The Good Jobs Strategy

February 3, 2014

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Zeynep Ton. The Good Jobs Strategy: How the Smartest Companies Invest in Employees to Lower Costs and Boost Profits. Seattle: Lake Union Publishing, 2014.

Why is it so hard to find a good job? Part of the problem is matching the good jobs with workers who are qualified to do them. We hear about hi-tech companies that can’t find enough applicants with the right technical skills. But even more often these days, we hear about the disappearance of jobs with decent pay and benefits, and the proliferation of jobs with low pay, no benefits, and erratic work hours.

Globalization and technological change are often cited as factors contributing to high unemployment and low wages. Many American workers are in a poor bargaining position, vulnerable to being replaced by an industrial robot or a lower-paid foreign worker. Workers with low pay can’t afford to spend very much, giving a competitive edge to businesses that can cut costs and hold down prices. So the conventional wisdom is often that businesses cannot invest very much in their labor forces and still make a profit. Maybe this is the real “class warfare,” the attitude that regards workers as an unfortunate expense to be minimized as much as possible.

Zeynep Ton is an adjust associate professor at the Sloan School of Management. Her studies of business management have convinced her that even in today’s competitive environment, businesses have a choice. They can profit from what she calls a “bad jobs strategy,” at least in the short run. But a “good jobs strategy is also a viable option:

You can certainly succeed at the expense of your employees by offering bad jobs— jobs that pay low wages, provide scant benefits and erratic work schedules, and are designed in a way that makes it hard for employees to perform well or find meaning and dignity in their work. You can even succeed at the expense of your customers; for example, by offering shoddy service. People may not enjoy buying from you, but plenty of them will do it anyway if you keep prices low enough.

In service industries, succeeding at the expense of employees and at the expense of customers often go together. If employees can’t do their work properly, they can’t provide good customer service. That’s why our experiences with restaurants, airlines, hotels, hospitals, call centers, and retail stores are often disappointing, frustrating, and needlessly time-consuming.

Many people in the business world assume that bad jobs are necessary to keep costs down and prices low. But I give this approach a name— the bad jobs strategy— to emphasize that it is not a necessity, it is a choice.

There are companies in business today that have made a different choice, which I call the good jobs strategy. These companies provide jobs with decent pay, decent benefits, and stable work schedules. But more than that, these companies design jobs so that their employees can perform well and find meaning and dignity in their work. These companies— despite spending much more on labor than their competitors do in order to have a well-paid, well-trained, well-motivated workforce— enjoy great success. Some are even spending all that extra money on labor while competing to offer the lowest prices— and they pull it off with excellent profits and growth.

Ton’s research focuses on the retail industry, notorious for its millions of bad jobs. Its median hourly wage in 2011 was $10.88; 40% of the jobs are only part-time; and unpredictable work schedules often make it hard to care for a family, go to school, or take a second job. Ton reasons that if better jobs can be created in retail, they can be created just about anywhere.

Ton highlights four companies that are succeeding with a good jobs strategy: Costco, the wholesale buying club; Mercadona, the biggest chain of supermarkets in Spain; QuikTrip, a convenience store chain; and Trader Joes, an American supermarket chain. They manage to make good profits, offer good value in prices and service to customers, and also create good jobs. Costco pays its hourly workers 40% more than Sam’s Club. In addition to better pay, these model employers provide their workers greater “opportunity for success and growth” by giving them adequate training, time and resources to do the job well. They are places where people generally like to work.

Investing in employees

Ton describes two main ingredients for success using a good jobs strategy: investment in employees and operational choices. Both are essential. The strategy requires an adequate quantity and quality of labor, but it also requires an efficient operation to make that labor productive and justify its high cost.

One could say that the company puts itself in its employees’ hands, then does its best to make sure those hands are strong, skilled, and caring. This is not a matter of happy talk, PR, and employee-of-the-month awards. This is concrete policy, manifested not only in wages and benefits but also in recruitment, training, scheduling, equipment, in-store operations, head count, and promotion.

Ton points out that not all tasks are simple enough to be reduced to standardized routines that the least skilled and trained worker can complete. Retail operations have actually become more complex over the years, but the investment in workers has declined. (The ratio of retail wages to average U.S. wages declined from 91% to 65% between 1948 and 2011.)

