Smart Money: Income equality and the economy

Posted Tuesday, December 24, 2013 in Analysis

Smart Money: Income equality and the economy

Trickle-down economics. Any questions?

by Gina Hamilton

A recent survey of three dozen economists bears out what seems like common sense: Income inequality has a depressive effect on the economy.  They echoed Nobel Prize-winning economists Robert Shiller’s words that rising inequality is the most important economic problem we are now facing, and Joseph Stiglitz’ explanation that the middle class is too weak to support consumer spending that drives American economic growth.

Of course, some economists disagree, but not many, not anymore, after five long years of economic stagnation during which the well-to-do and their banks have received outsized tax breaks, while not investing those gains back into the economy in any meaningful way.          

The majority of the economists surveyed two weeks ago said that in a consumer economy, such as the U.S. has, the ability for people across all income levels to spend their way out of recession is critical.  And right now, the majority of Americans don’t have that ability.

Why? The average income of the top 5 percent of households, adjusted for inflation, increased by 17 percent in the last 20 years.  The average income for the middle 20 percent ... the solid middle class ... rose less than 5 percent in the same period.   The lower middle class and the poor fared worse, and even the upper middle classes  didn’t do as well as the top earners.  

It gets worse.  Since 1999, the average American income fell more than 9 percent, mostly due to the 2008 recession; however, for the top 1 percent, incomes rose 31 percent since the end of the recession.  Last year, the top 1 percent took home 22 percent of the whole nation’s income; the top 0.1 percent took home half of that.

These figures are due to the fact that income increases from work have stagnated across most classes, even for professionals.  Income from investments accounts for much of the rise in the upper class’ income levels.

And while the wealthy, when they’re in a spending mood, do spend some of their income, most of their income is not spent.  It is either saved or invested, and much of the investment serves as income in the year to come.  And even if they do spend, the top one percent can’t possibly spend as much as the bottom 99 percent of the people. 

The middle class and poor, on the other hand, spend the majority of their income, mostly ploughing it back into the local economies.  Without disposible income, the local economies stagnate.  The middle class may put off braces for their children, may skip music lessons or dance classes, may make a winter coat or an old car do for another year.  The poor are even worse off; they may skip doctor appointments and dental appointments, setting themselves up for serious repercussions later on.  They may not be able to heat their homes adequately, or purchase nutritious foods.  And while the middle class and poor are putting off things that would be good for them, they’re also putting the economy on hold.

The reason is clear.  Without funds changing hands for dance classes, the dance studio may not survive.  The owner of the studio and the teachers who work for the studio lose their livelihoods, causing a spiral effect in the economy.  Even professionals are affected, unable to pay for more than one dental assistant or nurse, perhaps, forced to lay off employees who are talented and would rather be working.

Across the economy, inequality causes slowdowns in every sector, from large ticket purchases such as furniture, cars, appliances, or homes, to home repair and improvement, to medical, dental, and optometric care, to the most basic services such as personal grooming care.  All of these have effects beyond the showroom or office; a car or appliance that is not sold at the dealership is one that isn’t replaced, so manufacturing suffers.  A home that is not purchased means that rental rates go up while new home construction goes down.  If a household can jury-rig a sink rather than call a plumber, the plumber and the plumbing supplier lose business.  

In short, what these economists seemed to agree upon was that the trickle-down, supply-side theory that wealth stimulates the economy was tragically flawed.  Instead, they acknowledged - finally - what should have been obvious all along, that economies grow from the grassroots up, not from the lofty heights down.

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