November 09, 2018
This post was originally published on my Patreon page.
Several people on my Twitter feed touted the drop in the stock market last month as evidence of the failure of Donald Trump’s economic policy. I responded by pointing out that he was reducing wealth inequality. I was being only half facetious.
I have always been less concerned about wealth than income both because I think wealth is less well-defined and because income is the more important determinant of living standards. In the case of the stock market plunge, the vast majority of the losses go to the richest 10 percent of the population and close to half go to the richest 1 percent, for the simple reason that this is the distribution of stock ownership.
When people decry the rise in inequality in wealth over the last decade, they are basically complaining about the run-up in the stock market. The real value of the stock market has roughly tripled from its recession lows. With the richest one percent holding close to 40 percent of stock wealth and the richest 10 percent holding more than 80 percent, a tripling in the value of the stock market pretty much guarantees a big increase in wealth inequality. If we think this increase is bad, then why would we not think a drop in the stock market is good?
There is a correlation between the stock market and economic growth. The market generally rises when the economy is strong and falls in recessions, but this link is weak. Remember the recession of 1988?
I hope not, because the economy continued to grow at a healthy pace until the summer of 1990. This is in spite of the stock market’s largest one-day drop ever in October of 1987. (It did recovery half of its value by the end of the year.)
In short, the recent plunge in the market tells us little about the future direction of the economy. If we are troubled by wealth inequality then we should be happy, rich people now have substantially less wealth.
This is not the only case where our thinking about wealth may be problematic. The value of a bond is inversely related to interest rates. To oversimplify slightly, a very long-term bond has roughly twice the value when the prevailing long-term interest rate is 2.5 percent than when it is 5.0 percent. This fact means that, other things equal, when interest rates fall, wealth inequality increases (because rich people own most of the bonds). So should we be upset about the rise in inequality when interest rates drop?
Bonds are an interesting case since the payout is fixed independently of the bond’s value. With lower rates, rich bondholders have more wealth, but no more annual income.
The situation is actually similar with stocks. Stock returns come from either dividends or capital gains. When price-to-earnings ratios are high, dividend yields will be low. In the Golden Age following World War II, dividend yields averaged more than 4.0 percent annually, since price-to-earnings ratios were generally under fifteen. In recent years, with the price-to-earnings ratios well over twenty, dividend yields have been close to 2.0 percent annually.
As a result of lower dividend yields in recent years, stock returns were actually much higher in the Golden Age than in the last two decades. From 1947 to 1973, real returns averaged 8.4 percent. In the last two decades, they have averaged just 4.7 percent.
In effect, the rise in stock prices has meant that stockholders are getting lower returns for each dollar of stock they hold. The rich do have more wealth as a result of higher stock prices, but it doesn’t necessarily mean they will have more income. In any case, if we are really bothered by this wealth, then we should see a lower stock market as good news.
Wealth and Middle-Income Families
For middle-income families, wealth largely means owning a home. For the vast majority of middle-income families, their house is their main source of wealth. Median family wealth in 2016 was just under $100,000, a bit less than twice the median family, as measured by the Survey of Consumer Finance.[1] There are large differences in wealth by race, with the median for whites at $171,000, for blacks, $17,600, and for Hispanics, $20,700. This largely reflects the fact that the median white family is a homeowner, with homeownership rates of more than 70 percent. By contrast, the homeownership rate for blacks is just over 40 percent, and for Hispanics, it is a bit over 45 percent.
There has been much made of the fact that median wealth has not recovered to its 2007 levels. This is a bit misleading. The levels of 2007 were inflated by the housing bubble. Even though there was a sharp drop in the equity share of most homeowners (the share of the house’s value they had paid off), there was an increase in homeowner equity due to the run-up in prices. Since this run-up was ephemeral, it was inevitable that homeowners’ equity would plunge when the bubble burst.
The more serious concern than the comparison to 2007 is the longer-term trend in the wealth of middle class households. The wealth of families between the ages of 55 and 65 in the middle quintile of the distribution is essentially unchanged from where it was in 1989. For families between the ages of 45 to 54, it is actually down by almost 30 percent from its 1989 level.
This is a big deal, not only because we should expect the wealth of these households to increase more or less in step with the rate of growth of productivity in the economy (more than 80 percent since 1989), but also because we have seen traditional defined-benefit pensions largely disappear over this period. While most workers nearing retirement age could count on getting a defined-benefit pension in their retirement in 1989, this is much less the case today. In fact, less than 25 percent of the families who were between the ages of 45 and 54 in 2016 had a defined-benefit pension. This means that middle-income families will be much more dependent on the wealth they have accumulated over their working lifetimes to support themselves in retirement than had been the case in prior decades.
