Income inequality is a drag on economic growth – time for ‘trickle up’ economics

Well now it’s official: even the Wall Street ratings agency Standard & Poor’s says income inequality is damaging our economy. Inequality Is Damaging the U.S. Economy, S&P Study Says (Wall Street Journal blog):

U.S. income inequality is harming U.S. economic growth by excluding large swaths of the population from its cumulative benefits, Standard & Poor’s Ratings Services says in a new report.

Tackling an unusual subject for a credit-rating firm, S&P combines a review of recent studies on inequality with its own analysis to find that the gap in earnings between rich and poor can have lasting economic consequences.

“The current level of income inequality in the U.S. is dampening GDP growth, at a time when the world’s biggest economy is struggling to recover from the Great Recession and the government is in need of funds to support an aging population,” the firm said in the report published Tuesday.

Tracing some familiar themes for those studying the issue of inequality, S&P highlights a wide education gap as one fundamental underlying cause of income disparities.

“The findings suggest that last generation’s inequalities will extend into the next generation, with diminished opportunities for upward social mobility,” the report says.

S&P does not outline specific policy measures to address inequality. But it does offer some broad outlines of the types of steps that should be taken to mitigate the problem, which gained attention after the deep 2007-2009 recession that put nearly 9 million Americans out of work.

“Some degree of rebalancing—along with spending in the areas of education, health care, and infrastructure, for example—could help bring under control an income gap that, at its current level, threatens the stability of an economy still struggling to recover,” S&P concludes. “This could take the form of reallocating fiscal resources toward those with a greater propensity to spend, or toward badly needed public resources like roads, ports, and transit.”

Michael Hiltzik, the LA Times columnist for the Economy Hub, writes Dire warning from Wall Street: income inequality hurts U.S. growth:

Academic economists have been warning for years that rising economic inequality in the United States is hampering economic growth and punching holes in the social fabric. (See, for example, Piketty and Saez.) But they’re only professors, after all, so it’s been easy for their views to be ignored by bankers and investment types.

But now comes a warning from the heart of Wall Street–Beth Ann Bovino, the chief U.S. economist of Standard & Poor’s, and her staff, who write in a research brief released Tuesday that “increasing income inequality is dampening U.S. economic growth.”

Sounding a broader alarm, they observe that inequality “may also spur political instability….The affluent may exercise disproportionate influence on the political process, or the needs of the less affluent may grow so severe as to make additional cuts to fiscal stabilizers that operate automatically in a downturn politically unviable.” (Examples of such automatic programs are unemployment insurance and food stamps.)

The S&P economists acknowledge that some income inequality is necessary in a growing economy, as a spur to innovation and entrepreneurship. But “at extreme levels, income inequality can harm sustained economic growth over long periods. The U.S. is approaching that threshold.”

Left graph: Only highest-income Americans have increased their wealth since the recession. Right graph: The fairness of income distribution is the strongest factor relating to sustainability of growth. (Standard & Poor’s)

The S&P brief is filled with hard statistics about the rise in inequality over recent years, including the post-2008 recovery–anemic for everyone except those at the top of the income scale. The economists endorse others’ findings that funneling a disproportionate share of income to top earners suppresses growth because high-income households spend less of their income, so squeezing moderate- and low-income families forces them into debt and leaves them less to spend, placing sand in the economy’s gears.

They observe that income distribution has a stronger effect on the sustainability of economic growth (that is, less inequality fosters more growth) than any other factor, including national debt, political institutions and trade openness.

What to do about it? . . . They suggest, carefully, a “rebalancing” of the U.S. tax structure, including closing loopholes that chiefly benefit the rich; using tax revenues to finance public investment or spending on health and education, which disproportionately benefits the poor, will lead to “broadening the pathways for our future leaders, to the benefit of all.” The consequences of doing nothing are dire: at its current level, the income gap “threatens the stability of an economy still struggling to recover.”

Is this the harbinger of a new wisdom on Wall Street? That remains to be seen, but it’s the strongest acknowledgment to come from the financial sector yet. S&P’s clientele should listen carefully, for as its economists conclude, income inequality is “not just a problem for the poor.”

The New York Times’ Paul Krugman in his column today adds, Inequality Is a Drag:

Conservatives . . . have advocated trickle-down economics, insisting that the best policy is to cut taxes on the rich, slash aid to the poor and count on a rising tide to raise all boats.

But there’s now growing evidence for a new view — namely, that the whole premise of this debate is wrong, that there isn’t actually any trade-off between equity and inefficiency. Why? It’s true that market economies need a certain amount of inequality to function. But American inequality has become so extreme that it’s inflicting a lot of economic damage. And this, in turn, implies that redistribution — that is, taxing the rich and helping the poor — may well raise, not lower, the economy’s growth rate.

You might be tempted to dismiss this notion as wishful thinking, a sort of liberal equivalent of the right-wing fantasy that cutting taxes on the rich actually increases revenue. In fact, however, there is solid evidence, coming from places like the International Monetary Fund, that high inequality is a drag on growth, and that redistribution can be good for the economy.

Earlier this week, the new view about inequality and growth got a boost from Standard & Poor’s, the rating agency, which put out a report supporting the view that high inequality is a drag on growth. The agency was summarizing other people’s work, not doing research of its own, and you don’t need to take its judgment as gospel (remember its ludicrous downgrade of United States debt). What S.& P.’s imprimatur shows, however, is just how mainstream the new view of inequality has become. There is, at this point, no reason to believe that comforting the comfortable and afflicting the afflicted is good for growth, and good reason to believe the opposite.

Specifically, if you look systematically at the international evidence on inequality, redistribution, and growth — which is what researchers at the I.M.F. did — you find that lower levels of inequality are associated with faster, not slower, growth. Furthermore, income redistribution at the levels typical of advanced countries (with the United States doing much less than average) is “robustly associated with higher and more durable growth.” That is, there’s no evidence that making the rich richer enriches the nation as a whole, but there’s strong evidence of benefits from making the poor less poor.

But how is that possible? Doesn’t taxing the rich and helping the poor reduce the incentive to make money? Well, yes, but incentives aren’t the only thing that matters for economic growth. Opportunity is also crucial. And extreme inequality deprives many people of the opportunity to fulfill their potential.

Think about it. Do talented children in low-income American families have the same chance to make use of their talent — to get the right education, to pursue the right career path — as those born higher up the ladder? Of course not. Moreover, this isn’t just unfair, it’s expensive. Extreme inequality means a waste of human resources.

And government programs that reduce inequality can make the nation as a whole richer, by reducing that waste.

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Will the new view of inequality change our political debate? It should. Being nice to the wealthy and cruel to the poor is not, it turns out, the key to economic growth. On the contrary, making our economy fairer would also make it richer. Goodbye, trickle-down; hello, trickle-up.

Amen, brother!