Make the pie higher!

George W Bush was roundly mocked for his comment, when asked about inequality during the 2000 election, that the country shouldn't be focused on who has the biggest share of the pie: "We ought to make the pie higher!", he said.

But he actually made a decent point, one which seems to have been forgotten nowadays.

Real economic growth is becoming impossible in rich countries because corporations are hoarding money. US corporate profits are now at a 60-year peak, relative to GDP; cash holdings by businesses are also at record levels.

In normal times companies would be investing this windfall, but they aren't because they see dismal prospects for demand. One reason for this is that the ordinary people who they depend on for sales are short of cash. For decades, incomes have barely kept pace with inflation. The best way people found to get ahead in recent years was to take on a mass of mortgage and credit card debt; paying that down is now further choking off disposable incomes. With unemployment at historically-high levels, salaries everywhere are now being trimmed again, skewing returns even more towards capital rather than labour.

This column by Reuters' Jim Saft puts it brilliantly:

"At the moment it is hard to see what will break the Gordian knot presented by lack of confidence and unwillingness to invest or spend. But it is possible to start sketching the outlines of what a recovery would have to look like.

"Corporate profits must stabilise and probably fall as a share of GDP, as more of the fruits of production are directed towards workers (and consumers). Businesses will have to take far more risk by ending the accumulation of cash and liquid assets and instead investing in far less liquid fixed assets and creating more jobs.

"Reversing three decades of corporate policy and central bank theory, wages and other forms of compensation will have to start rising faster than prices for a time. Corporations and central banks will have to tolerate a period of “inflationary” wage gains.

"It is not clear how lower corporate profits would play out in equity prices. Prices would suffer from shrunken margins, but presumably gain from faster growth. It is possible to imagine a scenario in which the economy recovers but equity prices languish. It might be the only way for the economy to recover."

At the moment rich countries are in a vicious circle where as the economy grows weaker, the share of production going to capital rather than labour grows. As labour's share of production shrinks, so does demand for goods and services, further weakening the economy.

Companies are doing their duty to their shareholders by maximising their profits. But the overall result of an economy where everyone is doing this against a backdrop of moribund demand is that shareholder returns are ultimately weaker: profits are just making up a larger slice of a smaller pie.

I think societies work best when people are working together, with confidence, towards some mutually-beneficial outcome. But of late we've exchanged that vision for a desperate, zero-sum struggle over control of a dwindling resource. That certainly doesn't benefit the poor who are likely to lose out, but it doesn't help the winners much, either. We'd all be much better off making the pie higher.