rose in Canada but fell elsewhere. The U.S. rate remains the lowest aside from Japan which pursues a "zero interest rate" policy; it is interesting to note that this policy has not led to any revival of growth in that country.
The data we have reviewed are weak to mixed at best, but the stock markets have chosen to regard some stronger data as an indication that economies are again rising. All five indices have, consequently, risen. This may prove justified, or it may indicate nothing more than investor frustration at the low returns available on other investments. With rising prices, the S&P 500 earnings price ratio in June was back to where it was in 1998-2000, which was the lowest in a decade.
The current account surpluses of Canada and Germany grew in the first half while Japan's fell slightly. The British deficit widened considerably, and the U.S. deficit rose to another record of over half a $trillion (a.r.) in the first half, more than double what it was just five years ago.
The U.S. foreign exchange rate index fell from 127.19 in 2002 to 119.11 in July 2003. The Euro rose from $.95 to $1.13, a 19 percent increase. Apparently the demand for dollars is falling.
Real GDP rose 2.4 percent in the second quarter of 2003 after rising 1.4 percent in the first. The largest contributor to these increases was personal consumption expenditures which rose 1.40 and 2.34 percent in the two quarters. Gross private domestic investment turned positive in the second quarter but was still negative for the half. Net exports were negative for the half, but government expenditures and investment was positive.
Industrial production remained weak through June, particularly in non durable manufacturing. The capacity utilization rate, which was 74.9 in December, was still 74.2 in June. Manufacturers' new orders picked up a little in June and July, but the first half level was still below that of 2001.
New construction expenditures continued their historic rise. By July 2003, they were more than $100 million higher than in 1999, with all of the strength concentrated in residential construction, resulting from historically low interest rates.
Gross private investment was essentially flat in the first half with both quarters lower than fourth quarter 2002; renewed inventory liquidation in the second quarter contributed to the malaise.
Business sales in the first half surpassed the previous high set in 2000; inventories also rose but did not equal the previous high. Retail sales never actually declined during the downturn and rose faster in the first half than in 2002. This growth is no doubt due to the tax cuts and rebates plus continued high borrowing; the question is whether these stimuli will prove only temporary. Retail inventories trended higher.
The fiscal and monetary stimuli noted above led to continued growth in personal consumption expenditures which reached a new high of $23,231 in the second quarter.
Job losses continued through August with a moderate upturn reported for September. The losses were most notable in manufacturing with only a little change in services. Apparently the loss of income from these job losses has been offset so far by wage increases, unemployment payments and tax cuts.
National income growth picked up in 2002 and continued in first half 2003. Compensation of employees and corporate profits were the principal gainers in 2003; interest income also increased despite low rates. Per capita personal income grew in both quarters as did weekly earnings, but less strongly than in 2002.
Gross saving continued to shrink as the federal government current deficit soared to $-383.4 billion (a.r.) in the second quarter. This is the other side of the tax cuts the government hopes will stimulate the economy. If that effort fails, the whole financial system will be threatened. This is high stakes for sure.
Commodity prices have been strengthening from low levels. Some items such as gold, oil, and aluminum have been quite strong. Producer prices rose above their 200l high in the first half with increases in most categories. Capital equipment prices, however, were little changed.
Corporate profits are measured in a variety of ways, some of which benefited greatly from tax changes that allow companies to tax an immediate 50 percent depreciation write-off. Profits of nonfinancial corporations appear to have resulted mainly from cost reductions rather than higher prices. The ten year Treasury yield reached its lowest level in June and had risen to 4.52 percent by September. Apparently some money is leaving bonds in favor of stocks.
M-3 money supply growth slowed in 2002 and continued at this lower rate in the first half of 2003. The federal deficit was $-383.4 billion (annualized) in the second quarter, higher than any year in the 1990s.
Bank credit grew steadily in the first half, mainly in securities and real estate with another decline in commercial and industrial loans. Consumer credit is growing faster than in 2002 which was the slowest in five years.
Federal debt jumped 24.3 percent (a.r.) in the second quarter, and state and local debt grew 12.0 percent. The household sector picked up 9.9 percent in the first quarter and 11.5 percent in the second, primarily due to home mortgages. Business debt growth was just 3.5 and 6.4 percent. Total household debt at the end of June was $8.9 trillion, a record 110 percent of disposable personal income, compared to 95 percent in 1998. Truly Alan has led us to Neverland, but who would ever have thought it could be so easy!
Bankruptcies continued to rise in the first half.
The U.S. trade imbalance worsened considerably in the first half of 2003, from $-418.0 bn in 2002 to $-490.0 (a.r.) in the first half of 2003.
Exports of goods fell in 2002 and a small increase in FH 2003 did not bring them back to the 2001 level. Imports of goods increased in 2002 and continued to increase in 2003. Exports and imports of services both rose throughout the period and remain positive at a reduced level.
With direct investment valued at current cost, the negative U.S. international investment position increased $407.4 billion or 20.6 percent in 2002. This represented an increase in foreign owned assets in the U.S. as U.S. owned assets abroad were little changed. U.S. financial flows abroad (at current cost) totaled $179.0 billion but were almost offset by valuation adjustments of $-177.2 billion. Foreign flows into the U.S. totaled $707.0 billion with negative valuation adjustments of $297.9 billion.
At current cost, foreign direct investment declined $9.9 billion as net financial inflows were offset by price depreciation and capital losses. Foreign holdings of U.S. Treasury securities increased $114.6 billion as foreigners shifted to net purchases after 3 years of net sales, despite historically low interest yields. Japan and China were the largest holders of Treasury securities. U.S. currency held abroad grew $21.5 billion, a little less than in 2001 and increased most strongly in Argentina and Russia. Net foreign purchases of U.S. bonds were the third highest on record, but net purchases of U.S. stocks were the lowest since 1998. Stock holdings were affected severely by a decline of 23 percent in U.S. stock prices. The United Kingdom was by far the largest foreign holder of U.S. stocks and bonds, with 48 percent of bonds and 25 percent of stocks.
Copyright © Andrew Caughey, 2003
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