Presented by Mark PartridgeSwank Professor in Rural Urban Policy

And Amanda WeinsteinThe Ohio State University

May 18, 2012 Pacific Northwest Regional Economic

Conference Seattle, Washington

What does Rising Inequality Really Mean for Regional Economic Growth

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IntroductionThe current challenge in recovering from the Great Recession is job creation

The 7 years before the Great Recession had the slowest rate of U.S. job growth since the 1930s.

In looking to the future for our next challenge, the Great Recession may have covered some other structural trends.

American family incomes began to stagnate in the mid 1970s and inequality began to rise.

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IntroductionU.S. inequality equals the historic highs of the

late 1920s. Some critics argue that rising income inequality

is a major cause of lagging U.S. incomes and job growth. They contend that it is a major challenge facing our cities and regions that reduce their ability to globally compete.

Who are these people? MSNBC, Occupy Wall Street, Paul Krugman, Alan Krueger, Head of CEA, Maybe President Obama

Economists argue inequality is good unless it goes too far.

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Introduction

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Overview of what I am going to do:1. Discuss trends in the U.S. and compare

to international trends.2. Describe why inequality is needed for a

dynamic market economy3. Describe why inequality may be harmful4. Describe empirical evidence5. Discuss why inequality is increasing:

narrowing down on a possible solution.

Trends in Inequality

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What are the trends in U.S. inequality and how does this compare to other countries.

Until Piketty and Saez’s work with IRS tax return data, economists did not know the concentration of income inequality in the top 1% and above.Piketty and Saez are the topic of a New York Times

article on April 17, 2012. http://www.nytimes.com/2012/04/17/business/for-economists-saez-and-piketty-the-buffett-rule-is-just-a-start.html?hp

U.S. Household Gini Coefficient

0.380

0.390

0.400

0.410

0.420

0.430

0.440

0.450

0.460

0.470

Mid 1970s is when inequality takes off

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Income Growth in the U.S. by Percentile: 1973=100

1973

1976

1979

1982

1985

1988

1991

1994

1997

2000

2003

2006

0

100

200

300

400

500

600

0 TO 90 90-100 99-100 99.9-100

Incom

e L

evel

in 2

008

Doll

ars

(1

973=

100)

Slight decline in bottom 90%

Massive rise at very top

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International Gini Comparison

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Trends in Inequality

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Did the Great Recession end rising inequality?

Is this yesterday’s news? FRB ClevelandEzra Klein and Mike Konczal report updated

data from P&S for 2010—the first full year of economic recovery.See Klein’s Washington Post blog.

93% of the income gains in 2010 went to the top 1%.

How does this break down?

10Source: Ezra Klein, Washington Post blog. See notes for web address

Distribution of Gains in 2010 Income

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1928 Peak

2007 Peak

Mid 1970s

Source ©NY Times, April 16, 2012.

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1928 Peak

2007 Peak

Mid 1970s

2000 Gini Coefficient Comparison

The state with the most equally distributed income (Vermont) has higher inequality than the most unequal EU member (Portugal)

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Trends in Inequality

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Out of 135 countries, the U.S. now ranks behind 97 in terms of equality (CIA World Factbook).

The U.S. is now more unequal than countries such as Nicaragua, Argentina, and Venezuela (CIA World Fact book). Places that inequality is typically viewed as a major obstacle to growth and development.

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Income inequality over generations and the life cycle

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Cross-sectional inequality is a much smaller problem if there is income mobility over the life cycle. Perhaps a family has a bad year, but its income steadily rises over time.

This manifests itself with high mobility between poor and rich groups—the American Dream and rags to riches.

Income inequality over generations and the life cycle

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Ferrie (2005) finds high mobility in the 19th century through 1920, but this notably declined after 1973.

Gottschalk and Moffit (2009) and Kopczuk et al. (2010) find mobility has either declined or remained stable.

With stagnate mobility, more Americans are relatively falling behind.Before 1973, U.S. growth was generally

indicative of increasing wealth for all Americans (Goldin and Katz, 2007).

After 1973, Americans grew apart.

Income inequality over generations and the life cycle

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What about other countries?U.S. income mobility is lower than most European countries (OECD, 2010). Sweden is more mobile with far less inequality (Björkland and Jäntti 1997). Sweden has experienced consistently lower unemployment rates than the U.S. through the last decade (Eurostat, 2011).

Has rising inequality affected U.S. economic performance?

Inequality is Good for Growth!

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Equity/Efficiency Tradeoff we teach 1st year students (Okun, 1975).

