Another Alarming Failure of “Reagan” Economics

Except for a few Republicans stuck in the quagmire of Reaganesque , fallacy-riddled, supply-side economics, we know now that trickle-down economics simply does not work and never has.

For proof, one merely has to look at the plethora of independent data that has flooded both economists’ observations and leading publications for more than two decades.

For at least the past decade in the United States incomes at the very top have soared, while the earnings of the middle class has stagnated or declined. More interestingly, a growing body of academic research is promulgating that this previously-believed benign theory has a distinctive Mr. Hyde aspect that is emerging.

In fact, this phenomenon that two economists have dubbed ‘‘trickle-down consumption,’’ is having a powerful impact on the economy and politics of the United States.

The idea is that income inequality has a significant, deleterious impact on the 99 percent: It drives the rest of us to consume more, often beyond our means.

Occupy Wall Street Together. We are 99%. Poster.

Occupy Wall Street Together. We are 99%. Poster. (Photo credit: Wikipedia)

Robert H. Frank, an economist at Cornell University and columnist for the New York Times, is a pioneering student of this behavior. Professor Franks has been writing about the subject for nearly two decades, long before it became fashionable. Frank, who is the co-author of two economics textbooks with the Federal Reserve chairman, Ben Bernanke, believes that rising income inequality affects the rest of us through what he calls ‘‘expenditure cascades.’’

Professor Frank has been documenting that rising income inequality isn’t merely about the income gap between the 99 percent and the 1 percent; far from it.

It is also about growing differences across the entire breath and length of income distribution, including at the very top. The result is that we all see people we think of as our peers earning, and yes, spending much more than we would were it not for the “cascading” effect that we feel.

‘‘The main idea is that frames of reference are very local,’’ Frank said. Contrary to the ridiculous notion expressed by candidate Romney, ‘‘Bertrand Russell said beggars don’t envy millionaires, they envy other beggars who have a few more coins than they do. Expenditure cascades aren’t because the poor want to emulate the rich, they merely want to be on par with their peers.’’

Instead, he argues, each of us imitates those near us – and the result is a cascade of unaffordable consumption.

‘‘There has been extraordinary growth in the 1 percent,’’ Frank said. ‘‘Ordinary people don’t want to emulate them, but what happens is that the people who are next to them want to emulate them, and so on. That social cascade ultimately explains why the middle-class home got 50 percent bigger in the past three decades.’’ (Frank says that the average U.S. house went from 1,570 square feet, or 146 square meters, in 1970 to 2,300 square feet in 2007.)

This cascading increase in consumption might be considered benign effects, such as everyone working harder and more women entering the workforce. But it can also have malign ones. In ‘‘Expenditure Cascades,’’ a paper Frank wrote with Adam Seth Levine and Oege Dijk, the three show that more bankruptcies, a higher divorce rate and longer commutes all correlate with increased income inequality.

Marianne Bertrand and Adair Morse  support this view in a draft study that is attracting a lot of attention by the two University of Chicago economists. They coined the term ‘‘trickle-down consumption,’’ and in their paper of the same name they find that higher spending, bankruptcy and self-reported financial distress all increase if you live in a community with higher income inequality, compared with one with lower income inequality.

How Did We Not See This Coming?

“Expenditure Cascades” and “Trickle-Down Consumption” offer valuable insight into a major mystery of the past few decades.

In U.S. politics, and unrecognized until recently, income inequality has been on the rise since the late 1970s. It is only since the most recent financial crisis that it has gained any real attention by the general public or for that matter, academia. It’s posited that increased consumption actually shrouded the extent of the growing inequality. Overspending by the 99 percent meant the 99 percent neither noticed that the 1 percent was pulling away, nor to the extent to which it was occurring.

Bertrand and Morse offer ample empirical evidence of a key element that disguised these trends. In areas with higher income inequality, politicians were more likely to support measures to make consumer credit cheaper and more easily available. Income inequality wasn’t discussed much before 2009, but people felt it. With America being a democracy, the political system worked to soften it so that consumers would remain satisfied and less likely to seek change. Interestingly, because inequality grew at a time when overt redistribution was falling out of favor, politicians made it easier to borrow.

If you think the American middle class had too much debt before the crisis, and if you buy the notions of expenditure cascades and trickle-down consumption, the bad news is that the cycle may be about to start all over again. Ipsos MediaCT, a research firm, does a monthly poll of a group it describes as ‘‘the affluents,’’ or those consumers with a household income of more than $100,000. Their February, 2012 survey showed this group is poised to hit the stores again.

‘‘We have seen for some time what people call frugal fatigue,’’ said Steve Kraus, chief research and insights officer for Ipsos MediaCT. ‘‘Last month it jumped up from about a quarter to a third. They want to revisit the glory days of 2005 or 2006, when they could just buy something nice and treat themselves and not worry about it.’’

Occupy Wall Street Strikes Again

But credit is a lot tighter today than it was before 2008, so how will those who aren’t affluent cope when consumption at the top again becomes conspicuous? The alternative to easy credit for the poor is higher taxes for the rich. Surprisingly, Kraus found that his affluent respondents were willing to pay up. Nearly 60 percent were in favor of higher taxes for the rich and nearly 40 percent sympathized with Occupy Wall Street.

“The past 40 years have been the best 40 years for rich people in the history of rich people,’’ Kraus said. ‘‘There is a recognition that we’ve had a pretty good run and now something has got to be done.’’

Even at the very top, though, there turns out to be a class divide. Households with an income of more than $250,000 are far less supportive of higher taxes and more hostile to Occupy Wall Street.

‘‘When you get to the really high-end folks, you get more of a strident conservative,’’ Kraus said.

Just in case you wondering, it is this group of voters in the Republican primaries that have gone overwhelmingly into the voting booths and pulled the lever for one of their own….Willard Mitt Romney.


Harvey Gold


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