Tag Archives: growth

It’s a fact: inequality slows growth

My latest in Salon cites new research on the inequality and growth debate. Toward the end to the piece, I discuss the political implications of the findings:

First, we should not assume that the mere fact that inequality reduces economic growth will be enough to convince the rich to reduce it. 

On Twitter, @richisglorious objects:

 

Initially, I was tempted to respond simply that this is a slightly pedantic point – my argument is that even if the wealthy accept the proposition that inequality reduces growth overall, they may still oppose redistribution for other reasons.

As I thought about the question though, I realized the sentence is true: inequality reduces growth. To see why, simply imagine a perfectly unequal society where one person controls all income and everyone else has nothing. There will be no economic growth. Imagine a slightly less unequal society, where ten people control nearly all the income, and everyone else struggle to survive. Again, no growth. The question then, is not whether inequality reduces growth, it’s at what point inequality reduces growth.*

The evidence I summarize in my essay strongly suggests we might be at the point. Other research suggests this as well. But let us not re-litigate this and instead make an important distinction between good inequality and bad inequality.

In my interview with Branko Milanovic, we discussed this distinction. He tells me:

These two extremes [absolute inequality and absolute equality] are clearly not good. We know that the optimum must be at some point in-between. Now, we don’t know what it is. Is this the Gini of “X” or “Y”? We have no idea, but we have in mind a certain “good” range simply by observing things empirically or, sort of, heuristically looking at the world. We see that there are countries that do well economically and socially and what type of inequality they have. Moreover, we have now studies, and I’m quite encouraged by them, which  for the first time try to empirically ascertain what percentage of overall inequality is caused by so called bad inequality. And that leads us to the issue of “deserved” and “undeserved” inequality and social mobility.

The bad or undeserved inequality would be the one that arises from the factors over which you have no control: what was the income level of your parents, whether you were born male or female, what is your race, and things like that. Actually, these studies do show that, in some countries, a large chunk of inequality is due to these factors. Thus we can rank countries by their bad and good inequalities. The good inequality, calculated as the residual between overall and bad inequality, is inequality we effort, work, luck and so on.**

The studies to which he refers can be found here and here. They find, after studying Europe and the United States, that inequality which stems from factors beyond an individual’s control (father’s education/race) are correlated with lower growth. Their study of 23 U.S. states over a two decade periods finds, “Inequality is good for growth when that comes from differences in the returns to effort, while it is harmful for growth when that comes from differences in opportunity.” They also find a strong correlation between changes in total inequality and inequality of opportunity.

Inequality and Opportunity

I believe that there are persuasive reasons to believe that the much of the exploding income inequality in the U.S. is due not to the good inequality, but bad inequality. As inequality increases, the opportunities for rent-seeking through the political system, education system and labor market become greater.

It is also worth noting that good inequality quickly become bad inequality unless mitigated (see: Walton family). Call it the The First Law of Inequality: inequality tends to perpetuate itself unless acted upon by an outside force. Estate taxes and capital gains taxes can limit such rent-seeking.

To summarize: in a state of perfect inequality, there will be no growth. In the state of perfect equality there will be little growth. At some point, inequality will become high enough to choke off growth, mainly by reducing demand and opportunity. Most of the research here is being done by economists who aren’t as cocky as Reinhart/Rogoff and therefore uncomfortable declaring a cut-off point. Instead, we’ll have to use Potter Stewart’s maxim: “I know it when I see it.” I think we see it.

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* We might have a similar thought experiment with perfect equality, in which no one is motivated to work since they earn the same amount as everyone else. Even if we assume that Amour-propre provides some incentive, we can assume growth would be slower.

** The full interview will be available next week on the Demos Policyshop blog.

What if economic growth is no longer possible in the 21st century?

Co-Written with Lew Daly.

For decades, rapid economic growth has been the norm for developed countries. An educated workforce, a large population boom, major technological advances, and abundant fossil fuels were the key components of growth, generating substantial and broadly distributed increases in standards of living in many countries. We have grown so used to such growth that we inevitably view it as a panacea for a host of economic ills, whether it’s a deep recession or income inequality.

We now understand, however, that the postwar growth paradigm is not environmentally sustainable. We also know that the shared prosperity it once delivered is itself unraveling. With these combined trends, something has to give in order to maintain living standards.

One possible scenario, with surprisingly good news for average Americans, is that constraints on growth will force political leaders to accept redistribution as a policy tool. Indeed, if we cannot grow our way to broadly shared prosperity again, redistribution is the only way to save the middle class.

