The Inequality Fetish

By Patrick Brennan
Friday, June 22, 2012

There must be something in the water in Scandinavia: Nobel laureates, from our president to Paul Krugman and Joseph Stiglitz, all agree that high levels of inequality are a serious problem, if not the problem, facing our weak economy.

According to this liberal thesis, either the 2008 financial crisis and its attendant recession, or the sluggish recovery — and maybe both — can be attributed in large part to the high level of economic inequality in the United States. Further, in this view, inequality is an economic malady on its own, even in times of prosperity. Liberal commentators, of course, assert this as if it were a truism, but worse, economists of real distinction trumpet it like scientific fact.

Joseph Stiglitz, who claims that “there is broad consensus that one of the reasons for the weakness in the economy is the huge level of inequality,” further contends that the plight of the 99 percent is of such dire economic consequence that the 1 percent can’t afford to ignore the chasm. Sounding even more empirically minded, President Obama asserts that “research has shown that countries with less inequality tend to have stronger and steadier economic growth over the long run.”

But if there is a broad consensus in economics and social science on anything, it is certainly not this. For those who claim otherwise, ideology has taken the place of empiricism.

There are two elements of the ubiquitous thesis: Increased inequality generally slows economic growth, and it contributes to financial crises such as our current one. But there’s never been much good evidence to support either assertion. The best evidence for a causal link between inequality and economic growth, alluded to in the president’s cryptic claim above, is an IMF paper that suggests economic booms last longer and are steadier in countries with less income inequality. But this link relies on countries such as Cameroon and Colombia (two of the cases examined) — dysfunctional nations with extreme inequality that often leads to pervasive rent-seeking or political instability, causing uneven economic growth. For the question of inequality in the U.S., the most relevant study on the topic, which considers industrialized nations over the course of the 20th century, finds no meaningful link between inequality and income growth.

There is also almost no evidence that economic inequality causes financial crises. As a recent paper by Michael Bordo and Christopher Meissner argues, there is no “general relationship” between inequality and credit booms and crises — it isn’t hard to find a correlation between the two, but these two dynamics are also correlated with a huge number of other economic factors. Mark Thoma, a liberal professor of economics at the University of Oregon, has admitted, “I am not saying that the evidence stacks up against the idea that inequality contributed to the recession, it could very well be true . . . [but] the evidence I’m aware of doesn’t tell us much one way or the other.”

Scott Winship, of the Brookings Institute, explains that he finds it “amazing how willing some of the biggest names in economics are to assert that the growth in inequality has had deleterious consequences,” when “there’s little good evidence it has had important effects on opportunity, growth, stability, or politics.”

Because these big names probably do know there is no good statistical evidence for their thesis, they rely on a particular analytic narrative: A large increase in inequality encourages more consumer debt, leading to corporate cash gluts and asset bubbles, and, eventually, a financial crisis, which leads to a stubborn depression.

When laid out on the editorial pages of the New York Times, this may sound sensible, even obvious, but the case for causality rests on many unproven assumptions and links. For instance, this theory assumes that, when they face greater income inequality, middle-class households run up debt in order to maintain their level of consumption relative to others. But it turns out that inequality of consumption has closely tracked inequality of income; that is, as the rich have gotten richer, the middle class has not been increasing its debt for the sake of keeping up with the Joneses. The credit boom and subsequent crisis probably happened for other reasons.

Further, the only two case studies in support of this storyline are the Great Depression and our recent financial crisis. These crises can be readily explained by traditional causes of credit booms, such as low interest rates, economic expansion, and national current-account deficits. As Bordo and Meissner’s paper explains, “the anecdotal evidence from several historical credit booms finds little support for the inequality/crisis hypothesis.”

