The following article was submitted to Trinity College Dublin’s Student Economic Review in 1993. In the aftermath of the sub-prime crisis and the current credit crunch this topic appears to be more relevant than ever.

INTRODUCTION 

During the 1980s the concentration of wealth reached levels not seen since 1929. The fact that the 1929 Crash and subsequent Great Depression bear a strong similarity to the 1987 Crash and the current recession begs the question whether policy makers drew the correct conclusions from history. Surprisingly few economic textbooks deal with the issue of Wealth Concentration. It may be that economists are unwilling to speak against the “American Way!” Another reason may be the difficulty in obtaining the relevant data. This essay discusses the concentration of wealth in the USA and looks at some of its possible implications.

DEPRESSIONS IN THE USA

A depression is characterized by heavy unemployment, low consumer demand and substantial unused industrial capacity. Confidence is lacking and willingness to invest is low.

The USA’s three Great depressions have also involved a run on the banks. This financial panic is a critical factor in turning a recession into a depression.

The three depressions in the USA’s history occurred in the 1810s, the 1870s, and the 1930s. Nowadays Economists use IS/LM analysis to demonstrate how the actions of the Federal Reserve aggravated the 1930s Depression, by trying to balance their Fiscal Budget and increasing taxes instead of increasing government expenditure. In addition, they failed to prevent the collapse of the banking system in 1931-1933, which decreased the money supply thus deepening the depression.

Batra[1] says that the monetary policies and fiscal balancing employed by the Government after 1929 were the traditional Classical remedies and were no different to actions in previous recessions which had not become depressions. This has been confirmed by Milton Friedman who has argued that money growth decreased in every recession in the 19th Century.

So the question remains unanswered; what caused the Great Depression and what caused the collapse of the banking system in the first place? To attempt to find another answer we will later examine the evidence of high US Wealth Concentration since 1922.

The previous US depression was from 1860-69, with economic growth of 2% p.a., which was the lowest for any decade from 1820-1899. From 1840-59 growth was 4.6% p.a. and for 1870-1899 it was 4.4% pa. Evidence of high wealth concentration exists in the USA before 1860. According to Walton and Robertson[2] “There was a sharp advance in the concentration of wealth between 1774 and 1860 denoting a sharp break with the pattern of stabilised aggregate wealth concentration prevalent during the colonial period…. In 1774, 12.6% of total assets were held by the top 1% of wealth holders. By 1860 the wealthiest 1% held 29% of US total assets”. This period ended with the Civil War and the Depression of 1873. The levels of wealth concentration from 1860-1920 did not accelerate as they did earlier. “The high degree of income inequality reached on the eve of the Civil War was sustained….up to World War I, but the levels of concentration did not grow higher[3]“.

THE HISTORY OF US WEALTH CONCENTRATION SINCE 1922

In table A below we show the changes in the percentage of wealth held by the top 1% of the US population/households since 1922:

Note: The figures in Column 1 are based on US Estate duty returns for individuals. The figures in Column 2 are based on the Federal Reserve Consumer Finance Surveys for households.

The figures show that in 1929 before the Great Crash, 36.3% of the wealth was held by 1% of the population compared with only 31.6% in 1922. This is a considerable increase and we discuss below why the increase occurred. This concentration created fundamental instability in the economy. Firstly the top 1% put their money into the stock market. These stock market investments were further used as security for loans to buy even more stock, which was also highly leveraged by the use of investment trusts (as mentioned by Galbraith in his book The Great Crash 1929), increasing the leverage still further.

The figures also show that after 1929 there was a trend towards greater wealth equality, reaching a peak in 1949. This levelling parallels also the ‘revolutionary’ income levelling over the same period.” In 1929, the average income of the richest 20% was 15.5 times that of the poorest 20%. By 1951 this ratio had dropped to 9.0…. In no other extended period of US history did the available indicators swing so sharply towards equality”, write Williamson & Lindert[4].

In the 1970s and 1980s the trend towards inequality resumed, despite previous massive Government income transfer programs. Business Week (see bibliography) reported that the US economy grew by 10% in real terms from 1977-89. However the top 1% of families saw their average incomes soar by 80%. 

THE EFFECTS OF WEALTH CONCENTRATION ON THE BANKING SYSTEM

A high concentration of wealth, writes Batra[5], has the following effects on the banking system: 1) the number of persons with few assets rises and therefore their borrowing needs rise; 2) the borrowers in general become less credit-worthy than before because of their lack of security; 3) the commercial banks must  continue to compete for business and make loans to pay interest to their depositors, which results in an increase in the instability in the banking system due to the poor quality of their loan portfolio.

It is argued that this financial instability led to the collapse of the banking system and exacerbated The Great Depression.

