Inequality’s myriad problems dont end with justice and politics – it’s bad for the economy too. Everyone, rich and poor, does worse over the long haul when the distribution of wealth and-or income is too extreme.

The empirics behind this assertion are solid. Economies with extreme inequality grow more slowly and are more prone to recession. To understand why this is so, consider an economy with twenty families, each with an annual income of $50,000. They are likely to spend every last dollar they have – and maybe borrow and spend a few dollars they dont have too. By comparison, consider two families, each with $500,000 in annual income. Total income is the same – but those two families are likely to spend much less, and save a significant fraction of their income.

In the aggregate, when a huge share of national wealth and income are sucked up by a handful of wealthy families, you get a very high savings rate, and relatively low spending. And that’s exactly what the US economy looks like today. And too much saving is a problem because my spending is your income; therefore my savings is your lost income. One reason the US economy has expanded so anemically following the Great Recession (one-half the ordinary rate) is the enormous concentration of wealth and income in the hands of the rich, who are not inclined to spend it – their high savings rate is killing everyone else’s income. Corporations – perceiving, correctly, that people of ordinary means lack the income to buy more – are sitting on a mountain of cash, unwilling to invest.

So we know that inequality is bad for growth, and we’ve even identified the mechanism that holds growth back. But the remaining issue is whether we can get from here to there – from an unproductive distribution of wealth to one that’s more growth-friendly – without damaging the economy with our redistributive efforts. And the latest research shows that we can.

Classical economists – AKA conservatives – believe that the economy runs like a Swiss watch: its every operation self-correcting and self-sustaining. In the way that the universe weirdly bestowed just the right physical forces in just the right strengths to make life possible (if not probable!), classical economists believe human nature is somehow weirdly wired to facilitate an economy like a grand perpetual motion machine, without centralized governing agencies. According to classical theory, anything a central planner tries to do to “improve” an economy will necessarily do more harm than good. Analogous to the second law of thermodynamics, their effort to enhance one aspect of an economy will result in degrading the system as a whole to an even greater degree.

For good reason, no one fully subscribes to classical economics. Anyone who did would have to oppose public education as a grand waste of resources – since the education of children might as well be left to private markets, as is baking, brewing and butchering.

Conservatives like to claim that there’s nothing to be done about inequality – because any attempt to fix it will do more harm than good. But like the rest of classical economics, this assertion’s relationship with reality is growing ever more tenuous. The latest research shows that we can, in fact, take positive steps to reduce inequality without harming the economy as a whole. Classical economics is wrong here too.

The upshot is that the government should not be timid about tackling inequality head-on – by increasing marginal tax rates on the wealthy, big estates, and investment income; and by reducing taxes on working people, whose incomes have been stagnant for decades. In the long run, everyone comes out ahead. This is consonant with the Liberal Field Guide’s concept of Self-Interested Liberalism. Modern liberalism, after all, is not about selfless generosity. Inequality is bad for everyone. Combating it through fiscal policy is good for all of us. Liberal policies like educating poor children, guaranteeing healthcare to everyone, and combating inequality make us all better off – rich, poor and in between.

 

Refs:

inequality bad for growth: https://www.globalcreditportal.com/ratingsdirect/renderArticle.do?articleId=1351366&SctArtId=255732&from=CM&nsl_code=LIME&sourceObjectId=8741033&sourceRevId=1&fee_ind=N&exp_date=20240804-19:41:13

fixing inequality will not do more harm than good: http://blog-imfdirect.imf.org/2014/02/26/treating-inequality-with-redistribution-is-the-cure-worse-than-the-disease/

http://carltonthurman.me/2014/04/11/the-self-interested-liberal-and-trickle-up-economics/

http://www.nytimes.com/2014/08/08/opinion/paul-krugman-inequality-is-a-drag.html