Does inequality hamper economic growth?

More and more economists are looking at the consequences of increased inequality. A recent Nobel Prize winner argues that it hampers economic recovery.

There are four major reasons inequality is squelching our recovery. The most immediate is that our middle class is too weak to support the consumer spending that has historically driven our economic growth. While the top 1 percent of income earners took home 93 percent of the growth in incomes in 2010, the households in the middle — who are most likely to spend their incomes rather than save them and who are, in a sense, the true job creators — have lower household incomes, adjusted for inflation, than they did in 1996. The growth in the decade before the crisis was unsustainable — it was reliant on the bottom 80 percent consuming about 110 percent of their income.

Second, the hollowing out of the middle class since the 1970s, a phenomenon interrupted only briefly in the 1990s, means that they are unable to invest in their future, by educating themselves and their children and by starting or improving businesses.

Third, the weakness of the middle class is holding back tax receipts, especially because those at the top are so adroit in avoiding taxes and in getting Washington to give them tax breaks. The recent modest agreement to restore Clinton-level marginal income-tax rates for individuals making more than $400,000 and households making more than $450,000 did nothing to change this. Returns from Wall Street speculation are taxed at a far lower rate than other forms of income. Low tax receipts mean that the government cannot make the vital investments in infrastructure, education, research and health that are crucial for restoring long-term economic strength.

Fourth, inequality is associated with more frequent and more severe boom-and-bust cycles that make our economy more volatile and vulnerable. Though inequality did not directly cause the crisis, it is no coincidence that the 1920s — the last time inequality of income and wealth in the United States was so high — ended with the Great Crash and the Depression. The International Monetary Fund has noted the systematic relationship between economic instability and economic inequality, but American leaders haven’t absorbed the lesson.