Many people think income and wealth inequality is a social problem, but few have offered a coherent explanation of why it’s bad for the economy. One argument is people who live in an unequal economy consume less. Since consumption is 70 percent of the U.S. economy, that means less growth. Economist Larry Summersexplained why in the New York Times:
“Income is now more concentrated in the hands of the rich. Those well-off households tend to save and invest higher proportions of their earnings than middle-class or low-income families do. That might mean, on aggregate, less spending and less demand across the economy for a given level of income.”
Not everyone agrees that juicing consumption is a strategy for long-term growth. But let’s say that it is. Summers is arguing that, in the aggregate, we’re spending too little (and therefore saving too much). But savings right now is lower than its historical average—it was higher when there was more growth and less inequality.
With savings at near-record lows, it’s hard to argue that America is spending too little. And taking income or wealth from the rich and giving it to the poor in an effort to boost spending can backfire. Outside of the very richest Americans, the increases in wealth and income inequality aren’t wholly because the rich got richer. It’s partly because the baby boomers got older. Income and wealth increase over the course of your lifetime. The average 65 year-old is much richer and earns more than the average 30-year-old because he had more years to save and develop skills. Some, but not all, of the increase in wealth inequality is an aging population acquiring more assets than before.
In 1989 the average senior had nine times more wealth than a young adult. By 2013, senior wealth was 18 times bigger. The increased disparity reflects several trends: higher student debt, gyrations in the housing market, and the fact that Americans now finance their own retirement (the wealth data above don’t include defined benefit assets; the personal saving rate in the first figure does). Still, by most accounts, Americans near retirement still have not saved enough. When you consider that, by many estimates, a $1 million retirement account—a level of wealth accumulated by only 10 percent of the population—throws off only $40,000 per year of income, who is rich and who is middle class becomes less clear.
People with higher incomes do save more. But it’s also true that income peaks in middle age, which is when people normally start saving in earnest for their retirement. Aggressive redistribution, which aims to reduce saving, can lead to both less spending and a greater dependence on government benefits in retirement. Sustainable growth will require Americans, at almost all income levels, to save more.
The increase in inequality has led many to reject trickle-down economics. In fact, some forms of trickle-up economics can deliver more growth. Janet Yellen said last week that there are probably unrealized gains from unlocking the full potential of lower-income Americans. She argues that this can be achieved by improving access to education and business ownership. This has the potential to create economic value by investing in the future, rather than consuming more today.
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