WHERE IS THE WEALTH OF THIS 1% INVESTED AND HOW IS IT USED?

The US Federal Reserve’s 1983 Survey of Consumer Finances[6] revealed that 70% of the net worth of the top 1% of householders was represented by: “business assets (net)”, “public stock” and “bonds/trusts”. Their share in the private economy of all business assets was 52.8%, public stock 57.1% and bonds/trusts 69.5%. This public stock holding is not as large as that claimed by Atkinson in relation to Britain. He says that “ownership of wealth gives a right to income and the right to control over [its] use. The [richest] 1% own a disproportionate share of total wealth, but also hold it in a form which gives them a higher than average return and conveys a significant degree of control over industry… The top 1% … hold a large proportion of their wealth in real property and company shares. They account for 4/5ths of personally held company shares. In the past they have received substantial capital gains and have enjoyed protection against inflation[7]“.

We must conclude that the 1% exercise considerable influence on the economy. However, periodically, as in the 1920s, 1980s and at present they choose to use that control not to expand economic growth but to push up a bull market. Keynes argued that this excessive trading on the stock exchange tends to destabilise real investment.

Unfortunately economics focuses too much on the percentage of annual income that goes towards investment. The problem is that more than one year has to be looked at. Movements in composition of wealth over longer periods should not be ignored as they can have a large effect on the economy. For example US average family income in 1989 was $35,700 compared with family wealth of $183,700. Thus a change in how the wealth figure (5.1 times bigger than income ) is invested is very important.

THE “DANGEROUS TREND TOWARDS INEQUALITY”

The Crash of 19th October 1987 could have resulted in a collapse of the financial system, as in the 1930s, but was postponed by President Reagan’s flooding of the money markets with liquidity in the 4th Quarter of 1987. However, the underlying problem has not been addressed and so in the first Quarter of 1994 we see that the US, UK, German, French, and Swiss stock markets are at all time highs.

Tylecote refers to a “dangerous trend to inequality[8]“. He says that in the 1920s, the new “Fordist technological style, with the economies of scale it brought … had made manufacturing firms large and their markets oligopolistic, not competitive[9]“. Furthermore, “closer control over their workers, and increased market power led to redistribution of income from wages to profits and a consequent shortfall of consumer demand, which caused the depression[10]“. Firstly “demand becomes insufficient, for the rich do not spend as much of their income as the poor. [Secondly], suffering of the poor affects the supply side as they are unable to invest in education, training and health. Growth slows, unemployment increases and inequalities get worse[11]“.

This issue of high wealth concentration was addressed by the radical US reforms of the 1930s which gave us the strongest and longest international boom on record. Williamson stresses the importance of re-investment by the rich into productive investment, which can lead to benefits for poorer people. In a British context he also says that the equality of distribution of income, relative to the continent, gave rise to a booming mass market during the 18th century, thus arguing that “Lower inequality makes for rapid economic growth”.

Tylecote quotes Schumpeter who stresses technical progress in providing opportunities for profits and accumulation. He says that innovations launch a long-wave of growth. The initial impulse is gradually dissipated, leading to a downswing. This is followed by a period of no entrepreneurial investment, with short term capital accumulation and with no research and development. Wealth rises as it creates a financial bubble which inevitably collapses.

THE FREE MARKET and WEALTH CONCENTRATION

There is no reason why Milton Friedman’s fear of central government control should not apply equally to control by the top 1% holders of wealth, who are also the owners of industry. Although the US believes in the Free Opportunities Market where anyone can join the top 1% ; as Atkinson says,” rich men who spring from parents with insignificant resources are a minority…[and] the attention which that minority attracts [is] due to the fact that [they] are exceptional phenomena rather than numerous[12]“. He says that inherited wealth is a factor of great importance in giving rise to a high concentration of wealth.

Adam Smith’s “Wealth of Nations” (1776) established the principles of a Free Market, long before US industrial growth. Smith’s efficient market concept was valid for his time and can be seen in the expansion of the UK economy in the 18th Century. However, modern America is full of monopolistic inefficiency, maintained by US corporations in business and politics, undermining Adam Smith’s visions of the efficient market and his neo-classical contemporaries.

It is argued here that high wealth concentration can bring us beyond the boundaries of the efficient markets system. For example, the Great Depression saw the markets for money and capital not being cleared at any price-level for many years. This situation can be represented by a vertical Aggregate Demand (”AD”) Curve to the left of a vertical Aggregate Supply (”AS”) Curve. This is represents a breakdown of the Capitalist System.

