Is Inequality Holding Back the Recovery?

Price of InequalityBig happenings over the weekend. (You can take that as a joke if you like, but I’m quite serious.) Joseph Stiglitz wrote an extended OpEd over at the New York Times, Inequality Is Holding Back the Recovery. He presents four reasons for saying this. First, he notes the deleveraging problem: the middle class is feeling very poor because of the bursting of the housing bubble, but they haven’t seen their incomes increase since the crisis. Second, low income growth has caused the middle class to limit investment in things like education. Third, income inequality is keeping tax receipts low. And fourth, high income inequality is associated with economic instability.

Krugman responded in a blog post on Sunday. He noted that Stiglitz’s second and fourth points are important, but don’t really have anything to do with job growth since the bubble burst. But mainly, Krugman’s point is that the evidence isn’t that good for the theory that the rich don’t spend as much money as the poor. He notes that Milton Friedman showed that most of this correlation was actually due to people whose incomes had temporarily fallen. Understandably, they would spend more of their incomes on average. Similarly, people who get a suddenly windfall are likely to save more of it. So Krugman turns to data and shows that total spending was moving in the opposite direction than it would be given Stiglitz’s hypothesis.

Dean Baker then counters Krugman’s point by noting that much of the spending was driven by the stock and real estate bubbles where people thought they had more money than they actually did. He makes a number of other good points.

And then this morning, Krugman is back, yielding a little of the territory. But mostly, he is arguing again that economics is not a morality play. Just because you think something is right doesn’t mean it is good economics. It is entirely possible to have an unjust economy that works great. And this is where all three of these great economists agree: extreme income inequality is bad for us as a people. As we’ve seen over the last 35 years, the economy can grow without it improving the lives of the vast majority of its citizens. This counters the argument that Milton Friedman liked to make that even though the rich were getting far richer, the poor were also doing better than they would in a more egalitarian system. That simply is not true. (Of course, the moment you argued this with Friedman, he would switch to arguing some nonsense about rights and responsibilities—the typical libertarian bait and switch.)

See how fun economics is? If not, here’s your take home: income inequality is bad. It is turning us into a feudal system. Democracy requires some level of equality. If you don’t have it, then the rich can just buy whatever government they want. You know, just like in modern America.

Update (21 January 2013 11:55 am)

Matt Yglesias says that while he thinks Krugman may have the better argument, Stiglitz is probably still right:

Joe Stiglitz says high levels of inequality hold back economic recovery but Paul Krugman disagrees and I think gets the better of the argument. That said, I think Stiglitz’s conclusion may be correct. Krugman says you “you can have full employment based on purchases of yachts, luxury cars, and the services of personal trainers and celebrity chefs.” And I agree with him, you can. Or at least you could. But you don’t and that seems significant to me.
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About Frank Moraes

Frank Moraes is a freelance writer and editor online and in print. He is educated as a scientist with a PhD in Atmospheric Physics. He has worked in climate science, remote sensing, throughout the computer industry, and as a college physics instructor. Find out more at About Frank Moraes.

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