berenstein inequality

8/21/2019 Berenstein Inequality

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The Impact of Inequality on Growth

By Jared Bernstein December 2013


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The Impact of Inequalityon Growth

By Jared Bernstein December 2013


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1 Introduction and summary

5 Theories of growth as a function of inequality

14 Inequality and credit busts

16 Does empirical evidence support these models?

22 Political economy, credit bubbles, busts, andinequality: Whats the evidence?

27 Conclusion and policy implications

31 About the author / acknowledgements

32 Endnotes

Contents


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1 Center for American Progress |The Impact of I nequalit y on Growth

Introduction and summary

Among he mos imporan economic challenges acing he Unied Saes and

some oher advanced economies oday is he increase in he inequaliy o economic

oucomes. In he case o he Unied Saes, he disribuions o income, wages, and

wealh are more dispersed han ever.1Tough measuremen issues abound, i is

widely agreed ha U.S. economic inequaliy is a hisorically high levels.

Tis ac, however, has differen implicaions or differen observers. Many criics

o higher inequaliy sugges ha i violaes basic airness, paricularly when con-sidering, or example, he divergence o median compensaion and produciviy

growh. Such rends, hese criics hold, are evidence o working people no longer

geting heir air share o he growh ha hey are helping o generae.

Ohers noe ha inequaliy serves as a wedge beween growh and living san-

dards, unneling income largely o hose a he op o he scale and hus making i

harder a any given level o economic growh or living sandards o grow as hey

have in more equiable imes or or povery o all during business cycle expan-

sions. Economic growh, as his repor argues, has become a specaor spor or

oo many poor and middle-class households ha wach as he gross domesic

produc, or GDP, produciviy, he sock marke, and corporae profis rise while

heir incomes eiher sagnae or grow much more slowly.

o add a ew concree numbers o his observaion, noe ha so ar in his expan-

sion, which officially began in he second hal o 2009, he sock marke is up 60

percen, GDP is up 8 percen, corporae profis as a share o naional income are

a hisoric highs, ye median household income is down 5 percen, wih all figures

adjused or inflaion.2

Anoher more recen line o argumen holds ha persisenly high levels o

inequaliy are eroding opporuniy and mobiliy or hose whose living san-

dards and economic well-being are negaively affeced by he wedge dynamic jus


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described. Tis is a undamenal criique because i is widely held ha in America,

while we do no aspire o equal economic oucomes, we believe srongly in equal

opporuniy. I inequaliy were o hwar he opporuniies o he have-nos, his

would represen a significan violaion o a basic American ene.

While his paper will reerence hese argumens, he goal here is o examinesomehing differen, hough no unrelaed, o he problems noed abovespe-

cifically, he impac o inequaliy on growh. Virually all o he research on he

impac o inequaliy akes growh as a given and examines he disribuion o

ha growh, or in he case o he opporuniy research noed above, he exen

o which higher inequaliy is associaed wih less opporuniy and mobiliy.

Tis oher line o research asks wheher here is causal linkage beween higher

inequaliy and slower macroeconomic growh.

Tis paper begins by examining he channels hrough which such a causal rela-

ionship migh flow, recouning argumens made previously in oher repors.3Nex, i explores several heoreical models in a hun or empirical evidence o a

causal relaionship beween higher inequaliy and slower growh. Such evidence

is generally quie elusive, as migh be expeced. Boh inequaliy and growh are

complex phenomena wih many moving pars. While some o he heories are

clear and persuasive, finding evidence in he daa o suppor heir predicions is

ricky. I is widely believed, or example, ha he wealhy have a lower propensiy

o consume a he margin. Ta is o say, since heir income is such ha hey can

handily mee heir needs and wans, an exra dollar ha goes heir way is more

likely o be saved han spen. Tus, we would expec ha income concenra-

ion, by disribuing naional income away rom hose wih higher consumpion

propensiiesgenerally seen as poor and middle-class individuals o hose wih

lower consumpion propensiies such as he rich and he financially well off

would lead o slower growh in consumer spending.

Bu his was no a all he case in he previous economic expansion o he 2000s,

in par because easy access o credi and a housing bubble were inervening vari-

ables. Ta is, while hisorically high levels o inequaliy mean ha mos o he

economys growh was channeled o he op o he income scale, many middle-

class homeowners experienced sharply increased housing wealh. Tis higherwealh effeche exra spending ha occurs when asses you hold appreci-

aedrove consumer spending higher in recen years, even while real incomes,

excluding wealh effecs, were fla.


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O course, when he bubble burs, his wealh effec reversed, leading o he deep

and long recession rom which he U.S. economy is sill recovering.

Tese dynamics make i difficul o find evidence o suppor he mos commonly

cied negaive growh impac o higher inequaliy: ha in a highly consumpion-

driven economy such as ours, he upward disribuion o growh o hose wihlower propensiies o consume should lead o slower growh. Te logic is sound;

and, in ac, ha dynamic beter describes he curren recovery han he las one.

Bu he credi bubble inervened in ways ha canno be ignored.

Buand his is perhaps he mos ineresing finding o his reporwha i he

credi bubble isel is associaed wih inequaliy? I ha connecion is convincingly

made, given is impac on he deepes recession since he Grea Depressiona

recession ha we are sill climbing ou oi would be a srong indicmen o he

role o inequaliy in slower growh. Tere is circumsanial evidence o suppor

his connecion beween inequaliy, financial insabiliy, and credi bubbles. Tereis no smoking gun, bu recen work, boh heoreical and empirical, reveals poen-

ial linkages beween high levels o inequaliy ha appear o have ineraced wih

underregulaed financial markes, conribuing o overleveraging, he housing

bubble, he Grea Recession, and is afermah.

Financial bubbles and buss have clearly occurred in periods when inequaliy was

no as high as i is now, so i will ake a greaer and more careul examinaion o

deermine i his connecion really exiss. I evidence rom uure sudy in his rich

area o research suppors his linkage o inequaliy and he appearance o financial

bubbles, i will have uncovered an imporan and economically desrucive way by

which high levels o inequaliy are huring growh.

Oher causal channels deserve close waching as well. More and beter daa, or

example, coninue o surace, suggesing causal linkages beween inequaliy and

opporuniy, mos noably in he educaional sphere.4While such connecions

do no necessarily have a near-erm impac on growh, hey do imply a siuaion

where some children will no achieve heir producive poenial. Tis in and o

isel is a ragedy in a rich counry such as ours, bu i also has obvious longer-erm

growh implicaions, as he qualiy o human capial is an imporan inpu ino anycredible growh model.


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Moreover, oher connecions suggesed by he research reviewed below have

growh implicaions as well. Te ineracion beween high levels o wealh con-

cenraion and a poliical sysem heavily influenced by money hreaens o give

rise o poliics ha are more responsive o special ineress han, or example, he

need or invesmens in public goods ha would boos produciviy and growh.

As alluded o above, oher recen research is building connecions beween risinginequaliy and deeply damaging financial insabiliy as oo many amilies wih

sagnan incomes find ha borrowing is he only way hey can ge ahead. A he

same ime, i is argued ha high levels o wealh concenraion is leading o higher

savings among he wealhy and hus cheaper capial or leveraging households.

Again, all o his research is relaively new, and while i makes suggesive connec-

ions, here is no enough concree proo o lead objecive observers o unequivo-

cally conclude ha inequaliy has held back growh. Ye even i i is deermined by

uure research ha no such linkage exiss, here are sill good reasons o address

he excessive levels o inequaliy in he U.S. economy. Inequaliy pus a risk un-damenal American preceps: he belie ha hard work and air play pays off, he

convicion ha he opporuniies or upward mobiliy are available o all, and he

rus in he basic airness o American sociey. Tis remains rue no mater wha

effecs inequaliy has on growh.

In ha regard, he high level o inequaliy ha we have oday requires a policy

response leading o a more equiable and inclusive economy. Full employmen

is especially imporan, and given he persisence o weak labor markes since

2000very much predaing he las recessionachieving ull employmen may

require public-secor job creaion, eiher direcly hrough public inrasrucure

projecs or indirecly hrough public subsidies or privae jobs. Incenives such as

greaer union represenaion, increased minimum wages, a solid saey ne, pro-

gressive axaion, and secorial policies ha lif producive secors such as manu-

acuring can help raise he relaive incomes o middle- and low-wage workers.


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Theories of growth

as a function of inequality

One o he mos classic heories relaing growh o inequaliy is somehing ha

economiss reer o as he Kuznes curve. Renowned economis Simon Kuznes

posied ha as emerging economies grew, inequaliy grew as well, as he ew wih

high-asse endowmenslandowners, or insanceprofi rom heir ownership

o producive resources. Ten as indusrializaion evolves, a much larger porion

o he populaion has he chance o paricipae in higher value-added work, which

reduces inequaliy. Te resul is an invered U-shaped curve wih inequaliy on

he y-axis and per-capia income on he x-axis. As income grows, is disribuioniniially becomes more unequal, bu as he benefis o produciviy become more

widely shared, inequaliy diminishes.

