TheStreet

Should you have more money?

For decades America has gotten richer and individual workers have gotten more productive. We work longer hours, produce more per hour and raise stock prices to once-unimaginable levels… and almost no one has gotten a meaningful raise since the Carter administration.

Income equality has a lot to do with that.

What Is Income Inequality?

Income inequality measures how evenly income is distributed across an economy. When a journalist or economist writes about how much wealth the top 1% has or how much a CEO makes relative to their employees, this is a discussion of inequality.

Income inequality is expressed by the Gini coefficient, which uses a scale of 0 to 1. The higher the score, the more unevenly wealth is distributed. At a coefficient of 0 the society has perfect equality with all workers earning the same income. At a coefficient of 1 the society has perfect inequality with one person holding all of the wealth.

Economists look hard at income inequality, in part, because it measures how efficiently an economy distributes resources. An economy with no inequality raises concerns that it has stopped creating incentives for innovation and risk-taking behavior. This can lead to stagnation. An economy with high inequality, however, may have stopped rewarding workers in proportion to their contributions. This, too, can lead to both stagnation and volatility.

What Is the Right Level of Inequality?

Economists hotly debate how much inequality is good for an economy. A healthy economy should produce at least some because, if everything works well, people who create more value will receive proportionately greater financial rewards. Bill Gates should be rich (or, as economists like to say, it is economically efficient for him to have gotten rich) because he created something with value to millions of people.

While there is disagreement, the broad consensus is this: Inequality is good for growth when it is high enough to encourage investment and entrepreneurship, but not so high that it rewards those individuals beyond the value of what they create.

For example, consider John Smith who would like to start a neighborhood restaurant. This will have value because he's a good cook and the people near him would like a new place to eat. In an efficient economy, then:

  • Inequality will be high enough to convince Smith to open his business. Succeeding at creating a delicious neighborhood restaurant should make him money, otherwise he's unlikely to do it and everyone is worse off.
  • ...But low enough that it will not reward Smith beyond the value of his creation. A neighborhood bar only creates a maximum amount of value. Rewarding Smith beyond that point is inefficient and takes money from other potential entrepreneurs and workers.

In some cases, these two will not overlap. The value of a new enterprise isn't high enough to convince someone to start it. In that case, either the economy has effectively priced out an inefficient project (it just wasn't worth doing) or someone else will come along and work for that price.

As to exactly what this magical middle point is, this is another constant subject of debate, up to and including whether there are any practical upper or lower bounds on efficient inequality at all. There is no agreed-upon standard Gini coefficient for growth. But we are certain of one thing:

The Current State of Income Inequality

In the U.S., inequality has the momentum of a runaway train. Americans have not lived this financially far apart since the Gilded Age.

Too much income inequality can be both a symptom and a cause of a very unhealthy economy, and that's where America increasingly finds itself today. The wealthiest households don't simply have more than other people do. They have almost everything. The rich collect most of the income, own most of the wealth and have captured virtually all of the economic gains over the past 40 years.

Some numbers to make this more concrete.

Income

In the 1950s, an average CEO made about 20 times what one of his workers did. Today, a single wealthy worker can make hundreds of times as much as someone else in the same office. While the top 10% of earners do well, it's really the top 1% that leaves everyone else in the dust. They're helped by trends such as:

  • In 2015, a family in the top 1% nationally received, on average, 26.3 times as much income as a family in the bottom 99%, according to a report by the Economic Policy Institute. This isn't just about surgeons making more than fry cooks. This is about a handful of high-earners making more than everyone else.
  • A CEO at a large firm makes 312 times what one of their employees earns on average. This has been trending up every year since the early 1980s.
  • The richest 10% of Americans took home nearly half of all the country's income in 2017. The richest 1% of Americans took home a fifth of it. The other 90% of us got to divide the remaining pie among ourselves.

Wealth

Where income is what someone actually takes home in a year, wealth is the total amount of money and property that someone owns. Wealth concentration in America is higher than it has been since 1928. Today, a tiny 0.1% of U.S. households own almost a quarter of all the money and property in the country. Even more than that:

  • The richest 1% of households own approximately 40% of all U.S. wealth. This would be like living in an apartment building with 100 people, but one person claims all the even numbered units just for himself.
  • The richest 200,000 families in America own about as much wealth as the bottom 90% of all American households combined.

