Inequality or a weak economy – which is costing you more?

Two trends have socked American workers over the past three decades. The economy has grown more slowly than it did in the decades after World War II, and the growth we’ve seen has disproportionately boosted the incomes of the very rich. Both trends are important, but in a new paper, a liberal economist argues that one of them was far more consequential for the vast majority of Americans.

The economist, Joshua Bivens, is the research and policy director at the Economic Policy Institute. In his paper, he builds two alternate realities of the American economy from 1979 to 2007 (the eve of the Great Recession) to tease out whether slowing growth or widening inequality did more to depress incomes for the bottom 90 percent of U.S. workers.

In one model, growth changes but inequality stays the same. In the other, growth stays the same but inequality changes.

Bivens finds that incomes for that broad group of workers would be 20 percent higher in 2007 if inequality had simply stayed at its average level for the three decades after the war. That’s double the increase you get from holding growth constant at higher, postwar levels but allowing inequality to rise as it did.

That result drives Bivens to two conclusions, which we discussed in an interview this week, both of them related to how policymakers should think about inequality and growth. “This is not a call for equal incomes going forward,” he said. “It’s a call for equal distribution of growth going forward.”

The interview has been edited for length.

Tankersley: Walk me through this argument. What are you responding to?

Bivens: I’m responding to two things that I think are unrelated. The first one is that the primary problem facing the U.S. economy over the last few decades has been a lack of economic growth, and that should be a primary focus of policymakers, and worrying about the distribution of that growth is somehow a detour or sideshow or even outright damaging. I don’t think that’s right. We did grow slower in the past 30ish years, relative to the 30 years after World War II — that’s a problem. But the even bigger problem for the bottom 90 percent of households has been the rise in inequality.

And if we’re worried, as I am, about the rise in living standards for the bottom 90 percent, you just have to take inequality head on.

The second one is a school of thought that I have some sympathy for but that I think sets the bar too high for policy. It’s the idea that fighting inequality is a good thing because it will increase the rate of overall growth in the economy. Now, I think it might. But I think even if it doesn’t, it’s a good thing to fight inequality, because it will raise the incomes of the bottom 90 percent.

Tankersley: How do we know that a lot more growth would not have been enough by itself to help the workers who have been left behind in this period?

Bivens: There’s a bunch of ways you can do this, but there’s no way you can do it where inequality is not a huge part of the problem. The way I do it in the paper is really a simple look at average household income in the two periods — say, what if we had let the bottom 90 percent grow over the past 30 years at the rate of average growth; so basically, no rise in inequality but the average growth stays the same? That has a bigger effect on their incomes than if we did a counterfactual that says, let’s let the overall rate of growth go with the faster immediate prewar period but inequality still happens. The inequality effect is larger than the growth effect in keeping their incomes lower.

Tankersley: There is an argument that many liberals make that if we could reduce inequality, we could improve growth. You’re arguing that might be true but needs not be to justify fighting inequality?

Bivens: It’s a little bit dangerous to accept the burden of proof in the debate that says, if we stop the rise in inequality we will boost overall growth. Because even if we don’t, it will still be a worthwhile thing to do for my political goal of raising incomes for the bottom 90 percent.

Tankersley: Still, you break down the potential of some inequality-targeting proposals to raise overall growth.

Bivens: The clearest one that will be very good for both distribution and growth is obviously full employment — a recommitment to the idea that we need to push on employment to be as low as it can possibly be without sparking inflation. We know from the experience of the late 1990s that once labor markets got really, really tight, we saw the first burst of across-the-board wage growth in basically a generation.

A big campaign of public investment will help us get to full employment. It will help with long-run productivity growth. And public investment tends to have benefits that are more broadly distributed than private investment. It’s safe to say that building out subways and early childhood education and all sorts of other things we do with public dollars have benefits that are spread more widely than when Microsoft builds a new plant.

The rise of finance is a really big part of the story of the rise of inequality. There’s a really strong, growing literature that says the rise in finance (as a share of the economy) — you do not see the benefits of it in terms of boosting overall growth. In fact, the evidence seems to go the other way. Once you reach a certain point, the growth of finance begins dragging on the overall economy. So good regulation there is good for both things.

Tankersley: What about tax increases? Classic economic theory suggests that if you raise taxes to reduce inequality, you also reduce growth.

Bivens: Attacking inequality through tax and transfer policy is part of the bucket that I think of as roughly growth-neutral but beneficial for the bottom 90 percent. You’re right — in theory, higher tax rates can squeeze out economic efficiency. I think the empirics of starting from the level of American tax rates today looks like it’s going to have a really trivial effect on growth. There really is a convincing new strain of literature that … increasing top tax rates can actually reduce market-income inequality. That’s one where Econ 101 will lead you astray.

Tankersley: Your view is that inequality has widened because the very rich have amassed large amounts of economic and political power. How, then, could you expect political leaders to pass policies that would necessarily hurt the income growth of the very rich?

Bivens: If we’re really going to have the bottom 90 percent growing at an average rate, that means the top 1 percent are not going to have the crazy bonanza that they had over the past 28 years before the recession. That’s where the real political rubber hits the road. That is an incredibly daunting political problem.

I want to show that there’s no economic problem with delivering growth to the bottom 90 percent. We can do it.