Is it wise to expect continued output growth when most consumption was increased by high incomes?

There was an insightful article by Nelson Schwartz in the New York Times on how the hollowing out of the middle class is affecting business. He brought up some great points…

“The post-recession reality is that the customer base for businesses that appeal to the middle class is shrinking as the top tier pulls even further away.”

OK… so if business is shrinking for the middle class, it will just grow in other areas, right?

“Since 2009, the year the recession ended, inflation-adjusted spending by this top echelon has risen 17 percent, compared with just 1 percent among the bottom 95 percent.

“More broadly, about 90 percent of the overall increase in inflation-adjusted consumption between 2009 and 2012 was generated by the top 20 percent of households in terms of income, according to the study, which was sponsored by the Institute for New Economic Thinking, a research group in New York.”

The increased consumption by capital income between 2009 and 2012 is seen in the following graph. Yet it peaked and has been coming down. This graph uses preliminary numbers for 4th quarter 2013.

cap cons 4q13

OK… business that caters to the rich are doing well, but there is a warning given in the article. Mr. Schwartz quotes an economist Steven Fazzari of Washington University in St. Louis.

“It’s going to be hard to maintain strong economic growth with such a large proportion of the population falling behind,” he said. “We might be able to muddle along — but can we really recover?”

“Mr. Fazzari also said that depending on a relatively small but affluent slice of the population to drive demand makes the economy more volatile, because this group does more discretionary spending that can rise and fall with the stock market, or track seesawing housing prices.”

Economists like Krugman, Thoma, Baker, etc. expect real output to recover to levels close to those seen before the crisis. Yet, high incomes are starting to cut back consumption, even as labor share has already fallen 5% since the crisis. Are these economists in part basing their expectations of future output growth upon the increased spending by the rich over the past few years?

If so, that is not wise, because the spending by high incomes is volatile. The “rich” will adjust their spending depending on movements in asset prices and profits. I foresee that we will see a drop in high-income consumption spending when the data for 1st quarter 2014 comes out in 3 months due to the downward shocks in the stock market.

As long as stocks and other assets continued to rise in price, consumption by high incomes increased. QE helped bolster asset prices. Well, QE is being tapered. The little QE house of cards of trying to prop up asset prices is shaking. Are economists implicitly saying that asset prices will continue rising?

I wouldn’t think that. The rich have their limitations too. I predict that higher incomes over the next 6 months progressively protect their incomes and consume less. This will be one of the drags on real GDP.