This blog article is inspired by James K Galbraith's books Inequality and Instability and Inequality: What Everyone Needs to Know. I disagree with Galbraith's premises, and his conclusions, but he is a brilliant writer and a scholar in the very traditional sense of the word. Most important of all: he points with his whole hand to the problem discussed here, a problem that people on "my" side of the aisle have not paid enough attention to.
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One of the most important elements of a free, prosperous society is that you can pay for your own life expenditures even if you do not make a lot of money. You are able to provide for your loved ones even if you are among the lowest-earning heads of household. Increasingly, this is no longer the case in the Western world, even here in the United States. On the contrary, people increasingly depend on government for their basic needs; for example, since at least the 1940s, transfers from government - entitlements - have grown steadily as share of personal income:
Figure 1
Source: Bureau of Economic Analysis
In addition to our growing dependency on government, we also depend increasingly on credit for our personal expenditures. Figure 2 reports the rate of growth in consumer installment credit (blue columns), i.e., loans that we pay off in installments over a defined period of time (excluding mortgage loans), and he growth rate in current-price consumer spending (green):
Figure 2
Sources: Federal Reserve (credit; blue) and Bureau of Economic Analysis (consumption; green)
For a long period of time, from the mid-1960s to the mid-1990s, consumer spending grew faster than banks' lending of installment loans to consumers. Over the past 20 years, though, consumers have been taking out new installment loans faster than motivated by their spending. This strongly suggests that American families increasingly depend on loans to keep their consumption up - despite the fact that private consumption is growing slowly by historical comparison.
Interestingly, revolving credit - think credit cards - has decreased as share of consumer spending. In the mid-1990s American financial institutions provided consumers with revolving credit equal to 9-10 percent of consumer spending, a level that sustained to 2009. Since then, the revolving-credit to consumption ratio has declined and is now just a hair above seven percent.
The decline in lending through revolving credit would suggest that consumers are financing less of their expenditures with credit. That, however, is not true - on the contrary: in 2015, revolving and installment credit together amounted to 27 percent of consumer spending. That is the largest rate in history.
The fact that consumers are using less revolving credit and more installment credit suggests that they cannot afford high credit cards - and to an increasing degree do not qualify for them - but also have difficulties financing their expenses without access to credit. In fact, Figure 3, reporting annual current-price growth in disposable personal income, and credit-to-income ratios for consumer credit, suggests that it is precisely because of a stagnant trend in personal income that consumers turn to banks for financing their spending (please keep in mind, again, that installment credit does not include mortgages):
Figure 3
Sources: Federal Reserve (credit) and Bureau of Economic Analysis (income)
Add to this the increasing share of tax-paid transfers as part of personal income, and we have a disturbing scenario: Americans are decreasingly able to support themselves on their work-based earnings. We simply have a major systemic problem in the modern industrialized economy. I maintain that the problem, as I have explained, is the welfare state; others, from the egalitarian side of the aisle, will protest loudly. I welcome their arguments; what really matters here is that we get a conversation going about the erosion of the American worker's financial self determination.
One last point: this problem is of such a nature that we need to rely on good, old political economy to hash out a solution. Econometrics, Walrasian microeconomics and optimization theory are, with all due respect, not very useful tools in this context.
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