Myth-making about economic inequality

Unless you are exceptionally cold-blooded, it’s hard not to be disturbed by today’s huge economic inequality. The gap between the rich and the poor is enormous, wider than most Americans would

(almost certainly) wish. But this incontestable reality has made economic inequality a misleading intellectual fad, blamed for many of our problems. Actually, the reverse is true: Economic inequality is usually a consequence of our problems and not a cause.

For starters, the poor are not poor because the rich are rich. The two conditions are generally unrelated. Mostly, the rich got rich by running profitable small businesses (car dealerships, builders), creating big enterprises (Google, Microsoft), being at the top of lucrative occupations (lawyers, doctors, actors, athletes), managing major companies or inheriting fortunes. By contrast, the very poor often face circumstances that make their lives desperate. In an interview with The New Yorker , President Obama recently put it this way:

“[The] ‘pathologies’ that used to be attributed to the African-American community in particular — single-parent households, and drug abuse, and men dropping out of the labour force, and an underground economy — [are now seen] in larger numbers in white working-class communities.”

Solutions elude us. Though some low-income workers would benefit from a higher minimum wage, most of the very poor would not. They’re not in the labour force; they either can’t work — too young, old, disabled or unskilled — or won’t work. Of the 46 million people below the government’s poverty line in 2012, only six per cent had year-round full-time jobs. Among men 25 to 55 with a high-school diploma or less, the share with jobs fell from more than 90 per cent in 1970 to less than 75 per cent in 2010, reports Ron Haskins of the Brookings Institution. For African-American men ages 20 to 24, the working share was less than half.

It’s also not true, as widely asserted, that the wealthiest Americans (the notorious top one per cent) have captured all the gains in productivity and living standards of recent decades. The Congressional Budget Office examined income trends for the past three decades. It found sizeable gains for all income groups.

True, the top one per cent outdid everyone. From 1980 to 2010, their inflation-adjusted pre-tax incomes grew a spectacular 190 per cent, almost a tripling. But for the poorest fifth of Americans, pre-tax incomes for these years rose 44 per cent. Gains were 31 per cent for the second poorest, 29 per cent for the middle fifth, 38 per cent for the next fifth and 83 per cent for the richest fifth, including the top one per cent. Because our system redistributes income from top to bottom, after-tax gains were larger: 53 per cent for the poorest fifth; 41 per cent for the second; 41 per cent for the middle-fifth; 49 per cent for the fourth; and 90 per cent for richest.

Finally, widening economic inequality is sometimes mistakenly blamed for causing the Great Recession and the weak recovery. The argument, as outlined by two economists at Washington University in St. Louis, goes like this. In the 1980s, income growth for the bottom 95 per cent of Americans slowed. People compensated by borrowing more. All the extra debt led to a consumption boom that was unsustainable. The housing bubble and crash followed. Now, weak income growth of the bottom 95 per cent “helps explain the slow recovery.”

This theory is half right. An unsustainable debt boom did fuel an unsustainable consumption boom. From 1980 to 2007, household debt rose from 72 per cent to 137 per cent of disposable income. Consumption spending jumped from 61 per cent of gross domestic product (the economy) to 67 per cent for the same years, a huge shift. These increases could not continue indefinitely. But growing inequality didn’t cause these twin booms. Just because households wanted to borrow didn’t mean lenders had to lend. They lent, signifying relaxed credit standards, because they thought that the risks had dropped.

Convenient scapegoats

Optimism seemed justified. Beginning in the 1980s, inflation fell, reducing interest rates. Lower interest rates raised stock prices and home values. People felt wealthier and, on paper, were. Buoyant consumer spending kept the economy advancing and unemployment low. Recessions were mild and infrequent. Economists called this the Great Moderation. Its complacency led directly to the Great Recession. The boom and bust had little to do with economic inequality.

Americans in the top one per cent are convenient scapegoats. They don’t naturally command much sympathy, and their rewards sometimes seem outsized or outlandish. When most people are getting ahead, they don’t worry much about this economic inequality. When progress stalls, they do. There’s a backlash and a tendency to see less economic inequality as a solution to all manner of problems. We create simplistic narratives and imagine that punishing the rich will miraculously uplift the poor. This vents popular resentments, even as it encourages self-deception. — © 2014. Washington Post.

Economic inequality is usually a consequence of our problems and not a cause