Ton found that in many cases retail stores can increase profitability by adding workers rather than cutting them. The relationship between employees and profits can be described by an inverted-U-shaped curve (with employees on the horizontal axis and profits on the vertical axis). Profits are highest at a theoretical sweet spot where stores are neither understaffed nor overstaffed. But businesses often have a bias toward understaffing because they think of labor as an expense to be minimized. Whenever sales are lagging, managers may be under pressure to cut staff in order to hold payroll to a fixed percentage of sales. Businesses fail to weigh the short-term gain against the long-term harm to their operation. They have few models of companies that sustain a high commitment to their workforce.

Companies without that commitment easily fall into a “vicious downward cycle”: Low expenditure on labor leads to a low quality and/or quantity of labor, which leads to poor operational execution, which leads to low sales and profits, which leads back to low expenditure on labor.

There are many effects of failing to invest enough in one’s employees, including— but by no means limited to— phantom stockouts; promotions that are executed incorrectly or not executed at all; data corruption that undermines inventory and strategic planning; and loss of products due to theft, spoilage, and faulty paperwork. [Phantom stockouts are situations where what the customer wants is actually in stock, but nobody can find it.]

Investing in employees can create a more virtuous cycle in which higher expenditures on labor justify and sustain themselves by supporting better operational execution and higher sales and profits.

The operational choices that support the good jobs strategy will be the topic of the next post.

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The Political Economy of Human Happiness (part 2)

January 17, 2014

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Benjamin Radcliff wants to test the hypothesis that people are generally happier when government takes an active role in promoting economic well-being. The interventionist policies he has in mind include a generous welfare state, support for workers’ right to organize, and strong regulation of business.

Measuring happiness

This study depends, first of all, on being able to measure happiness. Social scientists try to do that without getting into deep philosophical questions about “true happiness.” They find it useful to define the term simply, as Radcliff does when he says, “Whether we call it life satisfaction, happiness, or, as some prefer, subjective well-being (SWB), we are speaking of the same theoretical and empirical entity: the extent to which the individual enjoys life.” Then the measurement of happiness requires only a simple self-report, such as the answer to this question from the World Values Study used by Radcliff: “All things considered, how satisfied are you with your life as a whole these days?”

Radcliff argues for the validity of such self-reports in this way:

…We find exactly what we would hope to find if self-reports of happiness are valid. Thus, people reporting to be happier than average have been demonstrated (among many other things), to laugh and smile more than others during social interactions, to be less likely to attempt suicide or to become depressed in the future, to be more likely to recall positive rather than negative life experiences, to be less introverted and shy, and to be more optimistic about the future. Crucially, self-assessments of happiness also correlate highly with external evaluations from friends and family members, as well as with clinical evaluations.

Simple questions about happiness are also very reliable, since people answer them readily and pretty consistently. In contrast, questions that are too difficult or confusing can produce a different answer each time a respondent is asked. Simple happiness questions also allow comparability across countries, since slight variations in wording or interpretation have been found to have little effect on how countries rank.

Individual and societal variations

Many of the reasons why some people are happier than others are very personal, and have little to do with the political factors Radcliff wants to study. Radcliff identifies the personality traits most strongly correlated with happiness as “extroversion, neuroticism [negatively correlated], optimism, self-esteem, and efficacy (the sense of being in control of one’s own life).” In addition, some personal conditions are predictors of happiness, such as being married and otherwise socially connected, being employed, enjoying good health and attending religious services. People with higher incomes are generally happier, but with some diminishing returns at the highest income levels. “Age displays a U-shaped pattern with happiness, such that both the young and the old are happier than are those in the middle,” other things being equal.

If the unit of analysis is the individual, and a large number of variables are considered simultaneously, then the government policies under which one lives will explain only a small portion of the total variation in personal happiness. That has led some researchers to dismiss political variables as largely irrelevant. However, one can see political effects more clearly by using countries as the units of analysis and making the average level of happiness in the country as the variable to be explained. A lot of individual variations then drop out, and the variation that remains is more clearly correlated with variations in national policy. Not all the national differences that affect happiness are relevant to Radcliff’s thesis. Factors like the general level of prosperity have to be taken into account so that variation attributable to them is not incorrectly attributed to the progressive policies he is interested in. Multiple regression is the statistical technique Radcliff uses to sort these matters out. He conducts separate analyses using first individuals and then countries as the units.

