Wednesday, January 29, 2014

Income Inequality and Wealth Distribution

Income Inequality Part 1 by Market Authority

In the next few days, I’ll be addressing the hot-button issue among economists of income inequality. I will try to provide an understanding of…

1. The origins of income inequality and creative destruction.

2. How technology is disrupting the workforce.

3. How Bernanke and QE exacerbated the problem.

4. A solution using available technology to build human capital and combat income inequality.

Today, we’re going to discuss the origins of income inequality.

To start off, I want you to take a trip down memory lane. Perhaps to the days of your youth, if you grew up in the US between the 1950s-1970s. Imagine yourself walking down Main St in the town you were raised. If it resembles anything like my hometown, you probably have a community savings bank, a diner, a five and dime, a local bakery, and a grocer. Most likely there isn’t a Starbucks (unless you’re in downtown Seattle), and I doubt your idyllic small town has anything resembling Walmart. People had jobs, businesses were easier to start, and the American Dream was alive and thriving.

Life started to change in the 1980s. Your grocer was replaced by a 7-11, your community savings bank became Bank of America, and your five and dime is now Walmart.

Why did this happen?

Profit-seeking investors began to create franchises that could deliver goods at a cheaper cost and still be profitable. This is how capitalism works, through a mechanism known as “creative destruction.” Coined by Austrian economist Joseph Schumpeter in 1942, entrepreneurs disrupt existing businesses causing short-term distress in labor until those workers can be re-trained for other types of work.

I know that may sound confusing so let me give you an example of creative destruction at work.

Sam Walton founded Walmart in 1962 in Bentonville, Arkansas. It was originally a small 5 and 10. Walmart now has 8500 stores in 15 countries and sells nearly $300bln in goods per year.

As Sam Walton began expanding the 5 and 10 business, he was able to leverage his growing distribution for better prices from suppliers. This allowed Walmart to move into new markets and offer consumers better prices. The existing businesses in those towns, mostly run by Mom and Pop’s, unable to compete were forced to shut down. As Walmart grew, sources of goods became cheaper and it became even easier to move into new markets, thereby causing rapid expansion in the 80s and 90s.

You can see this process in the rise in real wages of the 1% and upper incomes since 1980…

You can clearly see how all this creative destruction has only helped those at the very top. The Mom and Pop’s who previously ran their own 5 and 10′s are now working at the checkout counter at the local Walmart.

Although you probably paid more for your household goods shopping at a 5 and 10, but the money you spent stayed local. Your local profits from the 5 and 10 would be reinvested in your community either through direct spending by the business owners or through their taxes. In Walmart’s case, the revenues are funneled back to Arkansas and then distributed to WMT executives and equity holders. The next time you see a picture of one of Sam Walton’s offspring in Forbes, think of him as an amalgam of the 10′s of thousands of Mom and Pop’s they absorbed over the years.

Creative destruction is not only limited to retail. It has occurred in just about every industry in the past 30 years. There are positive and negative consequences. Goods may become cheaper, but wages have also risen slowly in order to compete with cheaper labor elsewhere or better technology.

Auto plants moved to Mexico or call centers moved to India - jobs have been leaving the US and (for the most part) not coming back. Technology and a “flat world” has accelerated this process.

But that doesn’t mean jobs aren’t being created in other sectors. The problem in the US is that workers don’t have the skills needed to fill the available jobs.

Every month, the BLS releases Janet Yellen’s favorite indicator - the Job Openings and Labor Turnover Survey (better knowns as JOLTS). As you can see in the chart below, available jobs have been rebounding since the recession and are at levels not seen since 2005…

The issue is that there’s been a huge shift in where these opportunities are available. While manufacturing and brick and mortar retail (Best Buy, Borders, etc) look like dying sectors, industries such as natural gas fracking, healthcare, and web development have plenty of openings.

This is due to the accelerating pace of creative destruction, especially as technology is disrupting existing business models at a faster pace than we’ve ever seen.

Next article, I’ll go over the reasons why creative destruction is occurring at a pace we’ve never witnessed.

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