While ha roughly describes he patern o income and inequaliys growh in

emerging democraic economies, i demonsrably does no reflec he patern

o American inequaliy over he pas cenury or more. As he work o inequaliy

expers Tomas Pikety and Emmanuel Saez, proessors a he Paris School o

Economics and Universiy o Caliornia, Berkeley, respecively, has shown, ha

rend is more o an acual U raher han an invered one, as inequaliy grew o his-

orical highs in he lae 1920s, ell during he Grea Depression hrough he 1970s,

and has since grown o heighs mached only by hose las seen in he lae 1920s.

Moreover, he underlying assumpion o he Kuznes curve is ha he benefis o

produciviy growh would flow more broadly as sociey advances. As noed earlier,

and as shown by Lawrence Mishel o he Economic Policy Insiue, since he

1970s produciviy and median compensaion have sharply diverged.5Neiher does

he Kuznes hypohesis associae higher inequaliy wih slower growh.

In conras, he heories linking inequaliy o growh fi generally ino supply-

side, demand-side, and poliical-economy heories. Anoher model discussedin his paper invokes inequaliys role in he credi booms and buss ha have

dominaedand deeply damagedour economy in recen years. Les look a

each model more closely.


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Supply-side theories: Inputs and growth

Mos heories o long-erm economic growh emphasize he supply side o he

economy; ha is o say, he amoun and qualiy o inpus along wih he level o

echnology and human capial ha ransorms hose inpus ino he goods and

services we need and wan. Economiss Heaher Boushey and Adam Hersh o heCener or American Progress, or example, cie he level o human capial, he

cos and access o financial capial, and he deph o invesmen in public goods

as key o growh and argue ha inequaliy significanly influences hese inpus.

Tis argumen is also associaed wih Nobel laureae economis Joseph Sigliz o

Columbia Universiy.

Tis paper examines his argumen in greaer deail below, bu a simple example

may prove helpul here. I is no hard o imagine ha higher inequaliy could lead

o worse educaional opporuniies or children in many households compared

o an economy where growh is more equiably disribued. In his model, higherincome inequaliy leads o higher educaional inequaliy, where low-income chil-

dren end up in lower-qualiy schools, benefi less relaive o higher-income chil-

dren rom parenal invesmens in child-enhancemen goods such as music and ar

lessons or vacaions o ineresing places, and have less access o higher educaion.

Much like a slower compuer or a machine ha makes ewer and poorer-qualiy

widges, he relaively low human capial o hese uure workers leads hem o

become less-effecive inpus ino he producion o economic oupu. Ta, in

urn, slows he rae o growh compared o an alernaive scenarioa counerac-

ualwhere all children ge high-qualiy schooling.

More complex versions o his model work hrough a poliical channel where

high levels o wealh concenraion, or example, yield poliical influence ha

suppors low axes, supply-side ax cus, and diminished governmen invesmens

in public goods and research and developmen expendiures, among ohers.

Tere is, in urn, compelling evidence ha underinvesmen in public goods can

hur produciviy and slow he economys growh, or o pu i anoher way, lower

is speed limi.6


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Demand-side theory

Anoher way in which inequaliy is likely o negaively affec growh is hrough

he differences in he marginal propensiy o consume across he income scale.

Because o he assumed diminishing marginal uiliy o moneyhe idea ha

he uiliy, or personal benefi, o he nex dollar you receive is a bi less han hedollar you received beoreeconomiss believe ha individuals wih higher

incomes have lower marginal propensiies o consume and hus have higher

endencies o save. Ta is o say, high-income people have he income hey need

o handily afford he hings hey need, such as groceries and housing, and wan,

such as jewelry and vacaions. So hey are less likely o spendas opposed o

savean exra dollar. Research cied in his paper by Boushey and Hersh sup-

pors hese assumpions.7

Te U.S. economy is 70 percen consumer spendingmuch higher han he 55

percen average in Europe, or example.8Tis means ha high levels o incomeand wealh concenraion a ha porion o he disribuion where he propensiy

o consume is low could plausibly depress demand relaive o a very differen se

o economic dynamics where middle- and lower-income amilies benefited more

rom growh.

Furhermore, Keynesian acceleraor models presume ha invesmen isel is a

uncion o oupu growh and hus consumpion. A robus consumer demand sig-

nals o invesors ha greaer capial sock will be needed in orhcoming periods

o mee he growing demand or oupuand vice versa in a recession, o course.

Tus i lower inequaliy generaes more consumer spending and growh hough a

higher propensiy o consume a he margin in some macroeconomic models, his

aser growh leads o more invesmen.

Again, a sylized example migh help cemen he conceps in play here. Imagine an

economy wih wo consumers and one invesor. Wih high economic inequaliy,

one consumerles call him Richieges mos o he growh and buys a flee

o cars and a ew ancy waches. Te second consumera low-income consumer,

who we will call Poebenefis litle rom growh and buys only necessiies, i ha.

Bu wih low inequaliy, consumer Poe now has enough money o buy an inexpen-sive car and perhaps a imex. While Richie is no as flush in he low-inequaliy

scenario, he sill has enough o buy a couple o cars and a pricey imepiece or wo.


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In he firs scenario, he invesor does no see enough demand o jusiy expand-

ing producion, say, o build a new line o mid-range producs. In scenario wo,

however, our invesor sees more demand, which moivaes her o expand her pro-

ducion line ha in urn leads o more growh han would oherwise prevail; and

she does so as a uncion o more he broadly based demand generaed by a more

equiable income disribuion.

Noe he role o Poes higher marginal propensiy o consume. In he high-inequal-

iy regime, Richie easily has he income o offse Poes reduced consumpion, bu

he derives litle uiliy rom anoher purchase a he margin. Poe, on he oher

hand, is saring ou on a much lower poin on his marginal uiliy curve, so i

some addiional income flows his way, he is a lo more likely o spend more o his

money. Tis is also he heory behind some o he commenary o Nick Hanauer,

an enrepreneur and venure capialis who argues ha high inequaliy leads o

lower growh hrough his consumpion channel.9

Tis all may sound anciul and heoreical, bu i has pracical meri. In planning

and execuing simulus measures, policymakers ofen recognize ha growh muli-

pliers are higher or ax cus argeed a middle-income earners raher han a high-

income households. Tis poin was relevan, or example, in he recen debaes

over he fiscal cliff deal where many economiss, as well as he Congressional

Budge Office, or CBO, argued ha increasing axes on he wealhy would be

expeced o have very litle impac on growh.10

Political economy

More complex models o inequaliys impac on economies involve poliical chan-

nels hrough which concenraed wealh influences policy oucomes in ways ha

serve o boh urher heighen inequaliy and block measures ha would sup-

por more equiable oucomes. No all o hese models, however, predic growh

impacs. Ta is, one class o models simply predics disribuional oucomes:

Concenraed wealh buys concenraed poliical power, which channels more

growh upwards. Bu unless we are willing o invoke he supply and demand

impacs jus discussed, such models do no necessarily predic slower growh.


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Anoher class o economic models, however, goes urher, predicing no only

slower growh bu he poenial o a ailed sae. In heir book, Why Naions Fail,

Massachusets Insiue o echnology economis Daron Acemoglu and Harvard

Universiy poliical scienis James Robinson presen sweeping hisorical evidence

o linkages beween wha hey call exracive poliical and economic insiuions

and high inequaliy, inense povery, deep human exploiaion, ailed poliicalsysems, and ulimaely ailed saes.11

Te U.S. poliical and economic sysems ineresingly are well in Acemoglu

and Robinsons hisorical review. Wheher i is he robber barons o he Gilded

Age power grabs, or he repressive or exracive regimes in he Jim Crow Souh

on he righ side o he poliical specrum, or ormer Presiden Franklin Delano

Roosevels atemps o pack he Supreme Cour on he lef, he auhors find ha

ofen afer long, painul sruggles, he undamenal inclusive insiuions in his

counry prevailed. o illusrae ha poin hey devoe a passage o he sruggle

or civil righs in he American Souh ha began in he 1950s and noe ha whileblacks in he Souh led he way in challenging exracive insiuions, hey were

no alone in his figh:

because he U.S. Souh was no a separae counry and he souhern elies

did no have ee reign as did Guaemalan elies, or example. As par o he

Unied Saes o America, he Souh would finally receive suppor om he U.S.

execuive, legislaure, and Supreme Cour parly because he civil righs move-

men was able o have is voice heard ouside he Souh, hereby mobilizing he

ederal governmen.12

Acemoglu and Robinson ell a relaed sory o how, wha hey call viruous

circles ha were ormed by inclusive insiuions, bused he monopolies o he

robber barons:

he reacion o he monopoly russ illusraes ha when poliical insiu-

ions are inclusive, hey creae a counervailing orce agains movemens away

om inclusive markes. Tis is he viruous circle in acion. rus busing in

he Unied Saes, in conras o wha we have seen in Mexico illusraes his

ace o he viruous circle.13


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Te quesion his line o argumen raises, o course, is o wha exen has income

and wealh concenraion undermined hese posiive dynamics in he curren U.S.

poliical economy? Why Naions Failis largely a hisorical reaise and hus does

direcly address his quesion. Bu Acemoglu views he case o Venice in he lae

Middle Ages as a warning or he Unied Saes.14

Te auhors ell a compelling sory o how Venice in he 13h and 14h cenuries

grealy prospered hrough inclusive insiuions such as poliical, enrepreneur-

ial, and rading regimes ha provided pahs or upward mobiliy and hus more

broadly shared prosperiy and sronger growh. Bu he Veneian elies, whose

wealh and power were diminished by hese developmens, managed o pass laws

ha shu down his process, severely resricing he economic opporuniies o he

nonelies. Te negaive impac on growh in his swich rom inclusive insiuions

o exracion insiuions persiss hrough he presen. I is worh noing ha his

secion o heir book is iled, How Venice Became a Museum.