The data for the international comparisons come from the World Values Surveys conducted between 1981 and 2007. Radcliff includes “the twenty-one traditional, core member states of the OECD: Australia, Austria, Belgium, Canada, Denmark, Finland, France, Germany, Great Britain, Greece, Ireland, Italy, Japan, the Netherlands, New Zealand, Norway, Portugal, Spain, Sweden, Switzerland, and the United States.”

Political factors affecting happiness

Radcliff uses these measures of the size of government:

  • a measure of “decommodification” developed by Esping-Anderson, intended to measure “the degree to which individuals or families can uphold a socially acceptable standard of living independent of market participation”; this depends on the availability of social insurance like disability or unemployment benefits
  • a similar measure developed by Scruggs, called a “generosity index”
  • government social spending as a share of Gross Domestic Product
  • government taxation as a share of Gross Domestic Product
  • a “size of government” index developed by the Fraser Institute

To assess government efforts to protect workers in particular, he uses:

  • an index of labor market regulation developed by the Fraser Institute
  • the Employment Protection Legislation index developed by the OECD

In both the individual-level and country-level analyses, the relationships are in the expected direction: People are generally happier when the government is more active in these ways. A particularly interesting finding is that the effects extend even to those who are not the most direct beneficiaries of the policies. A more generous welfare state increases the happiness of the wealthy as well as the poor. Protecting workers’ right to organize benefits even those who don’t personally belong to unions. Since we are talking about broad averages here, the findings don’t rule out negative policy effects on certain individuals or businesses, but on balance the more progressive, social democratic nations have the happier citizens.

How large are the effects? The regression coefficients vary from factor to factor, and their meaning is not always obvious even to statisticians (since they depend on what combination of variables is in a given equation), let alone to general readers. Radcliff does the best he can to assess the magnitude of the political effects by comparing them to other known effects. For example, he finds that in the individual-level analysis, the difference between living in the most generous versus the least generous welfare state is greater than the difference between being employed or unemployed, or the difference being married or unmarried.

Radcliff does not provide a ranking of countries on these variables, but he does mention that the United States falls more toward the conservative end of the political spectrum, with a small welfare state and relatively weak worker protections. He also conducts a separate analysis of American states to show that similar relationships hold at the state level. Other things being equal, states with more progressive policies have somewhat happier citizens.

Is “big government” better?

In his final chapter, Radcliff once again states his position rather bluntly:

In the debate between Left and Right over the scope or size of the state, it is eminently clear that “big government” is more conducive to human well-being. As we have seen, the surest way to maximize the degree to which people positively evaluate the quality of their lives is to create generous, universalistic, and truly decommodifying welfare states….Overall, it is clear that the quality of human life improves as more of the productive capacity of society comes under political–which is to say, democratic control. This subjection of the market to democracy thus appears to promote human happiness in precisely the way that advocates of social democracy have always argued.

I can’t emphasize enough that Radcliff is talking only about social democracy. His sample of nations does not include China, Eastern European countries during or after Soviet domination, or any totalitarian system. The real relationship between size of government and happiness may be curvilinear: Happiness rises as long as the state is becoming large enough to give people some economic security, but it falls if the state tries to take too much control of their lives. One of the main impulses of conservative thought is the justified fear of the totalitarian state, so their critique of big government isn’t entirely wrong.

Having said that, there remains much in Radcliff’s study to challenge conservatives. While they constantly sound the alarm about excessive government power, they are so enamored of the “free market” that they tend to overlook the dangers of excessive economic power. To them, freedom often means nothing but freedom from government regulation, never freedom from inadequate wages or catastrophic health bills. Not only do powerful economic interests commodify and devalue laborers to the point of keeping too many of them poor, but they also threaten to undermine democracy by “making the nominally democratic state dependent on pleasing the economic interests of the capital-owning class.” For a look at how one wealthy individual has shaped our politics, see Gabriel Sherman’s The Loudest Voice in the Room, about Roger Ailes of Fox News.

