Where Wealth Lives

For the past three years, the U.S. has enjoyed an almost unprecedented boom in productivity. Yet these gains have been distributed unevenly. Household net worth has reached an all-time high, surpassing even the bubble-influenced peak of early 2000. That has mainly benefited the top half of families, who own virtually all of the country's assets such as stocks, bonds, and homes.

Meanwhile, high unemployment and glacial job growth have left many workers, especially at the bottom end, suffering. The share of the economic pie going to wages and salaries has plummeted to just over 50%, its lowest level in at least the past 50 years, and perhaps longer.

The good news is that, with the reappearance of job growth, the recovery seems to be moving into a new phase. The latest employment report, released on Apr. 2 by the Bureau of Labor Statistics, showed a 308,000 increase in jobs in March. The gains were broad-based: Retailers and restaurants staffed up on low-wage positions, while on the high end, consulting and securities firms put out the help wanted sign.

ELECTION ISSUE. If these job gains continue, the benefits of growth and higher productivity will finally spread more widely. The unemployment rate will fall, and eventually wages will start to increase at a more rapid rate. Indeed, history tells us that the pendulum will eventually swing back, and the share of U.S. economic output going to labor will rise again.

Unfortunately, history also tells us that this process will not happen overnight. For the rest of this year -- and perhaps into 2005 -- most of the productivity gains are likely to show up as increasing wealth, not as higher income for workers. For one thing, real wages, while picking up a bit, are growing at a very slow pace. Moreover, production and supervisory workers -- about 80% of private nonfarm employees -- are still seeing their real hourly earnings fall. That probably won't change until unemployment drops below 5% -- and even at that level, pressure from cheap labor overseas may slow the revival of wage growth.

Meanwhile, asset owners should continue to profit from the combination of weak wage growth and strong productivity, which ought to lift corporate profits and the stock market. And the willingness of foreigners to keep putting money into the highly productive U.S. economy will help keep long-term interest rates low, boosting the housing market.

This disconnect between the strong surge in wealth and weak gains for labor income is helping to frame the 2004 campaign. President George W. Bush talks about tax cuts and a new "ownership society" -- and has boasted of how the wealth of average Americans has increased because of soaring housing prices and rebounding 401(k)s. Presumed Democratic candidate Senator John F. Kerry, meanwhile, argues that most Americans have not become wealthier during the Bush years, and he blames the President for low wages and the squeeze on the middle class.

LIQUID ASSETS. The continued importance of wealth in the recovery has in many ways surprised economic forecasters, who have repeatedly -- and wrongly -- warned that the expansion was unsustainable without job growth. To be sure, household net worth has always risen in the early stages of a business cycle. But for most of the 20th century, an increase in household wealth did little to boost economic growth. Hard assets such as homes, even if they rose in value, could not be converted easily into cash to spend on cars, furniture, travel, and the like. Even a surge in the stock market didn't do much, because the "wealth effect" from rising share prices was rather small and didn't always seem to show up in the data.

Three things have changed. First, the growing reach and efficiency of financial markets makes it far easier to take money out of a formerly illiquid asset, such as a home, without actually selling it. Refinancing a mortgage used to be a complicated and expensive process, limiting how often it could be done. Now, low-cost deals have enabled many to refinance repeatedly as rates have dropped. Similarly, it's far easier to get home equity loans, which now total over a trillion dollars.

Second, globalization means the market for assets is now worldwide. That's good news for the U.S., since the productivity boom and rapid growth make America an attractive destination for foreign funds, especially compared with such slow-growth regions as Europe.

The influx of foreign money has the effect of holding down interest rates and pushing up asset values, both of which have supported strong consumer spending despite the weak jobs performance. Over the past three years, foreigners have grabbed over $500 billion in U.S. corporate bonds, more than $400 billion in Treasury securities, and $225 billion more in agency securities, primarily mortgage-backed securities. In this last case, foreigners are effectively lending Americans money, using the appreciated value of their homes as collateral. This cash flows, eventually, into the pockets of U.S. homeowners, providing an enormous amount of financing for the housing boom and (indirectly) for consumer spending. The foreign inflow of money is the major reason why the interest rate on 10-year Treasuries still is as low as 4.2%, despite the big budget deficits and the rebounding economy.