Making matters worse, these younger cohorts will also be seeing lower Social Security benefits relative to their earnings since the increase in the retirement age between 2002 and 2022 effectively amounted to a 12 percent reduction in scheduled benefits. Changes in the calculation of the consumer price index (CPI) also have reduced benefits by close to 5 percent. (Benefits after retirement are tied to the CPI.) Also, retirees are looking at much larger health care expenditures, as the out of pocket bills left over after Medicare are considerably larger relative to their income than was the case three decades ago.
The role of pensions, Social Security, and Medicare show the trade-off between the need for wealth and the access to social programs or a regular source of income, in the case of traditional defined benefit pensions. In a context where a combination of Social Security and a defined-benefit pension provided a livable retirement income, and Medicare covered the bulk of health care costs, retirees did not have a need for large amounts of wealth. However, when few people have pensions, and Social Security benefits are not large enough to sustain a middle class living standard, retirees who have not accumulated substantial wealth can expect to face serious financial difficulties in retirement.
Wealth and Lower Income Families
If middle-income families don’t have enough wealth, for practical purposes lower-income families have none. The Federal Reserve Board did a survey last year that found that 40 percent of households could not come up with $400 if they needed it in an emergency. This is a dire situation for these families, but one that may not be best addressed through trying to ensure that these families have some wealth. After all, if they had a small amount of wealth and then faced inevitable emergencies, the wealth will be quickly dissipated.
As a practical matter, it might make more sense to deal with the emergencies that are likely to create the unexpected need for $400. At the top of this list would be medical expenses. If we had a good national health insurance system that covered most of health costs for the public (and pretty much all the costs for low- and moderate-income households) a major source of unexpected expenses will be eliminated. In addition, when someone is dealing with their own illness or that of a family member, it is not a good time to impose an additional burden.
Another source of unexpected costs is a car repair. Since many people need a car for work, facing a $1,000 repair bill and being unable to pay it, is a very serious issue. This highlights our neglect of mass transit. We have starved big city transit systems for funds, causing many to provide poor services and charge high fares. This is a case where a relatively small amount of money could go a long way, especially if it goes to provide bus service, which ramped up quickly, as opposed to various types of light-rail systems which take many years to put in place and typically come at very high cost.
Bail is also an unexpected emergency for many families. The simple story here is to eliminate cash bail in most instances. People should not face the prospect of spending months or even years in jail simply because they or their family cannot afford the bail set by a judge. The point here is to make sure people show up for trial, not to punish them before they have had a trial.
Housing expenses are a fourth common cause of unexpected expenses. This could be a needed repair in a home that is owned, or unexpected rent increase or other expense in a rented unit. We can’t protect people from needed repairs on their homes, but we can limit the ability of landlords to raise rents. Our housing policy has been hugely tilted towards promoting homeownership. This is unfortunate since roughly one-third of the population has been renters and that is likely to remain the case, even as we have modest fluctuations in the share of homeowners over time.
Some cities do have laws that protect tenants against excessive rent increases or arbitrary evictions, but these are the exceptions. While rent control can pose serious problems if poorly implemented, limiting rent increases for incumbent tenants can provide considerable security for renters.
The Quick Summary on Wealth
First, the inequality measure is primarily a measure of the stock market. I’m more troubled by income inequality than wealth inequality, but if the latter really bothers you, then you need to be rooting for a drop in the stock market.
Wealth has become more important for the middle class because of the disappearance of defined-benefit pensions. These pensions allowed most middle class people to maintain a reasonable standard of living in retirement. Most middle class workers are not accumulating substantial wealth in 401(k) type accounts both because they tend to change jobs frequently and also the high fees charged by the financial industry.
One solution to this problem is the state-level 401(k) plans that are being put in place by Illinois, Oregon, California, New York, and a number of other states. These plans will minimize the administrative costs and will also be portable so that workers will be able to keep the same plan as they change jobs within the state.
Ideally, these plans will also have a default annuity so that people will effectively end up with something very similar to a defined-benefit pension. All the states have people participating in these plans as a default option. This means that they will contribute unless they choose not to.
It will take time for these accounts to build up any substantial amount of assets and there is a real risk that many baby boomers and Gen-Xers will retire without traditional defined-benefit plans and little savings in their 401(k)s and little equity in their homes.
For lower-income families, it seems more reasonable to try to shore up the safety net so that they don’t suffer great hardship by virtue of the fact that they don’t have a substantial amount of wealth they can rely upon. Efforts to build wealth among lower-income families have often meant more money for the financial industry than the families. If we instead focus on ensuring that all people have access to health care, good public transportation, and secure housing, then the lack of wealth in low-income households will be less of a problem.
[1] The Survey of Consumer Finances (SCF) defines “family” to include a single person household. The more common definition requires at least two related individuals living together. This is why the SCF has a somewhat lower measure of median family income than is usually reported.
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