In wha can be read as a warning o he coemporary Unied Saes, Acemoglu and

Robinson conclude:

moves oward inclusive insiuions can be reversed. Venice became

prosperous. Bu is poliical and economic insiuions were overhrown, and

he prosperiy wen ino reverse. Te ac ha inclusive insiuions can go

ino reverse shows ha here is no simple cumulaive process o insiuional

improvemen.15

Te model described nex embodies precisely his Veneian ype o developmen

where economic elies, enriched by highly concenraed wealh, influence he

poliical process o disassemble inclusive and opporuniy-providing insiuions,

hus enorcing even greaer inequaliy and ulimaely undermining growh. In his

model, concenraed wealh ineracs wih poliics in ways ha avor he haves

over he have-nos, or he beneficiaries o he inequaliy versus hose on he

shor end. Previous repors have elaboraed on his model in some deail; his

repor provides a summary wih an emphasis on implicaions or growh.

A key par o his model posis ha wih levels o inequaliy ha prevail in heUnied Saes oday, he opporuniies or less-advanaged amilies and especially

heir children o achieve heir poenial are significanly diminished. Les begin by

considering an economy wih a sable income disribuion.In such an economy,

growh, which sars ou as exogenous o he model, leads o income growh and


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povery reducion or middle- and low-income amilies. Tis provides he chil-

dren in such amilies wih, or example, educaional opporuniies, which in urn

enhances heir economic-mobiliy prospecs. Trough schooling and oher learn-

ing experiencessuch as ineresing vacaions, qualiy neighborhood libraries, and

parenal invesmens in child-enhancemen goods and services hese children

achieve heir inellecual and producive capaciy, which is imporan or growh.

Bu once we inroduce high and growing levels o inequaliy ino he model, he

resuls change. GDP and produciviy growh are divered rom lower-income

amilies, and under his scenario middle incomes and povery raes sagnae or

worsen. Tis in urn blocks opporuniies, including educaional opporuniies,

and reduces upward mobiliy. Children rom lower- and middle-income amilies

ail o reach heir producive poenial, which eeds negaively back on growh.

Tus ar, hese dynamics are covered in he models cied earlier, bu he ineresing

par o his model is he predicion ha income concenraion eners ino he polii-cal realm by promoing policies ha proec he beneficiaries o inequaliys growh

and blocking policies ha would push back agains i. Tis is paricularly likely o

be he case in a counry such as ours where privae conribuions play a much larger

role in campaigns han in oher advanced democracies. Te model hereore gener-

aes he ollowing se o hypoheses wherein poliics and policy reinorce rising

inequaliy and block policies ha would promoe more broadly shared growh:

Less-advanaged children will, over ime, experience less-avorable educaion

opporuniies, boh in erms o qualiy primary school educaion and college

access and compleion.

Raes o economic mobiliy will flaten or all.

Te poliical process will become increasingly solicious o he preerences o

he wealhy.

Policies ha exacerbae inequaliy, such as regressive ax policies or advana-

geous reamen o nonlabor income, will ge a more avorable hearing han

hose policies ha push back agains inequaliy, such as minimum-wageincreases, progressive ax changes, and policies relaed o increasing collecive

bargaining, jus o name a ew.


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In urn, here are some corollary indicaors ha we would expec o see i he

dynamics prediced by his model were in play:

Regressive ax changes

Shif rom labor o capial incomes

Deregulaion and expansion o financial markes

Regular bubbles in financial secors, accompanied by excessive leverage, under-

priced risk, and financial innovaion

Privaizaion o social insurance

Eroding labor sandards, including lower minimum wages and ewer labor

proecions

Diminished unionizaion and opposiion o collecive bargaining

Increased ousourcing o jobs

Moneary policy avoring low inflaion over ull employmen

Diminished governmen commimen o educaion

Erosion o saey-ne programs

Few rules resricing campaign finance

Smaller governmen oulays and receips as share o GDP

Diminished invesmen in public goods

And finally, as per growh, ani-Keynesianism and pro-auseriy fiscal policies

resuling in slack labor markes and oupu gaps


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Te oucomes o some o hese predicions are eviden in he U.S. daa, while

ohers are no. Over he pas ew decades, or example, he effecive ax raes o

he wealhies axpayers have, in ac, declined significanly. Daa rom he Inernal

Revenue Service shows a decline in he effecive ax rae or he op 400 wealhies

axpayers rom abou 26 percen in he early 1990s o abou 20 percen in 2009,

he mos recen year ha daa are available.16

On he oher hand, while regressive ax changes have cerainly been proposed and

championed in much he way he model would predichrough poliicians sup-

pored by very wealhy donorshe mos recen changes o U.S. ax policyhe

American axpayer Relie Ac o January 2013, less ormerly known as he fiscal

cliff deal, were airly progressive.17Atemps o privaize social insurance have

similarly ailed. Recen moneary policy has iled aggressively oward fighing

unemploymen. Despie he models predicion, his was no he norm o he pas

ew decades, hough i bears noing ha he Federal Reserve is o no small degree

poliically insulaed.

Ye oher developmens suppor he models predicions. Naional income shares

have shifed quie sharply oward profis and away rom compensaion; saey-ne

programs have aced budge cus largely hrough spending cus o various pro-

grams benefiing he poor; campaign finance is largely unresriced; ausere fiscal

measures are in ascendency; and, as discussed below, invesmen in public goods

has slowed. Imporanly, no only have financial bubbles inflaed as a uncion o

underpriced risk and so-called financial innovaionhe prolieraion o com-

plex financial insrumens ha derive heir value rom movemens o oher finan-

cial insrumensbu policy effors o regulae he indusry are being opposed

and even blocked in ways he model would predic.

Moreover, a valid economic model does no jus describe he presen; i predics

he uure. Even a cursory review o recen poliics reveals ha many o he aore-

menioned bulles are high up on he lis o conservaive aspiraions. Keynesian

policies, while clearly needed, are nowhere o be seen on he poliical landscape,

and recen budge proposals by conservaives have explicily emphasized he goal

o locking in hisorically low raios o governmen spending o GDP.18

Bu wha does any o his have o do wih growh? Some connecions such as

ani-Keynesian auseriy are obviously linked, bu oher predicions such as

lower minimum wages, less unionizaion, and even regressive ax changes are

more relaed o disribuional oucomes han o growh oucomes.19Te linkage

beween deb, credi, and financial volailiy, however, is poenially implicaed in

recession and slower growh.


17/37


Inequality and credit busts

A final model linking inequaliy o growh invokes inequaliys role in promoing

deb bubbles. An aricle by Michael Kumho and Romain Rancire, economiss

a he Inernaional Moneary Fund,20and anoher aricle by economiss Barry Z.

Cynamon o he Federal Reserve Bank o Sain Louis and Seven M. Fazzari o he

Washingon Universiy in S. Louis,21boh consruc models o his phenomenon:

Te wedge o inequaliy divers income growh rom middle- and low-wage work-

ers; a he same ime, high-income households acquire more capial asses. Tisincreases he savings o wealhy households relaive o lower-income households.

In order o keep heir living sandards rom declining, he middle class borrows

more. Financial innovaions, including new ypes o securiizaion, increase

he liquidiy and lower he cos o loanable unds available o he borrow-

ers. As Kumho and Rancire pu i, Te botom groups greaer reliance on

deband he op groups increase in wealhgeneraed a higher demand or

financial inermediaion.22

Te financial secor hus grows rapidly, as do he deb-o-income raios o he

middle class relaive o he wealhy. (Cynamon and Fazzari; see Figure 6)

Te combinaion o rising middle-class deb and sagnan middle-class incomes

increases insabiliy in financial markes, and he sysem evenually crashes, lead-

ing o a large demand shock as he relaively large borrowing class deleverages.

(Cynamon and Fazzari; see Figure 8)

Regarding his las sep, unique developmens in he Unied Saes and laer

in Europe amplified ha par o he model. Financial innovaionssuch assecuriizaion ha increased he disance beween he loan originaor and he

loan holder, which conribued o looser underwriing sandardsineraced in

a paricularly volaile way wih deregulaory zeal and he belie, ofen associaed

wih ormer Federal Reserve Chairman Alan Greenspan, ha financial acors

would sel-regulae.


18/37


o summarize his secion on differen models, a number o hem clearly posi

negaive causal relaionships beween growh and inequaliy. In he supply-side

model, inequaliy leads o less-producive labor inpus. In he demand-side model,

inequaliy leads o less-robus consumpion and invesmen. In he credi-bus

model, inequaliy leads o an overleveraged middle class, financial marke insabil-

iy, and a credi bubble-and-bus cycle.