Many economists have warned that the old model is dying out. In a much-cited paper, Robert Gordon argues that the rapid growth we take for granted is not only historically anomalous but likely to slow significantly in the 21st century, pointing in particular to diminishing returns from technology as one major drag. Developed countries have already picked the “low-hanging fruit” of technological advance (in Tyler Cowen’s phrase), and future innovations will produce far less growth, he argues.

Steven King, chief economist at HSBC, similarly argues, “The underlying reason for the stagnation is that a half-century of remarkable one-off developments in the industrialized world will not be repeated.” Gordon also points to rising inequality, which has led to stagnating middle-class wages, as a drag on future growth. As a result of these trends and others, average annual growth will fall below 1 percent in the 21st century, he predicts.

Then there is the impact on the global economy that will result from combating global warming. Working from a conservative carbon budget of 450 parts per million (PPM), Humberto Llavador, John Roemer, and Joaquim Silvestre predict that achieving this target will require a substantial slowing of growth, mainly borne by the United States and China. The U.S. and China must keep growth within the threshold of 1 percent and 2.8 percent of GDP per year, respectively, for the next 75 years, they say.

In an interview, Roemer tells us that these results are optimistic; after all, some economists have argued that growth may not occur at all. In the paper, the three argue that “there is no politically feasible solution to the climate change problem unless” both the U.S. and China “honestly recognize the connection between restricting emissions and curbing growth.” In contrast, the Congressional Budget Office’s long-range analyses use a growth projection of 2.2 percent on average over the next 75 years.

Other economists have come to similar conclusions about the connections between growth and sustainability. Early in 2012, Kenneth Rogoff argued that maximizing growth must be weighed against the negative possibilities of growth, like global warming. Indeed as James Gustave Spethnotes, environmental impacts are the most significant challenges to growth: “Economic activity and its growth are the principal drivers of massive environmental decline.”

Growth constraints will push the issue of distribution to the forefront of political discussions. In his forthcoming book Capital, Thomas Piketty predicts that growth will slow to between 1 and 2 percent — 19th-century levels — by the end of the 21st century. This trend, he further argues, will be accompanied by higher returns to capital and lower returns to labor, thereby exacerbating inequality.

The conclusions that flow from these observations are stark. The old economic paradigm relied on unsustainable growth, so we must change the paradigm. For decades, our rising standard of living came at a deep cost to our environment and our children’s future. There is simply not enough planetary bio-capacity to grow our way out of the messy moral discussions of distribution. The idea that inequality is merely an inefficiency to be corrected with a technocratic fix or perpetual growth is no longer tenable.

Fortunately, we have plenty of GDP that could help the middle class, with approximately $200,000 a year potentially available for each family of four. Given that the median family of four only gets about $67,000 a year at this point, it should be clear that it is possible to grow and strengthen our middle class, significantly, while adjusting to the lower GDP growth we are likely to experience in the future.

The question is, will political leaders accept the need for distributional remedies, or will they continue to side with the wealthy against the struggling middle class?

Originally published on The Week.

Natural Gas Will Not Save the U.S. Economy

Co-Written with Lew Daly

Economist Kenneth Boulding famously said, “Anyone who believes exponential growth can go on forever in a finite world is either a madman or an economist.” But it’s not just economists who believe that anymore. Such ideas are still widely accepted by thought leaders, journalists, and politicians who, together, form a strong consensus that the U.S. recovery should be bolstered by natural gas exploration and production. The McKinsey Global Institute claims in a recent report that a natural gas boom is one of the most important “game changer” ideas for U.S. economic growth, while The Economist writes, “Become a champion of a global fracking revolution, Mr. Obama, and the world could look on America very differently.” And in his recent State of the Union address, President Barack Obama said “I’ll cut red tape” for factories that use natural gas, and that “Congress can help by putting people to work building fueling stations that shift more cars and trucks from foreign oil to American natural gas.”

But the belief that natural gas can be a “bridge fuel,” allowing us to grow rapidly in the age of global warming, is fit for a madman.

The current consensus is that if global temperatures rise more than 2 degrees Celsius above preindustrial levels, the consequences would be catastrophic (the Arctic melt would raise sea levels by tens of meters). So scientists have proposed a “carbon budget”: the total amount of carbon dioxide that can be released into the atmosphere without raising temperatures by 2 degrees. Using a conservative carbon budget of 450 parts per million—which has been endorsed by the International Energy Agency and Britain’s Stern Review—economists Humberto Llavador, John Roemer, and Joaquim Silvestre have thrown cold water on the idea that natural gas is our nation’s economic savior. In a forthcoming paper, they argue that given that budget, the world’s two largest CO2 emitters, the U.S. and China, must keep GDP growth within the threshold of 1 percent and 2.8 percent of GDP per year, respectively, for the next 75 years.