Growth

The wealth gap is getting worse. The wealthiest Americans have captured virtually all of the wealth created in recent decades. While over the past 40 years most Americans averaged less than 0.9% annual wage growth, the richest 1% grew their wages by more than double that. The richest 0.001% did seven times as well. This led to effects such as:

  • Five percent of Americans took home 25% of all the wealth created by the U.S. economy in 2017.
  • From 1980 to 2016 the inflation-adjusted average income for the bottom half of American households went from $16,000 to $16,200. The average hourly wage ticked from a little over $20 to $22.65. For the top 1% of American households in that same period, inflation-adjusted wages grew from $428,200 to $1.3 million.

The rich are getting richer and the process is picking up steam.

Why Income Inequality Matters

Income inequality is a story that resists being told. It is easy for this to simply look like sour grapes in the face of other people's success, and getting into the weeds on this issue means badgering readers with a dry wall of statistics.

But this is about more than numbers. More and more of America's wealth is held by increasingly few people. This has been getting worse since the 1980s, but now it has reached levels not seen since shortly before the Great Depression. The economy of the last 40 years has made a few people very, very rich, and everybody else much poorer. Here are a few specific ways that it has probably affected your life:

Inequality Might Be Helping to Kill Retail

It has become harder and harder to go out and buy anything anymore. Whether you want to go get a pair of shoes or a new tablet, increasingly you have to go online. This is in part because online retail has begun to out-compete traditional retailers.

It's also because there is evidence that income inequality has slowed down the economy.

Inequality takes income from the middle- and lower-class households, which tend to spend new money as it comes in, and concentrates it into high-income households.

A 1% household might have 26 times the income of a middle class family, but they don't eat dinner 26 times as often. They don't have 26 times as many hours in the day to read books or watch TV, and don't have 26 times as many hobbies. At a certain point, a consumer has all of his needs and wants met. At this point he tends to save each new dollar instead of spending it. With rich households, new money tends to go into the bank.

This causes a problem known as "secular stagnation," defined as a long term drop in consumer demand. People aren't spending enough money in part because they don't have it anymore. Inequality has shifted new income from the people who would spend new money to the people who won't.

If that money were spread out, it might create new consumers for local businesses. Instead, it is simply earning interest, and your local florist has to close up shop. A wealthy husband doesn't need 26 times as many roses on Valentine's Day.

Inequality Might Be Costing You Money

If historic trends are any guide, you are due for a massive raise.

From World War II until the end of the 1970s, wages for the average worker grew hand-in-hand with productivity. As Americans created more wealth, they got to keep more. In fact, between 1962 and 1974 alone, the poorest Americans saw their inflation-adjusted incomes grow by 50%. Meanwhile, in Michigan, factory work grew from a job for people without options into a career that made vacation cottages and pontoon boats part of the local culture.

From 1948 to 1973, productivity (how much each worker produces per year) increased by 95.7% and wages went up by 90%. The pie was getting bigger and everyone was getting a bigger slice of it.

Since then productivity has continued to go up. Thanks to technology, better business practices and longer hours, workers today create 77% more products per year than they did in 1973. But wages haven't kept up. While productivity keeps growing, from 1973 until now wages have only gone up by 12%. 

The pie kept getting bigger. Most Americans just stopped getting a bigger slice of it.

Inequality Can Make the Economy Less Stable

Inequality prevents most consumers from keeping up with modern costs of living. While overall inflation has remained low for more than a decade, in many specific sectors it has not. So consumers struggle to pay for modern costs of education, rent and health care on salaries that wouldn't have looked out of place in 1987 relative to the price of bread.

As we noted above, this has deeply hurt consumer spending. People have less and less extra money lying around, so they spend less and rely on credit cards more. The economy, then, depends increasingly on the whims of the rich; so much so that 70% of the changes in U.S. consumer demand between 2003 - 2013 was found to be driven by the top 10%.

The result is the death of the middle. Increasingly, consumers are either stretched to the ends of their means or part of a relatively wealthy few. This may come as a familiar observation to anyone who has walked through a shopping mall lately and noticed how few options remain between luxury goods and Old Navy, and it makes the economy potentially quite volatile.

Consumer market depends more and more on the potentially fickle decisions of a wealthy few. Further, average consumers will have little (if anything) in the way of a rainy-day fund. When things go badly, like an economic downturn, most consumers have spent their savings and already owe money on their credit cards. They have few reserves to prop up consumer spending, making the economy far more vulnerable to minor incidents that turn into major crises.

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