While inequaliy is cenral o he poliical-economy model, is growh implica-

ions are no obvious. Growh could be exogenous o he model, and all he

dynamics jus described would affec a given growh levels disribuion. For our

purposes, however, i is imporan o explore ways in which growh migh be

endogenous o his model and he oher models, which we will urn o nex.


19/37


Does empirical evidence

support these models?

Tis secion goes model by model o see i here is any empirical evidence o

suppor or disprove he predicions o hese models. In sum, here is no srong

empirical suppor or all o hese linkages. Some o hissimilar o he predic-

ions made by Keynesian models ha variaion in he marginal propensiy o

consume may sem rom daa limiaions or, more ineresingly, ways in which

amilies whose incomes were consrained by inequaliyound oher ways o

increase heir consumpion and, o course, he possibiliy ha he heory does no

hold. Some recen work provides circumsanial evidence or he model linkinginequaliy o overleveraging o he middle class, o he credi bubble, and o he

very large demand conracion known as he Grea Recession. Here oo, however,

alernaive explanaions ha do no invoke

inequaliy canno be ruled ou.

Supply: Does inequality lower

the quality of inputs?

While here is compelling evidence ha

inequaliy has a negaive impac on educa-

ional opporuniy and srong economic logic

relaing diminished educaional opporuniy

o growh, here is no much evidence link-

ing inequaliy o reduced labor qualiy. Te

measuremen challenges invoked by his ques,

however, are dauning.

Te figures below rom he volume iled,Whiher Opporuniy?23sugges connecions

beween greaer income dispariy and dimin-

ished educaional opporuniies or children.

Figure 1 shows enrichmen expendiures on

children by income class a he op and botom

FIGURE 1

Enrichment expenditures on children from 197220

in 2008 dollars

$0

$2,000

$4,000

$6,000

$8,000

$10,000

20052199419951983198419721973

Top income quintile Bottom income quintile

Note: Enrichment expenditures refers to the amount of money families spend on books, computhigh-quality child care, summer camps, private schooling, and other things that promote the capaof their children. Source: Greg J. Duncan and Richard J. Murnane, Introduction: The American Drea

Then and Now. In Greg J. Duncan and Richard J. Murnane, eds. Whither Opportunity? Rising InequSchools, and Childrens Life Chances (New York: Russell Sage Foundation, 2011).


20/37


quiniles over ime. Such expendiureson

music or ar lessons, books, exracurricular

spors, and uoringgrew much more quickly

or higher-income children relaive o low-

income children. Te raio o expendiures

grows rom abou our o abou seven overhe years shown in he figure, a period when

income and wealh inequaliy grew sharply.

Te nex figure examines relaive college

compleion raes or differen birh cohors

by income quarile across ime. While college

compleion raes rise wih income or boh

cohors and raes or all income classes have

gone up over ime, he slope o he later curve

or he mos recen cohor is seeper, implyinggreaer dispariy in compleion raes over ime.

For he early 1960s cohor, he college comple-

ion gap beween he op and botom quariles

was 31 percenage poins, and or he early

1980s cohor i was 45 percenage poins.

Social scieniss have long-idenified limied

amily resources as a cenral explanaion or

why poor children lag behind heir peers.24Bu

he quesion here is in regard o evidence ha

links his oucome o uure labor qualiy or

macroeconomic oucomes. Te lieraure ha

accouns or growh quie clearly predics ha

a less-educaed workorceone wih less-pro-

ducive labor inpuswill lower he economys

growh rae. Bu do labor-qualiy measures cor-

relae negaively wih inequaliy rends?

FIGURE 2

Fraction of students completing college by income

quartile and birth year

Source: Martha J. Bailey and Susan M. Dynarski, Inequality in Postsecondary Education. In Greg J. D

and Richard J. Murnane, eds. Whither Opportunity? Rising Inequality, Schools, and Childrens Life C(New York: Russell Sage Foundation, 2011).

0.0

0.1

0.2

0.3

0.4

0.5

Topquartile

Thirdquartile

Secondquartile

Lowestquartile

Diff = 0.45

Diff = 0.31

0.54

0.32

0.21

0.09

0.05

0.14

0.17

0.

19791982 bir th cohorts 19611964 birth cohorts

FIGURE 3

Labor quality 19692012

Index (1969=1)

Source: John Fernald, Productivity and Potential Output before, during and after the Great RecessWorking Paper 2012-18 (Federal Reserve Bank of San Fransisco, 2012), available at http://www.frbs

publications/economics/papers/2012/wp12-18bk.pdf.

1975

1980

1985

1990

1995

2000

2005

2010

2

0

5

10

15

20

1969


21/37


In one word, no, bu or reasons ha are prety inuiive. Te key inpus ino mea-

sured labor qualiy are he educaion and experience o he workorce. Te demo-

graphics o an aging and hus more-experienced workorce and he evoluion

o greaer access o educaion have led o he relaively seady upward patern as

seen in Figure 3 rom he work o economis John Fernald.25Research by Federal

Reserve Bank o Chicago economiss Daniel Aaronson and Daniel Sullivan, orexample, poin ou ha educaion upgrading o he workorce has been occur-

ring or more han a cenury, generaing large increases in high school and college

graduaion raes, which ranslaes direcly ino higher values o labor qualiy.26

Fernalds series is also somewha counercyclical: I acceleraes in recessions as

less-skilled and less-experienced workers disproporionaely leave he labor orce.

Noe he seeper slopes in he deep recessions o he early 1980s and he mos

recen sharp economic downurn.

Moreover, Fernalds research shows ha labor

qualiy has been a quaniaively consanconribuor o produciviy growh since he

mid-1970s, conribuing abou 0.4 percen per

year.. iming obviously maters in his sor o

evaluaion because children acing poorer edu-

caional opporuniies oday will no depress

labor qualiy unil many years down he road.

Bu a correlaion beween hese serieseduca-

ion qualiy and he income share o he op

1 percendoes no exis, regardless o he

lag srucure, largely because he labor-qualiy

series grew considerably aser beween 1979 o

2011 when inequaliy was increasing han rom

1947 o 1979 when inequaliy was sable or all-

ing. Tis resul is no a uncion o he large recession in he later period, which

would inflae labor qualiy. Te same resul holds or a residual labor-qualiy series

atained by regressing he series on unemploymen.

So while a solid empirical case ha higher inequaliy diminishes educaional

oucomes and he heoreical case ha such oucomes hur growh can be made,an empirical correlaion beween inequaliy and Fernalds index o labor qualiy

canno be ound.

FIGURE 4

Real per-capita consumer spending and inequality19472011

Source: Authors analysis of data from Bureau of Economic Analysis. Thomas Piketty and EmmanueIncome Inequality in the United States, 1913-1998, The Quarterly Journal of Economics 143 (1) (20

5

10

15

20

25

5,0

10

15

20

25

30

35

1947

1950

1960

1970

1980

1990

2000

2011

Real per-capita consumer spending

Share of income going to top 1 percent

Share

ofincomegoingtotop1percentofearners(%)


22/37


In sum, while diminished educaional opporuniy appears o be a uncion o

higher inequaliy, and growh is widely agreed o be negaively affeced by less-

educaed and less-producive inpus, he empirical evidence o hese logical link-

ages is hard o find.

Demand: Does the lower marginal propensity

to consume of the haves slow GDP growth?

Evidence exiss o he diminished marginal propensiy o consume o high-income

households relaive o households wih lower incomes .27Te quesion or his

secion, however, is wheher here is any evidence ha his effec ineracs wih

higher inequaliy in such a way as o depress macro consumpion growh agains a

couneracual o a more equal disribuion.

Here again, simple correlaions do no appear in he daa. Much like he educa-ional-inpu argumen above, his one oo has solid heoreical oundaions rom

microeconomics. Bu, also similar o he educaion case, finding he evidence in

he macrodaa is again a challenge. As wih he labor-qualiy index, real consump-

ion per capia grows airly consisenly around an inequaliy rend ha has grown

much aser in recen decades han in he poswar decades (see Figure 4 which

plos real spending per person agains he Pikety-Saez measure o he share o

income held by he op 1 percen). o make he poin, consider ha beween

he lae 1940s and 1970sspecifically, 1948 o 1979, comparing business-cycle

peaksreal per-capia consumpion rose 2.4 percen per year, while he income

share going o he op 1 percen ell by a couple percenage poins. Beween 1979

and 2007 per-capia consumpion grew slighly more slowly, up 2.2 percen per

year. Bu he income share going o he op 1 percen wen up 13.5 percenage

poins. I higher inequaliy slowed consumpion growh by disribuing less mar-

ke income o he botom 99 percen, we would likely expec much larger differ-

ences han his o show up in he daa.

Simple regression analysis does no beter han hese broad differences. able 1

below shows he coefficiens rom a ime-series regression o log changes in per-

capia consumpion on he op 1 percen income-share variable and a se o con-rols, including unemploymen and home prices, he later o which capures wealh

effecs on consumpionhe ac ha when a persons asses increase in value, hey

end o spend more even i heir income has no gone up. Te firs enry shows ha

he level o inequaliy does no correlae a all wih he annual change in real spend-

ing. Bu because he inequaliy series does no have a consan meaninsead, i

has a uni roo in levels bu no in changeshe oher models ener i in changes.


