Inequality Is Not What We Imagine

Rising inequality in America, according to a number of economists and many more pundits and political actors, has hurt economic growth. By reducing economic mobility, it is said to have inefficiently allocated talent. Similarly, outsize salaries in the financial sector are said to distort career decisions of college graduates. Inequality, others say, reduces worker motivation and happiness and social trust, which affect productivity. It lowers aggregate demand because the rich consume a lower percentage of their income and in ways that do not promote future growth. It reduces entrepreneurship by saddling college graduates with student debt.

These contentions make intuitive sense and are eminently plausible. The problem with most analyses of rising inequality is that they do not take the all-important step of actually examining the evidence. Such ad hoc hypotheses about inequality’s effects on growth are easy to spin. From the right, Edward Conard and others have just as plausibly argued that rising inequality gives people the incentives to take risks and work hard — elements crucial for robust economic growth; if it would induce more people to pursue Steve Jobs levels of innovation, maybe we need higher inequality still!

What does the evidence show? The liberal Center for American Progress recently released a report purporting to show how inequality hurts the economy. If the research on the link between inequality and growth persuasively showed a strong connection, you can be sure that the center would have trumpeted it. Here is what the authors, Heather Boushey and Adam S. Hersh, instead wrote:

“There is, of course, a rich literature on the relationship between inequality and growth. Although there are many conflicting views, there is ample evidence that inequality can, in fact, hurt growth under many circumstances. But this literature focuses mostly on the experience of developing countries, and its applicability to the challenges currently facing the United States is not entirely clear.”

Widely cited research by I.M.F. economists — embraced by the chairman of the Council of Economic Advisors, Alan Krueger, in a speech in January and highlighted by Annie Lowrey in The New York Times this week — has this very problem of focusing primarily on developing countries. Inequality in dictatorships and oligarchies with mass poverty is a very different matter than inequality in rich democracies.

Indeed, research by Christopher Jencks of Harvard University looking at the experience of 12 developed countries over the past century indicates no relationship across those countries between the share of income received by the top 1 percent and economic growth rates. Since 1960, however, countries with higher inequality have experienced more growth. Boushey and Hersh do not cite Jencks’s study but nevertheless conclude that, “Ultimately, data and methodological issues mean that analyses are too imprecise to deliver definitive answers to this old and central question in economics research.”

Studies that look at some of the specific hypotheses mentioned above also are inconclusive or refute the idea that inequality is harmful to growth. Inequality does not appear to lead to financial crises. Its link to opportunity is highly questionable. The evidence that it distorts political outcomes is similarly thin and again based largely on developing countries.

It is not enough to construct arguments about why inequality might matter; in the end this is a question we can subject to empirical testing. The evidence does not give much reason to worry that inequality saps growth, or much reason to think that it increases it.