It thus began to seem that the old bargain, in which inequality
bought rising incomes for all, had failed--much as the Keynesian bargain
(bigger government, faster growth) had failed two generations earlier.
"The majority of Americans have simply not been benefiting from the
country's growth," Stiglitz wrote, overstating things--but not by a lot.
PATHWAYS TO PERIL
So much for "extreme." Next came the financial-system meltdown of
2008 and the Great Recession, which bring us to "distort"--how an excess
of inequality may have warped the economy.
As the data on inequality came in, economists noticed something else:
The last time inequality rose to its current heights was in the late
1920s, just before a financial meltdown. Might there be a connection? In
2010, Moss plotted inequality and bank failures since 1864 on the same
graph; he found an eerily close fit. That is, in both the 1920s and the
first decade of this century, inequality and financial crisis went hand
in glove. Others noticed the same conjunction. Although Moss recognized
that a simple correlation based on only two examples proves nothing, he
wasn't alone in wondering if something might be going on. But what?
Different economists suggest different pathways by which inequality
at the microeconomic level might cause macroeconomic problems. What
follows is a composite story based on common elements.
As with supply-side, the case starts with the two extreme ends of a
curve. Supply-siders pointed out that two tax rates produce no revenue:
zero percent and 100 percent. Inequality traces an analogous curve. At
both extremes of inequality--either perfect inequality, where a single
person receives all the income, or perfect equality, where rewards and
incentives cannot exist--an economy won't function. So, Moss said, "the
question is: Where are the break points in between?"
Suppose various changes (globalization, technology, increased demand
for skills, deregulation, financial innovation, the rising premium on
superstar talent--take your pick) drove most of the economy's income
gains to the few people at the top. The rich save--that is, invest--15 to
25 percent of their income, Stiglitz writes, whereas those on the lower
rungs consume most or all of their income and save little or nothing. As
the country's earnings migrate toward the highest reaches of the income
distribution, therefore, you would expect to see the economy's mix of
activity tip away from spending (demand) and toward investment.
That is fine up to a point, but beyond that, imbalances may arise. As
Christopher Brown, an economist at Arkansas State University, put it in
a pioneering 2004 paper, "Income inequality can exert a significant
drag on effective demand." Looking back on the two decades before 1986,
Brown found that if the gap between rich and poor hadn't grown wider,
consumption spending would have been almost 12 percent higher than it
actually was. That was a big enough number to have produced a noticeable
macroeconomic impact. Stiglitz, in his book, argues that an
inequality-driven shift away from consumption accounts for "the entire
shortfall in aggregate demand--and hence in the U.S. economy--today."