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US: Why Inequality Matters

Why Inequality Matters - or Why Joseph Stiglitz Hits It and Paul Krugman Misses

By William Spriggs

With the Super Bowl just ending, fantasy football fans will have to wait until next season to ponder the success of Russell Wilson. But it turns out there is a fantasy league for economists. So sorry to those of you with Paul Krugman on your team, because I am siding with Joseph Stiglitz in his argument that income inequality is slowing the recovery.

Both Stiglitz and Krugman are Nobel laureates in economics. Both agree that inequality hurts the economy in the long run, mostly because in a market-based economy, high levels of income inequality lead to too many very talented and smart poor children being trapped by low income out of the investments in their schooling, enriching life experiences and opportunities to become the scientists, engineers, doctors and leaders we need to grow as a nation.

Where Stiglitz and Krugman disagree is on how inequality shapes the important outcomes of the market in the present. Here they differ because Krugman argues against the idea that income growth that favors the rich hurts restoring demand for goods and services that make employers hire more people because the rich save rather than consume. Krugman points to the evidence showing that despite rising income inequality, aggregate consumption has been quite healthy.

But, while consumption by the rich is helping the sale of goods and services, and so keeping Gross Domestic Product (the value of all goods and services produced in the country) growing, rich people spending is a not poor person spending. Stiglitz believes inequality is slowing the current recovery.

Economists Steven Fazzari and Barry Cynamon point out that consumption by the top 1 percent has grown by 17 percent since 2009 when the "recovery" began and just 1 percent for the bottom 95 percent. Business knows that spending patterns are different, as a New York Times article explained this week. Darden, a chain of sit-down restaurants, grew from a base of its middle-class restaurants-Olive Garden and Red Lobster.

Those brands now sag in sales, while their upscale brand Capital Grille is growing fast. But it is more than restaurants that differ. If it is simply that more is spent at Capital Grille than Red Lobster, Kruger argues then presumably the wages and number of workers Darden would allocate to Red Lobster would fall but rise at the Capital Grille, so employment and income for the bottom 95% also would grow.

But something else happens with inequality; a rising share of all consumption takes place at the top. There are two problems when a high share of consumption is concentrated at the top.

First, for things like housing and education, where the rich consume the bulk of private consumption, it tilts prices toward their income levels. Just as Darden will chase the dollars in the market place by changing its mix of restaurants, home builders will chase the dollars and tastes and preferences and willingness to pay of the rich in building homes.

Elite institutions favored by the rich, like Harvard and Stanford, will raise tuition to capture the ability and willingness to pay of the rich, and in turn use those resources to bid for the best faculties in business and engineering. The ripple effect of those price shifts is to up the ante for those in the middle who want to become homeowners or send their children to college.

Fazzari and Cynamon document that indeed the middle class kept up with those rising prices by borrowing heavily-too heavily as it led to a collapse in middle class demand when debt levels rose too high. The housing collapse froze middle-class homeowners, but families have continued to chase quality education by increasing their debt for college student loans.

The second problem is that middle-class incomes lead to increased purchases of more things that lead to more jobs-like more automobiles. Increase income at the top instead leads to production of items with higher profit margins and prices-luxury automobiles and high-end appliances-not more cars and more appliances. So the collapse and lack of recovery of incomes in the middle mean that current consumption isn't translating into more people being hired, just higher profits and higher prices for luxury items.

Unfortunately, the lack of income recovery at the bottom is that rising prices are still outstripping the ability of many families to buy food. So passing farm bills that subsidize rich farmers, while cutting food to lower-income families will continue to exacerbate the difficulties we are having in growing demand at the bottom-demand that is linked to more jobs.

ENDS

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