Friday, June 22, 2012

The Inequality Fetish

There is little evidence that unequal income causes economic ills.

There must be something in the water in Scandinavia: Nobel laureates, from our president to Paul Krugman and Joseph Stiglitz, all agree that high levels of inequality are a serious problem, if not the problem, facing our weak economy.

According to this liberal thesis, either the 2008 financial crisis and its attendant recession, or the sluggish recovery — and maybe both — can be attributed in large part to the high level of economic inequality in the United States. Further, in this view, inequality is an economic malady on its own, even in times of prosperity. Liberal commentators, of course, assert this as if it were a truism, but worse, economists of real distinction trumpet it like scientific fact.

Joseph Stiglitz, who claims that “there is broad consensus that one of the reasons for the weakness in the economy is the huge level of inequality,” further contends that the plight of the 99 percent is of such dire economic consequence that the 1 percent can’t afford to ignore the chasm. Sounding even more empirically minded, President Obama asserts that “research has shown that countries with less inequality tend to have stronger and steadier economic growth over the long run.”

But if there is a broad consensus in economics and social science on anything, it is certainly not this. For those who claim otherwise, ideology has taken the place of empiricism.

There are two elements of the ubiquitous thesis: Increased inequality generally slows economic growth, and it contributes to financial crises such as our current one. But there’s never been much good evidence to support either assertion. The best evidence for a causal link between inequality and economic growth, alluded to in the president’s cryptic claim above, is an IMF paper that suggests economic booms last longer and are steadier in countries with less income inequality. But this link relies on countries such as Cameroon and Colombia (two of the cases examined) — dysfunctional nations with extreme inequality that often leads to pervasive rent-seeking or political instability, causing uneven economic growth. For the question of inequality in the U.S., the most relevant study on the topic, which considers industrialized nations over the course of the 20th century, finds no meaningful link between inequality and income growth.

There is also almost no evidence that economic inequality causes financial crises. As a recent paper by Michael Bordo and Christopher Meissner argues, there is no “general relationship” between inequality and credit booms and crises — it isn’t hard to find a correlation between the two, but these two dynamics are also correlated with a huge number of other economic factors. Mark Thoma, a liberal professor of economics at the University of Oregon, has admitted, “I am not saying that the evidence stacks up against the idea that inequality contributed to the recession, it could very well be true . . . [but] the evidence I’m aware of doesn’t tell us much one way or the other.”

Scott Winship, of the Brookings Institute, explains that he finds it “amazing how willing some of the biggest names in economics are to assert that the growth in inequality has had deleterious consequences,” when “there’s little good evidence it has had important effects on opportunity, growth, stability, or politics.”

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