Inequality’s Effect On The Lower Rungs

At Project Syndicate, Raghuram Rajan explores the correlation of the declining pre-Great Contraction U.S. household savings rate and income inequality.

Bertrand and Morse find that in the years before the crisis, in areas (usually states) where consumption was high among households in the top fifth of the income distribution, household consumption was high at lower income levels as well. After ruling out a number of possible explanations, they concluded that poorer households imitated the consumption patterns of richer households in their area.

Consistent with the idea that households at lower income levels were “keeping up with the Vanderbilts,” the non-rich (but not the really poor) living near high-spending wealthy consumers tended to spend much more on items that richer households usually consumed, such as jewelry, beauty and fitness, and domestic services. Indeed, many borrowed to finance their spending, with the result that the proportion of poorer households in financial distress or filing for bankruptcy was significantly higher in areas where the rich earned (and spent) more. Were it not for such imitative consumption, non-rich households would have saved, on average, more than $800 annually in recent years.

This is one of the first detailed studies of the adverse effects of income inequality that I have seen. It goes beyond the headline-grabbing “1%” debate to show that even the everyday inequality that most Americans face – between the incomes of, say, typical readers of this commentary and the rest – has deep pernicious effects.

This is a type of consumption that I have always heard of anecdotally but never seen personally. But it is a type of pathological response of the middle class to a society bend on ostentatious consumption. Once the bank grants the mortgage you cannot really afford on a house in a nice neighbor you probably become hell-bent on displaying belonging. So you borrow on that shaky mortgage to lease a luxury car to park in your driveway and get a weekly maid service, and max out some credit cards to fill your house with expensive technological goods and cloth yourself in designer brands. This process is something we could all probably acknowledge if we really looked deep into our habits and inner longings, but when credit is loose and pressures for “imitative consumption” are constant, there is apparently no stopping until you hit bankruptcy. Looking at household savings rates, you can see that these would plunge as people spent more than their income to fuel their consumption. Leveraged over their eyeballs when the recession hit, the middle class had to deleverage since 2008.

Revolving credit (e.g. credit cards) has plummeted down from 2008 Q4 highs to but the rate of change has rolled over and credit started to rise again from 2011 Q2 lows. Deleveraging halted performed an about face. As Bertrand and Morse hypothesize, the middle class debt overhang emerged well before the Great Recession, and it has since dogged middle class balance sheets ever since. As inflation hits the goods the lower rungs of income distribution need to survive; energy, food, and health care. Credit is needed to buy the same amount of goods and services they once used. Rising revolving credit, stagnant or declining real wages, and declining personal consumption expenditures is creating a maelstrom of debt just to survive. Imitative consumption is a problem of the past. Now inequality has brought a rash of borrowing to get to work, borrowing to put food on the table (or applying for SNAP), and borrowing for a roof over your head. This now is the crux of American inequality.

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