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Five faults of capitalism: The unequal distribution of wealth

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The idea that income inequality is an economic byproduct of capitalism is far from a contemporary realization; it has been studied since the beginning of the 20th century in great detail.

This inequality has, until recently, been widely accepted by economists as a “necessary evil” of capitalism. Economists justified its existence by stipulating, as journalist Jonathan Rauch recently explained in his National Journal article, “Inequality and its Perils,” “inequality is the price America pays for a dynamic, efficient economy; we may not like it, but the alternatives are worse. As long as the bottom and the middle are moving up, there is no reason to mind if the top is moving up faster, except perhaps for an ideological grudge against the rich – what conservatives call the politics of envy.”

This reasoning enjoyed its predominant acceptance among economists until recently. In his most recent book, “The Price of Inequality: How Today’s Divided Society Endangers Our Future,” which is mentioned in Rauch’s article, Joseph E. Stiglitz, the Nobel Prize-winning economist, noted that “widely unequal societies do not function efficiently, and their economies are neither stable nor sustainable in the long term. Taken to its extreme – and this is where we are now – this trend distorts a country and its economy as much as the quick and easy revenues of the extractive industry distort oil- or mineral-rich countries.”

Rauch’s explanation of the philosophical and economic theory backing the acceptance of wealth inequality as an unfortunate but necessary byproduct of capitalism is contingent upon the following statement being true: as the wealthy become wealthier, the poor and middle class must also be becoming wealthier, albeit at a slower pace.

The problem with this theory is that the observed trend of wealth distribution depicts an opposite scenario: as the wealthy become wealthier, the poor and middle class become poorer.

Rauch explains the effect of this trend in the National Journal article, stating that “the economy, propped up on shaky credit, becomes more vulnerable to shocks. When a recession comes, the economy takes a double hit as banks fail and credit-fueled consumer spending collapses. That is not a bad description of what happened in the 1920s and again during these past few years.”

The Economic Policy Institute recently released a graph depicting the changes in the share of household income held by the bottom 99.5 percent of households. According to the data, between 1973 and 2008, the bottom 99.5 percent of households lost 10.6 percent of the total share of U.S. household income.

During this same period, the annual income of the top 1 percent of earners rose by roughly 15 percent.

The data illustrates the proposition that increased income for the wealthy “trickles down” to the poor and middle class is economically and statistically invalid.

According to a recent study by economics professors Emmanuel Saez of the University of California Berkeley and Thomas Piketty of the Paris School of Economics, U.S. income inequality has increased more than any other major western country since 1960. In some European countries, the top 1 percent of earner’s income declined, according to the study. In many countries examined, it rose by up to 4 percent. But in the U.S., income inequality increased by 9 percent during the same period, more than twice that of most nations.

Furthermore, the Congressional Budget Office recently reported that between 1979 and 2007, the pretax income of the bottom 80 percent of earners fell, while the pretax income of the top 1 percent nearly doubled. The report was cited in Rauch’s National Journal article.

The fact of the matter is simple: income inequality is not a “necessary evil” as economists once thought. It’s a reversible trend that is seriously damaging the U.S. economy.

Increasing income inequality, as has been observed in the U.S., is characteristic of two important trends. First, income in the U.S. is characterized by a small group of super wealthy (who are only 1 percent of the population but earn 20 percent of all U.S. income) individuals and a majority of individuals who make considerably less (sharing 80 percent of the remaining wealth amongst 99 percent of the population). Secondly, the wealthy retain their wealth by saving a large portion of their money, while the poor and middle class spends the majority of their wealth.

As the wealthy become wealthier, they save more. As the poor and middle class become poorer, they are forced to either spend less, or borrow more.

Rauch explains this trend by noting that “in a democracy, politicians and the public are unlikely to accept depressed spending power if they can help it. They can try to compensate by easing credit standards, effectively encouraging the non-rich to sustain purchasing power by borrowing. They might, for example, create policies allowing banks to write flimsy home mortgages and encouraging consumers to seek them. Call this the ‘let them eat credit’ strategy.”

This economic plan of mitigating the detrimental effects of wealth inequality through credit is as economically precarious as it sounds. Rauch reported in his article that “the last time inequality rose to its current heights was in the late 1920s, just before a financial meltdown.”

In 2010, David Moss, an economist at Harvard Business School who is featured in Rauch’s article, explored the relationship between high rates of inequality and financial crises by plotting inequality and bank failures since 1864. The resulting graph demonstrated a clear and undeniable correlation between high rates of inequality and bank failures.

In his second inaugural address, President Barack Obama noted that “…the people understand that our country cannot succeed when a shrinking few do very well and a growing many barely make it. We believe that America’s prosperity must rest upon the broad shoulders of a rising middle class.” He further explained: “We know that America thrives when every person can find independence and pride in their work; when the wages of honest labor liberate families from the brink of hardship. We are true to our creed when a little girl born into the bleakest poverty knows that she has the same chance to succeed as anybody else, because she is an American; she is free, and she is equal, not just in the eyes of God but also in our own.”

Not only are the high levels of unequal wealth distribution in the United States damaging to the economy; they are crushing the American dream.

Makai McClintock is a Collegian columnist. He can be reached at mmcclint@student.umass.edu.

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