23/37


Enering he inequaliy variable in annual changes yields a

significan variable suggesing a 1 percenage-poin increase in

he share o income going o he op 1 percen is correlaed wih

a 0.4 percen increase in real consumer spending per person.

Bu even hough he simple model conrols or unemploymen,

i urns ou ha he coefficien loses is significance when weexclude he Grea Recession, a period when capial losses led

o a sharp and emporary all off in inequaliy a a period when

consumer spending also conraced sharply.

Since we migh no expec changes in inequaliy o have a con-

emporaneous impac on spending, i is reasonable o consider a

lag srucure. Te las coefficien in he able eners all he change

variables in he regressionconsumer spending, inequaliy,

and home pricesin wo-year inervals. Here again, he model

runs hrough 2007. Te coefficien is o he wo-year change inhe op 1 percen income share is significan, and once again, i

has he opposie sign prediced by he marginal propensiy o

consume, or MPC, heory elaboraed above.

While he absence o he expeced correlaion may seem surprising here, here

is likely a leas one good reason or i. While numerous daa sources show ha

higher inequaliy coincided wih sagnan middle-class incomes and sicky pov-

ery raes, oher dynamics regarding he income and spending o Americans were

aoo in hese years, especially since 2000. Te mos significan o hese dynamics

was a credi boom ha helped o inflae a housing bubble, making many middle

and moderae income households a lo wealhier han hey would appear i you

ignored his par o heir balance shee.

No analysis o consumer spending over hese years can omi he increase in

housing wealh, which leads Cynamon and Fazzari o reer o hese years as

he consumer age. Economiss Rober Shiller o Yale Universiy, Karl Case o

Wellesley College, and John M. Quigley o he Universiy o Caliornia, Berkeley,

or example, find quaniaively large effecs rom housing wealh on consumpion,

ye he impac o housing wealh on spendingin paricular, is disribuionaleffecsis ofen lef ou o he macro analysis because changes in housing wealh

are lef ou he naional GDP and consumer spending accouns.28

Top 1 percent -0.0003

d(Top 1 percent) 0.0042

d(Top 1 percent)* 0.0031

d(Top 1 percent)** 0.0051

* Through 2007; excludes Great Recession

** Two-year change in dependent variable and two-year lag in d (

percent).d refers to the difference in a variables value between thand previous period.

Significant at p


24/37


Does he accumulaion o significan housing wealh among amilies hroughou

he income scale disprove linkages beween MPC heory and he resuls shown so

ar? Te answer is no. I does, however, provide an imporan reminder ha here

are many moving pars o he relaionship beween inequaliy and growh. A more

sophisicaed model is needed o incorporae inequaliy, credi dynamics, wealh

effecs, bubbles, and buss. Les urn o such models nex.


25/37


Political economy, credit bubbles,

busts, and inequality:

Whats the evidence?

As noed above, Kumho and Rancire inroduced a model wherein inequaliy

leads o greaer demand or credi by amilies acing sagnan earnings and a larger

sock o loanable unds held by he wealhy. Combined wih some o he dynam-

ics rom he poliical-economy model, also described above, he prediced resul

is a relaively large group o overleveraged households inflaing a credi bubble

osered by inadequae regulaory oversigh and underpriced risk. Once ha

bubble burss, a proraced demand conracion ollows, as households deleverage.

Popular research argues ha such credi-bubble recessions are longer and deeperhan average economic downurns.

Surely ha sounds amiliar, and i also creaes a causal linkage beween higher

inequaliy and he so-called shampoo cyclebubble, bus, repeaha has

characerized he U.S. economy in recen decades. Bu does any evidence exis o

suppor his model?

Cynamon and Fazzari look closely a hese relaions using unique U.S. daa on

spending and saving rom he pas ew decades.29Tey begin wih he noion ha

under he radiional MPC hypohesis, higher income concenraion among he

rich should have depressed consumpion and hus lowered demand relaive o

more equiable disribuions. Bu, as wih he cursory correlaion hun above, hey

did no find ha oucome in he U.S. daa. Insead, hey ound consumpion was

equally srong, i no sronger, over he period o higher inequaliy. Tis led hem

o ask: How, in a period o rising inequaliy and sagnan incomes or he middle

class, could heir spending rise as much as i did in he 2000s? Teir answer:

American households, ouside o hose in he op o he income disribuion, wen

on an exended borrowing binge. Household deb relaive o afer-ax incomerose o unprecedened levels. And i was he resuling financial agiliy ha

caused boh residenial consrucion and broader measures o household spend-

ing o plumme, leading o he mos severe economic conracion in he U.S. since

he Grea Depression.30


26/37


One clear implicaion o his model is higher savings raes or he rich relaive

o he res o he populaion. Bu savings daa disaggregaed by income class are

hard o find. By mapping microdaa on balance-shee composiions rom he

Survey o Consumer Finances, which come ou only every hree years, ono he

changes in each asse and liabiliy caegory repored in he Federal Reserves Flow

o Funds repor, which comes ou quarerly, Cynamon and Fazzari have a daase ha impues savings and spending raes by income class.31radiional macro-

expendiure daa, such as he U.S. Bureau o Economic Analysiss Naional Income

and Produc Accouns, or NIPA, ables, classiy home consrucion as residenial

invesmenand hus no assigned o household accounswhile, or owner-

occupied housing, hey impue renal income and add i o disposable personal

income and renal expense, which is subraced rom personal-consumpion

expendiures. Te auhors reverse he impuednoncashiems and reclassiy

consrucion o single-amily residences as real invesmen by households, and

hus expendiures ha add o consumer demand.

Te auhors hen esablish hese empirical acs:

Aggregae demandconsumer spending, including new residenial produc-

ionrelaive o income rose consisenly rom he early 1990s unil he Grea

Recession.

In he 2000s boh demand and deb-o-income raios rose more or he botom

95 percen han or he op 5 percen. In 2007 he deb-o-income raios were

around 140 percen or he botom 95 percen and abou 60 percen or he

op 5 percen. Tose are quie differen paterns han in he 1990s, when boh

demand and deb-o-income grew a equal raes or boh groups. Tis observa-

ion also suggess somehing more han inequaliy was behind hese develop-

mens since inequaliy grew in he 1990s as well.

When he housing bubble burs, his deb raio became unsusainable or he bo-

om 95 percen and heir savings raes grew sharply, slamming aggregae demand.

Up o his poin, Cynamon and Fazzaris conribuion is a more empirical analysis o

his chain o evens han oher papers ha make similar argumens. Bu a key ques-ion or an analysis o he impac o inequaliy on growh is, wha evidence links his

chain o he high levels o inequaliy ha prevailed over he pas ew decades?


27/37


Overleveraging by isel, or example, does no seem obviously conneced o

higher inequaliy. Suppose, or whaever reason ha money was uniquely cheap.

Migh we no expec middle-class households, even in a more income-equiable

climae, o leverage up as hey did in he 2000s? Perhaps i hey were geting ahead

wihou borrowing, hey would no have borrowed so much. Bu his does no

sand ou as a srong predicion given he price o credi.

Cynamon and Fazzari address he quesion by presening an esimae as o how

heir demand index or he botom 95 percen migh have rended had his groups

share o naional income no allen as i has since 1989. Tey arrive a he couner-

acual by assuming he income share o he botom 95 percen does no all he way

i acually did over he pas ew decades. Had ha loss o income share no occurred,

he disposable-income growh o he botom 95 percen would have roughly

equaled he dissavingspending beyond your incomeha uelled heir exra

consumpion. In oher words, he botom 95 percen could have suppored heir

demand in he 2000s wihou all he borrowing, or in he auhors words, he real-ized level o household demand ha simulaed he economy during he Consumer

Age could have been suppored wihouhe realized decline in he saving rae.32

iming is imporan in hese ypes o narraives. Te scenario o Cynamon and

Fazzari, as well as ha o Kumho and Rancire, is ha in he presence o heigh-

ened inequaliy, demand was mainained hrough dissaving and a hisorically large

growh in deb-o-income by he botom 95 percen. Bu he dynamic was unsus-

ainable and when he bubble burs, we had a long, deep, and inracable reces-

sion ollowed by a weak recovery. While Cynamon and Fazzaris daa on savings

and spending do no go back beore he 1980s, heir findings do show he same

evidence ound in he Federal Reserves Flow o Funds daa showing ha deb o

disposable income was sable a around 60 percen rom 1959 hrough he early

1980s, he very years beore inequaliy sared growing.

