Worldly Philosopher: Income Inequality and Demand Side Limitations
This week's Worldly Philosopher, Rishabh Kumar, writes on the wealth inequality debate.
The wealth inequality debate has taken center stage since the publication of Tom Piketty's new book, "Capital in the Twenty-First Century." Piketty drives home the point that wealth owners are better off than income earners because the rate of return on capital is higher than the return on income. Since wealth holders increase as we move up the class distribution, this implies an increasing income gap between the poorest and richest households.
In recent (and upcoming) research, my co-authors and I are examining the income distribution for the United States between 1986-2009. Using data from the Congressional Budget Office (CBO) and Bureau of Labor Statistics (BLS), we observe the gap between the super rich (the top 1 perce) and the bottom groups is indeed increasing (Figure 1: Shares of Different Household Groups in Total Household Income. Source: Upcoming in Taylor, Rezai, Kumar and Barbosa, 2014). But unlike Piketty, we did not count capital gains, and we discovered that the super rich are also increasing their share of income. Therefore, the rapidly increasing inequality that favors a few does not solely depend on capital and wealth, as Piketty's analysis implies.
Thus, even without wealth gains, the top 1 percent was able to increase its share of "non-wealth" income (the black line in Figure 1) from just under 9 percent in 1986 to around 18 percent by 2009. This happened while the income shares of the other groups remained relatively stagnant, if not decreasing. Piketty ascribes inequality to the concentration of wealth in the hands of the few. Our findings complement the story – the richest class in the United States has also benefited from higher (real) labor compensation and transfers (interest, dividends etc). In a broad sense, the total growth in income in the United States over the last two decades is heavily skewed in favor of the super rich.
These data directly address an old aggregate demand question in Keynesian economics. Figure 2 shows the share of different groups in total household consumption, while the incongruency in income and consumption shares are shown in Figure 3. While the bulk of consumption happens via the middle class, the income -consumption ranking is completely turned around for the Top 1%. Most of their remainder income goes into savings and tax payments. Strikingly, close to 14 percent of income results in less than 3 percent of consumption (for the middle classes, this consumption-income ratio is closer to 1), bringing out the question of the potentially unspent demand.
From another perspective, Greg Mankiw defends the macroeconomic role of the Top 1% for their entrepreneurial impulses, contributions to innovation and promoting economic growth. While these innovation aspects are important (though not if you believe Robert Gordon), there's a demand side argument to be made regarding unspent excess money. If the government wants to remain averse to outstanding deficits (and thereby not increase its net lending to the bottom), there is merit in at least influencing the behavior of the super rich to avoid hoarding. Whether this happens by penalizing their excess income and boosting demand at the bottom, or by simply hiking up the minimum wage, is an interesting question.
We will continue this research by next looking at the other end of the income distribution, following up a recent CBO study on minimum wage hikes and examine the impact of redistributive policies on the given income distribution as well as economic growth.