The New York Times, June 25, 2006
INCOME INEQUALITY, AND ITS COST
[Rachel's introduction: The gap between the rich and the poor has recently been widening at an alarming rate. Today, more than 40 percent of total income is going to the wealthiest 10 percent, their biggest share of the nation's pie in at least 65 years. The social and political repercussions of this disparity have been widely debated, but what about the effects on the economy?]
By Anna Bernasek
Inequality has always been part of the American economy, but the gap between the rich and the poor has recently been widening at an alarming rate. Today, more than 40 percent of total income is going to the wealthiest 10 percent, their biggest share of the nation's pie in at least 65 years. The social and political repercussions of this disparity have been widely debated, but what about the effects on the economy?
Oddly, despite its position in the political debate, the question has received little attention from economists. Mostly, they have focused on measuring income inequality and establishing its causes. Some research has been done, however, and the results, including insights from related disciplines like psychology and political science, are disturbing.
Start with recent findings in the field of public health. Some scientists believe that growing inequality leads to more health problems in the overall population -- a situation that can reduce workers' efficiency and increase national spending on health, diverting resources away from productive endeavors like saving and investment.
Sir Michael Marmot, a professor of epidemiology and public health at University College London and director of its International Institute for Society and Health, has spent most of his career studying the link between inequality and health around the world. In a much-publicized paper published in May in The Journal of the American Medical Association, Sir Michael and three colleagues studied health in the United States and in Britain. They found that at various points throughout the social hierarchy, there was more illness in the United States than in Britain.
Sir Michael theorizes that a reason for the disparity was the greater inequalities in the United States and heavier stresses resulting from them.
Other researchers have focused on how income inequality can breed corruption. That may be especially true in democracies, where wealth and political power can be more easily exchanged, according to a study of 129 countries by Jong-Sung You, a graduate student at the Kennedy School of Government at Harvard, and Sanjeev Khagram, a professor of public affairs at the University of Washington in Seattle.
Corruption, of course, can hurt growth by reducing the efficient allocation of public and private resources and by distorting investment. That may end up creating asset price bubbles.
Unchecked inequality may also tend to create still more inequality. Edward L. Glaeser, a professor of economics at Harvard, argues that as the rich become richer and acquire greater political influence, they may support policies that make themselves even wealthier at the expense of others. In a paper published last July, he said, "If the rich can influence political outcomes through lobbying activities or membership in special interest groups, then more inequality could lead to less redistribution rather than more."
In the United States, there is plenty of evidence that this has been occurring. Bush administration policies that have already reduced the estate tax and cut the top income and capital gains tax rates benefit the well-to-do. It seems hardly an accident that the gap between rich and poor has widened.
There may be other ways in which growing inequality hurts the economy. Steven Pressman, professor of economics at Monmouth University in West Long Branch, N.J., has identified a psychological effect that may lower productivity and reduce efficiency. Professor Pressman draws on the work of Daniel Kahneman, a Nobel laureate in economics, and his experiments on fairness. One experiment, called the ultimatum game, involves two people with a fixed sum of money that must be divided between them. One person is to propose any division he likes; the other can only accept or reject it. If the division is accepted, each person receives the proposed amount; if it is rejected, neither gets anything.
It might be expected that a rational individual in the role of divider would take a large part of the money and that rational receivers would accept a small portion rather than walk away with nothing. But it turned out that when faced with an offer they considered unfair, most people rejected it outright. Perhaps in anticipation of this, many dividers made substantial offers.
Professor Pressman relates those results to economic behavior in corporate America. "If a C.E.O.'s salary is going through the roof and workers are getting pay cuts, what will happen?" he said. "Workers can't outright reject the offer -- they need to work -- but they can reject it by working less hard and not caring about the quality of what they are producing. Then the whole efficiency of the firm is affected."
The effects of income inequality aren't entirely negative. Without some inequality, there would be little economic incentive to earn more. And some researchers, particularly advocates of supply-side theories, predict that as the rich get richer, their increased wealth will be used for greater savings and investment, thereby bolstering growth. The latest data on the American economy, though, do not seem to support this prediction.
Savings among top income earners have actually declined. According to the Federal Reserve's latest Survey of Consumer Finance, the percentage of families in the top 10 percent by income that saved anything at all dropped to 80.6 percent in 2004 from 84.3 percent in 2001. And this was during a period when President Bush cut top marginal income tax rates and taxes on capital gains and dividends.
The trend of growing income inequality may eventually be reversed, but at the moment, current policies appear to be worsening the situation. If more researchers turned their attention to the subject, they would find plenty to explore.