A strong middle class supports inclusive political and economic institutions, which underpin economic growth This dynamic of a strong middle class boosts efficient and honest governance of an economy’s enterprises. In the U.S. context, less inequality and a stronger middle class support more inclusive political institutions and steer politics away from only responding to an economically powerful elite. This provides the foundation for more inclusive economic institutions, which, in turn, promote growth. This includes encouraging effective governance that supports broad-based economic growth through establishing secure property rights; investing in public goods and quasi-public goods, such as education, health, and infrastructure; and a level playing field, including transparent and accountable legal and regulatory structures. A strong middle class prevents the concentration and exploitation of power that led to entrenched privilege in aristocracies—the antithesis of dynamic societies throughout human history. The evidence of the role of the middle class in economic growth To be clear, we do not assert that the middle class is the only factor affecting economic growth. The price of capital, taxes, resource endowments, luck, chance, and other causes all have important roles to play. But after surveying the available theories and evidence, it is difficult to point to anything else so central to so many causes of economic growth as a strong middle class. This paper explains the most current, empirically grounded economic evidence showing how income distribution affects the efficient functioning and growth potential of our economy. In this paper the concepts of “inequality” and “middle class” are broadly construed. When we say “middle class,” we mean more than just families who are, broadly, in the middle of the income distribution. By middle class, we do not mean rich, but we do mean families with enough financial security to make ends meet, provide investments in the next generation’s success, and have a little margin of safety to boot. A middle-class family has some economic security, be that a good job with health insurance and a retirement plan, or some savings in the bank to tide them over in an emergency, send a child to college, or even float a loan to a family member who wants to start up a business. This is consistent with individuals’ perceptions: Surveys show that most Americans believe they are in the middle class, from those generally in the 20th or 30th percentile of the income distribution to the 80th and even above. Our conception of inequality is tied mostly to income, although there is a high degree of overlap between individuals with very high incomes and individuals with high net worth. Throughout the paper we examine the ways that either category affects economic growth. There are distinct ways in which each can relate to the growth potential for an economy. The security that a middle-class family provides goes beyond wages to include a sense of a longer time horizon for economic decision making than a family hovering on the edge of poverty, or the way that a middle-class child may be able to pursue a field of study suited to their interests. Nevertheless, given the interrelationship and overlap between the two, it makes sense to include both in our thinking as we discuss causal relationships with macroeconomic performance. Finally, we wish to make a note on our approach to the subject of the relationship of inequality and the strength of the middle class and U.S. economic growth. There is, of course, a rich literature on the relationship between inequality and growth. (see box on next page) Although there are many conflicting views, there is ample evidence that inequality can, in fact, hurt growth under many circumstances. But this literature focuses mostly on the experience of developing countries, and its applicability to the challenges currently facing the United States is not entirely clear. The United States is a developed economy at the edge of the technological frontier, with the highest levels of income inequality it has ever seen. Panel data studies analyzing how inequality affects growth across a range of countries are unlikely to tell us much about this unique situation. Thus, we have taken a different approach in this investigation. Instead of looking broadly at analyses of inequality and growth in other countries, we have looked at the evidence regarding the specific ways in which inequality and the strength of the middle class might affect economic growth in the U.S. context. If, in fact, there are specific ways that growth is affected, then it is reasonable to assume that there is a relationship overall. At the end of the day, the conclusions that economists come to about what makes an economy grow are important for how we understand the complexities of an economic system. Economists are often seen as the arbiters of credibility about what is good for the economy. Thus, sifting through how disparate pieces of the economic evidence fit together to tell a cohesive story about how inequality and the middle class affect economic growth is a critical and timely task. We turn now to examining in detail the leading channels through which the middle class impacts economic growth.
Posted on: Tue, 30 Jul 2013 23:58:48 +0000
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