07/05/2011 12:09 pm ET | Updated Sep 04, 2011

The Economics of Poverty -- Thinking in Win-Win Terms

Everyone seems to be playing the blame game this political season. Did Obama deliver the change in Washington he promised, ask both his supporters and opponents? Conservatives and progressives are unhappy with the slow-growing economy and jobless rate still hovering around 9 percent. And no one is quite sure who to blame -- Obama or GW Bush? Is it too much government, or too little?

But rather than play the blame game, why not think in Win-Win terms? Why not correct the causes of so much economic instability, which can lead us out of the swamp of debt that has resulted? There is a much deeper reason for the malaise, in other words. Most of us have not seen a rise in either real incomes or wealth since the 1970s. And this in turn has led to a deep-seated pessimism and loss of confidence in both private and public institutions.

The 1970s coincided with the end of the longest U.S. war in history at that time -- Vietnam. The fact that two more wars are draining our resources, and could ultimately cost upwards of $3 trillion, is also a contributing cause to the current sluggishness. Monies and resources diverted from producing butter to guns means those resources are wasted and not recycled back into the economy to create more wealth.

Economists have studied the costs of wars, but not the effects of income inequality. Yet we are suffering from the greatest redistribution of wealth since 1928. And such inequality is probably the major cause of our worst economic downturns -- both the Great Depression and just ended Great Recession.

We now know income inequality has reached levels of 1928-29, the beginning of the Great Depression, because potential Nobel economists Thomas Piketty and Emmanuel Saez have documented it (See Feb. 2003 Quarterly Journal of Economics). Such extreme inequality created a credit bubble that burst and so led to a sharp diminishment in aggregate demand, which is the sum of domestic public-private spending, net exports and investment, and which is approximated by U.S. Gross Domestic Product data.

The relationship is intuitively simple, yet was hard to verify before Piketty and Saez did their research. As more income flowed to the top income brackets -- much of it from tax laws that favored investors over wage and salary earners -- the lower and middle-income classes had to borrow more to keep up their consumption patterns. Easy credit available with the last housing bubble accelerated that borrowing, to the tune of $2.3 trillion extracted from housing in the last decade. But the excess housing supply produced during the bubble caused housing values to crash, losing more than $4 trillion and counting of the $11 trillion in housing assets.

President Roosevelt's Federal Reserve Chairman, Marriner Eccles, first put his finger on this problem of inequality as a cause of the Great Depression.

"...a giant suction pump had by 1929-30 drawn into a few hands an increasing portion of currently produced wealth. This served them as capital accumulations. But by taking purchasing power out of the hands of mass consumers, the savers denied to themselves the kind of effective demand for their products that would justify a reinvestment of their capital accumulations in new plants. In consequence, as in a poker game where the chips were concentrated in fewer and fewer hands, the other fellows could stay in the game only by borrowing. When their credit ran out, the game stopped."

Hardest hit have been families living in deep poverty. Today that is defined by the Census Bureau as incomes of less than $22,000 per year for a family of four. In fact, the number and percentage of people in deep poverty hit a record high in 2009, with the data going back to 1975. Nineteen million people were living in deep poverty in 2009, up 2 million from 2008, according to the U.S. Census Bureau and CBPP.

Yet we know there is enough wealth for all. The historical personal income rate of increase for all American households averages 5.6 percent per year, before inflation, so no income segment has to see a reduction in income. In fact, modern economic theory says as much. When incomes are more fairly distributed -- whether via progressive taxation or other wealth equalizing policies (such as greater access for all to an adequate social safety net), the economy grows faster for everyone.

Put more money into consumers' pockets (i.e., the lower and middle class income brackets that spend the most, as we have said) and we all win. It creates greater aggregate demand -- i.e., effective demand in Eccles' words -- for not only more goods and services, but investments that create jobs. This is something understood by most reputable economists. Such demand can be created from either the public or private sectors, in other words.

So there is a Win-Win solution to the demand problem if we allow a more level income field. This policy, a recognition that what harms each of us harms all of us, is a truth most explicitly formulated by John Maynard Keynes. He is the economic theorist reviled by those who oppose most forms of government spending -- except for defense, of course.

It is also a solution to the wildly fluctuating financial markets that have impoverished so many. In fact, if we realize the potential for growth inherent in the U. S. economy, we might not be having such a debate between the have and have-nots. One example is the controversy over social security solvency. The headlines say its Trustees predict it will run out of money in the 2040s. Yet the reality is that if the average annual Gross Domestic growth rate of the last 75 years, including the Great Depression (which is 3.5 percent per year) were continued, social security would not run out of funds -- ever.

But its Trustees have chosen to use a more conservative projection of 2.6 percent -- one of three included in the Trustee's annual report -- which has only happened during the worst downturns. The lesson is that if we focused on policies that nurture sustainable economic growth, social security doesn't become a potential problem in 2043, or ever.

That is why wealth redistribution should be discussed, because it is a way of ensuring sustainable growth. Not only the middle class, but most income segments have seen a decline in their real (after inflation) incomes since the 1970s -- except for the top 1 percent income bracket, as we now know.

For example, according to the Center for Budget Policies and Priorities, just between 1979 and 2007:

• The top 1 percent's share of the nation's total after-tax household income more than doubled, from 7.5 percent to 17.1 percent.
• The share of income going to the middle three-fifths (or 60 percent) of households shrank from 51.1 percent to 43.5 percent.
• The share going to the bottom fifth of households declined from 6.8 percent to 4.9 percent.
• The share going to the bottom four-fifths (80 percent) of the population declined from 58 percent to 48 percent.

The Great Recession is but one example of the consequences of such a continued degradation of middle and lower-income brackets. There is no good economic or political reason for such inequality to continue, if we want more sustainable -- and predictable -- economic growth. But first we have to win over the Win-Lose crowd who don't believe the U.S. economy is capable of growing as much as it has over the past 75 years. Then it will be a Win-Win solution for all.

Harlan Green © 2010