Radcliff points to a fundamental contradiction in conservative thought. Conservatives uphold the classic eighteenth-century liberal notion that rational individuals have the right to organize together in pursuit of an economic goal. That’s the basis for the economic corporation. They insist that such an entity is a legal “person” with the right to speak and act as one. But if workers want to bargain collectively by forming a union, or citizens want to join together to legislate a minimum wage, conservatives see that as an infringement on freedom. So organization that enhances the power of capital advances freedom, but organization that enhances the power of ordinary citizens is, in von Hayek’s words, the collectivist “road to serfdom.” If Radcliff is right, that philosophy may be getting in the way of taking reasonable measures to promote the common good and increase human happiness.

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The Political Economy of Human Happiness

January 15, 2014

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Benjamin Radcliff. The Political Economy of Human Happiness. Cambridge University Press, 2013.

Political scientist Benjamin Radcliff takes on the formidable task of demonstrating that government intervention in the economy is positively associated with human happiness. He expects both the nations and the US states with more interventionist policies to have generally happier citizens, and he presents statistical evidence to support that claim.

Many readers may react to Radcliff’s claims with skepticism, especially if they are unfamiliar with social-scientific methods in general and studies of life satisfaction in particular. Readers who follow his presentation all the way through may become more receptive to the possibilities of finding out how happy people are and relating their sense of well-being at least partly to the economic and political conditions of their lives.

A longstanding issue

Although the idea of measuring happiness is fairly new, the idea that government ought to promote the general happiness is as old as the Declaration of Independence. Before the eighteenth century, “happiness had always been conceived of as either something that only a tiny handful of exceptional people might obtain through long application or something to be found only in the next world.” New philosophies of secular progress changed that. Joseph Priestley asserted, “The good and happiness of the members, that is the majority of the members of the state, is the great standard by which every thing relating to that state must finally be determined.” John Adams declared that “the form of government which communicates ease, comfort, security, or, in a word, happiness to the greatest number of people, and in the greatest degree, is the best.”

In very broad terms, that meant democratic government. But how democratic, and how powerful? Did government facilitate the “pursuit of happiness” mainly by leaving people alone to find it themselves, or by actively helping them meet their needs?

Liberal democracy developed alongside a closely related institution, the market economy. While they complemented each other in many ways, they were also in some tension, especially because the economic inequalities generated by the market contrasted with the fundamental equality recognized by democracy (though originally limited to white males). Was the role of the democratic state to protect the property rights of individuals and respect their freedom to use their property as they saw fit, or was it to insure that all citizens benefited from the wealth available? James Madison wanted only a limited democracy because he feared the power of the majority to redistribute the wealth of the richer minority. Thomas Jefferson, on the other hand, argued that property rights were contingent on the use of property for the common good. He favored progressive taxation, free public education, and land grants to anyone who wanted to work the land. Thomas Paine anticipated the modern welfare state by suggesting that the state provide a basic income for people who failed to make a living through no fault of their own. These early differences of opinion developed into the familiar debate between modern-day conservatives and progressives. Conservatives want to protect private property and economic activity from the state, while progressives want to use the power of the state to improve the lives of people poorly served by market outcomes.

Critique of the market economy

Radcliff’s view of the market economy is interesting because it is simultaneously so positive and so negative. This passage gets to the heart of it:

Given that the market does fulfill more basic human needs than other modes of production, and given that the gratification of such needs are [sic] essential for human happiness, the market certainly does, as its conservative proponents argue, warrant its status as the basis for any economic system devoted to “making human life as satisfying as possible” [in the words of Einstein]. There is also much to be said for the contention that the market promotes human liberty: we can acknowledge both the practical and ideological limitations of market freedoms without dismissing them as being empty or without value. At the same time, the market demonstrably and of necessity operates in dialectical opposition to the most basic and universal of human moral codes, in that it demands that some individuals (employers or investors) use other human beings (employees) solely as means to making profits for themselves.