These results may sound surprising, but they are in line with a growing body of research on stranded carbon assets, which are assets such as fossil fuels (oil, coal and natural gas) that will lose their value well before they’re expected to. This can happen as a result of, say, market disruption (rapid advances in green technology like wind and solar polar or divestment) or government regulation (a carbon tax or stricter fuel economy standards). That latter is more likely because, even now, we have found way more fossil fuels than we could possibly burn without inviting long-term environmental disaster.

The Intergovernmental Panel on Climate Change’s carbon-budget model, widely considered the most reliable, puts the budget for 2012-2100 at between 886 and 1119 gigatons of CO2. Total known fossil fuel reserves in the world, if burned, would add 2860 gigatons of CO2 to the atmosphere. Thus, simple math indicates that almost two-thirds of all known fossil fuel reserves must remain unburned if global temperatures are to remain habitable. And these are optimistic estimates. James Hansen of the Columbia Earth Institute and other leading scientists and economists argue that all extraction of coal and other unconventional fossil fuels, like the Canadian Tar Sands, must cease immediately and the extraction of conventional fossil fuels, like oil and natural gas, must be significantly pared down.

Projects like the Keystone XL pipeline and other attempts to revive the U.S. economy based on fossil-fuel extraction are the equivalent of running up billions in debt and then running off to borrow more. The international community is already blowing through its carbon budget; the IPCC predicts that given “business as usual,” we’ll burn 1,000 gigatons of CO2 between 2012 and 2033, depleting the more conservative budget entirely and nearing the upper bound. We’ve already seen the consequences of temperatures growing by less than one degree Celsius, yet we’re on track to see themrise by more than six degrees by 2100. Our current trajectory tempts ecological and economic collapse, and yet, many are arguing that we accelerate the process.

Part of the problem is that our measure of growth, GDP, does not take into account the costs or sustainability of growth. One billion dollars of growth in the production of solar energy is not the same as $1 billion produced by coal in terms of ecological harm and sustainability, but GDP counts them equally. Instead we should measure progress using more extensive metrics like the Genuine Progress Indicator, which factors the impact of greenhouse gas emissions into its calculations. Further, we should institute a carbon tax, preferably an international one. Some companies currently price carbon internally—meaning that they put a price on the carbon produced by their projects, and subtract that from any expected returns—but do so at widely varying rates. A Carbon Disclosure Project study finds that nine of the largest energy companies in the United States internally price carbon dioxide emissions, at a cost ranging from $15 per ton (Devon) to $60 per ton (ExxonMobil). Governments should consider the social and environmental cost of carbon dioxide when they are making infrastructure and research investments, regulating extractive industries like fracking and offering tax incentives. Against the EPA’s recommendation, the State Department decided not to consider the social cost of carbon in its analysis of the Keystone pipeline.

The State Department also didn’t consider the very likely possibility that the pipeline will become a stranded asset. We can only hope it will—because that would mean we’ve finally learned that if we don’t live within our carbon budget, the long-term ecological and economic harm caused by our relentless extraction and burning of fossil fuels will obviate any short-term benefits to the economy. If we build our recovery on natural resources that need to remain underground to keep global temperatures stable, then we’ll be like the foolish builder in the Gospel of Matthew “who built his house on sand. The rain came down, the streams rose, and the winds blew and beat against that house, and it fell with a great crash.”

Originally published on The New Republic.

Why more GDP might not make us happy

Eugenio Proto and Aldo Rustichini have written a new column for VOX in which they argue that once GDP per capita reaches a certain level, it actually begins to correlate with lower life satisfaction.

Of course, this result shouldn’t be too surprising; GDP is a measure of economic production, and an excellent measure at that. But as Robert Kennedy noted in his 1968 speech,

Our Gross National Product [a measure of economic production that considers ownership rather than geographic location], now, is over $800 billion dollars a year, but that Gross National Product – if we judge the United States of America by that – that Gross National Product counts air pollution and cigarette advertising, and ambulances to clear our highways of carnage. It counts special locks for our doors and the jails for the people who break them. It counts the destruction of the redwood and the loss of our natural wonder in chaotic sprawl. It counts napalm and counts nuclear warheads and armored cars for the police to fight the riots in our cities. It counts Whitman’s rifle and Speck’s knife, and the television programs which glorify violence in order to sell toys to our children.

Simon Kuznets, the Nobel-prize winning economist who developed GDP, wrote in The New Republic, “Economic growth involves a variety of costs that must be recognized. Because of this, “goals for ‘more’ growth should specify more growth of what and for what.”

