Imagine your great grandparents spent a day with you. After showing them the internet, smartphone apps, and the coffee thingy that brews a perfect cup with the push of a button, they would probably think you were living on another planet.
They may be overjoyed to think that the past 30 years were filled with economic progress. If we look at average statistics that are widely reported, they would be right.
However, if we compare economic progress for the top 40% (over $80k in household income) vs. the bottom 60% (below $80k in household income), we see a different picture.
Over the past 30 years, real (inflation-adjusted) household income for the top 1% has tripled and income for the top 10% has doubled. Meanwhile, the bottom 60% has experienced no income growth since 1980.
As we will see, the income gap in America is about as high as ever and the wealth gap is the highest since the late 1930s - which was a period of massive social upheaval.
This accelerating wealth gap between the top 40% and the bottom 60% is turning into the defining problem of our generation. If we don't find a way to solve it, the future of the American Dream will be in jeopardy.
In this post, we explore what makes countries succeed, current issues in America, and what should be done. Let's start by looking at why some economic systems work and others don't.
An Overview of Economic Systems
Ever since the economic growth of the Industrial Revolution, capitalism has emerged as the dominant economic system in well-functioning societies.
The past 200 years have shown us that any sound economic policy must answer two questions:
- Does it motivate people?
- Does it allocate resources in a way that increases living standards?
Socialism tends to break down because citizens aren't motivated to succeed since they share their profits equally with others.
Meanwhile, capitalism is an effective motivator of people because it rewards people with private profits.
Additionally, capitalism is an effective allocator of resources because to maintain wealth, people are incentivised to invest profits in productive activities.
However, we are beginning to see cracks in modern capitalist systems.
Capitalism is great at increasing the economic pie, but struggles with redistributing the pie in a way that raises living standards for all citizens.
This is the key to understanding why there is an accelerating wealth gap in America. The economic pie is growing, but it's not being redistributed fairly.
Don't get me wrong, I am a firm believer in capitalist systems.
But capitalism needs to be reformed in a way that continues to incentivise productivity growth, while redistributing profits in a way that gives every citizen a shot at the American Dream. Otherwise, internal conflict may abolish capitalism completely.
However, economic resources are scarce, so we need to prioritize where this wealth should be redistributed.
Research has shown that there are four factors that materially drive economic growth:
- Free and well-regulated markets for goods, services, labor, and capital. These markets should provide incentives, savings, and financing opportunities to most people.
- Equal opportunity in education and work
- Good upbringing through high school
- Civilized behavior in a system that most people think is fair
Let's look at data in these areas to determine how America is doing. This will help us get a sense of the current economic trajectory.
America's Economic Report Card
First, let's look at whether the current economic system is providing savings and financing opportunities to most people.
The key is to look segment statistics by the top 40% and the bottom 60%. As we saw earlier, the bottom 60% has experienced no real income growth in the past 30 years, which is hidden by looking at averages.
The percentage of 30-year olds earning more than their parents has declined from 90% to 50% since 1970
The income gap and wealth gap between the top 1% and the bottom 90% has rapidly increased over the past 30 years and is at the highest levels since the The Great Depression.
Research has also shown that 40% of Americans would struggle to raise $400 in the event of an emergency.
Pretty scary given the current economic shutdown.
The income and wealth data above are lagging indicators. What about leading indicators like education levels and emotional health?
Turns out, America is in the bottom 15% in test scores out of developed countries.
Students in the bottom 60% of America also report some of the highest levels of social and emotional distress.
This increasing income / wealth / opportunity gap is leading to populist movements across the U.S. Populism is a political stance that emphasizes the importance of "the people" versus "the elite".
Throughout history, social upheaval has been driven by these types of populist movements.
Healthy populist movements are characterized by open dialogue and compromise between political parties. Meanwhile, destructive populist movements are driven by charismatic leaders that aren't willing to compromise.
