Inequality in America: Pox and Progress

Cross-posted from New Deal 2.0 (September 20, 2011)

By Georgia Levenson Keohane

The gap between America’s rich and poor is growing wider, and a new IMF study shows why that inequality is hurting our economy.

Nowhere is the divide in America between the haves and have-nots a stark as it is in New York City, where one in five people — and 30 percent of children — have fallen into poverty. Last week, as global dignitaries and local luminaries crisscrossed midtown between UN gatherings, CGI’s soirees, and presidential-hopeful fundraisers, the Census Bureau conferred on Manhattan a less-than-luminous distinction: It is now the income inequality capital of the United States.

In the city’s center, the top fifth of earners makes 38 times as much as the bottom fifth, which means that by Gini coefficient — the ratio economists use to measure economic inequality — Manhattan ranks among some of the world’s most economically unstable and politically unsavory countries.

Unfortunately, our country as a whole doesn’t fare much better. That the recent Census data confirming depressing — and Depression — levels of poverty were “worse than many economists expected” just tells us that economists don’t get out much. 42 million Americans and rising are poor, and median family income continues to decline while those earning more than $100,000 have experienced improvementsin income. This kind of inequality — the growing chasm between the rich and the rest — is at levels unseen since 1929.

The United States falls well behind France, Germany, the UK, and almost all other developed countries on this score. We are living, some argue, in a North American banana republic: our income inequality is worse than that of Guyana, Nicaragua, and Venezuela. When it comes to shared prosperity, we keep company with Iran and Yemen.

Though Manhattan may reign supreme, it turns out that poverty in the U.S. is not an urban — or even rural — phenomenon. Most poor Americans — nearly one third of all people in poverty in this country — live in the suburbs, where poverty has exploded by more than 50 percent since 2000. By any measure — antiseptic community survey data, lines in our cities’ soup kitchens, hidden and hard-to-reach hardship in large swaths of the country — poverty is a national crisis. And inequality — want amidst unprecedented prosperity — is not only a dystopic inversion of the American dream; it represents a series of moral and policy choices we have made as individuals and a society. Reversing this slide — to salvage a lost decade and give us hope for the next — demands a very different set of choices. This won’t be easy (for starters, it will require the political will to reform tax, immigration, labor, and education policy, and to rethink the relationship between the financial sector and the rest of the economy).  So why bother?

Concerns about local and global inequality are not new, but our understanding of the causes and consequences may be showing signs of progress. Lost in last week’s hullabaloo about class warfare was the quiet publication of a report from IMF economists challenging the macroeconomic orthodoxy that there is an inherent trade-off between the pursuit of economic equality and efficiency. As articulated by the late Yale economist Arthur Okun and others, that logic goes something like this: equal distribution of incomes reduces incentives to work and invest, and the costs of redistributive tools — say, increasing income taxes or the minimum wage — can outweigh the benefits.

In their groundbreaking reappraisals, Andrew Berg, Jonathan Ostry, and Jeromin Zettlemeyer examine the long-term growth of countries over the last half century and find that this trade-off may, in fact be false. “Do societies inevitably face an invidious choice between inefficient production and equitable wealth and income distribution?” they ask. “Are social justice and social product at war with one another? In a word, no.” The author’s conclusions get to the heart of the “why bother?” matter. “More inequality,” they find, “seems associated with less sustained growth.”

It may seem counterintuitive that inequality is strongly associated with less sustained growth. After all, some inequality is essential to the effective functioning of a market economy and incentives are needed for investment and growth… But too much inequality might be destructive to growth.

The notion that we have long passed the growth-maximizing level of inequality in the U.S. has been gaining currency. By supplying rigorous analytics for the economic growth case for greater equality, Berg, Ostry, and Zettlemeyer may have profoundly altered the way we collectively think, talk about, and act on gaping economic disparities.

Throughout history, we have been concerned with the moral dimensions of inequality, yet even in the United States — a country founded on egalitarian precepts — the last 50 years have shown that the case for fairness rarely wins the economic policy day. The fact that inequality correlates so closely with other noxious social indicators (poor life expectancy, high infant mortality rates, low levels of health insurance and physical and mental well being) and that the U.S. lags most of its developed country peers on these measures has also failed to move the policy needle, even when we know that remediation of these problems is costly. The failure of this evidence to sway U.S. policy makers does not surprise those who make the political corruption case that inequality — and the plutocratic influence of the super-rich (who do just fine on social indicators) — subverts our politics process.

What then of instability? Surely the threat of political and economic fragility worries our elites?  Some contend that pronounced inequality caused the 2008 financial crash (this argument usually has two variants — the “let them eat credit” school, which posits that politicians respond to economic anxiety in the electorate by allowing easy credit, and the reckless investor theory of asset bubbles). To the extent that Wall Street has recovered from the ‘08 unpleasantness, these arguments hold even less truck there. On the political side, comparisons to unstable Latin American or repressed Middle East regimes could beg the uprising question; indeed, the last time we saw these levels of inequality in the U.S. in 1929, fear of socialist revolution was real and palpable. In response, we developed important safety net features like Social Security and Medicare, which, for the most part, have kept seniors out of poverty. The success of these programs ensures that political revolt in this country will not take the form of Bastille-storming for greater egalité. It may amount to voting President Obama from office, but this prospect has not galvanized the Republican Congress to fight economic inequality.

This is why the findings of Berg, Ostry, and Zettlemeyer — their challenge to the efficiency trade-off, their linkage of equality and growth — are so important. This fundamental paradigm shift in how we understand inequality may be our best hope for combating it. Our nation’s economic recovery and long-term health is at stake.

Georgia Levenson Keohane is a Fellow at the Roosevelt Institute.

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