Obama Puts the Middle Class First (Surprise: So Do Economists)

President Obama's second term could spell the end of "trickle-down" and the beginning of something that might be called "middle-out" economics

615 obama 2 inaugural.jpg

Reuters

"We believe that America's prosperity must rest upon the broad shoulders of a rising middle class," President Barack Obama said in his second inaugural address Monday in Washington, D.C. It sounds like a remarkable, even wishy-washy, bromide. In fact, it's the backbone of a bold and somewhat revolutionary new economic policy.

Many people suspect there is a trade-off between what is good for profitability and what is good for workers. It's the underlying narrative for today's economy: Business and government leaders have to make tough choices--choices that sometimes mean a business cannot afford to pay workers a living wage or that our government cannot afford to provide services to the poor or income support to the elderly.

Yet, the reality is that this trade-off is based on a faulty view of economic reality. There is a large--and growing--body of research showing that the economy grows from the middle out and that seemingly "soft-hearted" notions about investing in people or communities are actually the key to a competitive economy.

TOUGH LOVE vs. HARD-NOSED ECONOMICS

Supply-side economics takes what might be called a "tough love" approach to the economy. It starts from the position that for the economy to grow, investors must have access to money to invest in good ideas. Coming from this perspective, high inequality, which allows economic winners to keep more of their income through lower taxes and less regulation, means they have more money to invest in successful projects, leading (eventually) to more growth for the whole economy. But this story about the economy starts in the middle of the story (with investors' cash-on-hand) whereas middle-out economics starts at the beginning.

On its face, the idea that the economy grows from the middle out may sound like some sort of "win-win" notion crafted by gimlet-eyed marketing specialists, rather than a concept grounded in hard-nosed economics. For sceptical, this sense of "too-good-to-be true" is probably underscored by the fact that middle-out economics was a theme pushed by President Barack Obama during his re-election campaign. As the Wall Street Journal put it last September, he "linked helping the middle class to boosting economic growth ... Thus has the fairness argument morphed into a growth argument."

This begs the question: Is middle-out economics a convenient bullet-point of liberal politicking or the basis of serious economic research?

Over the past couple of years, my colleagues and I have been sifting through economics papers and talking to leading economists around the world. We have found that there is a growing body of research showing that high inequality hinders economic growth and stability through a variety of mechanisms. While there isn't one perfect, econometrically unimpeachable paper that proves that the economy grows from the middle out, the abundance of research suggests that the strength and size of the middle has a strong effect on the all the key factors that propel an economy forward.

The extent of the evidence for middle-out economics is a live debate within economics. A series of recent books have sought to tease out the various ways that inequality or the strength of the middle class affects economic growth and stability. In his 2010 book, Fault Lines, former International Monetary Fund chief economist and Chicago Booth School professor Rajan Raghuram argues that the lack of income growth for lower- and middle-income families created an economic fault line in the United States. As income growth slowed to a crawl, families took on more debt to sustain their standard of living, a situation made possible in Raghuram's view by deregulation and government policies to promote home ownership. This was sustainable so long as housing prices kept rising, but once the music stopped, and the bubble burst, millions of families were saddled with mortgages they could no longer afford.

Raghuram, like many economists, notes that in recent decades, most of the economic growth gains have gone to the rich while the middle of the income distribution has lost ground in relative terms. Of course, rising inequality does not have to go hand in with lack of income growth for those in the bottom or middle, but in the United States the trend since the mid- to late-1970s has been for a few at the very top of the income distribution to see their incomes rise sharply, while everyone else has seen relatively slow growth, both compared to the top earners and compared to the 30 years prior to the late 1970s.

The crux of Raghuram's argument is that the problem is not simply that families took on too much debt in the run-up to the crisis; the problem is that high inequality created the macroeconomic conditions for those at the top to have both the capacity and the incentives to lend evermore amounts of money to everyone else.

WHAT DOES INEQUALITY REALLY COST?

In his new book, The Price of Inequality, Columbia University economist and Nobel Laureate Joseph Stiglitz argues that, "today's divided society endangers our future." He, like Raghuram, begins from the recognition that the level of inequality in the United States is unprecedented among modern societies in how vast the gap is between those at the top and everyone else.

Also like Raghuram, Stiglitz focuses his attention on the ways that rising inequality--specifically, the rise of the super-rich--are affecting the U.S. political process and what this portends for economic growth. In his analysis, rising inequality has led to a rise in what economists call "rent seeking," that is, actors seeking to take a bigger piece of the pie, rather than seeking to grow the pie. He points to a variety of ways that the wealthy have used their outsized power and influence to rig the game in their favor, documenting how the financial industry for years focused its energies on selling products to low- and moderate-income families that they could ill afford. And when the bubble collapsed, it was the industry that put all this in motion that received massive taxpayer funds as policymakers sought to avert a full-on repeat of the Great Depression.

Presented by

Heather Boushey is the executive director and chief economist at the Washington Center for Equitable Growth.

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