Jan 21 2013

Income Inequality and the Economic Recovery

(2 pm. – promoted by ek hornbeck)

Nobel Prize winning economist Joseph E. Stiglitz posted an interesting piece in the New York Times Opinionator that examines how income inequality is holding back the economic recovery:

The re-election of President Obama was like a Rorschach test, subject to many interpretations. In this election, each side debated issues that deeply worry me: the long malaise into which the economy seems to be settling, and the growing divide between the 1 percent and the rest – an inequality not only of outcomes but also of opportunity. To me, these problems are two sides of the same coin: with inequality at its highest level since before the Depression, a robust recovery will be difficult in the short term, and the American dream – a good life in exchange for hard work – is slowly dying.

Politicians typically talk about rising inequality and the sluggish recovery as separate phenomena, when they are in fact intertwined. Inequality stifles, restrains and holds back our growth. [..]

Prof. Stiglitz notes four factors that are the cause:

The most immediate is that our middle class is too weak to support the consumer spending that has historically driven our economic growth. [..] The growth in the decade before the crisis was unsustainable – it was reliant on the bottom 80 percent consuming about 110 percent of their income.

Second, the hollowing out of the middle class since the 1970s, a phenomenon interrupted only briefly in the 1990s, means that they are unable to invest in their future, by educating themselves and their children and by starting or improving businesses. [..]

Third, the weakness of the middle class is holding back tax receipts, especially because those at the top are so adroit in avoiding taxes and in getting Washington to give them tax breaks. [..]

Fourth, inequality is associated with more frequent and more severe boom-and-bust cycles that make our economy more volatile and vulnerable.

Noting that one fifth of US children live in poverty, the professor points out that children living in Canada, France, Germany and Sweden have better economic futures simply because education and training are more affordable. The countries that responded best to the crisis on Europe had strong unions and strong social safety nets, something that this country is seems hell bent to destroy.

However, Prof. Stiglitz’s contemporary, Paul Krugman, somewhat disagrees arguing that these factors may have caused the recession, they are less of a draw on the recovery than Prof. Stiglits beleives. In the face of the recovery, Prof. Krugman rejects the “underconsumption” and tax receipt hypothesis:

It’s true that at any given point in time the rich have much higher savings rates than the poor. Since Milton Friedman, however, we’ve know that this fact is to an important degree a sort of statistical illusion. Consumer spending tends to reflect expected income over an extended period. If you take a sample of people with high incomes, you will disproportionally include people who are having an especially good year, and will therefore be saving a lot; correspondingly, a sample of people with low incomes will include many having a particularly bad year, and hence living off savings. So the cross-sectional evidence on saving doesn’t tell you that a sustained higher concentration of incomes at the top will lead to higher savings; it really tells you nothing at all about what will happen. [..]

Joe also argues that high income inequality depresses tax receipts, fueling fiscal fears. Again, I have trouble with this point: our tax system isn’t as progressive as it should be, but it is at least mildly progressive even when you take state and local taxes into account.

I’m in agreement with Prof Stiglitz on this, even with my rudimentary knowledge of economics. It would seem logical that if incomes are falling and the middle class is shrinking, then consumption of goods and services will fall as people have less disposable income. It follows that all tax revenues would also decrease.  

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