All  “civilizations” have had a “mechanism that allows an elite segment of society to expropriate from the productive majority a portion of the surplus wealth created by that group’s labor, with surplus conceived of simply as the difference between the actual level of economic production and the amount required for the subsistence of the workforce.” Capitalist democracies accomplish this through wage labor, in contrast to the more coercive mechanisms employed in pre-democratic societies. In Radcliff’s view, that doesn’t remove the essentially exploitative nature of the arrangement. Workers must receive less than the value of what they produce, so that owners can make a profit. The labor market commodifies workers, turning them into means of extracting profit rather than ends in themselves, in violation of Kant’s moral imperatives.

I find this argument a little more extreme and categorical than necessary to support the general argument for the progressive state. The claim that “all wage labor contracts are of necessity exploitative” depends on the assumption that the entire value of what is produced is attributable to the workers, and profit is an expropriation of that value. But if capital contributes anything that enhances value, such as plant and equipment, can’t profit be a legitimate return on that capital contribution? Granted that the share of rewards going to the workers is often unfairly low, doesn’t it depend on the bargaining power of labor vs. capital in the negotiation of wages? Aren’t there some employees, especially managers and elite professionals, who are overpaid because of their ability to influence their own compensation? And while I agree that commodification is a very useful concept, and that being “subject to market forces that are beyond their control” is a significant problem for modern workers, I’m not convinced that dehumanization is a uniquely economic problem. As a sociologist, I would argue that every social institution has the potential to treat people as objects of control rather than creative subjects. Governments conscript armies and jail dissidents; churches indoctrinate and persecute; even families over-discipline and abuse. I’m sympathetic to Radcliff’s main argument, that progressive policies can promote happiness by protecting citizens against the ravages of the capitalist marketplace. But I fear that many readers may reject the book out of hand because they can’t get past his somewhat blunt assumptions.

Fortunately, Radcliff also draws on fairly mainstream critiques of free markets, including the work for which Joseph Stiglitz received the Nobel Prize in Economics in 2001. The idea that a free market is optimally efficient in allocating resources to the most productive uses turns out to be true only under certain circumstances (such as perfect information by all parties) which are rarely if ever achieved. Left to themselves, markets often display boom and bust cycles in which resources are invested foolishly or not at all. Radcliff also questions whether productive efficiency is a sufficient goal anyway. “It seems evident that simply maximizing the total amount that the economy produces, without regard to what is produced or, more importantly, how it is distributed, need not translate into greater well-being.”

Social democracy

Radcliff then presents the “grand argument” for the interventionist political economy he calls “social democracy”:

Social democratic institutions…are the only effective countervailing institutions for limiting the market’s potential for converting human beings into commodities….

The institutions of what I have labeled as social democracy–the labor union, the welfare state, and labor market regulations to protect workers–can be argued to positively affect overall quality of life because they provide a higher standard of living, reduce insecurity, improve satisfaction with one’s work, and promote one’s sense of dignity and equality with one’s fellows. These things in turn help to nurture positive emotional and psychological well-being, which spills over from work to personal life, facilitating the creation and maintenance of the close interpersonal relationships that so contribute to a satisfying life.

My next post will present Radcliff’s evidence in support of this hypothesis.

Continued

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Fifty Years of the War on Poverty

December 30, 2013

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Liana Fox, Irv Garfinkel, Neeraj Kaushal, Jane Waldfogel, and Chrisopher Wimer, “Waging War on Poverty: Historical Trends in Poverty Using the Supplemental Poverty Measure.” Paper presented at the Association for Public Policy and Management Conference, Washington, DC, Nov. 8, 2013.

Fifty years ago next week, President Lyndon Johnson declared the “war on poverty.” Obviously, poverty remains undefeated even in a country as wealthy as the United States, let alone around the world. Have we made any progress at all, and if so, have the government programs intended to combat poverty contributed very much to that progress?

Measuring poverty

Recently, the Census Bureau developed a more refined measure of poverty, following a number of recommendations from the National Academy of Sciences. This Supplemental Poverty Measure (SPM) takes better account of the different kinds of households, the variety of spending needs, and the range of government benefits households may be receiving. For example, it includes child care expenses in the assessment of needs, and includes food stamps as a form of income. The authors of this paper use the SPM not only to estimate the current rate of poverty, but also to estimate what the rate would have been if the same measure had been used ever since poverty rates were first published in 1967.