When people talk about GDP, they rarely understand the limitations of GDP as a measure of progress. GDP does not account for the social or environmental consequences of growth, nor the economic sustainability of growth. It doesn’t consider whether we’re producing bombs or butter. It doesn’t consider whether our economic growth may be coming at the expense of consumer safety, a worrying problem in the wake of thecontaminated water in West Virginia.

For poor and developing countries, positive GDP growth serves as a proxy for eliminating immiseration. For a developed country, immiseration is not as great a threat, and environmental and social sacrifices that may have been tolerated for growth are no longer countenanced. Already countries like Brazil, China and India are worrying about the environmental consequences of untrammeled growth. In American, people want more time with their families and shorter commutes.

A better measure of what matters is the Genuine Progress Indicator (GPI), which takes into account 26 economic, social and environmental indicators. States across the U.S. are beginning to implement GPI, and they’ve discovered that much of their recent GDP growth hasn’t budget the GPI. Here’s what it looks like in Vermont:

Eric Zencey, a key architect of Vermont’s move to GPI and one of the economists who is developing it with the Gund Institute, told me, “sound business practices requires deducting costs from benefits. We can change the conversation to what matters.” Here’swhat GPI looks like for the U.S. as a whole:

This helps explain why GDP is divorced from life satisfaction for developed nations.

ALEC-Laffer Ranks Are About Ideology, Not Economic Policy

The American Legislative Exchange Council (ALEC) released its 2013 Rich State, Poor State rankings report in May. The report ranks states by “economic outlook,” but by the report’s standards a positive economic outlook  is narrowly defined by the extremity of regional anti-worker laws and regulations. ALEC’s metrics are more concerned with ideology than economic growth, prioritizing twisted value judgments over facts.

ALEC’s selective reasoning is blatantly obvious in its ranking of Mississippi as the state with tenth strongest economic outlook, largely because of low taxes, low minimum wage, and weak unions. ALEC’s rosy outlook on Mississippi is in stark contrast with this description of Mississippi from The Economist:

Mississippi spends less per student on education than all but four other states. It has a law that directs extra funds to schools in poor counties, but has not complied with it, [David Jordan, a state senator from Greenwood] complains, shortchanging the neediest spots by a billion dollars over the past four years. In all the states of the region and at the federal level, [Christopher Masingill, joint head of the development agency Delta Regional Authority] concedes, budgets for education and development have been getting skimpier.

The Mississippi Delta is in a particularly bad position, The Economist further reports: “The entire county has ten private businesses (other than farms), employing just 99 people. Like the region as a whole, it suffers from low rates of education and high rates of obesity and diabetes.”

ALEC’s ranking bears little resemblance to reality.  A recent report by Peter Fisher finds that ALEC, “fails to predict job creation, GDP growth, state and local revenue growth, or rising personal incomes.”

Another example of the report’s failure is the fact that this year’s BEA numbers show the economies of Washington, Oregon, California and Utah growing at about the same rate.  Why  does ALEC rank Utah as number one, while Washington is 36, Oregon is 44, and California is 47? The only reason for these rankings is a  bias against progressive economic policy. Utah is bolstered by its anti-unionism, low workers compensation payments, low minimum wage, and regressive tax system. The other states, although growing just as quickly, are held back in the ALEC report by their liberal policies.

The purpose of these rankings is to push the ugly legislative agenda of ALEC, which gives a state like Wisconsin, with disturbingly low growth rates but shown a penchant of anti-unionism, a gold star while more union-friendly states get hit with low marks. ALEC assumes that taxes drive wealthy people out of state, decreasing tax revenues. That’s false. Lower taxes will bring in more revenues? That’s false. Estate taxes reduce growth? That’s false.

The worst thing about the rankings isn’t the blatant partisanship masquerading as rigorous analysis.  State governments take these rankings seriously, and change policy accordingly. When Peter Fisher analyzed how states that followed ALEC’s prescriptions performed, he found the states were more likely to see a decline in median family income and an increase in poverty. The purpose of ALEC’s rankings is not to promote growth, but to give conservative legislators’ intellectual credibility. Look, they have white papers too!

ALEC’s lobbying goes practically unopposed in some states because the American labor movement is a shell of its former self. The Organization for Economic Cooperation and Development (OECD) data for 2008 (the most recent year for which all countries are available) shows that the unionization rate for America is far below average. This means that in America we have two parties beholden to corporate interests and no counterbalance. Is it any wonder that Larry Bartels found in 2005 that politicians respond almost exclusively to the preferences of wealthy voters and ignore the needs of poor voters?  There should be no surprise that lower unionization rates correlate with higher levels of inequality.  But if the union movement in America remains suppressed by powerful corporations, it’s hard to imagine anything other than ALEC-style legislation winning the day.

Originally Published on Alternet.org

Contact Sean at: seanadrianmc@gmail.com