Where does the US stand today? Turns out, our political parties are the least compromising they have ever been in history. Senators and House Representatives are unwilling to vote against party lines.
To recap, the income / wealth gap is increasing, which is leading to an opportunity gap (e.g., lack of education and job opportunities) between the top 40% and the bottom 60%.
At the same time, populism is rising on the right and left while neither side is willing to compromise.
I believe these trends will be accelerated as we experience the fallout of COVID-19.
A majority of fiscal policy from COVID-19 has been allocated to bail out private corporations instead of incentivising them to invest in the production of goods and services.
A a result, the bottom 60% will have fewer job opportunities, which will lead to decreasing incomes, and can lead to social unrest through populist movements.
We are in for one hell of a ride if we don't get our shit together.
Over the next few years, we face for key issues:
- Effective monetary policy
- Effective fiscal policy
Automation. Companies in pursuit of greater profits and efficiencies will lead to replacing manual labor with technology
Outsourcing. Companies in pursuit of greater profits and efficiencies has also led to outsourcing production of goods and services to foreign workers. This leads to lower incomes and spending for US workers.
Effective monetary policy. Since 2008, Central banks' have been printing trillions of dollars which have mostly gone to investing in financial assets like stocks and bonds. This leads to two issues:
- It enriches the top 40% since they own a majority of financial assets and leads to lower wealth for the bottom 60% because they rarely own financial assets.
- This incentivises the top 40% to invest in financial assets (because the government is artificially inflating the price which leads to higher returns) instead of productive assets like goods and services. This leads to less job opportunities for the bottom 60%.
Effective fiscal policy. Policy makers focus too much on budgets instead of return on investment. For example, education is a large investment so it usually doesn't receive much support. However, this is a short-term view that ignores the long-term return on investment from having a well-educated society. This will only increase the wealth gap.
Given these issues, let's explore some potential solutions.
What Can We Do
There are five areas we can focus on to put the American Dream back on track:
- Bipartisan cooperation
- Clear metrics and accountability
- Redistribution of resources in a way that helps the majority of people
- Coordination of monetary and fiscal policies
- Build productive assets
Bipartisan cooperation. We need political leaders on both sides to put aside their differences and compromise to come up with policies that benefit the American people as a whole - not just their political party.
Clear metrics and accountability. Governments should be run more like corporations with clear metrics and personal accountability. These metrics should be easily available to the public and should be used to frame policy decisions as opposed to political ideology.
Redistribution of resources in a way that helps the majority of people. Partnerships between public and private institutions to increase the effectiveness of education and health care. Tax harmful activities like carbon emissions and pollution in order to fund government spending and disincentivize poor behavior. Raise taxes from the top in a way that doesn't significantly decrease productivity.
Coordination of monetary and fiscal policies. Monetary policy drives interest rates and the money supply. Meanwhile, fiscal policy determines how the increased money supply is spent and tax rates. The key issue is making sure printed money is allocated in the most productive way to ensure sustainable economic growth for all Americans - not just the top 40%.
Build productive assets. Bring production of goods and services back to America to increase jobs in areas like manufacturing and to provide resilience to supply chain shocks. Regulate monopolies and oligopolies in a way that incentivises innovation instead of entrenching incumbents.
We are at an inflection point that will decide the future of the American economy.
Since 2008, Central banks have lowered interest rates and printed money to buy financial assets. This has made the rich even richer while leaving the bottom 60% behind. These fiscal policies and new technologies have led to a widening income / wealth / opportunity gap. As a result, populist movements have increased on the right and left, leading to unproductive national dialogue and less cooperation over time.
Fiscal policies in response to COVID-19 so far have once again helped the top 40% at the expense of the bottom 60%.
Over the next few years, our political parties must come to a compromise and work together to reform capitalism in a way that continues to incentivise productivity growth while redistributing wealth fairly.
Otherwise, the idea of the American Dream will be exactly that - a dream - to the next generation of Americans.