Revising the poverty measure does not change the recent overall poverty rate very much. In 2012 it was 15.1% with the old measure and 16.0% with the SPM. Changing the measure does make poverty rates more similar across age groups, lowering the rate for children from 22.3% to 18.0%, but raising the rate for seniors from 9.1% to 14.8%.

How much progress?

Applying the new measure as consistently as they can, the authors estimate the general poverty rate in 1967 as 19.2%. That means that the rate has declined by about three percentage points since then. The historical decline in poverty has been greatest for seniors, much smaller for children, and nonexistent for the working-age population.

There may be an additional historical change that is not detected by the official poverty measures, old or new. The official poverty thresholds take into account current spending patterns in the population. Consumer units are considered poor if their spending falls below the 30th percentile within the distribution of consumer spending on food, clothing, shelter and utilities. As living standards rise, so do the percentiles, so people need more money to rise above the poverty threshold. The authors estimate that today’s poverty rate would be an additional five points lower if the poverty thresholds had been adjusted only for inflation and not for rising living standards. By constant 1967 standards, poverty has been cut by eight points, from 19% to 11%.

Effects of government programs

Many of today’s households rely on some form of government “transfer” for at least a portion of their income. “These transfers include: food and nutrition programs (SNAP/Food Stamps, School Lunch, WIC); other means tested transfers (SSI, cash welfare…, Housing Subsidies, EITC, LIHEAP); and social insurance programs (Social Security, Unemployment Insurance, Worker’s Compensation, Veteran’s Payments, and government pensions).” Since these programs have expanded greatly since the 1960s, they have no doubt had some effect in lifting households out of poverty.

To estimate how large an effect, the authors recalculate the annual poverty rates with all government transfers excluded from income. They conclude that without these transfers, the official rate (using the SPM) would have gone from 24.8% in 1967 to 30.7% in 2011. Instead of dropping by three points, poverty would have increased by six points. At about 16%, today’s rate of poverty is only about half of what it might be without government transfers.

We do have to say “might be,” however, because we are discussing a counterfactual. We don’t really know what a world with a smaller government would be like. Defenders of government transfers can argue that they accomplished what the labor market couldn’t–lifting people out of poverty during an era when jobs with good wages became scarcer. Critics of government transfers can argue that the labor market could have lifted more people out of poverty, except that the government transfers had a different, more subtle and sinister effect–a disincentive for people to work. Theoretically, the apparent connection between rising transfers and falling poverty could hide a very different dynamic: A growing economy has been reducing poverty, and would have reduced it even more if government transfers hadn’t discouraged people from taking full advantage of job opportunities. According to this view, whatever success the antipoverty programs appear to have had is largely an illusion.

The authors acknowledge that this issue lies beyond the scope of the paper. “Because we do not model potential behavioral responses to the programs, these estimates cannot tell us what actual poverty rates would be in the absence of the programs.”

My own view is that the evidence is stronger for the anti-poverty effect of government transfers than for the work disincentive effect. For one thing, the government has strengthened work incentives by phasing out the old welfare program that provided cash assistance to non-employed single mothers, and replacing it with a system of temporary assistance, work requirements, and tax credits based on earned income. In addition, we know of many macroeconomic reasons for low incomes–increasing wage disparities between rich and poor, failure of the minimum wage to keep pace with inflation, proliferation of part-time jobs, and loss of good jobs due to new technologies and global competition. The spike in unemployment associated with the Great Recession has more to do with financial speculation and unsustainable debt than with any sudden desire to live on unemployment compensation and food stamps. Of course, some people are less ambitious and industrious than others, but it hardly follows that government assistance creates more poverty than it alleviates.

During economic recessions, government transfers provide a safety net, keeping poverty from rising as much as unemployment does. The authors of this paper observe that “government transfers seem to mute the effects of the business cycle, especially for deep poverty.” Both supporters and critics of government assistance programs might hope that a stronger economy would reduce the need for them. That leads to a different political-economic debate, over the role of government in maintaining full employment, as discussed recently by Dean Baker and Jared Bernstein.