Te ac sill remains ha we have experienced financial bubbles in he Unied

Saes and oher advanced economies in periods wihou rising inequaliy. I is

reasonable o suppose ha 2000s-syle securiizaion and underpriced risk would

have led o greaer borrowing by middle-income households, even in he absence

o higher inequaliy. Cynamon and Fazzari were asked how hey hink hingsmigh have played ou differenly i inequaliy had no gone up so much. Would

we have been less likely o have experienced a deep recession and slow-growh

recovery. Teir response:


28/37


I absen high inequaliy, he botom 95 percen had become equally leveraged,

we would have had more demand and more oupu. I i had happened o a grea

enough degree o cause a financial crisis we sill would have had a recession. Bu

he level o which we ell would probably have no been so deep, because he bo-

om 95 percen would have had more income o keep spending a a higher level

afer he supply o new credi dried up. So, wihou he rising inequaliy, he paho he economy would have been higher, even i i had been similarly volaile.33

Also, in suppor o inequaliys role, here is reason o quesion wheher he

Federal Reserve would have suppored such easy moneyha is o say, kep

ineres raes as lowi a more equiable disribuion in hose years suppored

adequae demand absen a bubble. Tis is no o sugges ha he Feds hinking

hroughou he high-inequaliy, high-demand period was ha, we need o offse

he income dampening impac o inequaliy on he middle class wih low ineres

raes. Te suggesion is insead ha i demand had already been sronger han i

acually was in hose years and he Feds observed so many households leveragingup, hey migh have worried more abou overheaing han hey did.

Te inequaliy scholars, Tomas Pikety o he Paris School o Economics and

Emmanuel Saez o he Universiy o Caliornia, Berkeley, also weigh in on he

quesion o wheher causal linkages exis beween highly elevaed levels o inequal-

iy and wha hey erm macroeconomic ragiliy bu which can be inerpreed o

mean financial-marke ragiliy leading o he boom-bus cycle described above.34

Based on heir long-ime series o he disribuion o marke income, Pikety and

Saez ask wheher i is a mere coincidence ha he highes concenraions o

income occurred righ beore boh he Grea Depression and he Grea Recession.

Teir answer is inconclusive as i is difficul o parse correlaion rom causaion.

As noed above, hisory shows ha i clearly does no ake high inequaliy or

desrucive financial bubbles o orm. In an ineresing and broad sudy o his

quesion o inequaliy and financial crises across ime and counries, economiss

ony Akinson and Salvaore Morelli o Oxord Universiy35also find incon-

clusive resuls, discovering, or example, ha banking crises were as likely o

be preceded by al ling inequaliy as by rising inequaliy. I seems, however, ha

researchers probably need o dig ino he naional accouns and examine savingsand spending by income class, as per Cynamon and Fazzari, o ge a more granu-

lar view o hese dynamics.36


29/37


Ye Pikety and Saez argue ha i is highly plausible he rising op incomes did

conribue o exacerbae financial ragiliy, and hey cie a mechanism or his,

which compors well wih Cynamon and Fazzaris findings.37I hose whose

income share has allen seeply as inequaliy has risen do no perceive his shock

o heir income o be permanen, hey will ry o offse he poenial or reduced

consumpion wih deb accumulaion. Cynamon and Fazzaris evidence suggessha his dynamic was in ac operaive during he 2000s.

Finally, i is imporan o consider he poliical-economy model discussed above,

wherein income concenraion ineracs wih money in poliics o drive economic

and regulaory policy. Such a model would predic deregulaion o financial mar-

kes, aciliaing innovaions in securiizaion and ulimaely supporing risky

credi flows o he broad household secor. In his sense, financial deregulaion,

including a Federal Reserve willing o overlook is oversigh role o he banking

secor, plays a key roleone ha neiher Kumho and Rancire nor Cynamon and

Fazzari speciy in his sequence o evens. Simply pu, a lo o regulaors neededo remain asleep a he swich or all his dissaving and borrowing o replace he

demand sapped by inequaliy. Moreover, ha dynamic needed o happen or a long

enough ime o inflae a bubble ha was o be so damaging o growh.


30/37


Conclusion and policy implications

Tere are numerous reasons or policymakers and ciizens o be concerned abou

he rise o inequaliy, no he leas o which are is impac on he basic American

social conrac ha says ha work pays off; he diminishing o opporuniy; he

rise in socieal unres; and is impac on poliical uncionaliy. Bu he concern o

his paper is he impac o inequaliy on macroeconomic growh.

Te review o he evidence suggess ha while some o he radiional channels by

which inequaliy affecs growh have solid heoreical backing, empirical evidenceis elusive. Inuiive and hisorically verified growh-accouning mehods predic

ha i inequaliy, hrough is impac on diminished educaional opporuniy, leads

o a less-well-educaed workorce agains a couneracual wih less inequaliy,

growh will be diminished. Bu or a number o reasons saed in he ex, here

is no correlaion, even wih he requisie lags beween rends in inequaliy and

rends in labor qualiy.

Nor is here evidence, a leas no a firs blush, linking higher levels o income

concenraion o reduced consumer spending as heories o marginal propensiy

o consume or save would predic. One explanaion or his seeming conradic-

ion, however, is ha sharply rising household equiy and is wealh effecs offse

his effec, leading o ar sronger consumer demand han would have oherwise

prevailed.

Various scholars have suggesed ha inequaliy played a role in he credi bubble

ha led o he Grea Recession, and i so, his would cerainly be an imporan

and worrisome link. Te idea is ha as inequaliy channeled income growh away

rom mos amilies, he only way or hem o ge ahead was hrough borrowing.

As more income concenraed a he op among hose wih higher propensiieso save and as Fed policy and financial innovaions led o much cheaper credi,

deb-o-income raios among he broad middle class rose o new heighs, creaing

an unsusainable deb bubble.


31/37


o his causal chain connecing inequaliy o he credi boom and bus o he

2000s, a poliical-economic dimension has been added, urher linking inequaliy

o deregulaory policies and pracices ha amplified he sequence jus described.

Economiss Cynamon and Fazzari, as described in some deail in he previous sec-

ion, presen empirical evidence in suppor o many o hese connecions.

Tus, depending on how convincing his model o he recen deb and growh

dynamics is, some readers may consider his o be an ap descripion o how

inequaliy has affeced growh in recen decades. Tis paper, however, raises a

number o challenges o he model and is resuls; mos imporanly, i challenges

he role o inequaliy.

Regardless o is impac on growh, inequaliys impac on incomes, povery,

opporuniy, and mobiliy calls or a policy response. Recall, or example, Figures

1 and 2, which show a relaionship beween inequaliy and worse educaional

oucomes, including greaer inequaliy in child-enrichmen spending. Teseobservaions poin oward he need or policies ha help disadvanaged children

overcome educaional barriers.

While here is a lo o parisan poliical rheoric coming rom all sides in avor o

educaional opporuniy, here are worrisome budgeary rends ha poin in he

oher direcion. Specifically, Congress has legislaed cuslower spending caps

in he nondeense discreionary side o he budge, he par o he budge ha

unds Head Sar and oher pre-K programs, along wih college-access measures

argeing less-advanaged sudens, such as Pell Grans. According o Richard

Kogan o he Cener or Budge and Policy Prioriies, given curren spending caps,

Pell Grans are already $50 billion shor over he nex decade in erms o mee-

ing curren services, much less expanded access, afer adjusing or inflaion and

populaion growh.38

Oher policy ideas consisen wih he findings described above should address

wo large and persisen flaws in he U.S. economy: he lack o bargaining power o

many in he workorce and he inheren insabiliy in our financial markes.

Compared o mos oher advanced economies, union densiy in he Unied Saesis very low. Since a cenral goal o collecive bargaining is a broader disribuion

across he workorce o a firms profis, he loss o his uncion has been shown o

be associaed wih increases in wage inequaliy over ime. Privae-secor union-

izaion raes are currenly so lowaround 6 percenha here may no be a


32/37


grea deal o inequaliy-reducing racion a his margin righ now.39Sill, policies

ha would level he playing field or union organizing, such as reducing he ime

beween cerificaion and voing or union represenaion a a workplace, make

sense and should be pursued.

Low-wage workers, who are invariably noncollege educaed, have litle bargainingclou in our labor marke and hus depend on ederal and sae minimum wages

ha keep pace wih inflaion i no produciviy growh. Wage-floor policy is hus

also a par o he soluion.

While higher minimum wages and more unionizaion would help, heir impacs

on inequaliy would likely be small relaive o he benefis o ull employmen

o middle-wage and lower-wage workers. Exensive research has shown ha he

elasiciy o real-wage growh wih respec o lower unemploymen is larger and

more significan or workers on he lower end o he wage scale relaive o higher-

paid workers.40Moreover, he one period over he pas ew decades where low andmiddle real incomes rose wih produciviy growh was he lae 1990s, which was

also he sole period where he job marke was a ull employmen.41

Bu how do we ge o where incomes or he majoriy rise wih produciviy

growh given he slack labor markes ha have been he norm in recen decades?

I markes canno provide he needed quaniy o jobs, and especially i our

saey-ne programs coninue o move oward greaer emphasis on work, hen

U.S. policymakers may need o consider more direc orms o job creaion. Tis is

clearly a large and poenially expensive endeavor, bu here may be no oher way

o boh absorb excess labor and reduce wage and income inequaliy and sagna-

ion, paricularly among less-skilled workers.

Te evidence suggess ha he channel hrough which inequaliy hurs growh

is asse bubbles and financial-marke insabiliy, so policies ha impose adequae

oversigh in ha secor also flow rom his research. Following he linkages in he

models sugges ha more careul underwriing pracices are necessary o avoid

overleveraging by middle-income households. More oversigh o innovaive

securiizaion pracices by he financial secor should similarly help correc he

risk-pricing mechanism, which severely underpriced risk during he bubble years.


