Why a Strong Middle Class Is Necessary For Growth

May 18, 2012Mike Konczal

A new paper maps out the best progressive arguments about how inequality is hurting our economy.

It's great to get to watch the arguments against inequality in the United States being built in real time. On issues ranging from political corruption to a lack of a serious, sustained response to the economic crisis, people are telling sharper and more critical stories about why inequality should be a concern for the country. Which is important, as inequality is not going away.

One of the issue areas where this has been lacking is long-term economic growth. The research has been substantial, but few have collected and curated it into a set of arguments for why inequality is bad for the health of our economy. This is one of the more important battles. The normal assumption is that inequality helps everyone by allowing the economic pie to grow as big and as quickly as it possibly can. The background thought animating this is that there's a serious tension between efficiency and equality -- to support equality is to necessarily sacrifice economic efficiency.

Heather Boushey and Adam S. Hersh from the Center for American Progress have a new paper out, "The American Middle Class, Income Inequality, and the Strength of Our Economy: New Evidence in Economics," that summarizes the case for why inequality can damage the economy. They start by reviewing the literature trying to link income inequality and growth, and find that the link is, if anything, in the other direction. "Roland Benabou of Princeton University surveyed 23 studies analyzing the relationship between inequality and growth. Benabou found that about half (11) of the studies showed inequality has a significant and strongly negative effect on growth; the other half (12) showed either a negative but inconsistently significant relationship or no relationship at all. None of the studies surveyed found a positive relationship between inequality and growth."

But why should this be? If the long-term health of the economy is driven by human capital, savings, and technology, what does inequality have to do with anything? Here is where they create a map of the arguments through which a strong middle class and a more egalitarian distribution of income can build long-term growth:

We have identified four areas where literature points to ways that the strength of the middle class and the level of inequality affect economic growth and stability:
 
A strong middle class promotes the development of human capital and a well educated population.
A strong middle class creates a stable source of demand for goods and services.
A strong middle class incubates the next generation of entrepreneurs.
A strong middle class supports inclusive political and economic institutions, which underpin economic growth.
They pull together the current research, as well as the range of supporting evidence, for each point. They focus on how educational attainment is becoming more tied to parents' income, the instability of growth and macroeconomic risks to weak middle-class demand, the fact that the Kauffman Foundation found that less than 1 percent of entrepreneurs come from extremely poor or extremely rich backgrounds, and the way inequality is involved with our polarized politics. All of these have consequences for our economy.
 
The research will continue to move forward here. There's a lot of fascinating work done on the relationship between inequality, balance-sheet recessions, and slow recoveries right now. I'm interested in the way the government creates and enforces property changes under massive, entrenched inequality. Do exclusive, 1%-dominated political and economic institutions produce property regimes -- high rents from patents, repressive creditor/debtor relationships, all labor income from finance viewed as capital income for tax/regulatory purposes, privatization of public goods, corporation structures predisposed for financialization -- that are terrible for growth?
 
This paper gives us the best up-to-date arguments that progressives discussing inequality should understand inside out. I thought I was fairly versed in these arguments, and I learned a ton from it. As they say, read the whole thing.
 

Mike Konczal is a Fellow at the Roosevelt Institute.

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