Another key tenet of the inequality thesis is that growing income inequality has given the super-rich the ability to dominate and exploit our political system. But wealthy citizens’ outsized ability to influence our political system isn’t sufficient proof of this; it must be shown that the extreme wealth (and comparative poverty) created by America’s growing inequality has allowed the super-rich to exploit politics in economically problematic ways. It seems doubtful that, for instance, higher CEO pay has given CEOs significantly greater political influence than the top decile or percentile of American society has ever had before. In fact, greater levels of wealth seem even less relevant when one considers the relative pittances spent on politics: Liberals worry that the shadowy rich might spend $2 billion on this year’s presidential election, or one-third of what Americans spent on Porsches last year.

In addition, besides lower marginal tax rates (which many wealthy Americans don’t want), it’s not entirely clear what an American political system at the disposal of the wealthy would look like. There is no one set of economic policies favoring ultra-wealthy corporations: Some businesses benefit from more regulation or protectionism, others from less. The causal argument linking growing inequality with policies that favor the elite and hinder economic growth does sometimes bear out in developing nations, where it is possible for the wealthy and the politically connected to capture industry or natural resources.

This dynamic does not obtain in the United States; America’s super-rich are nothing like the political-economic elites who run the developing world. This is not least because America retains fairly healthy middle-to-upper-class mobility. Most of the top 1 percent of income earners drop out of that category after a few years, representing nothing like a calcified super-rich overclass of individuals protecting their interests over the course of decades.

Further, the evidence, discussed above, that high levels of inequality might make growth unsteady relies on a different, and contradictory, dynamic — that is, the idea that politicians in more unequal societies are more likely to resort to inefficient redistributionist policies (such as punishingly high tax rates on the rich, or the nationalization of an industry). Thus, even if we live in a society where income inequality has begun to burden the economy, the evidence suggests that the worst thing we could do might be to ask the federal government to address it.

Some liberal economists point to the lack of monetary stimulus as evidence of an economic system tilted toward the wealthy: The Federal Reserve has chosen to protect the investor class from inflation, rather than moving to address unemployment. Those interests may or may not thus aligned, but there’s no evidence that the Fed has chosen its policies to protect the interests of the upper class at the expense of everyone else.Polls indicate that most Americans want the Federal Reserve to be audited or otherwise reined in, rather than allowed to address unemployment via monetary policies that would either risk inflation or actively encourage it. Have the super-rich brainwashed the public?

Indeed, Krugman and Robin Wells came close to admitting as much by laying out an even more tenuous explanation in an April Salon article: Inequality causes political polarization; polarization causes policy paralysis; policy paralysis causes economic stagnation. In other words, inequality may be bad for the economy, if you buy a series of connections that have no solid basis in evidence.

If income inequality doesn’t pose a problem for our economy, does it contribute to social maladies that might merit a public-policy response, or that might eventually have a bearing on our economic growth? Again, empirical studies find little reason to think so: Works such as the 2009 book The Spirit Level find some cross-national link between inequality and various social ills, but more rigorous research suggests that these simple correlations don’t really tell us much — countries might have more or less equality and have better social outcomes because of another lurking variable. When one examines the effects of increased inequality on measures of well-being — as Christopher Jencks of Harvard’s Kennedy School did in a 2002 paper — one finds little evidence of such a connection.

Further, when inequality grows, it does so more at certain levels than at others, and the poor are not the ones left behind. Instead, gaps widen between the wealthy and the middle class; the rich get richer in real terms, while the median income and lower-percentile incomes are unaffected. This is not to say that inequality does not cause any social ills, but there remains little substantial evidence of what they might be.

In view of the evidence, one may still argue that inequality is intrinsically a problem; conservatives as well as liberals might find spectacular levels of inequality to be unseemly or morally problematic. But since there is little evidence that greater inequality per se presents a problem for our economy, economists, politicians, and pundits should not baldly assert that it is a public-policy problem, and certainly not our nation’s most pressing one.

Indeed, the ubiquity of liberals’ inequality thesis, and the confidence with which they assert it, betrays something important about the Left.

Egalitarian liberals worship equality and find inequality so disturbing that they blindly assume there must be evidence that it causes social ills. If they did not also idolize empiricism, they might be more willing to admit that their concern is ideological, not pragmatic.