33/37


Finally, he poliical-economy model srongly suggess ha he oxic ineracion

o wealh concenraion and increasingly pervasive influence o money in poliics

is anoher obvious inervenion poin. Specific recommendaions o policies o

beter conrol campaign financing and reign in lobbying advancing policies ha

exacerbae inequaliysupply-side ax cus, or exampleare beyond he scope

o his paper, bu hey oo are essenial.

Te research on inequaliy s impac on growh remains inconclusive. Inuiive

connecions, backed by circumsanial rends such as high inequaliy and high

leveraging among he broad swah o have-nos, exis beween inequaliy and

diminished educaional opporuniy, diminished public invesmen, he rise o

dysuncional poliics, and perhaps even he bubble boom-bus cycles ha have

become an uncomorable eaure o he U.S. economic landscape.

Bu even i uure research ails o find causaliy where here is now jus correlaion,

here are sill good reasons o push back agains such excessive levels o inequal-iy ha now exis in he U.S. economy. Fundamenal American precepssuch as

basic airness, he convicion ha opporuniies and upward mobiliy should avail-

able o all, and he social conrac ha links hard work and playing by he rules wih

a chance o ge aheadare a risk when inequaliy is where i is oday. Tis will

remain rue no mater how inequaliy impacs macroeconomic growh.

Even i inequaliy is ulimaely ound o have litle impac on growh, he high

levels we have oday are sill highly problemaic. Tis realiy poins oward anoher

body o research ha is increasingly necessary in he service o a more equiable

economy: invesigaing he impac o policies ha push back agains inequal-

iy. Greaer union power, higher minimum wages, a solid saey ne, progressive

axaion, secorial policies ha lif manuacuring relaive o finance, and public

job creaion o achieve ull employmen can all help raise he relaive incomes o

middle- and low-wage workers. Bu policymakers and many economiss will argue

ha o promoe such policies risks growh and jobs, among oher hings. In he

ineres o developing and implemening policy acions agains rising inequaliy,

researchers need o evaluae hese claims wih paricular atenion o he empirical

impacs o hese progressive inervenions.


34/37


About the author

Jared Bernsteinis a senior ellow wih he Cener on Budge and Policy Prioriies.

He was he chie economis and economic advisor o Vice Presiden Joe Biden

rom 2009 hrough 2011. Bernsein is a co-auhor o nine ediions o Te Sae o

Working America and numerous books or popular and academic audiences. Heis an on-air commenaor or CNBC and MSNBC, conribuor o Te New York

imesEconomix blog, and hoss jaredbernseinblog.com.

Acknowledgements

Te auhor wishes o hank Heaher Boushey, Barry Cynamon, Seve Fazzari, John

Fernald, and Jay Shambaugh or helpul commens and/or daa. Any misakes are

he auhors own.


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Endnotes

1 Chad Stone, Danilo Trisi, and Arloc Sherman, Guideto Statistics on Historical Trends in Income In equality(Washington: Center on Budget and Policy Priorities,2012), available at http://www.cbpp.org/files/11-28-11pov.pdf. Lawrence Mishel, The Wedges BetweenProductivity and M edian Compensation Growth(Washington: Economic Policy Ins titute, 2012), availableat http://www.epi.org/files/2012/ib330-productivity-vs-

compensation.2012-04-26-16:45:37.pdf.

2 Stock market data from S&P 500, available athttp://us.spindices.com/indices/equity/sp-500 (last accessedAugust 2013);, GDP and corporate profits from Bureauof Economic Analysis, NIPA Tables 1.1.6 and 1.12(De-partment of Commerce, 2013); Household income dataare from Godron Green and John Coder, HouseholdIncome Trends: May 2013 (Annapolis, MD: Sentier Re-search, 2013), available at http://www.sentierresearch.com/reports/Sentier_Household_Income_Trends_Re-port_May2013_06_26_13.pdf.

3 Jared Bernstein, Inequality and Growth, On theEconomy blog, September 29, 2012, available at http://

jaredbernsteinblog.com/inequality-and-growth.

4 For a review, see Jared Bernstein, Inequality andMobility, Again, On the Economy blog, June 26, 201 3,

available at http://jaredbernsteinblog.com/inequality-and-mobility-again/.

5 Lawrence Mishel, The Wedges Between Productivityand Median Compensation Growth (Washington:Economic Policy Institute, 2012), available at http://www.epi.org/publication/ib330-productivity-vs-com-pensation/.

6 Josh Bivens, Public Investment: The Next New Thingfor Powering Economic Growth (Washington: Eco-nomic Policy Institute, 2012), available athttp://www.epi.org/publication/bp338-public-investments/.

7 Heather Boushey and Adam Hersh, Middle ClassSeries: The American Middle Class, Income Inequality,and the Strength of Our Economy (Washington:Center for American Progress, 2012), available athttp://www.americanprogress.org/issues/economy/

report/2012/05/17/11628/the-american-middle-class-income-inequality-and-the-strength-of-our-economy/.

8 Jared Bernstein, Consumption Shares, Inequality, andGrowth, On the Economy blog, January 10, 2013, avail-able at http://jaredbernsteinblog.com/consumption-shares-inequality-and-growth/.

9 Nick Hanauer, Raise Taxes on Rich to Reward TrueJob Creators, Bloomberg News, November 30, 2011,available at http://www.bloomberg.com/news/2011-12-01/raise-taxes-on-the-rich-to-reward-job-creators-commentary-by-nick-hanauer.html.

10 David Lawder and Kim Dixon, Tax Hike For WealthyWont Kill Growth, Reuters, November 8, 2012, availableathttp://www.reuters.com/article/2012/11/09/us-usa-fiscal-cbo-idUSBRE8A71D020121109.

11 Daron Acemoglu and James Robinson, Why Nations Fail(New York: Crown Publishers, 2012).

12 Ibid.

13 Ibid.

14 Personal communication from Daron Acemoglu,Elizabeth and James Killian Professor of Economics,Massachusetts Institute of Technology, March 7, 2013 .

15 Acemoglu and Robinson, Why Nations Fail.

16 Michael Parisi and Michael Sturdler, SOI-Tax Stats Top400 Individual Income Tax Returns with the Largest Ad-

justed Gross Incomes (Washington: Internal RevenueService, 2009), available at http://www.irs.gov/uac/SOI-Tax-Stats-Top-400-Individual-Income-Tax-Returns-with-the-Largest-Adjusted-Gross-Incomes.

17 Annie Lowrey, Tax Code May Be the Most ProgressiveSince 1979, The New York Times, January 4, 2013, avail-able athttp://www.nytimes.com/2013/01/05/business/after-fiscal-deal-tax-code-may-be-most-progressive-since-1979.html?_r=0.

18 Center on Budget and Policy Priorities, State-ment by Robert Greenstein, President, On Chair-man Ryans Budget Plan, Press release, March 12,2013, available at http://www.cbpp.org/cms/index.cfm?fa=view&id=3920...

19 Thomas Piketty, Emmanuel Saez, and StefanieStantcheva, Optimal Taxation of Top Labor Incomes: A

Tale of Three Elasticities (Cambridge: National Bureauof Economic Research, 2011), available at http://elsa.berkeley.edu/~saez/piketty-saez-stantchevaN-BER11thirdelasticity.pdf.

20 Michael Kumhof and Romain Rancire, Inequality,Leverage and Crises. Working Paper 268 (MonetaryFund, 2010).

21 Barry Z. Cynamon and Steven M. Fazzari, Inequalityand Household Finance During the Consumer Age(Rochester, NY: Social Science Research Network,2013), available athttp://papers.ssrn.com/sol3/papers.cfm?abstract_id=2205524.

22 Kumhof and Rancire, Inequality, Leverage and Crises.

23 Greg J. Duncan and Richard J. Murnane, Whither Op-portunity? Rising Inequality, Schools, and Childrens LifeChances (New York: Russell Sage Foundation, 2011).

24 Neeraj Kaushal, Katherine Magnuson, and Jane Wald-fogel, How is Family Income Related to Investmentsin Childrens Learning? (Washington: The BrookingsInstitution, 2008), available athttps://xteam.brookings.edu/psied/PSIED%20Papers/Kaushal_Magnuson_Wald-fogel.pdf; Duncan and Murnane, Whither Opportunity.

25 John Fernald, Productivity and Potential Outputbefore, during and after the Great Recession (SanFrancisco: Federal Reserve bank of San Francisco, 2012),available at http://www.frbsf.org/publications/econom-ics/papers/2012/wp12-18bk.pdf; Fernalds data areavailable at http://www.frbsf.org/economics/econo-mists/jfernald/quarterly_tfp.xls.

