America is 'Going Broke'

Americans are getting poorer.  The U.S. government has just released many new statistics about poverty in America, and once again this year the news is not good.  

According to a special report from the U.S. Census Bureau, 46.2 million Americans are now living in poverty.  

The number of those living in poverty in America has grown by 2.6 million in just the last 12 months, and that is the largest increase that we have ever seen since the U.S. government began calculating poverty figures back in 1959.  

Not only that, median household income has also fallen once again.  In case you are keeping track, that makes three years in a row.  

According to the U.S. Census Bureau, median household income in the United States dropped 2.3% in 2010 after accounting for inflation.  Overall, median household income in the United States has declined by a total of 6.8% once you account for inflation since December 2007.  

So should we be excited that our incomes are going down and that a record number of Americans slipped into poverty last year?  

Should we be happy that the economic pie is shrinking and that our debt levels are exploding?

The underlying cause of the financial collapse is growing inequality; the solution is strong government expenditures.

The financial sector's inexcusable recklessness, given free rein by mindless deregulation, is the obvious precipitating factor of the crisis.

Without bubble-supported consumption, there would have been a massive shortfall in aggregate demand. Instead, the personal saving rate plunged to one per cent, and the bottom 80 per cent of those in the US were spending, every year, roughly 110 per cent of their income.

Even if the financial sector were fully repaired, and even if Americans hadn't learned a lesson about the importance of saving, their consumption would be limited to 100 per cent of their income. So anyone who talks about the consumer "coming back" - even after de-leveraging - is living in a fantasy world.

Fixing the financial sector is necessary for economic recovery, but far from sufficient. To understand what needs to be done, we have to understand the economy's problems before the crisis hit.

First, the US and the world are victims of their own success. Rapid productivity increases in manufacturing has outpaced growth in demand, which means that manufacturing employment decreased. Labor shifted to services.

The problem is similar to that which arose at the beginning of the twentieth century, when rapid productivity growth in agriculture forced labour to move from rural areas to urban manufacturing centres. With a decline in farm income in excess of 50 per cent from 1929 to 1932, one might have anticipated massive migration. But workers were "trapped" in the rural sector: They didn't have the resources to move, and their declining incomes so weakened aggregate demand that urban/manufacturing unemployment soared.

For the US and Europe, the need for labor to move out of manufacturing was compounded by shifting comparative advantage: Not only are the total number of manufacturing jobs limited globally, but a smaller share of those jobs will be local.

Globalisation has been one, but only one, of the factors contributing to the second key problem - growing inequality. Shifting income from those who would spend it to those who won't lowers aggregate demand. By the same token, soaring energy prices shifted purchasing power from the United States and Europe to oil exporters, who, recognising the volatility of energy prices, rightly saved much of this income.

The final problem contributing to weakness in global aggregate demand was emerging markets' massive buildup of foreign-exchange reserves - partly motivated by the mismanagement of the 1997-98 East Asia crisis by the International Monetary Fund and the US Treasury.

Countries recognised that, without reserves, they risked losing their economic sovereignty. Many said: "Never again." But, while the buildup of reserves - currently around $7.6 trillion in emerging and developing economies - protected them, money going into reserves was money not spent.

Where are we today in addressing these underlying problems? To take the last one first, those countries that built up large reserves were able to weather the economic crisis better, so the incentive to accumulate reserves is even stronger.

Similarly, while Corporate Capitalists have regained their bonuses, workers are seeing their wages eroded and their hours diminished, further widening the income gap. Moreover, the US has not shaken off its dependence on oil. With oil prices back above $100 a barrel this summer - and still high - money is once again being transferred to the oil-exporting countries. And the structural transformation of the advanced economies, implied by the need to move labor out of traditional manufacturing branches, is occurring very slowly.

Government plays a central role in financing the services that people want, such as education and health care. And government-financed education and training, in particular, will be critical in restoring competitiveness in Europe and the US. But both have chosen fiscal austerity, all but ensuring that their economies' transitions will be slow.

The prescription for what ails the global economy follows directly from the diagnosis: Strong government expenditures, aimed at facilitating restructuring, promoting energy conservation, and reducing inequality, and a reform of the global financial system that creates an alternative to the buildup of reserves.

Eventually, the People will come to recognize this. As growth prospects continue to weaken, they will have no choice. But how much pain and suffering will we have to bear in the meantime?