The Real Cost of Inequality in the USA: Stagnating Growth

There is a really interesting piece in the conservative US News and World Report by Barry Brodwin about the real cost of rising inequality in the USA suggesting the real costs of inequality are in economic growth. Once an advanced economy reaches a GINI index of .45 which the USA is rapidly approaching, growth grinds to a standstill, because there is insufficient trickle down from the rich, and the inequality damages educational meritocracy and insufficient demand in the economy to power it along and create enough employment. So it argues that everyone rich, middle class or poor should be concerned out of self interest for such an extreme distribution of income and wealth.

Original article at: http://www.usnews.com/opinion/blogs/economic-intelligence/2013/09/12/record-high-income-inequality-threatens-us-growth

 
 

  

A report released this week by an economist at the University of California, Berkeley, shows  that income inequality in the U.S. economy is at a new high. As the economy struggles  in the wake of the Great Recession, income inequality broke records going back  nearly 100 years.

 

      According to the study, incomes among the top one percent rose by 31.4 percent between 2009 and 2012, while incomes for everyone else grew just 0.4 percent. The top decile of earners in the economy now captures more than half the total income.

Predictably, the debate rages about  fairness. Commentators on the  left argue  that this income distribution couldn’t possibly be fair to  workers, while those on the right suggest that any  distribution is  inherently fair as long as all Americans have the opportunity  to  compete to make it to the top. 

It is difficult to show that any  particular distribution of income  is the right place to draw the line between  fair and unfair. Let’s  leave that  question to others and focus solely on the question of  whether disparities of  this magnitude help or hinder the economy as a  whole.

[See a collection of political cartoons on the economy.]

Economists have shifted their  position on this issue over time. At  one  point, most economists agreed that inequality probably helps the  economy. Inequality spurs people to work harder. In addition, some  inequality is needed to  create a pool of concentrated wealth that can  be invested to finance the early  stages of economic development:  harvesting timber, building factories and so  on.

However, more recent research suggests that while some inequality is  necessary, too much inequality undermines growth: The research shows  that the U.S. economy is  probably at or near the point where the negative  effects of inequality outweigh  the positive effects.   

Now, inequality dampens growth in  three ways:

  • Wealthy people handle their money  differently than the rest. They  tend to  save a much higher percentage of their incremental income, or  invest it in fixed  assets like vacation homes. These forms of  saving  and investment do not trickle down to create significant wage income for   others. In contrast, incremental money that flows to the middle class and  poor  people gets spent much more quickly. It’s  spent on food, clothing  and basic products that are produced in factories and on farms by people  who earn wages. Money  that flows to the middle class and poor has a  multiplier effect, rippling  through the economy to create more jobs and  income for others. As a result, a  shift in income towards the top  results in less overall demand.
  • In a nation like ours, where higher  education is expensive,  greater inequality means that fewer people get the  skills they need for  well-paying jobs. But as World Bank economist Branko  Milanovic writes, “now that human capital is scarcer  than machines, widespread education  has become the secret to growth.” Facing a less prepared workforce,  companies shift  research and advanced manufacturing facilities  offshore, which further erodes economic  growth. The shift increases the  chance  that the next Facebook will be founded in India or China. Some  other country  will reap the economic benefit that comes from hosting  breakthrough innovation.
  • Other factors beyond the hard costs  of higher education are  important as well, as inequality rises and class lines  harden. Consider  two children, both with  the same innate potential for accomplishment,  one born to a family in the top  1 percent and the other to a family in  the bottom 20 percent. The first one will have parents who read to  them  as a pre-schooler, stimulating his or her brain. The second one,  probably not. The first one will grow up surrounded by role  models  whose hard work brought them success; the second one will grow up   surrounded by others whose hard work brought them barely-livable  incomes. Is it any wonder that the two children will enter  adult life  with a different readiness to use their intellect, a different level  of  motivation and confidence and a different awareness of how to build a   successful career?

[Vote: Should McDonalds and Burger King Workers Strike for Higher Wages?]

Two  economists, Andrew Berg and Jonathan D. Ostry of the   International Monetary Fund, have quantified the impact of inequality on   economic growth. In a 2011 article,  “Inequality and Unsustainable Growth:  Two Sides of the Same Coin?” they examined why some countries enjoy long years  of steady economic  growth while other countries see their growth trail off  after only a  few years.

Berg and Ostry found that income inequality is the  single  most important factor in determining which countries can keep their   economies growing. For example, income  distribution is more important  than open trading arrangements, favorable exchange  rates and the  quality of the country’s political institutions.

Berg and Ostry go on to measure  the extent to which economic growth  falls as inequality rises. They  gauge inequality  using the GINI coefficient, which ranges for 0 –  100. At one extreme, a society where everyone  earns exactly the same  would have a GINI score of 0. At the other extreme, a  society in which  one person owned all the wealth would have a GINI score of  100. For economies with  GINI below 45, growth  can be robust, but once it crosses above roughly 45,  growth slumps. The  GINI of the U.S. economy is in the low 40’s currently, so we  are  dangerously close to the point of decline.

Inequality in the U.S.  shows no sign of abating, even as the economy  recovers. The decline of unions, the pace of  globalization, the  abundance of workers in many industries and changes in  health care and  taxes have combined to staunch the earning power of working  Americans,  even as the economy grows and productivity increases. There are few  options, and none that are  consistent with the political climate of the  time. But the trend is reaching  the point that endangers growth  itself, and that should concern everyone, regardless of the size of your  paycheck.

David Brodwin is a cofounder and board member of American Sustainable Business Council. Follow him on Twitter at @davidbrodwin.

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About creativeconflictwisdom

I spent 32 years in a Fortune Five company working on conflict: organizational, labor relations and senior management. I have consulted in a dozen different business sectors and the US Military. I work with a local environmental non profit. I have written a book on the neuroscience of conflict, and its implications for conflict handling called Creative Conflict Wisdom (forthcoming).
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