The center-left has a Grand Unified Theory of Why the US Economy Stinks. Otherwise known as “secular stagnation”or “middle-out economics,” it holds that income inequality hurts economic growth by reducing middle-class spending power. Its chief promoter is Larry Summers, former Obama White House economist and Clinton administration Treasury Secretary.
Apparently, Standard & Poor’s is now also a believer. In a new report, “How Increasing Income Inequality Is Dampening U.S. Economic Growth, And Possible Ways To Change The Tide,” S&P’s US Chief Economist Beth Ann Bovino digs through the data and concludes thusly:
Our review of the data, as well as a wealth of research on this matter, leads us to conclude that 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.
Now this is kind of a big deal, since S&P isn’t some progressive think tank doing the bidding of Hillary 2016. It’s a still influential bond-rating firm. And that shows, argues The New York Times’s Neil Irwin, “how a debate that has been largely confined to the academic world and left-of-center political circles is becoming more mainstream.”
But as this debate grows in importance and visibility, making sure it is data driven and research rich is critical. And there are problems with this report.
1.) S&P accepts the idea that since the 1% appear to be grabbing an ever-greater share of income gains in recent decades, rising income inequality is slowing economic growth because they rich have a higher marginal propensity to save than those lower down the income distribution. But as Paul Ashworth of Capital Economics noted in a recent report, if rising inequality were actually holding back the economy, you would expect to see the household savings rate rising over the past few decades and consumption accounting for a smaller share of overall GDP. Rather, the household savings rate has been rising for three decades, and “even allowing for the drop back over the past few years, consumption now accounts for a larger share of GDP. That suggests rising income inequality has not been a dominant macro force.”
While richer people most certainly do have a lower propensity to consume, the magnitude of this effect is clearly dwarfed by forces like the Asian saving glut and potentially overvalued dollar. Luxury markets are booming: and it may not be to a good liberal’s taste, but demand for chauffeurs and butlers creates employment just like that for apparel and electronics. Indeed, to the extent richer people consume at the margin on non-tradable services, the leakage is also lower.
2.) S&P suggests rising inequality and the “imbalances” it creates can lead to “a boom/bust cycle such as the one that culminated in the Great Recession.” This comes very close to blaming inequality for downturn. I would refer Bovino to “Does Inequality Lead to a Financial Crisis?” by Michael Bordo and Christopher Meissner. The economists examined data from a panel of 14 countries for over 120 years, finding “strong evidence linking credit booms to banking crises, but no evidence that rising income concentration was a significant determinant of credit booms.” And here, again, is Ashworth:
It is true that households further down the income distribution increased their debt burdens during the housing boom years. But that debt was taken on principally to buy over-valued real estate rather than to fund everyday non-discretionary spending because incomes weren’t keeping up with inflation. The upshot is that we don’t think rising income inequality is holding back the economic recovery, at least not to any significant degree
(See here for a market monetarist explanation for the Great Recession.)
3.) S&P blames rising income inequality for reducing social mobility. Bovini: “Aside from the extreme economic swings, such income imbalances tend to dampen social mobility and produce a less-educated workforce that can’t compete in a changing global economy.
I would refer Bovini to a study from the Equality of Opportunity Project, which found US mobility has changed little in nearly half a century. Indeed, the EOP study also found that family structure, education, and geographic segregation are bigger issues than 1%-99%-style inequality, which has zero correlation with climbing the opportunity ladder. As the study put it: “upper tail inequality is uncorrelated with upward mobility … .”
4.) There is plenty of research showing no correlation between rising inequality and slower economic growth in advanced economies. Scott Winship:
Recent work by Harvard’s Christopher Jencks (with Dan Andrews and Andrew Leigh) shows that, over the course of the 20th century, within the United States and across developed countries, there was no relationship between changes in inequality and economic growth. In fact, between 1960 and 2000, rising inequality coincided with higher growth across these countries. In forthcoming work, University of Arizona sociologist Lane Kenworthy also finds that, since 1979, higher growth in the share of income held by the top 1% of earners has been associated with stronger economic growth across several countries.
5.) S&P’s discussion of potential solutions to the inequality “problem” almost entirely concern those pushed by the left: higher minimum wage, raising taxes on capital income such as through the Buffett rule, limiting executive pay, more public investment. More spending, more redistribution. As an alternative I would suggest wage subsidies to boost low-end incomes and reward work, helping startups by reducing crony capitalist regulation, lower or ending corporate taxation to boost take-home pay for middle-class America.
Again, here is social scientist Lane Kenworthy: “Faster economic growth would be a good thing (particularly if with it came a shift towards greener growth). But there is little evidence that the American economy will grow more rapidly if the US manages to reduce income inequality. … Income inequality is too high in the US. It would be good to reduce it. But it is a mistake, in my view, to put inequality reduction at the top of the agenda.”
Might income inequality be a headwind in the future? Sure. And it does make stagnant mobility more punitive. But does it explain what’s wrong with the US economy right now? I am doubtful.