Is a strong middle class the key to a strong economy?

The Hutch Report

In our previous article titled “Where did the US go off track?” The article was meant mainly to revisit Bernanke’s planned wealth effect from quantitative easing and indicate that it was an ill advised idea that put many into deeper trouble than before. The title was a general statement of wonder as opposed to identifying where the US did go off track.

This time we look at where the US went off track by identifying when the US was at its strongest and why. If we can understand where it really went off track then we can look for solutions or at least understand what kind of solutions are required.

Economies have ebbs and flows. In spite of what they teach you in economics 101 nothing is ever in equilibrium. There are just too many parts as well as internal and external influences although there are times when activity is stronger than others.  The US built one of the greatest economic powerhouses on earth after World War II, however it was already well on its way from the 1800s as it built out its infrastructure and put many to work. There was a time when the US consumed the majority of what it produced as a nation and then exported the remainder. Who was responsible for the consumption? It was the middle class. The middle class made up the majority of the population. They had jobs and respectable salaries. So what happened?

According to a research report by the Pew Research Center in 2012, “The Lost Decade of the Middle Class”they state:

“For the half century following World War II, American families enjoyed rising prosperity in every decade—a streak that ended in the decade from 2000 to 2010, when inflation-adjusted family income fell for the middle income as well as for all other income groups, according to U.S. Census Bureau data.”

The above graph shows that the 50s and 60s had the strongest middle class. In 1950 and 1951 the US had successive years of 8% GDP growth. The report also highlights how the net worth of middle income families—that is, the sum of assets minus debts— took a hit from 2001 to 2010 from the Federal Reserve’s Survey of Consumer Finances. Median net worth fell 28%, to $93,150, erasing two decades of gains. So we have a situation where consumer debt has increased over the years and incomes have fallen. There are a large number of reasons for this. The manufacturing base has shrunk as companies chose to produce goods in other countries in order to take advantage of cheap labour so they could give themselves pricing advantages. There is, what has become to be known as the “Walmartization” of America. Author John Atcheson writes, “If you want to know why the middle class disappeared and where they went, look no further than your local Walmart.  People walked in for the low prices, and walked out with a pile of cheap stuff, but in a figurative sense, they left their wages, jobs, and dignity on the cutting room floor of the House of Cheap.” Driving prices lower and lower is just a race to the bottom that erodes everyone’s quality of life.

This is just scratching the surface. There is also the invention of the 401k. We hold a total of $17.5 trillion in retirement funds – the single biggest source of money the big banks, Wall Street, and assorted other speculators use to play with.

The power of capitalism has been the freedom for entrepreneurs to create and provide value to others which has in turn provided jobs and increased wealth. However, we are now seeing that there are limits to that. The Economist recently revisited some of Karl Marx’s thinking regarding capitalism:

“Marx argued that capitalism is in essence a system of rent-seeking: rather than creating wealth from nothing, as they like to imagine, capitalists are in the business of expropriating the wealth of others. Marx was wrong about capitalism in the raw: great entrepreneurs do amass fortunes by dreaming up new products or new ways of organising production. But he had a point about capitalism in its bureaucratic form. A depressing number of today’s bosses are corporate bureaucrats rather than wealth-creators, who use convenient formulae to make sure their salaries go ever upwards. They work hand in glove with a growing crowd of other rent-seekers, such as management consultants (who dream up new excuses for rent-seeking), professional board members (who get where they are by not rocking the boat) and retired politicians (who spend their twilight years sponging off firms they once regulated).”

What country currently resembles the US of the 1950s with roughly 8% GDP growth? You probably guessed right, China. Aside from the fact that China has been handed every manufacturing job in the world from others, the result has been a growing middle class which will soon become larger than the population of the US. According to a study by consulting firm McKinsey & Company, 76 percent of China’s urban population will be considered middle class by 2022. That’s defined as urban households that earn US$9,000 – US$34,000 a year. (That might not sound like a lot, but adjusted for prices, it delivers a roughly comparable “middle class” existence to other countries.) In 2000, just 4 percent of the urban population was considered middle class.

So if building the middle class back up is to make the US stronger once again, what are some solutions? Providing better paying jobs for Americans by bringing back the manufacturing base to the US? Prices may increase but if your job is providing you a salary that enables you to afford it you may not mind. That would mean forcing US companies back to the US. That would mean providing them incentives in the form of tax breaks. We have already seen that those tax breaks are turning into stock buybacks. This is just exacerbating the situation, meaning, the government will forgo potential revenue that could have come in the form of those taxes. The tax breaks are not being used for capital investment, which would flow into the economy. The result is a larger national debt burden. How about incentivizing foreign companies to move their manufacturing to the US? Forget the financial engineering of the economy, the focus has to be on developing enterprises, but only to a point.

Companies like Amazon and Walmart have destroyed many small and medium sized companies by driving prices lower at the expense of putting many out of work. We have seen no evidence that Amazon and Walmart have created more jobs than they have destroyed. Google and Facebook have essentially taken over the advertising industry. So would it make sense to cap how large a company could grow? There are laws against monopolies and oligopolies however their political capital has become so strong that they can easily avoid these laws. However, it may make sense to break these companies up.

We can follow Marx and reduce the number of corporate bureaucrats that are sponging off the system, many of whom are found in banks. Banks are now much larger than the too big to fail era. Now they are way too big to fail. Breaking them up is currently being discussed. In fact, investment banks should be completely separated from commercial banks, or better yet community banks. Banks that serve only their communities. In this way, if investment banks makes bad decisions they are penalised by their investors, as opposed to sucking money out of their commercial counterparts in turn penalising the depositors (beware the coming bail-ins during the next financial crisis)! Regardless of the solutions implemented, it has to be accepted that they will not please everyone.

The Hutch Report

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