Why Inequality Matters: Or, Why Joseph Stiglitz Hits it and Paul Krugman Misses

With the Super Bowl over, the fantasy football season has ended. But it turns out there is a fantasy league for economists. So, sorry to those of you with Paul Krugman on your team, but I am siding with Joseph Stiglitz in his argument that income inequality is slowing the recovery.

Both Stiglitz and Krugman are Nobel laureates in economics. Both agree that inequality hurts the economy in the long run, because in a market-based economy, high levels of income inequality lead to too many talented and smart poor children being prevented by low income from investments in schooling, enriching life experiences and opportunities to become the leaders we need to grow as a nation.

Where Stiglitz and Krugman disagree is on how inequality shapes the market in the present. Krugman argues against the idea that income growth that favors the rich hurts the demand for goods and services that make employers hire more people, because the rich save rather than consume. Krugman points to the evidence showing that despite rising income inequality, aggregate consumption has been quite healthy.

But, while consumption by the rich is helping the sale of goods and services and keeping the Gross Domestic Product (the value of all goods and services produced in the country) growing, a rich person spending means a poor person is not spending. Stiglitz believes that inequality is slowing the current recovery.

Economists Steven Fazzari and Barry Cynamon point out that consumption by the top 1 percent has grown by 17 percent since 2009 when the “recovery” began, but just 1 percent for the bottom 95 percent. Businesses know that spending patterns are different, as a New York Times article explained this week. Darden, a chain of sit-down restaurants, grew thanks to its middle-class restaurants, Olive Garden and Red Lobster.

Those brands now sag in sales, while their upscale brand, The Capital Grille, is growing fast. But it is more than restaurants that differ. If more is spent at The Capital Grille than Red Lobster, Kruger argues, then presumably the wages and number of workers Darden would allocate to Red Lobster would fall but rise at The Capital Grille, so employment and income for the bottom 95 percent also would grow.

But something else happens with inequality: a rising share of all consumption takes place at the top. There are two problems when a high share of consumption is concentrated at the top.

First, for things like housing and education, where the rich consume the bulk of private consumption, that trend tilts prices toward their income levels. Just as Darden chases the dollars by changing its mix of restaurants, home builders will chase the dollars and tastes of the rich in building homes.

Elite institutions favored by the rich, like Harvard and Stanford, will raise tuition to capture the ability and willingness to pay of the rich, and in turn use those resources to bid for the best faculties in business and engineering. That ups the ante for those in the middle who want to become homeowners or send their children to college.

Fazzari and Cynamon document that indeed the middle class kept up with those rising prices by borrowing heavily—too heavily, as it led to a collapse in middle-class demand when debt levels rose too high. The housing collapse froze middle-class homeowners, but families have continued to chase quality education and increase student loan debt.

Also, middle-class incomes lead to purchases of things that lead to more jobs, including automobiles. Increase income at the top instead leads to production of items with higher profit margins and prices—luxury automobiles and high-end appliances, not more cars and more appliances. The collapse of incomes in the middle mean that consumption isn’t translating into more people being hired, just higher profits and higher prices for luxury items.

William Spriggs serves as Chief Economist to the AFL-CIO, and is a professor and former Chair of the Department of Economics at Howard University.

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