Inequality and Growth

I have a new paper out with Dan Andrews and Christopher Jencks, on the relationship between inequality and growth. We reach a finding that is pretty standard in this literature – when we restrict the sample to 1960-2000, more inequality seems to be good for growth. However, if the inequality arises from a transfer from the bottom 90% to the top 10%, we’re skeptical that the bottom 90% get enough back in growth to make up for their loss in share.

Here’s the abstract:

Do Rising Top Incomes Lift All Boats?
Dan Andrews, Christopher Jencks & Andrew Leigh
Pooling data for 1905 to 2000, we find no systematic relationship between top income shares and economic growth in a panel of 12 developed nations observed for between 22 and 85 years. After 1960, however, a one percentage point rise in the top decile’s income share is associated with a statistically significant 0.12 point rise in GDP growth during the following year. This relationship is not driven by changes in either educational attainment or top tax rates. If the increase in inequality is permanent, the increase in growth appears to be permanent, but it takes 13 years for the cumulative positive effect of faster growth on the mean income of the bottom nine deciles to offset the negative effect of reducing their share of total income.

The paper was written up in the Wall Street Journal last Tuesday, under the headline “Trickle-Down Economics Fails to Deliver as Promised”. Here’s a snippet:

The paper does not argue that trickle-down economics is without merit. It’s just that it doesn’t appear to generate enough bang for the buck. It was written by Harvard’s Dan Andrews and Christopher Jencks, and Australia National University’s Andrew Leigh.

“Increases in inequality lead to more growth,” the paper’s authors wrote. “There appears to be some trickle-down effect in the long run, but since the impact of a change in inequality on economic growth is quite small, it is difficult to be sure from our estimates whether the bottom 90% will really be better off or not.”

In an interview, Jencks said it’s a real challenge to gather the information needed to determine whether trickle-down economics works as its advocates believe.

But he concludes the evidence shows “it certainly didn’t deliver as much as many said” and to the degree it did work, “the effects are really small.”

The paper’s findings were based on data from 12 developed nations, observed over most of the last century into the current century.

Trickle-down economics’ day is probably done, for now at least. The financial crisis will bring not just stricter regulation and tighter oversight for many markets. The massive budget deficits that the U.S. will be left with as a consequence of the bailouts and economic stimulus spending will require tax hikes that are likely to reach beyond the rich.