Economic Costs of Income Inequality

As a quick summary, the huge gap between the rich and poor is a fairly recent phenomena driven by changes in government policy that started with Ronald Reagan. We are now in uncharted territory. We have never had the level of income inequality that we are currently experiencing. There has been a huge transfer of wealth from poor and middle class families with no end in sight. Poor and middle class wages over the past 15 years have gone down while the wages of the wealthy have increased.

I will do my best to stay away from discussions of morality in this post and focus on how this affects our economy.

Narrow Spending Base

A majority of economists surveyed by the AP in December felt the current level of income inequality was unhealthy.

“What you want is a broader spending base,” said Scott Brown, chief economist at Raymond James, a financial advisory firm. “You want more people spending money.”

That’s because discretionary spending by the wealthy tracks the stock market. When the market is up, they spend. When the market is down they don’t. This makes consumer spending much more volatile than it has been in decades past. This volatility leads to slower economic growth because businesses are less willing to invest as demand increases for fear that the demand spike is only temporary.

“The broader the improvement, the more likely it will be sustained,” said Michael Niemira, chief economist at the International Council of Shopping Centers.

Scott Brown agrees that the current levels of income inequality are slowing economic growth, “there’s not much denial of that … and you’re starting to see some research saying, yes, it does slow the economy.”

Warped Economy

It isn’t only that the spending base has narrowed.

The way that the wealthy spend their money is different from the way that middle and lower classes consume. That difference tends to increase the concentration of wealth at the top of the income range rather than spread it throughout the whole economy.

Here’s how that works.

Because the wealthy have already satisfied their basic needs, they spend their discretionary income on goods whose value stems from the talent of other top earners. Let me say that again in a slightly different way. The wealthy spend their discretionary income on goods and services that only they can afford. The producers of those goods and services are able to charge a premium for their services because they produce the best of whatever it is that differentiates them for everyone else. As a result, these “best of breed” producers also become wealthy.

Here’s how the NYT describes it.

Wealthy people don’t choose just any architects, artists, lawyers, plastic surgeons, heart specialists or cosmetic dentists. They seek out the best, and the most expensive, practitioners in each category. The information revolution has greatly increased their ability to find those practitioners and transact with them. So as the rich get richer, the talented people they patronize get richer, too. Their spending, in turn, increases the incomes of other elite practitioners, and so on.

Technology has also made the best performers far richer than they could have been even a decade ago. That’s because the best musicians, athletes, and artists can now reach audiences of virtually unlimited size. Artisans can ship their products anywhere in the world. Which allows them to dominate their markets in ways never imagined possible.

Education markets are warped because the wealthy can afford the tutors, camps, travel, and exclusive prep schools that provide their children a distinct advantage in the competition for slots at the world’s best colleges and universities. Hunter Prep School in NYC was created to provide a public alternative to private prep schools for NYC children. In the 70’s the demographics of Hunter pretty much reflected the demographics of NYC. Now almost 80% of the Hunter students are children of alums. Their parents DID succeed because their Hunter education got them into Ivy League schools which turned into lucrative jobs on Wall Street. They were able to send their children to exclusive elementary schools and after school programs to prepare them for the Hunter entrance exam. It’s a perfectly understandable response, but that response is effectively destroying the meritocracy on which Hunter was originally based. In its place is an oligarchy, which is what Hunter was supposed to weaken.

Finally income inequality is warping the political process. The wealthy have more access to legislators than the middle class or the poor. The 2012 Republican Primary is a great example. Two of the three candidates in the final run for the nomination (Santorum and Gingrich) received virtually all of their funding from just one person. Gingrich from Sheldon Adelson. Santorum from Foster Friess. Not surprisingly, Gingrich’s platform reflected Adelson’s strong support for Isreal. Santorum’s platform reflected Friess’ conservative Christian views.

Summary

Income inequality is real.

It has accelerated over the past 30 years to the point that the wealthy represent the only group enjoying an increasing income share. Everyone else is financing that increase with their own decreasing shares.

Concentrating so much purchasing power in the hands of such a small number of people weakens our economy and slows economic growth.

It warps the consumer economy by creating a feedback loop where the rich only spend their money with organizations and individuals who are also rich. This isn’t necessarily the overt intent of the rich, but it is the practical outcome of their rigging the system for their own benefit.

It warps our educational system by limiting access to the best schools to those who parents can afford to send them to the best elementary and prep schools. The wealthy aren’t any smarter than anyone else. They are just way better educated, financed, and connected.

It warps our political process by making the votes of the wealthy more valuable that the votes of everyone else. Those votes have supported a system of lower taxes and reduced regulation which became the foundation for their success.

Next up, a brief analysis of how moral foundations also warp our view of the rich. Then a discussion of the economic value of a more level playing field and then finally what government can do to encourage a more level playing field.

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