Stock markets and corporate profits are up, wage growth anemic. So Fed Governor Sarah Bloom Raskin is wondering whether the “large and increasing amount of inequality in income and wealth” is hampering the current US economic recovery and perhaps “pose a significant headwind years to come.” The concern echoes that of economist Robert Gordon, whose recent paper, Is US Economic Growth Over? Faltering Innovation Confronts the Six Headwinds, highlights inequality as one of six headwinds potentially reducing long-run economic growth.

But which way does the causality run? In a speech yesterday, Raskin points to globalization and automation as reasons why some two-thirds of all job losses in the recession were in middle-wage occupations, but those occupations have accounted for less than one-fourth of the job growth during the recovery. By contrast, lower-wage occupations have accounted for only one-fifth of job losses during the recession but more than one-half of total job gains during the recovery. As such, Raskin says “the earnings potential for many households likely remains below what they had anticipated in the years before the recession.”

So the middle part of the labor market is being hollowed out, what economists call “job polarization.”

employment shares by skill levelCurrent population survey and author's estimates

But is inequality hurting economic growth? Brookings scholar Scott Winship has his doubts, telling the New York Times, “The evidence does not give much reason to worry that inequality saps growth, or much reason to think that it increases it.” Among his reasons:

1. It seems that for authoritarian nations with emerging economies, but that relationship has been tough to pin down for democratic, advanced economies.

2. A highly regarded 2010 study Do Rising Incomes Lift All Boats looking at data from 1905 to 2000 found “no systematic relationship between top income shares and economic growth in a panel of 12 developed nations observed for between 22 and 85 years.”

3. A March 2012 study by Michael Bordo and Christopher Meissner, Does Inequality Lead to a Financial Crisis, concludes “low interest rates and economic expansions are the only two robust determinants of credit booms in our data set. Anecdotal evidence from US experience in the 1920s and in the years up to 2007 and from other countries does not support the inequality, credit, crisis nexus. Rather, it points back to a familiar boom-bust pattern of declines in interest rates, strong growth, rising credit, asset price booms and crises.”

In Brink Lindsey’s excellent new book, Human Capitalism, he notes a disconnect between the demand for high-skill human capital and inability of society to widely provide a fertile environment for its development. “Educational attainment has stalled, and the lowest skill jobs are increasing, not decreasing, their share of employment.”

He offers several ideas, which I will list briefly but promise to later explore in depth: 1) maintain economic growth by encouraging entrepreneurship, 2) reform K-12 education by unleashing competition, 3) compensate for disadvantaged environments through early childhood interventions, 4) combat social exclusion of low-skilled adults, 5) improve higher education by limiting tuition subsidies, 6) remove regulatory burdens to entrepreneurship and upward mobility. Rather than focus on the 1% per se, better to keep growth high and enhance the ability of more Americans to take part in a growing economy — which will boost growth further and create a virtuous circle.

Copyright 2013.