Talk about inequality today, and the immediate response will be that you're a socialist who likes class warfare. So long as everyone's life is getting better, they say, it doesn't matter that the richest people's lives are getting relatively better than the poorest's. And that would be fine... if it were true. But Jared Bernstein points us to this graph indicating that, starting in 1973, while real wages (adjusted for inflation) were more or less stagnant up until 1980 (interestingly, they dipped for the super-rich top 5%, but rose a bit for the upper-middle class and the bottom 10%), once Reagan took office, a strange thing happened. The wages of the rich took off like a rocket. From 1981 to 1989, the wages of the top 5% went from about 95% of their real 1973 level to about 107% of that level in 8 years. Meanwhile, in those 8 years, wages for the poorest 10% dropped by more than 10%, a shocking decline. And it wasn't just the poor that got shafted- the median wage stayed essentially stagnant through Reagan's presidency. Coinciding with the beginning of Bill Clinton's presidency, a curous thing happened. Wages of the rich took off, and kept rising. Since 1993, the real wages of the top 5% have increased by about 1/3. It was nearly as dramatic for the next 5%, and slightly less dramatic, but still significant for the 10% after that. Then, a bit later, the wages of the middle and lower classes took off, too. From 1995 to 2003, they grew by about 8-10%; nowhere near as much as the super-rich, but definitely a significant across-the-board improvement. Then, in 2003, while the wages of the rich kept exploding, the wages of the middle- and lower-middle classes stagnated, and the wages of the poor fell. So, since 1973, real wages have grown by under 5% over the course of almost 40 years, and all of that growth came during a 5-year window in Bill Clinton's second term. Meanwhile, the wages of the richest 5% have grown by about a third, the next 5% by slightly less than that, and the next 10% by about 20% (not bad, but far from great). In other words, the average American earns no more now than they did 40 years ago. That's a terrible track record.
And here's why it matters. Inequality isn't just about feeling good and having class-consciousness. Reading Marx is important for cultural reasons for the same reason reading Hayek and Schumpeter is, but none of them tell us anything useful about the macroeconomy. But inequality, besides being inherently bad, is also a drag on growth. Think of it this way. What the economy produces is largely dictated by aggregate demand. If someone wants something and has the cash to buy it, someone else will likely come along and produce it. Demand is generated by someone having something valuable to exchange for the required good or service, whether it's currency or another good or service. And the amount of that product that is demanded depends on how much currency (whether referred to as the literaly medium of exchange or a different valuable good or service) others have to exchange for it. And what matters then isn't just the amount of currency in the system-- it's the distribution of that currency.
This makes intuitive sense if you think about it. Here's a stylized example that's pretty straightforward. Say the only good in a community is food. Everyone demands food because we're hungry and we get the munchies on the reg. But there's a cap to how much food we demand. Whether I'm Bill Gates or Joe Factory Worker, or Homeless Bob, I demand between 2000 and 3000 calories of food a day. If Bill Gates were a giant prick (not saying he is, but let's imagine) who wanted to eat caviar for every meal... he still wouldn't demand all that much more food than Joe or Bob. Now let's turn this example to the grocery store owner's perspective. She sells food to a community of, say, 10 people. Let's further assume that there are 100 currency units in the community. Nominally, we shouldn't care if one person has 91 currency units, while the other 9 have 1 each-- the size of the economy is the same. Practically, the store owner is very concerned about just that. If each member of the community has 10 currency units, each might spend 3 of those on food, which gets the grocery store owner 30 currency units of revenue. Now imagine 9 people have 2 units each, and the last person has 82 units. The first 9 spend all of their currency on food because otherwise they'd starve. Now, even if one person can afford to spend double what they might otherwise spend on food if the distribution were equal (say they want to eat more and eat better food), the store owner still ends up with 24 units of revenue instead of the 30 they would have, for a 20% decline in total revenue. The example is stylized, but the point is the same-- the more equal the distribution of wealth, the more aggregate demand you end up with in markets for mass-produced consumer goods.
This discovery is nothing new-- Henry Ford figured out that he could generate huge demand for automobiles by hiking his workers' wages so that they could afford to buy his cars. So it's not just for feel-good reasons that closing income gaps is good-- it also makes for a stronger economy and more demand for businesses.
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