Tuesday, Aug. 5, 2014
Standard & Poor’s released a report Tuesday stressing that the wealth gap in the United States is slowing economic growth. The widening economic disparities, the report states, has stinted the economic recovery and increased the likelihood of “boom-bust cycles.”
The S&P report advises that to lessen the gap, promoting educational achievement is a better recourse than raising taxes. Yet some economists argue whether the wealth gap has any effect on the country’s economic growth.
Leslie Stratton, Ph.D., professor of economics in the Virginia Commonwealth University School of Business, explained what effect the wealth gap has on economy recovery and growth.
Why does the wealth gap affect the economy? What are the arguments for and against the gap slowing economic growth?
Economic growth is highly dependent on consumer spending. Consumer spending accounts for upwards of 60 percent of the economy. Government spending and business investment account for much of the remaining 40 percent. Consumer spending is dependent upon both income and borrowing. Borrowing today occurs, obviously, at the expense of spending tomorrow. So while borrowing today can boost economic growth today, it does so at the expense of growth tomorrow. Thus, it is better for growth to come from spending out of earnings. The wealth gap has an effect on the economy because the wealthy spend a smaller fraction of their income than the poor. Hence the greater the fraction of additional income going to the wealthy, the lower the growth from spending income.
This is not to say that the economy would be better off if income were evenly divided or if income growth were evenly distributed over the population. Earnings differentials attributable to productivity differentials provide an incentive for workers to be productive — being more productive they can earn more. More productive workers increase economic growth.
S&P advises that economic disparities need to be watched. How can that help this issue? Can economic disparities be decreased?
“Watching” accomplishes little.
Can economic disparities be decreased? History tells us they can be. One measure of the disparity comes from what is called the Gini Coefficient. A Gini Coefficient of 0 implies that income is equally distributed across the population. A Gini Coefficient of 1 implies that one person has all the income.
In 2010 the Gini Coefficient for the United States was estimated to be 0.469 (see https://www.census.gov/hhes/www/income/data/historical/inequality/IE-1.pdf). It actually peaked at 0.470 in 2006, was 0.428 in 1990-91, was 0.403 in 1980, and 0.394 in 1970. Thus inequality has been rising for some time.
However, estimates of the Gini Coefficient for the U.S. put it over 0.45 through the 1930s, falling precipitously in the early 1940s. Thus, we are not destined to have rising income inequality forever.
However, we also do not want to relive the great crash and WWII.
Note further that the degree of income inequality varies by country. It is higher in Mexico and lower in Denmark and Norway (see table at http://www.oecd-ilibrary.org/sites/factbook-2013-en/03/02/01/index.html?itemId=/content/chapter/factbook-2013-25-en).
The key question is how economic disparity can be addressed. One approach that some research has found to have influenced disparity at least amongst those who have earnings at below the median (50th percentile level) is to raise the minimum wage. Increased educational attainment has also helped, but there is also evidence that technology is making many of the jobs formerly held by the middle class (those in the middle of the income distribution) obsolete. Purely manual jobs like gardener and janitor still exist and jobs creating technology have expanded, but middle-level managers have declined in numbers.
What role does education play here? How can educational achievement be increased among workers?
Education is important. The U.S. used to be a leader in education. We still have a more educated workforce than almost every other nation. A number of other nations, however, now have somewhat more educated 25-34 year olds than we do. President Obama has been pushing higher education in order to turn this trend around. More educated workers do tend to be more productive. I do believe that education increases productivity. Thus, education can help boost incomes. Indeed, there is even evidence that less educated individuals who work with more educated individuals are more productive and earn more — what economists call positive externalities.
However, there are also concerns with this approach. No one can predict the future. I try to outline some of the arguments for and against advocating for increasing educational attainment below. This is certainly not a complete list.
· It is likely the case that individuals who are more productive/smarter before enrolling are more likely to pursue higher education. There is some concern that by encouraging everyone to go to college, one may reduce the average productivity of college graduates because one is attracting less able individuals to go to college.
· There is also a concern that increasing enrollments may attract more students who will not complete college. These individuals will incur some of the costs (debt) but reap relatively few benefits.
· Employers have been complaining that college graduates are unprepared for the workforce. Thus, there is some concern that colleges are not adequately preparing students.
· College does not prepare one for every job opportunity. Some skills are better learned on the job. There is less job training in the U.S. than in many other countries — either as provided by the government/educational system or by firms.
· Higher education costs more in the U.S. than it does in many developed nations. The high cost discourages some high-ability individuals from applying to college. There is substantial evidence that the fraction of individuals attending college is positively associated with income, even controlling for ability (test scores). Thus, if the “right” individuals were encouraged to pursue more education, we could increase growth and reduce the earnings differential.
There are a lot of unknowns.
Subscribe for free to the weekly VCU News email newsletter at http://newsletter.news.vcu.edu/ and receive a selection of stories, videos, photos, news clips and event listings in your inbox every Thursday. VCU students, faculty and staff automatically receive the newsletter.