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Why Inequality Is a Problem and Growth a Red Herring

(Image: Wealth Inequality via Shutterstock)

As the recession that began in late 2007 drags through its sixth year, people are finally starting to ask if maybe inequality is to blame. After all, slow growth throughout the 2000s was associated with rising inequality, and inequality today is greater than it has ever been. Perhaps America’s falling growth rates and rising poverty rates share a single cause: inequality.

Not everyone would be surprised by this question. Marxist economists have long argued that capitalism will collapse due to rising inequality. Their argument in a nutshell is that inequality will rise to the point where workers can no longer afford to buy the products they are producing. With no customers, the economy will stagnate, leading to crisis and collapse.

Many orthodox economists also argue that inequality is bad for growth. High inequality encourages rent-seeking: it becomes more profitable to make money by moving to a higher-paid position in the economy than by increasing one’s own productivity. So for example industrial firms invest in finance, because that’s where the big rewards are. A few individuals get rich while the economy as a whole stalls.

There are many other variations on the idea that inequality is bad for growth. Of course, there also exist unreconstructed neoliberals who cling to the notion that inequality is good for growth. Despite all the evidence of the last forty years they still argue that inequality creates incentives that encourage people to work harder and be more productive.

Unfortunately for everyone in this debate, there is no empirical evidence whatsoever that economic inequality has any effect on economic growth. Personally, I am convinced that inequality is bad for growth. But I can’t prove it. The data give no clear answer either way.

One thing I can prove, however, is that inequality makes a small number of people incredibly richer and a large number of people much poorer. In the United States, for example, ordinary Americans are about half as well off as they would be if America had the same level of inequality today as it did forty years ago.

Rich Americans, on the other hand, are fantastically richer than they would be if America had the same level of inequality today as it did forty years ago. Exact numbers are hard to come by, but the figure is in the range of 20 times as rich. The rich have done very well from rising inequality.

Rising inequality since 1973 has essentially meant a vast transfer of income and wealth from the lower 80% or 90% of Americans to the top 1% or 0.1% of Americans.

Americans with JDs, MBAs, and MDs are about as well off today as they would have been had inequality remained at 1973 levels. Everyone below that level is worse off than they would have been. People without college degrees have been hit especially hard: they are worse off in absolute terms. They have actually seen their incomes decline since 1973.

Unlike the effect of inequality on growth, the effect of inequality on income distribution is not theoretical. It is direct and incontrovertible. High inequality means that many must do with less in order that some can have more. That’s not a theory of inequality. That’s the definition of inequality.

So to the inequality and growth debate, I say: who cares? If something is bad for 80% or 90% of the population, does it really matter whether or not it is also bad for growth? Isn’t it bad enough that it is bad for 80% or 90% of the population?

No one really knows how to promote economic growth. Everyone has their pet ideas — including me. But if we knew how to promote growth, would be doing it already. Everyone likes growth.

On the other hand, we know exactly how to reduce inequality. We can raise the minimum wage, increase taxes on investment income, expand public education, and make it easier for workers to join unions. Most of all, we can tax the rich at a higher rate and use the income generated to invest in making life better for everyone.

The inequality and growth debate is a red herring. It just doesn’t matter. The problem is inequality, and its solution is simple. It may not be easy to get rich people to give up some of their enormous gains of the last forty years, but it’s straightforward. Tax them. And use the proceeds to make our country — and our world — a better place for all.

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