The slow growth, rising indebtedness, and financial bubbles and crises of the past few decades have a common root cause: the skewed distribution of income, which is only being made worse by the pandemic. While many investors have so far been shielded from the consequences, thanks to soaring stock prices and asset valuations, a reckoning is coming.
But it can be avoided if investors remember the insights of business leaders such as Henry Ford and Marriner Eccles, who knew that rising prosperity requires rising wages for all. Counterintuitive as it may seem, investors would benefit from sacrificing some wealth and income today in exchange for higher returns in the future.
The simple reason for this trade-off is that most people spend almost everything they earn on goods, services, interest payments, and other outlays over the course of their lives, and all of that spending generates income for others that can be used to support further spending and saving. Younger people may borrow to pay for schooling and housing, but they usually switch to repaying debt and buying assets as they get older to prepare for retirement. And once they stop working, they typically draw down their savings to cover their expenses. This is why most people, if given an extra $1,000, will eventually spend it on something that generates income and employment for others.
But the people with the highest incomes simply can’t spend all of their earnings on goods and services that create income for others—no matter how expensive their tastes—so instead they end up buying lots of assets. To someone at the top of the distribution, an extra $1,000 won’t turn into income for someone else, if it gets noticed at all, but will instead end up boosting demand for stocks, bonds, real estate, art, and other assets.
This means that changes in the distribution of income have macroeconomic effects. Whether those effects are good or bad depends on each society’s circumstances. When there’s too much consumer spending relative to businesses’ ability to make more goods and services, for example, forcing up corporate profitability by suppressing wages can make everyone better off.
Over the past few decades, however, the world has had to deal with a different problem: not enough consumer spending to absorb all of the goods and services that businesses are capable of producing. The issue isn’t excess capacity—despite the apparent abundance, there is still plenty of poverty, even in the world’s richest countries. Instead, the world is suffering from insufficient consumption, which, as I and my co-author, Michael Pettis, explain in more detail in Trade Wars Are Class Wars: How Rising Inequality Distorts the Global Economy and Threatens International Peace, has its origins in the skewed distribution of income.
Globally, the share of income going to the highest earners has risen sharply since the 1970s. While the average American’s real income rose by 89% from 1977 to 2018, the real median income earned by American men ages 25 to 54—a reasonable proxy for the typical worker’s pay—grew by less than 2% over the same period. The corollary to the massive gap between the average and the median is the fact that the share of U.S. national income earned by people in the top 1% of the distribution has roughly doubled.
How did this happen? After all, businesses as a whole can’t increase sales and profits unless their customers are spending more. And ultimately, those customers are workers. This was Henry Ford’s insight when he decided to pay his workers far more without sacrificing profitability.