Conclusions

What can we say after fifty years of the war on poverty?

  1. Poverty in the United States remains widespread, with about one-sixth of the population below the official poverty threshold.
  2. Poverty has declined since the 1960s through a combination of rising living standards and government transfer programs.
  3. On the face of it, government transfers appear to lift many people out of poverty who would be there because of macroeconomic conditions beyond their control. This anti-poverty effect could be somewhat offset by a work disincentive effect that leads some people to choose government income over employment opportunities.

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The Impact of Inequality on Growth

December 11, 2013

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Jared Bernstein, “The Impact of Inequality on Growth.” Center for American Progress, December 2013.

In this paper, economist Jared Bernstein summarizes the research on a vital economic and political question: “Is there a causal linkage between higher inequality and slower macroeconomic growth”? If the increasing economic inequality in the United States is a drag on the growth of the economy, that would be one good reason–though not the only reason–for developing public policies to reduce it.

Bernstein reports that since the current economic expansion began in 2009, “the stock market is up 60 percent, GDP is up 8 percent, corporate profits as a share of national income are at historic highs, yet median household income is down 5 percent, with all figures adjusted for inflation.” The increasingly uneven distribution of economic rewards is getting a lot of national attention and criticism, with many critics charging that it violates basic fairness, impedes the longstanding drive to raise living standards for most people, and undermines the traditional American values of equal opportunity and social mobility. While Bernstein shares these concerns, believing they are good enough reasons to work for equality, he focuses this paper on the narrower question of inequality’s impact on the growth of the economy. He does this by reviewing the main theoretical reasons why inequality might impede growth, and then looking for empirical evidence to support them.

In a classic theory, Simon Kuznets described an inverted U-shaped curve relating inequality to economic growth, but with inequality as the dependent variable. He observed that inequality tends to increase in the early stages of economic development, when owners of productive assets such as land benefit more than others. But as industrialization proceeds, it gradually benefits more people such as factory workers, and inequality tends to fall. This theory does not work very well for the past century in the US, where inequality fell from the 1930s to the 1970s, but then went back up to “heights matched only by those last seen in the late 1920s.” It also proposes no causal effect of rising inequality on growth. For that, Bernstein looks at four kinds of theories: supply-side, demand-side, political-economy, and a more recent credit bubble theory.

Supply-side theories discuss how inequality might affect the quality of inputs to the production of goods and services, especially the quality of human labor. If too much wealth and income are concentrated in the hands of the rich, then more children will grow up in impoverished families and neighborhoods that cannot invest much in their human development and education. That will presumably hurt growth by making it harder to raise labor productivity.

Demand-side theories assert that the distribution of income affects the general demand for goods and services in the economy because of its effect on the “marginal propensity to consume.” A rich person who receives additional money is not as likely to spend it (as opposed to saving it) as a person with a modest income. Since it is consumer spending that accounts for 70 percent of economic activity, too much inequality can lead to underconsumption and economic recession. Saving and investment are important too, but a low demand for consumer goods and services also discourages investments to expand production.

Political-economy theories mostly concern a political mechanism through which economic inequality feeds on itself. The wealthy can use their power and influence to bring about public policies that benefit themselves at the expense of others, especially where campaign finance regulations are minimal. In extreme cases this dynamic can lead to “intense poverty, deep human exploitation, failed political systems, and ultimately failed states.” Democracies can defend against this by having inclusive political systems that create a countervailing force against this tendency toward oligarchy. How well those countervailing forces are working today is a good question. Political-economy theories do not necessarily say that inequality hurts economic growth; that would depend on the specific policies pursued by the rich and powerful. But the supply-side and demand-side theories suggest some ways that self-serving policies could take the economy in the wrong direction; for example, if elites oppose public spending on education or social insurance because the private market serves their needs just fine.

The credit bubble theory develops the connection between rising inequality and unsustainable bubbles of credit and debt. “The wedge of inequality diverts income growth from middle- and low-wage workers; at the same time, high-income households acquire more capital assets.” The middle class sustains its standard of living by borrowing more; the wealthy have ample capital to lend, and the financial sector expands by making loans more widely available, with decreasing regard for risk. The increasing ratio of debt to income is ultimately unsustainable, and when consumers have to cut back spending, the economy crashes. A political-economy notion can enter into this argument too, since those who profit the most from the bubble may have the power to block regulations that might keep the financial sector from taking on so much risk.

