Consumption, Production, Capital, and Wealth Redistribution

20 Dec

This article developed during a discussion with Rainbow Camouflage and his post.  It was his post and the ensuing discussion that spurred my research and inspired the below post. I hope it is cogent and that my many references are integrated in an understandable fashion considering this post was by no means a linear creation.  Thank you.

I recently read an article titled “Raise Taxes on Rich to Reward True Job Creators”, by Nick Hanauer.  In his piece he makes the argument that rich people do not create jobs but it is the middle class that creates jobs.  What he is claiming is that the demand the middle class has for consumer goods is what creates jobs and that the top 1% of income earners should pay more in taxes in order to help the middle class spend more on pants, shirts, shoes, TVs, and all manner of disposable consumer goods.  While I agree that in a free market the consumer is boss I think it is short-sighted to focus only on the middle class consumers when in it comes to the overall economy.  If you want jobs and the middle class to have more disposable income, the only long-term solution is to grow the economy. 

I think the author has missed a key ingredient that has got our economy to where it is today – Capital accumulation.  There is no doubt that in a free market economy, the consumer is boss. That is a great thing and something we should all be protecting.  That is also what is plainly obvious.  There’s more to the story.

Some points on Capital Accumulation and past economic growth:

1)      “Capital input increased much more than labor input from 1850 to 1950”

2)      “This further rise in the productivity of land is accounted for by the application of five times more labor and twenty times more capital to land by 1929 than in 1850”

3)      “The growth in labor productivity…was caused entirely by a relative increase in the quantity of capital…”

4)      “Capital increase by itself would have raised the productivity of labor by 75 percent between 1850 and 1929.”

Source: Capital Accumulation, Technological Change, and Economic Growth

During the time period when the middle class was being created, capital accumulation appears to have been a major contributing factor to the overall growth of the economy.  These types of investments for long-term growth are what really created wealth because productivity increases are what created the middle class.  The great thing about capital is that it can be bought and sold to other producers, so that if a company fails to employ that capital in a manner in which consumer’s do not approve, they will be forced to sell to someone who does make the consumer happy.  Capital will change hands (be retooled, applied differently, etc.) and market forces, guided by the demand of the consumer, will reallocate resources accordingly.  Consumer demand does not exist in a vacuum and neither does production.  The “what if there is no demand” argument is bunk.  If there were no demand for any products, then it is valid, however just because demand shifts from one place to another only makes the point of capital reallocation as described above. 

Example:  Since there is demand for houses, let’s assume there has not been capital accumulation.  There are no back hoes, cranes, and other advanced building equipment (capital).  In this environment, there would be plenty of jobs because everything would have to be done by hand.  Unemployment solved.  Yet, everyone is much less productive, it takes more people to produce the same amount, and it takes more time.  This lowers overall production in the entire economy.  This will also cause lower wages (due to decreased per worker productivity) and less money for the labor force to spend on consumer goods.  I am NOT saying consumers play no role in the economy.  I am saying that there is much more to the overall story and this is what I believe the author has missed in his analysis of “job creation”.

What does this all mean and how does it relate to Nick Hanauer’s claim that all we need are more shoppers?  It’s Not about Consumption!  Robert Higgs points out that “real personal consumption recovered from its recession decline by the fourth quarter of 2010” and it continues to grow “even further above its prerecession peak.”  This means consumers are not only spending the same as they were before the recession, they have actually increased their level of consumption.  So if consumption has recovered, why hasn’t the economy?  Robert Higgs concludes:

The economy remains moribund not because consumption spending has failed to recover and not because government spending has failed to increase but because the true driver of economic growth — private investment — remains deeply depressed. Gross private domestic fixed investment fell steeply after the second quarter of 2007, and in the second quarter of 2011 it remained 19 percent below its prerecession peak. This figure fails to show how bad the investment situation really is, however, because the bulk of the investment spending now taking place is for what the accountants call the “capital-consumption allowance,” the amount estimated as necessary to compensate for the wear and tear and obsolescence of the existing capital stock.

At the end of Nick’s article, he advocates for taking money from the “1%” to “invest” back into our economy.  This is really just another stimulus plan / redistribution of wealth scheme.  No matter how you redistribute wealth, there is always a dead weight loss to the total output.  Maybe I am mistaken, but he seems to be arguing for taking money from the upper “1%” in order to sprinkle back to projects Congress deems worthy.  This does not grow an economy.    

“In 2009, the top 1 percent of tax returns paid 36.7 percent of all federal individual income taxes and earned 16.9 percent of adjusted gross income (AGI), compared to 2008 when those figures were 38.0 percent and 20.0 percent, respectively.” –   This same 1% also had an average tax rate of 24% (adjusted gross income).  The author claims he only paid 11%, so he must have a great tax lawyer to beat the average by more than half.  This appears hypocritical to me.  The entire argument that the “rich” are not paying their fair share just isn’t a fair characterization.  What is “fair share”?  If 1% of the population paid 36.7% of all federal income taxes and this is painted as unfair, what is fair?  Maybe I’m missing something.

One theme throughout the article is that income disparity among “fat cats like him” and the rest of us have dramatically increased – the typical argument of “The rich get richer and the poor get poorer.”  But this is not exactly accurate.

In an article written by Gary Galles titled “The Rich Aren’t Dispossessing the Rest”, he states:

The Congressional Budget Office’s just-published Trends in the Distribution of Household Income Between 1979 and 2007 found an increasing concentration of income over that period, ranging from 275 percent income growth for the top 1 percent of households and 65 percent growth for the rest of the top 20 percent down to 18 percent growth for the lowest 20 percent of household incomes.

Now it would appear that Nick Hanauer is correct and that “all that happens is that the rich get richer.”  But that is not how things are really happening.  Thomas Sowell explains:

Although such discussions have been phrased in terms of people, the actual empirical evidence cited has been about what has been happening over time to statistical categories — and that turns out to be the direct opposite of what has happened over time to flesh-and-blood human beings, most of whom move from one category to another over time.

So what does this mean?  It means that the disparity in incomes is not based on individuals, but on categories.  Individuals are not categories. 

The Treasury found that those with the very highest incomes in 1996 — the top 1/100 of 1 percent — had their incomes halved by 2005 (missed by using statistical classes, because such decreases move people out of the top category).


From 1996 to 2005, the incomes of those originally in the top 1 percent and 5 percent both declined; the incomes of those originally in the top 20 percent increased 10 percent; but those originally in the bottom 20 percent saw a 91 percent increase in income (missed by using statistical classes, because such increases move people out of the lowest 20 percent).

So the story is not about one group of people constantly being put down while a rising over class continues to rise above the rest.  On the individual level, the people who were in the bottom 20 percent are seeing higher increases in income than people who were in the other categories and that those who were in the top 1 to 5 percent range both declined in income.

In conclusion, it is not only consumption that grows an economy or creates jobs and taking more money from the rich in order to have Congress appropriate it hither and yon also does not grown an economy.  If you want a strong economy where long-term growth can be maintained and value-adding jobs can be created, then capital accumulation spurred by private investment appears to be the solution.  So why haven’t the investments been made in capital? 

“…apprehension and the consequent reluctance to make new capital commitments is regime uncertainty — in this case, a widespread, serious fear that the government’s major policies in areas such as taxation, Obamacare, financial reform, environmental regulation, and other areas will have the effect of depriving investors of control over their capital or diminishing their ability to appropriate the income that the capital generates. (It’s Not about Consumption)

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Posted by on December 20, 2011 in Uncategorized


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