Income Inequality and Economic Growth

Standard & Poor’s adds fuel the the already raging fire of economic illiteracy with its research report entitled, “How Increasing Income Inequality Is Dampening U.S. Economic Growth, and Possible Ways to Change the Tide.” The S&P paper mines the Marxian-Pikettian vein of “underconsumption,” which (in the Marxian-Pikettian view) leads to economic collapse. (That Marx was wrong has been amply demonstrated by the superior performance of quasi-free economies, which have lifted the poor as well as the rich. Many writers have found grave errors in Piketty‘s reasoning– and data — these among them.)

The remedy for economic collapse (in the Marxian-Pikettian view) is socialism (perhaps smuggled in as “democratic” redistributionism). It is, of course, the kind of imaginary, painless socialism favored by affluent professors and pundits — favored as long as it doesn’t affect their own affluence. It bears no resemblance to the actual kind of socialism experienced by the billions who have been oppressed by it and the tens of millions who have been killed for its sake.

I have read two thorough take-downs of S&P’s screed. One is by Scott Winship (“S&P’s Fundamentally Flawed Inequality Report,” Economic Policies for the 21st Century at the Manhattan Institute, August 6, 2014). A second is by John Cochrane (“S&P Economists and Inequality,” The Grumpy Economist, August 8, 2014). Cochrane summarizes (and demolishes) the central theme of the S&P report, which I will address here:

[I]nequality is bad [because] it is bad for growth, and if the reason it is bad for growth is that it leads to insufficient consumption and lack of demand….

That bit of hogwash serves the redistributionist agenda. As Cochrane puts it, “redistributive taxation is a perennial answer in search of a question.” Indeed.

There’s more:

Inequality – growth is supposed to be about long run trends, not boom and slow recovery.

Professor of Public Policy at U.S. Berkeley Robert Reich argues that increased inequality has reduced overall aggregate demand. He observes that high-income households have a lower marginal propensity to consume (MPC) out of income than other households.

Let us begin at the beginning, that is, with some self-evident postulates that even a redistributionist will grant — until he grasps their anti-redistributionist implications:

  • All economic output is of two distinct types: consumption and investment (i.e., the replacement of or increase in the stock of capital that is used to produce goods for consumption).
  • The output of consumption goods must decline, ceteris paribus, if the stock of capital declines.
  • The stock of capital is sustained (and increased) by forgoing consumption.
  • The stock of capital is therefore sustained (and increased) by saving.
  • Saving rises with income because persons in high-income brackets usually consume a smaller fraction of their incomes than do persons in middle- and low-income brackets.
  • The redistribution of income from high-income earners to middle- and low-income earners therefore leads to a reduction in saving.
  • A reduction in saving means less investment and, thus, a reduction in the effective stock of capital, as it wears out.
  • With less capital, workers become less productive.
  • Output therefore declines, to the detriment of workers as well as “capitalists.”

In sum, efforts to make incomes more equal through redistribution have the opposite effect of the one claimed for it by ignorant bloviators like Robert Reich.

So much for the claim that a higher rate of consumption is a good policy for the long run.

What about in the short run; that is, what about Keynesian “stimulus” to “prime the pump”? I won’t repeat what I say in “The Keynesian Multiplier: Phony Math.” Go there, and see for yourself.

For an estimate of the destructive, long-run effect of government see “The True Multiplier.”