Macroeconomic theories are hard to test. I’d love to be able to conduct a controlled experiment on the economy, re-running the last thirty years while holding inequality constant. Would we have had better educational outcomes, more middle-class spending with less debt, less influence of big money in Washington, and–most to the point–more sustainable economic growth? None of the theories linking inequality and growth are conclusively supported by the data, although Bernstein finds the credit bubble theory very plausible.

Supply-side theory proposes that inequality creates educational disadvantages, which in turn impede economic growth. The first part is well supported; for example, as the income gap has widened, so has the gap in college completion, as well as the gap in what households spend to provide private education and other “enrichment” experiences for their children. The impact on economic growth is not as clear however, since average educational attainment and worker productivity have both been rising for a long time, whether inequality was falling or rising. One can speculate that the economy would do even better if all segments of the population participated more equally in these advances [and even that an emerging high-tech economy depends on it], but the data reported here don’t really answer that question.

Demand-side theory says that the concentration of wealth and income reduces economic demand because the rich have a lower marginal propensity to spend. During the period of increasing inequality between 1979 and 2007, per-capita consumption grew a little more slowly than in the previous three decades, but the difference was only 0.2 percent. As in the case of educational advances, a general trend of rising consumption overshadows any growth constraints imposed by inequality.

However, the credit bubble theory provides an explanation for that. Economic demand can remain high despite rising inequality if consumers take on more debt. Especially after 2000, the housing boom financed by riskier lending made households with stagnating incomes feel wealthier and encouraged them to keep spending. So inequality may not slow down growth, but instead create a more volatile, unstable pattern of growth, with bigger booms and busts.

Cynamon and Fazzari, who wrote one of the major papers on credit bubble theory cited by Bernstein, put forth these facts in support of their theory: that after 1990 consumer spending rose more than income, that after 2000 the debt-to-income ratio rose dramatically for the bottom 95% of the population, and that this ratio became unsustainable when the housing bubble burst. They also calculate that if the share of income going to the lower 95% had not fallen, those households would have been able to support their increased spending without increasing their borrowing. Maybe other factors would have induced them to borrow too much anyway, but a role for inequality seems very plausible. Piketty and Saez wonder if it can be just a coincidence that both the Great Depression and Great Recession occurred after periods of rising inequality. Bernstein points out that inequality does not seem to be a necessary cause of financial bubbles, since bubbles have occurred in times of falling inequality as well. But it may be an important cause of certain very damaging ones.

With regard to the political-economy theories, it is easy to show that the rich often have a self-serving political agenda, such as favoring tax cuts for themselves. The theory does not say that they always have their way despite democratic resistance, or that the policies they endorse are always bad for economic growth. Research would have to proceed policy by policy, drawing on the other theoretical perspectives and empirical evidence as needed. Some policies raise fundamental economic questions, such as whether budget-balancing austerity measures hurt the economy by reducing aggregate demand, or help it by leaving more capital available for private investment. Bernstein acknowledges that many economists see a threat to growth and jobs coming more from efforts to combat inequality, such as by strengthening unions or raising the minimum wage. That made me wonder if there are credible theories that see positive rather than negative effects of inequality on economic growth. Another way of asking this is whether “trickle-down” economics has much serious intellectual support any more, or if it is mostly an ideological position popular with rich conservatives.

In the end, Bernstein reaches two main conclusions: First, that the research remains inconclusive even though some alleged negative effects of inequality on economic growth are plausible. Second, even if inequality turns out to have little effect on growth, excessive inequality is offensive for other reasons.

Fundamental American precepts–such as basic fairness, the conviction that opportunities and upward mobility should [be] available to all, and the social contract that links hard work and playing by the rules with a chance to get ahead–are at risk when inequality is where it is today. This will remain true no matter how inequality impacts macroeconomic growth.

In a previous post, I discussed Bernstein’s plea for pursuing full employment, with obvious relevance for both reducing inequality and stimulating economic growth.

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Posted by Ed Steffes

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