The AS Curve represents millions of voices and also huge levels and ranges of capital. However, the top 1%, whom we have been discussing, control the AD curve. Thus we see that the control of the whole economic system rests in too few hands. When they act responsibly the markets continue to operate. However, due to inherited wealth not being complemented by inherited entrepreneurial spirit or the prospects of easy money in a 1920s Bull Market, these few do not act rationally in the long term.

The 1929 Crash wiped 25% of the value from the stock market. However, this was not the end of the fall. The top 1%, who were shocked by the reality that there was no ‘easy money’ to be made, continued to act irrationally. They stopped investing in industry and sold shares into a Bear market which fell to only 25% of its pre-Crash value in 1933. There were a few speculators who recognised that shares were undervalued in relation to break-up value. However, this minority were unable to influence the price. The market, without doubt, failed to operate efficiently. It is argued that this was instigated by high wealth concentration.

CONCLUSION

After the high wealth concentration of the 1870s and 1930s we saw a radical reaction. What the reaction to the present concentration in the USA will be remains to be seen. Certainly it means that more investment could be made in manufacturing capital and research, and that too much is being put into the financial markets. This means that the anticipated US boom cannot be sustained unless there is a fundamental restructuring or the owners of US industry and services, who are the top wealth holding minority, increase their entrepreneurial spending.

This will not only benefit the rest of society but also, in the longer term, the wealthy minority, because if the trend towards high wealth concentration continues, then there will be a breakdown or collapse of the entire economic system which will benefit nobody.

Bibliography:

Dr.Ravi Batra, (1987),”The Great Depression of 1990″, Dell Publishing

J.K. Galbraith, (1972) 3rd Ed., “The Great Crash 1929″, Hamish Hamilton

Andrew Tylecote, (1992), “The Long Wave in the World Economy”, Routledge.

Gary Walton & Ross Robertson, (1983) 5th Ed.,”History of the American Economy”,Harcourt Brace Jovanovich

A.B.Atkinson, (1972), “Unequal Shares (Wealth in Britain), Allen Lane The Penguin Press

Paul Davidson & Jan A. Kregel, (1989), “Macroeconomic Problems and Policies of Income Distribution, Aldershot Elgar

Jeffrey G. Williamson & Peter H. Lindert, (1980), “American Inequality”, Academic Press

Periodicals:

Business Week (Jun 8, 1992, p:86-88);

Forbes (Oct 19, 1992, p:78-89), “Why the 1980s were not the 1920s”, by Lawrence B. Lindsey

Federal Reserve Bulletin, Jan 92, “Changes in Family Finances from 1983 to 1989: Evidence from the Survey of Consumer Finances”,

Financial Times, Weekend FT III, (2 August 1992), “The downswings that should worry us all”, by Andrew Tylecote

Acknowledgement: I am grateful to Fergal Shortall and Pamela Warrington for their suggestions and criticisms in preparing this essay, and also to Garrett Dempsey of Irish Life (Dublin) and Brian Loughman of Price Waterhouse (New York) for obtaining material on the Federal Reserve’s 1989 US

 [1] “Great Depression of 1990″, Batra P.131

 [2] “History of the American Economy”, Walton & Robertson P.263

 [3] Walton & Robertson P.319

  [4] American Inequality, Williamson & Lindert P.84

  [5] Batra P.135/6

  [6] Source: “Macroeconomic Problems & Policies of Income Distribution”, Davidson & Kregel P.38/39

  [7] “Unequal Shares”, A.B Atkinson P.43

 [8] FT. article, Tylecote (see bibliography)

  [9] “The Long Wave in the World Economy”, Tylecote P.90

  [10] Tylecote P.18

  [11] FT article, Tylecote

  [12] Atkinson P.76

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What is recession?  Recession is a slowdown in economic activity for a period of time which contracts businesses. In the period of recession, Gross Domestic Product (GDP) which is a macro economic indicator shows a decline and other factors of investments, household incomes and business profits also indicate a decline.

Generally, governments undertake the introduction of stimulus packages in order to increase money supply in the money market.  In the recent years, U.S was affected with recession due to housing market and sub prime mortgages and as a result consumers have been badly affected as the house prices had dropped. There were severe job cuts in many companies in the year 2008 and as a result unemployment rate increased in U.S which stood at 8.5 percent in March 2009 and there have been 5.1 million job losses till March 2009 since the beginning of recession in December 2007.

The effects of recession are very negative such that there is a possibility of many job losses, bankruptcies, deflation, foreclosures and credit crunch.  Recession can affect any country and with proper economic and financial packages, there are remedies available.

At times, global recession can also occur.  International Money Fund considers that when global growth is less than 3 percent it indicates that there is a global recession. IMF also estimates that global recession occurs between 8 and 10 years.

There should be a constant economic review in order to avoid and prevent recession and it is also important to introduce new economic reforms keeping in view of changing scenario in globalization.