26 Daniel Aaronson and Daniel Sullivan, Growth in WorkerEquality (Chicago: Federal Reserve Bank of Chicago,2002), available athttp://www.chicagofed.org/digital_assets/publications/chicago_fed_letter/2002/cflfeb2002_174.pdf.
http://us.spindices.com/indices/equity/sp-500http://us.spindices.com/indices/equity/sp-500http://www.epi.org/publication/ib330-productivity-vs-compensation/http://www.epi.org/publication/ib330-productivity-vs-compensation/http://www.epi.org/publication/ib330-productivity-vs-compensation/http://www.epi.org/publication/bp338-public-investments/http://www.epi.org/publication/bp338-public-investments/http://jaredbernsteinblog.com/consumption-shares-inequality-and-growth/http://jaredbernsteinblog.com/consumption-shares-inequality-and-growth/http://www.reuters.com/article/2012/11/09/us-usa-fiscal-cbo-idUSBRE8A71D020121109http://www.reuters.com/article/2012/11/09/us-usa-fiscal-cbo-idUSBRE8A71D020121109http://www.irs.gov/uac/SOI-Tax-Stats-Top-400-Individual-Income-Tax-Returns-with-the-Largest-Adjusted-Gross-Incomeshttp://www.irs.gov/uac/SOI-Tax-Stats-Top-400-Individual-Income-Tax-Returns-with-the-Largest-Adjusted-Gross-Incomeshttp://www.irs.gov/uac/SOI-Tax-Stats-Top-400-Individual-Income-Tax-Returns-with-the-Largest-Adjusted-Gross-Incomeshttp://www.nytimes.com/2013/01/05/business/after-fiscal-deal-tax-code-may-be-most-progressive-since-1979.html?_r=0http://www.nytimes.com/2013/01/05/business/after-fiscal-deal-tax-code-may-be-most-progressive-since-1979.html?_r=0http://www.nytimes.com/2013/01/05/business/after-fiscal-deal-tax-code-may-be-most-progressive-since-1979.html?_r=0http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2205524http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2205524https://xteam.brookings.edu/psied/PSIED%20Papers/Kaushal_Magnuson_Waldfogel.pdfhttps://xteam.brookings.edu/psied/PSIED%20Papers/Kaushal_Magnuson_Waldfogel.pdfhttps://xteam.brookings.edu/psied/PSIED%20Papers/Kaushal_Magnuson_Waldfogel.pdfhttp://www.frbsf.org/publications/economics/papers/2012/wp12-18bk.pdfhttp://www.frbsf.org/publications/economics/papers/2012/wp12-18bk.pdfhttp://www.frbsf.org/economics/economists/jfernald/quarterly_tfp.xlshttp://www.frbsf.org/economics/economists/jfernald/quarterly_tfp.xlshttp://www.chicagofed.org/digital_assets/publications/chicago_fed_letter/2002/cflfeb2002_174.pdfhttp://www.chicagofed.org/digital_assets/publications/chicago_fed_letter/2002/cflfeb2002_174.pdfhttp://www.chicagofed.org/digital_assets/publications/chicago_fed_letter/2002/cflfeb2002_174.pdfhttp://www.chicagofed.org/digital_assets/publications/chicago_fed_letter/2002/cflfeb2002_174.pdfhttp://www.chicagofed.org/digital_assets/publications/chicago_fed_letter/2002/cflfeb2002_174.pdfhttp://www.chicagofed.org/digital_assets/publications/chicago_fed_letter/2002/cflfeb2002_174.pdfhttp://www.frbsf.org/economics/economists/jfernald/quarterly_tfp.xlshttp://www.frbsf.org/economics/economists/jfernald/quarterly_tfp.xlshttp://www.frbsf.org/publications/economics/papers/2012/wp12-18bk.pdfhttp://www.frbsf.org/publications/economics/papers/2012/wp12-18bk.pdfhttps://xteam.brookings.edu/psied/PSIED%20Papers/Kaushal_Magnuson_Waldfogel.pdfhttps://xteam.brookings.edu/psied/PSIED%20Papers/Kaushal_Magnuson_Waldfogel.pdfhttps://xteam.brookings.edu/psied/PSIED%20Papers/Kaushal_Magnuson_Waldfogel.pdfhttp://papers.ssrn.com/sol3/papers.cfm?abstract_id=2205524http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2205524http://www.nytimes.com/2013/01/05/business/after-fiscal-deal-tax-code-may-be-most-progressive-since-1979.html?_r=0http://www.nytimes.com/2013/01/05/business/after-fiscal-deal-tax-code-may-be-most-progressive-since-1979.html?_r=0http://www.nytimes.com/2013/01/05/business/after-fiscal-deal-tax-code-may-be-most-progressive-since-1979.html?_r=0http://www.irs.gov/uac/SOI-Tax-Stats-Top-400-Individual-Income-Tax-Returns-with-the-Largest-Adjusted-Gross-Incomeshttp://www.irs.gov/uac/SOI-Tax-Stats-Top-400-Individual-Income-Tax-Returns-with-the-Largest-Adjusted-Gross-Incomeshttp://www.irs.gov/uac/SOI-Tax-Stats-Top-400-Individual-Income-Tax-Returns-with-the-Largest-Adjusted-Gross-Incomeshttp://www.reuters.com/article/2012/11/09/us-usa-fiscal-cbo-idUSBRE8A71D020121109http://www.reuters.com/article/2012/11/09/us-usa-fiscal-cbo-idUSBRE8A71D020121109http://jaredbernsteinblog.com/consumption-shares-inequality-and-growth/http://jaredbernsteinblog.com/consumption-shares-inequality-and-growth/http://www.epi.org/publication/bp338-public-investments/http://www.epi.org/publication/bp338-public-investments/http://www.epi.org/publication/ib330-productivity-vs-compensation/http://www.epi.org/publication/ib330-productivity-vs-compensation/http://www.epi.org/publication/ib330-productivity-vs-compensation/http://us.spindices.com/indices/equity/sp-500http://us.spindices.com/indices/equity/sp-500


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27 David S. Johnson, Jonathan A. Parker, andNicholas S. Shoules, Household Expenditure and theIncome Tax Rebates of 2001. Working Paper 10784 (Na-tional Bureau of Economic Research, 2004), available athttp://www.nber.org/papers/w10784.

28 Karl E. Case, John M. Quigley, and Robert J. Shiller, Wealth Effects Revisited 1975-2012 (New Haven:Cowles Foundation for Research in Economics YaleUniversity, 2011), available at http://cowles.econ.yale.edu/P/cd/d18b/d1884.pdf.

29 Cynamon and Fazzari, Inequality and HouseholdFinance During the Consumer Age.

30 Ibid.

31 The imputation was originally done by Dean M. Makiof Putnam Investments and Michael G. Palumbo of theBoard of Governors of the Federal Reserve and was aug-mented with data provided by Mark Zandi of MoodysAnalytics. Dean M. Maki and Michael G. Palumbo,Disentangling the Wealth Effect: A Cohort Analysis ofHousehold Saving in the 1990s (Washington: The Fed-eral Reserve Board: Finance and Economic DiscussionSeries, 2001), available at http://www.federalreserve.gov/pubs/feds/2001/200121/200121abs.html.


33 Personal communication from Barry Z. Cynamon andSteven M. Fazzari, May 17, 2013.

34 Thomas Piketty and Emmanuel Saez, Top Incomesand the Great Recession: Recent Evolutions and PolicyImplications (Washington: International MonetaryFund, 2012), available at http://www.imf.org/external/np/res/seminars/2012/arc/pdf/PS.pdf.

35 A. B. Atkinson and Salvatore Morelli, Economic Crisesand Inequality (New York: United Nations Develop-ment Programme: Human Development Reports,2011), available at http://hdr.undp.org/en/reports/global/hdr2011/papers/HDRP_2011_06.pdf.

36 Atkinson and Morelli, Economic Crises and Inequality.


38 Richard Kogan, Non-Defense Discretionary ProgramsWill Face Serious Pressures Under Current FundingCaps (Washington: Center on Budget and Policy Priori-ties, 2012), available at http://www.cbpp.org/files/12-4-12bud.pdf.

39 U.S. Bureau of Labor Statistics, Union Members2012,Press release, January 23, 2013, available athttp://bls.gov/news.release/pdf/union2.pdf.

40 Jared Bernstein and Dean Baker, The Benefits of Full Em-ployment: When Markets Work for People(Washington:Economic Policy Institute, 2003).

41 Ibid.
http://www.nber.org/papers/w10784http://cowles.econ.yale.edu/P/cd/d18b/d1884.pdfhttp://cowles.econ.yale.edu/P/cd/d18b/d1884.pdfhttp://www.imf.org/external/np/res/seminars/2012/arc/pdf/PS.pdfhttp://www.imf.org/external/np/res/seminars/2012/arc/pdf/PS.pdfhttp://www.cbpp.org/files/12-4-12bud.pdfhttp://www.cbpp.org/files/12-4-12bud.pdfhttp://bls.gov/news.release/pdf/union2.pdfhttp://bls.gov/news.release/pdf/union2.pdfhttp://bls.gov/news.release/pdf/union2.pdfhttp://bls.gov/news.release/pdf/union2.pdfhttp://www.cbpp.org/files/12-4-12bud.pdfhttp://www.cbpp.org/files/12-4-12bud.pdfhttp://www.imf.org/external/np/res/seminars/2012/arc/pdf/PS.pdfhttp://www.imf.org/external/np/res/seminars/2012/arc/pdf/PS.pdfhttp://cowles.econ.yale.edu/P/cd/d18b/d1884.pdfhttp://cowles.econ.yale.edu/P/cd/d18b/d1884.pdfhttp://www.nber.org/papers/w10784


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