Likewise, as equity markets become more global, the sale of high-priced stocks to foreigners has helped finance the U.S. consumption of imports. Foreign investors purchased $84 billion in U.S. corporate equities in the fourth quarter of 2003 as the stock market rose. That inflow was sufficient to finance much of the current-account deficit for that quarter.

Finally, the changes in the tax code, under Presidents Bill Clinton and Bush, have tended to reduce the tax burden on wealth. For example, Bush's tax cut on dividends may have helped boost stock prices, making the U.S. richer. And Clinton's 1997 expanded tax exemption for capital gains on home sales may have helped spur the housing market.

This all helps to explain why wealth has taken on a much larger role in sustaining U.S. economic growth. But the growing importance of wealth widens the social and economic chasm between rich and poor. Ownership of assets is highly concentrated, far more than income. The top 1% of families, as measured by net worth, receive about 15% of income but own 30% of the nation's assets -- including stocks and bonds, homes, and closely held businesses. That's according to the Federal Reserve's Survey of Consumer Finances. The top 10% of families, as measured by net wealth, own 65% of assets, and the top 50% own a stunning 95% of assets. That means the gains from rising wealth have effectively left out half the population.

INTENSIFYING INEQUALITY. Surprisingly, even housing wealth is more concentrated than people realize. True, almost 70% of households own their own homes, according to the Census Bureau. But it turns out that the top half of families own almost 90% of the housing wealth, based on the Federal Reserve's survey.

These percentages have budged little over the past 10 years. The implication is that the gains in productivity, which have pushed up household wealth, have only benefited the top 50% of the population. The bottom half of families -- many of whom don't own homes or bought them in less prosperous neighborhoods -- have largely been left behind.

Worse, a weak job market tends to accentuate the inequality. When labor is plentiful, employers generally hire the most skilled workers. Over the past year, the economy has generated almost 1 million jobs for college-educated workers, according to the household-survey data from the BLS. Meanwhile, the number of employed workers without a college degree has actually fallen by roughly 100,000.

There's no doubt that the job market is beginning to improve. Employment in the first quarter rose from the same period a year earlier -- the first year-over-year gain since 2001. By itself that's not much. However, these job gains, as they pick up speed, will eventually spread the benefits of growth more widely, just as they did in the 1990s.

Remember, though, that even in the '90s, labor's share of national income -- that is, the total of the wages, benefits, profits, rents, and interest generated by the economy -- kept falling until 1997. That was when the unemployment rate dropped below 5% and stayed there for several years. Similarly, real wages were stagnant until 1997 even though job growth picked up as early as 1994.

Based on what happened in the '90s, reducing unemployment to the point where labor's share of income starts to rise again won't happen quickly. Consider: It would take about 1 million new jobs to drive the unemployment rate down to 5%. An additional 700,000 new positions, at least, would be needed to account for all the people who have stopped looking for work over the past year but would be drawn back into the labor market if employers started to hire again. And the growing population of the U.S requires about 150,000 more new jobs per month.

Add that all together, and the economy will have to add almost 350,000 jobs per month to push unemployment down to 5% by the end of 2004. Even that strong performance may not be enough to get wages moving strongly upward again right away if workers fear that their jobs are in danger of being outsourced to India or China.

The bottom line: Workers are going to benefit from faster productivity growth, perhaps as early as next year -- but it is almost certainly not going to happen before the November election. That means Bush and Kerry will be competing in an economic landscape where wealth is still the central driving force for growth -- and where many workers, while employed, will be without decent raises. By Michael J. Mandel in New York, with Richard S. Dunham in Washington

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