Inequality creates incentives for acquiring skills & education, investing in capital, and promoting entrepreneurship & innovation. Inequality means that you are rewarded

handsomely for being the best and “punished” for not being very good (Welch, 1999)

Inequality promoted American cities as global cities in particular fields. If you succeeded in technology, you went to

places like Silicon Valley and Seattle.If you succeeded in finance, you went to New

York.If you succeeded in entertainment, you went

to Los Angles.

Inequality is Good for Growth!

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What does the empirical evidence say?Using data up through 2000, past studies suggest

U.S. states with more inequality had greater income growth.

Partridge (1997, 2005); Frank (2009)

Metro areas (especially large ones) have a positive inequality-growth link (Fallah and Partridge 2007).Fallah and Partridge contend that more growth occurs

where there are economic incentives for innovation and new market ideas—i.e. inequality (incentives) enhances agglomeration economies in promoting growth.

Inequality is Good for Growth!

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Despite incentives, there are still tradeoffs.The jobs vs. equity institutions literature of the late

1990s early 2000s is a good example that resonates today.

The great strength of the U.S. economy in the latter 25 years of the 20th Century was job creation!

Conventional Wisdom: Flexible U.S. labor markets allow less skilled workers to

obtain work (their wages could fall), but income inequality is higher.

“Inflexible” European labor markets experience less inequality but have very little job creation and high unemployment. Nickell (1997); Blanchard & Wolfers (2000); Bertola, Blau & Kahn (2001); At the U.S. State Level Partridge (2006)

Inequality is Good for Growth!

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The U.S. should have been better placed for the Great Recession (for example) because flexible wages would allow wages to fall and allow the U.S. to have fewer job losses than Europe.

What is the U.S. record post-2000?

U.S. Employment to Population Ratio

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

2008

2010

0.45

0.5

0.55

0.6

0.65

0.7

0.75

U.S. Male Female23

19992000200120022003200420052006200720082009

-4.0

-3.0

-2.0

-1.0

0.0

1.0

2.0

3.0

EU-27United States%

Ch

an

ge C

om

pare

d w

ith

P

revio

us

Year

Annual Employment Change

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Is Inequality Harmful for Growth?

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Has inequality crossed a tipping point?U.S. inequality is reaching levels found in

plutocracies.Welch (1999) even notes that inequality is

problematic when people view the system as rigged.

If inequality rises beyond a threshold, then fewer people are receiving a tangible share of the rewards from greater skills, innovation, & entrepreneurship, reducing incentives to work hard Looks more like a lottery that is not worth buying a ticket

Is Inequality Harmful for Growth?

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How does inequality reduce growth?Inequality is linked to more poverty, crime,

poor health outcomes—perhaps less social cohesion and equity concerns (Noah, 2010). So there are tradeoffs.Greater inequality may cause social instability and

political turmoil (Perotti, 1996; Persson and Tabellini, 1994).

Ironically, economists have not focused on whether inequality allows wealthy groups to capture a disproportionate share of political power—say the Occupy Wall Street hypothesis. Crony Capitalism reduces growth.Decoupling productivity from compensation.

Is Inequality Harmful for Growth?

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Galor and Zeira (1993) and Aghion et al. (1999) show that as inequality rises, increasing numbers of low-income households face credit constraints, limiting access to capital to finance education, entrepreneurship, capital investment, & innovation.The relative supply growth of U.S. college educated workers

has decreased since 1980 despite greater average returns to education (Goldin and Katz, 2007).

OECD (2011) reports that the U.S. high school graduation rate is only 76.4% versus the OECD average of 82.2%. U.S. also lags in educational quality. Could this be incentive based?

OECD (2011) finds that the U.S. 25-34 year olds have about middling ranges of college educated workers compared to other advanced economies—i.e., a major shift from a generation ago.

Is Inequality Harmful for Growth?

Middle class consensus: A form of social capital for governance that promotes stability and facilitates a good business climate (Easterly, 2001). Partridge (1997, 2005) found that a greater middle-class income share (Q3) is associated with greater income growth—Middle Class consensus.

But Q3 is falling—suggesting less future growth.

Diminished expectations and credit constraints may then offset the positive effects of inequality.

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2009 Metro Inequality: A tale of two inequalitiesThe top 10 MSAs in terms of income inequality

(for MSAs larger than 300,000). Shows varying positive and negative effects of inequality

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Empirical Analysis

The positive growth/inequality relationship that predominated prior to 2000 could have reversed—i.e., it is past the tipping point.

The results show that inequality is inversely associated with job growth (at the 10% level), though there is no statistically significant association with the employment-population ratio.

