I’ve got a new commentary up at the NYT about a theme that was central to the President’s speech the other day: linkages between income inequality and economic growth.
One thing I didn’t have space to get into in the piece was the evidence for this theory, some of which was helpfully discussed by Jim “Tank” Tankersley (I’ve played basketball with him) in the WaPo.
Tank’s first group of studies emphasizes the basic point, one you hear repeated a lot, that a strong middle class boosts growth. In my link above, I support a nuanced version of this in the US case: I think it holds at times like the present, when growth is a spectator sport for the middle; at other times, I think it works more through the economic shampoo cycle (bubble, bust, repeat).
But I’m not sure the citations he provides work for advanced democracies. The IMF study gets its explanatory juice out of correlations between the growth of inequality and that of real per capita income. But if you look at their first figure, for the US and the UK, the growth rate is quite stable since the 1950s, especially relative to a) developing countries (see their figure 1b) and b) the actual rise in US inequality, which is largely a post-1979 phenomenon.
Similarly, the Easterly hypothesis is driven by correlations between political stability and more national income going to the middle class. But while we certainly have dysfunctional politics, itself related to the toxic mix of high wealth concentration and all the money that drives US politics, we decidedly don’t see the rioting by the poor that Tankersley mentions. (This observation reminded me that the US actually fared well in the book “Why Nations Fail” that also gets at this instability dynamic).
Tank also cites studies on entrepreneurs coming from the middle class. Sure, but here again, not sure there’s much correlation with inequality’s growth. Eyeballing charts like these give one the sense that entrepreneurship grew apace in the 1990s and less so in the 2000s (particularly if you look at the important data in chart 2 re jobs created). But inequality grew strongly in both periods.
That’s an “N” of two (i.e., two business cycles), so it’s of course an extremely weak test. But that’s part of the challenge with these inequality/growth connections. Both processes—inequality and growth—involve a lot of moving parts, and it’s tricky to find reliable connections. As I point out in my post—and this gets to another of Jim’s points—even the basic propensity to consume arguments don’t always hold up. Once you include housing and wealth effects, middle-class spending was strong in the 2000s. Moreover, as I argue, and Jim agrees, this too looks like a dangerous side effect of inequality in terms of bubbly asset inflation.
As we economists say at the end of every conference, there’s a lot of great work here, but more research is needed.