Inequality Is a Drag – by Paul Krugman

Liberals have generally viewed this as a trade-off worth making, arguing that it’s worth accepting some price in the form of lower G.D.P. to help fellow citizens in need. Conservatives, on the other hand, have advocated trickle-down economics, insisting that the best policy is to cut taxes on the rich, slash aid to the poor and count on a rising tide to raise all boats.

But there’s now growing evidence for a new view — namely, that the whole premise of this debate is wrong, that there isn’t actually any trade-off between equity and inefficiency. Why? It’s true that market economies need a certain amount of inequality to function. But American inequality has become so extreme that it’s inflicting a lot of economic damage. And this, in turn, implies that redistribution — that is, taxing the rich and helping the poor — may well raise, not lower, the economy’s growth rate.

You might be tempted to dismiss this notion as wishful thinking, a sort of liberal equivalent of the right-wing fantasy that cutting taxes on the rich actually increases revenue. In fact, however, there is solid evidence, coming from places like the International Monetary Fund, that high inequality is a drag on growth, and that redistribution can be good for the economy.

Earlier this week, the new view about inequality and growth got a boost from Standard & Poor’s, the rating agency, which put out a report supporting the view that high inequality is a drag on growth. The agency was summarizing other people’s work, not doing research of its own, and you don’t need to take its judgment as gospel (remember its ludicrous downgrade of United States debt). What S.& P.’s imprimatur shows, however, is just how mainstream the new view of inequality has become. There is, at this point, no reason to believe that comforting the comfortable and afflicting the afflicted is good for growth, and good reason to believe the opposite.

Specifically, if you look systematically at the international evidence on inequality, redistribution, and growth — which is what researchers at the I.M.F. did — you find that lower levels of inequality are associated with faster, not slower, growth. Furthermore, income redistribution at the levels typical of advanced countries (with the United States doing much less than average) is “robustly associated with higher and more durable growth.” That is, there’s no evidence that making the rich richer enriches the nation as a whole, but there’s strong evidence of benefits from making the poor less poor.

But how is that possible? Doesn’t taxing the rich and helping the poor reduce the incentive to make money? Well, yes, but incentives aren’t the only thing that matters for economic growth. Opportunity is also crucial. And extreme inequality deprives many people of the opportunity to fulfill their potential.

Think about it. Do talented children in low-income American families have the same chance to make use of their talent — to get the right education, to pursue the right career path — as those born higher up the ladder? Of course not. Moreover, this isn’t just unfair, it’s expensive. Extreme inequality means a waste of human resources.

Consider, for example, what we know about food stamps, perennially targeted by conservatives who claim that they reduce the incentive to work. The historical evidence does indeed suggest that making food stamps available somewhat reduces work effort, especially by single mothers. But it also suggests that Americans who had access to food stamps when they were children grew up to be healthier and more productive than those who didn’t,which means that they made a bigger economic contribution. The purpose of the food stamp program was to reduce misery, but it’s a good guess that the program was also good for American economic growth.

The same thing, I’d argue, will end up being true of Obamacare. Subsidized insurance will induce some people to reduce the number of hours they work, but it will also mean higher productivity from Americans who are finally getting the health care they need, not to mention making better use of their skills because they can change jobs without the fear of losing coverage. Over all, health reform will probably make us richer as well as more secure.

Will the new view of inequality change our political debate? It should. Being nice to the wealthy and cruel to the poor is not, it turns out, the key to economic growth. On the contrary, making our economy fairer would also make it richer. Goodbye, trickle-down; hello, trickle-up.

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Profits Without Production – By Paul Krugman

One lesson from recent economic troubles has been the usefulness of history. Just as the crisis was unfolding, the Harvard economists Carmen Reinhart and Kenneth Rogoff — who unfortunately became famous for their worst work — published a brilliant book with the sarcastic title “This Time Is Different.” Their point, of course, was that there is a strong family resemblance among crises. Indeed, historical parallels — not just to the 1930s, but to Japan in the 1990s, Britain in the 1920s, and more — have been vital guides to the present.

Yet economies do change over time, and sometimes in fundamental ways. So what’s really different about America in the 21st century?

The most significant answer, I’d suggest, is the growing importance of monopoly rents: profits that don’t represent returns on investment, but instead reflect the value of market dominance. Sometimes that dominance seems deserved, sometimes not; but, either way, the growing importance of rents is producing a new disconnect between profits and production and may be a factor prolonging the slump.To see what I’m talking about, consider the differences between the iconic companies of two different eras: General Motors in the 1950s and 1960s, and Apple today.Obviously, G.M. in its heyday had a lot of market power. Nonetheless, the company’s value came largely from its productive capacity: it owned hundreds of factories and employed around 1 percent of the total nonfarm work force.Apple, by contrast, seems barely tethered to the material world. Depending on the vagaries of its stock price, it’s either the highest-valued or the second-highest-valued company in America, but it employs less than 0.05 percent of our workers. To some extent, that’s because it has outsourced almost all its production overseas. But the truth is that the Chinese aren’t making that much money from Apple sales either. To a large extent, the price you pay for an iWhatever is disconnected from the cost of producing the gadget. Apple simply charges what the traffic will bear, and given the strength of its market position, the traffic will bear a lot.Again, I’m not making a moral judgment here. You can argue that Apple earned its special position — although I’m not sure how many would make a similar claim for Microsoft, which made huge profits for many years, let alone for the financial industry, which is also marked by a lot of what look like monopoly rents, and these days accounts for roughly 30 percent of total corporate profits. Anyway, whether corporations deserve their privileged status or not, the economy is affected, and not in a good way, when profits increasingly reflect market power rather than production.Here’s an example. As many economists have lately been pointing out, these days the old story about rising inequality, in which it was driven by a growing premium on skill, has lost whatever relevance it may have had. Since around 2000, the big story has, instead, been one of a sharp shift in the distribution of income away from wages in general, and toward profits. But here’s the puzzle: Since profits are high while borrowing costs are low, why aren’t we seeing a boom in business investment? And, no, investment isn’t depressed because President Obama has hurt the feelings of business leaders or because they’re terrified by the prospect of universal health insurance.Well, there’s no puzzle here if rising profits reflect rents, not returns on investment. A monopolist can, after all, be highly profitable yet see no good reason to expand its productive capacity. And Apple again provides a case in point: It is hugely profitable, yet it’s sitting on a giant pile of cash, which it evidently sees no need to reinvest in its business.Or to put it differently, rising monopoly rents can and arguably have had the effect of simultaneously depressing both wages and the perceived return on investment.You might suspect that this can’t be good for the broader economy, and you’d be right. If household income and hence household spending is held down because labor gets an ever-smaller share of national income, while corporations, despite soaring profits, have little incentive to invest, you have a recipe for persistently depressed demand. I don’t think this is the only reason our recovery has been so weak — weak recoveries are normal after financial crises — but it’s probably a contributory factor.Just to be clear, nothing I’ve said here makes the lessons of history irrelevant. In particular, the widening disconnect between profits and production does nothing to weaken the case for expansionary monetary and fiscal policy as long as the economy stays depressed. But the economy is changing, and in future columns I’ll try to say something about what that means for policy.