These findings run counter to prevailing conventional wisdom that flexible labor markets (more inequality) improve labor market performance. It also runs counter to the findings comparing Europe to the U.S. pre-2000 and for U.S. states between 1960-2000 (Partridge, 2006). These results need to be confirmed with further analysis, but they suggest that patterns shifted post-2000.

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MSA Change in Employment and Employment-Population Rate

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Change in Metropolitan Median Income

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Consequences of Inequality

As inequality increases, the U.S. makes remarkably little progress in reducing poverty or in providing basic necessities.

Poverty rates have risen from 11.1% in 1973 to 15.1% in 2010 (U.S. Census Bureau, 2011). This is the highest since 1983.22% of children lived in poverty in 2010. In 2010, about 1/6th of the population had no health insurance

(U.S. Census Bureau, 2011). States and countries with more inequality have greater health

problems including mental illness, drug and alcohol abuse, obesity, and shorter life expectancy (Wilkinson and Pickett 2009). From 1980-2000, life expectancy for the lowest 10% rose at just

half the rate of the top 10% (Gordon and Dew-Becker2008; Kawachi and Kennedy, 1997).

None of these patterns are consistent with greater economic productivity or social cohesion.

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What are the possible causes of higher inequality?

Skill-biased technological change; immigration; declining unionization; financial deregulation, tax policy that is favorable to the wealthy; falling real value of the minimum wage; globalization (tournament/star power á la Lazear and Rosen, 1981; Rosen, 1981), off-shore sourcing, public education, etc.

What about SBTC? It is non-political and a world-wide pattern.

Rising inequality is not universal. The entire developed world has experienced SBTC and globalization, which should have common international effects.

Atkinson et al. (2011) show income shares of the top percentile have remained stable or decreased in Sweden and most EU countries.

The timing in wage inequality growth is difficult to explain using SBTC. Technical change began well before 1973 when inequality began to increase. (Card and DiNardo 2002; Lemieux 2006; Goldin and Katz 2007)

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2009 Occupation Distribution Top 1% and Bottom 99%

Man

agem

ent

Busine

ss O

pera

tions

Fina

nce

Prof

ession

alLa

w

Educ

atio

nAr

ts

Health

Serv

ice

Sale

s

Adm

inistra

tive

Mai

nten

ance

Agric

ultu

re/M

inin

g

Const

ruct

ion

Man

ufac

turin

g

Tran

spor

tatio

n

Milita

ry-0.05

0.00

0.05

0.10

0.15

0.20

0.25

0.30

0.35

0-99

99-100

Em

plo

ym

en

t S

hare

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What’s left to explain rising inequality?Other causes are ultimately political

decisions (Hacker and Pierson, 2010; Noah, 2010; Atkinson et al., 2011).

How in a democracy do the outcomes of the political process not represent the interests of the majority?U.S. campaigns are drawn out. Not short

parliamentary elections and less attachment to political party. Each campaign is important.

Together, this produces a race for political contributions to fund lengthy expensive “modern” campaigns that require TV ads to be competitive.

Kawachi and Kennedy (1997) find the richest 3% account for 35% of private campaign donations for president. This does not fully account for their influence as corporations, CEOs and company shareholders contributions.

Today there are very few limitations on contributions or spending on elections by special interests or Super PACs.

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What’s left to explain rising inequality?

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It is unsurprising that public policy outcomes strongly reflect the preferences of the wealthy (Gilens, 2005).

Political concentration of power in the wealthy and corporations appear to be the common element behind rising inequality.

What should the U.S. do?

The U.S. needs major political institutional change before it will make the policies to address rising income inequality. These need to equalize the political power and limit crony capitalism.

Other “economic” changes in an age of “austerity”—Better education—especially for low income groups

and early childhood education. (Haskins and Sawhill, 2009).

Reform U.S. tax structure to balance its burden across economic groups.

Reform the way U.S. corporate executives are paid.While other structural changes would be “nice,” they

will not matter or happen until political reform is undertaken. 38

ConclusionInequality provides incentives to promote

skill acquisition, enhance innovation, and entrepreneurship & risk taking.

Inequality is a “negative” when social cohesion breaks down and people no longer believe hard work and good ideas are rewarded.

As growing U.S. inequality has shifted from the broad upper income groups (say top 25%) to just the top 1%, its positive effects in promoting growth and facilitating global U.S. cities has waned.

Current trends in inequality are unsustainable and it will increasingly cause reduced growth and hurt the development of American cities.

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Conclusion

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We conclude that only political institutional change will make a tangible difference.

As shown by reforms in the Progressive Era and the New Deal, electoral reforms are possible in the face of very high inequality.

The U.S. has shown great resilience when political reforms are necessary to support the middle-class and our democratic system.

THANK YOU!Email:

partridge.27@osu.edu

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