Does inequality matter in the big economic picture?
I’m not going to discuss here why economic inequality is worsening. That it’s getting worse is an unarguable fact. What drives the worsening is not yet perfectly clear—is it mainly the inevitable outcome of market forces, or is it a side-effect of “rent-seeking” by rich folks and rich corporations? (I will treat rent-seeking issue in another post.)
Does increasing economic inequality harm the economy as a whole? Does it suppress growth in total wealth? (Agreed that definition of “wealth” is slippery. IMO the Gross Domestic Product does not exactly measure wealth, since it includes the production of a lot of Stuff no one really needs, some of it downright absurd, such as the more than two billion annually spent on Halloween costumes for pets. But the movement of the GDP is the best guide we have to economic growth, or the lack of it.)
I’m not addressing the somewhat different issue of fairness here. It is obvious that huge inequalities are unfair to those on the lower rungs. Enough people are talking about that, that I don’t need to chime in.
Aside from fairness, does the canard that the “Rising Tide Lifts All (or most)Boats” hold, when economic inequality is a main driver of the tide?
Contrasting views of the impact of inequality on the economy as a whole
The first view, call it extreme libertarianism, is that inequality doesn’t matter, because poverty is the real problem—and if the economy grows sufficiently in wealth, then charity (or more euphemistically, philanthropy) from the well-off will answer the poverty problem. (As long as charity will go to the really needy, not lazy people or those who will not take jobs that are readily available.) That the libertarian policy is not working very well is not the fault of inequality, it is simply a result of not enough wealth, and sufficient wealth would be generated if government didn’t get in the way of free markets and unfettered business growth. Sufficient wealth to enrich everyone and lift people out of poverty would result from unfettered markets, but the market has been too closely fettered by the government ever since the New Deal.
That’s the libertarian view. Political “conservatives” in general do not go whole hog on the libertarian position. They do agree there should be a safety net, but believe that the net needs some shrinking and made less generous. As to stripping away regulation in order to free markets, they’re all for it.
The libertarian and conservative ideology posit that inequality, rather than hampering wealth creation, is a DRIVER of wealth creation. It spurs those with lower incomes to better themselves. The “self-made man” example is used to demonstrate how inequality spurs the able and ambitious to rise to the top, while generating fabulous wealth overall, regardless of how big a share they take for themselves.
The second is my position, that inequality does hamper the growth of the economy, as I argue in the next section.
Research does not definitively answer the question: answers range all over the map. Look it up on the web, and you’ll see there are many studies with contrary conclusions devoted to the question. Take the “center of gravity” of these studies, and the answer is: maybe.
So it falls to nonexperts to assert a position based on observation and common sense. Having lived through waves of economic change since the 1950s, I will take credit for the authority born of experience.
How does inequality cripple an economy?
For starters, I’m not talking about slashing inequality by something like 50%, as advocated by some. Overly flatten the playing field, cutting incentives for hard work and initiative too much, and you end up with a flat economy—and even sinking, on account of the proliferation of free riders.
Natural selection—the fundamental driver of evolution—shows the necessity of inequality. If all species were created equal, we’d have a world populated only by a few lucky microorganisms (few in species, although huge in numbers). As it is, biodiversity and ecological health are improved by competition within species as well as between species.
So some inequality is beneficial. Inequality is a major motivator in the world of work—for the majority, decisive. But how much? Where on the equality vs inequality continuum is the threshold where growing inequality results in harm for all but the very rich? And if the threshold is crossed, when does the perception catch up with the reality—when does the average citizen come to feel that the deck is so badly stacked against them, there’s nowhere to go but down? And, once the perception sinks in, when and how can they fight back?
I don’t know. But a major sign that we’ve crossed the threshold in the U.S. is the growth of economic populism. Working people are demoralized, and . demoralized in great part by gross inequality—what both Donald Trump and Bernie Sanders called a rigged system. Demoralization produces despair and/or anger. In the case of Donald Trump we see a lot of anger—rage justified by exploitation by elites. They see an economy that is working for the very rich but has left them behind. So demoralized that many who even voted for Obama turned around and voted for a con-man to be President. Trump, amazingly, cast himself as the Champion of the People, and Hillary Clinton as the Enemy, as she had consorted with the very rich who had brought down the economy in 2007 with no cost to themselves. That message worked. It brought in Sanders voters whose disgust for the system overcame their disgust for Trump. The fact that Trump also consorts with rich people—many of whom are outright crooks (lately the news seems to be disclosing that most of them are crooks) —seemed not to matter to so many who were captured by his message.
MORALE is a major factor in the health of the economy. High morale increases productivity. Demoralized people, people in despair, lose hope, lose ambition, and become prey to frauds like Donald Trump. Hope energizes.* Optimistic people who perceive that the deck is not stacked against them work harder. Energized by hope, they believe they can take care of their families, get their kids better educated, get promoted, or start their own business, get more education for themselves, or otherwise advance in life. (Whether policies fulfill those hopes is another matter. See footnote on Reaganomics.)
HOPEFUL PEOPLE SPEND MORE. Well, duh. The rich may have piles of wealth, but they tend to sit on them. For a solid argument on how the middle class drives the economy, see a progressive view here.
ACCESS TO MONEY is the foundation of growth, and usually this foundation is built of loans. If you don’t already have access, you need to get a loan, or capital from those who see opportunity in your venture. That’s critical to most startups. The wealthy get loans easily—often inexplicably easily, as in the case of Donald Trump, whose serial bankruptcies didn’t seem to wise up the banks to his cons until there were six of them.
This happens while at the same time, the less wealthy get declined for loans outright, or are able to obtain loans only on unfavorable terms. The lower you are on the economic ladder, the more likely you are to lack collateral, no matter how successful you have been in the work world. Who wants to take risks on a new venture, when the penalties for default threaten to take everything away from you and your family?
How to Reverse the Trend
Reversal of the current trend involves overlapping factors, the most immediate of which is tax policy. That’s why the current tax debate in Congress is vital not only to promote fairness, but to promote wealth-creation as a whole. As for other policy areas that factor in, I won’t raise for fear of getting in over my head, but any suggestions would be welcome.
I address taxes in a separate post, How to Cripple an Economy, Part 2: Taxes, to be found at https://www.markheinickewrites.com/2017/11/21/how-to-cripple-an-economy-part-2-taxes/
Finally, a big disclaimer:
While I talk a lot about wealth generation, I don’t mean short-term wealth generation at long-term cost! That’s the phenomenon we see writ large in the Trump administration—and in the Republican agenda. Deregulation poses special danger for the health of the environment, and the health of all creatures such as ourselves who need a healthy environment. You don’t get a whole lot more long-term risk than a degraded environment. Energy policy rallies to the cry of “drill baby drill,” putting pipelines in sensitive environments and promoting coal. Regulation of pollution is being undermined, with some regulations simply getting the axe; others that persist through statute are not being enforced by those who have the power—in particular, new office holders installed by Trump, such as Scott Pruitt at the EPA. Pruitt irresponsibility
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* A good example of how hope energizes is the Reagan presidency. Even while his economic policies built the launch pad for the inequalities we see today, his message and his sunny disposition made the average worker believe that it was Morning in America. People went back to work, and unemployment fell sharply.
For a look at party politics and economic growth, see What policies enhance growth?