Politics & Law

A cost of inequality: growth

Claude Fischer

A recent story in The New York Times, back in its business section, had important news about inequality: “Income Inequality May Take Toll on Growth.” A couple of economists at the IMF reported research (here) showing that, across many countries, periods of greater income inequality tend to be followed by slow-downs in economic growth.

graph

Percent of all income gained by top tenth, 1917-2007 (Atkinson et al, 2011)

This is, actually, old news. About twenty years ago the research literature already showed that inequality probably damped the economy (see pp. 126ff here). But this remains important to repeat – not just because reporting the baleful effects of inequality now has the imprimatur of the IMF, but also because so many people still resist the news; they insist instead on believing the opposite, that inequality stimulates the economy, to the benefit of everyone. And, of course, this insistence has political implications right now.

Denial

Anecdote: Back in 1999, I was invited to give a paper to a conference, held at an eminent law school, exploring the contemporary role of the corporation. I presented the state of knowledge on the empirical question of whether inequality was necessary (or even helpful) for spurring overall economic growth; the research said no and suggested that inequality may well be harmful to the economy. The discussant for my paper was an eminent state jurist, one with considerable influence on corporate law. He summarily dismissed my conclusion – and the research it drew on – because “everyone knows” and economic logic tells us that the prospect of getting rich is necessary for people to work hard and to invest. Inequality must be necessary for economic growth. Case closed.

Many Americans have also felt that way. In 1987, 71% of survey respondents (to the GSS) said that it is probably or absolutely the case that “in order to get people to work hard, . . .  large differences in pay are necessary.” But phrasing the issue another way, we see some skepticism. In the same 1987 survey, only 29% agreed that “large differences in income are necessary for America’s prosperity.” That percentage has slowly shrunk: 29% again in 1996, 28% in 2000, and 24% in 2008 (shrunk basically because Americans in the bottom half have become less persuaded that the differences are necessary).*

“Job creators”

The controversy appears in our current political debates. Governor Romney complains that raising or even keeping our current tax rates on the wealthy will strip the “job creators” of the funds they need to invest in new businesses and new hires. In other comments, he shows himself sympathetic to the idea that current or higher tax rates undermine Americans’ desire to work hard. This is totally in tune with the theory that sizable income and wealth gaps are needed for economic growth.

When President Obama defends the tax-the-rich policy, he does so largely on the grounds of fairness and of addressing the deficit. When, however, he argues that “we grow the economy from middle out,” he is, knowingly or not, alluding to an alternative theory about the sources of economic growth: that income for and spending by the working and middle classes drive growth. The 99% much better “incentivize” businesses and investors than tax cuts can, because well-off consumers buy the products businesses would sell, thereby creating a virtuous circle. (Even Henry Ford knew that.) Wealthy individuals with no prospective customers do not build business; they buy chalets and gold coins.

To the extent that facts matter in such a politicized debate, it is becoming increasingly clear that equality rather than inequality is a better policy for economic growth.
….

* Interestingly, Americans in the lower half of the family income distribution were likelier than those in the upper half to endorse the necessity of large income differences! However, that pattern reverses once education is taken into account (the more educated are much more skeptical of inequality); at equal levels of education, those with higher incomes more often claim that inequality is necessary.

Cross-posted from Claude Fischer’s blog, Made in America: Notes on American life from American history.

Bookmark and Share
Comments to "A cost of inequality: growth":
    • jaman miah

      More than a dozen social scientists have joined news-media advocacy groups in urging the U.S. Supreme Court to take up a case involving government efforts to force Boston College to hand over confidential interviews with former members of the Irish Republican Army. In an amicus curiae, or “friend of the court,” brief filed on Wednesday, 14 social-science scholars, all from universities in Indiana.

      [Report abuse]

    • Howard

      If we measure the ability of social welfare or transfer payments to reverse the trend of “income inequality”, it would appear they are ineffective since we are now at the highest level since 1917.

      [Report abuse]

    • Rudolph

      You are ignoring the many political forces that have caused the rise of inequality, especially since the 1980s. I strongly recommend the following for detailed information on US inequality: http://detailedpoliticalquizzes.wordpress.com/us-inequality-quiz/

      Consider Question 1. True or False: Rising income inequality is simply the result of impersonal economic forces that have affected the US and the rest of the advanced world.

      -False. “The sharp rightward shift in U.S. politics is unique among advanced countries; Thatcherite Britain, the closest comparison, was at most a pale reflection. The [impersonal] forces of technological change and globalization, by contrast, affect everyone. If the rise in inequality has political roots, the United States should stand out; if it’s mainly due to impersonal market forces, trends in equality should have been similar across the advanced world. And the fact is that the increase in U.S. inequality has no counterpoint anywhere else in the advanced world. During the Thatcher years Britain experienced a sharp rise in income disparities, but not nearly as large as the rise [in the U.S.]…, and inequality has risen modestly if at all in continental Europe and Japan.”

      “[T]he forces of technological change and globalization have affected every advanced country: Europe has applied information technology almost as rapidly as we have, cheap clothing in Europe is just as likely to be made in China as is cheap clothing in America….In terms of institutions and norms, however, things are very different among advanced nations: In Europe, for example, unions remain strong, and old norms condemning very high pay and emphasizing the entitlements of workers haven’t faded away….There is…a…case for believing that institutions and norms, rather than technology or globalization, are the big sources of rising inequality in the United States.” (Paul Krugman, The Conscience Of A Liberal, W. W. Norton, New York: 2007, 9, 137, 140-1. Hereinafter referred to as, Krugman.)

      -“[W]hen economists, startled by rising inequality [in the early 2000s], began looking back at the origins of middle-class America, they discovered…that the transition from the inequality of the Gilded Age [1870s to the beginning of the 20th century] to the relative equality of the…[post WWII] era wasn’t a gradual evolution. Instead, America’s postwar middle-class society was created, in just the space of a few years, by the policies of the Roosevelt administration…”

      [Report abuse]

    • Aaron

      All this graph shows is that the poor are hit disproportionately hard during periods of economic decline. The graph offers absolutely no evidence in favor of a causal link that runs from inequality to lower growth.

      [Report abuse]

    • pabelmont

      I think that social security may originally have been designed, at least in part, as a way to prevent the social unrest that extreme poverty might bring on.

      As to job-creation from huge wealth, it would seem that huge wealth allows the creation of worker-free industries — factories with many machines and few workers. This may make profits for manufacturing corporations, but not many jobs. In America, where our (2nd-world!) workers can still demand higher wages than the workers of 3rd world countries, investment by the VERY RICH may not create many jobs at all.

      Has anyone measured?

      What, by the way, is the (or any) steady-state economic plan for a stabilized population steadily growing older?

      [Report abuse]

Leave a comment

 

 

You can use these HTML tags

<a href="" title=""> <abbr title=""> <acronym title=""> <b> <blockquote cite=""> <cite> <code> <del datetime=""> <em> <i> <q cite=""> <strike> <strong>


4 × 8 =