October 14, 2012


Inequality and Its Perils : Emerging research suggests that the growing gap between rich and poor harms the U.S. economy by creating instability and suppressing growth. (Jonathan Rauch, September 28, 2012, National Journal)

Different economists suggest different pathways by which inequality at the microeconomic level might cause macroeconomic problems. What follows is a composite story based on common elements.

As with supply-side, the case starts with the two extreme ends of a curve. Supply-siders pointed out that two tax rates produce no revenue: zero percent and 100 percent. Inequality traces an analogous curve. At both extremes of inequality--either perfect inequality, where a single person receives all the income, or perfect equality, where rewards and incentives cannot exist--an economy won't function. So, Moss said, "the question is: Where are the break points in between?"

Suppose various changes (globalization, technology, increased demand for skills, deregulation, financial innovation, the rising premium on superstar talent--take your pick) drove most of the economy's income gains to the few people at the top. The rich save--that is, invest--15 to 25 percent of their income, Stiglitz writes, whereas those on the lower rungs consume most or all of their income and save little or nothing. As the country's earnings migrate toward the highest reaches of the income distribution, therefore, you would expect to see the economy's mix of activity tip away from spending (demand) and toward investment.

That is fine up to a point, but beyond that, imbalances may arise. As Christopher Brown, an economist at Arkansas State University, put it in a pioneering 2004 paper, "Income inequality can exert a significant drag on effective demand." Looking back on the two decades before 1986, Brown found that if the gap between rich and poor hadn't grown wider, consumption spending would have been almost 12 percent higher than it actually was. That was a big enough number to have produced a noticeable macroeconomic impact. Stiglitz, in his book, argues that an inequality-driven shift away from consumption accounts for "the entire shortfall in aggregate demand--and hence in the U.S. economy--today."

True, saving and spending should eventually re-equilibrate. But "eventually" can be a long time. Meanwhile, extreme and growing inequality might depress demand enough to deepen and prolong a downturn, perhaps even turning it into a lost decade--or two.

So inequality might suppress growth. It might also cause instability.

Which is why the Third Way, which defines contributions instead of benefits, and Neoconomics seek to turn even the poor into savers/investors.
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Posted by at October 14, 2012 8:41 AM

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