Inequality is bad for business

This afternoon, the State Chamber of Oklahoma is hosting a public affairs forum with a keynote speech titled “Defending the Dream: Why Income Inequality Doesn’t Threaten Opportunity.” The speech will be delivered by David Azerrad from the Heritage Foundation, who co-authored a report which claims that we shouldn’t care about income inequality and that those who do are just envious of the rich.

In the real world, a large body of research shows that rising inequality is dangerous for all of us. Over the past few decades, inequality in the U.S. has risen to extreme levels, and it has already reached at point at which it is hampering economic growth, creating economic instability, and damaging our human capital.

Inequality threatens American opportunity for these reasons:

1) Inequality has grown to dangerous extremes.

A favorite argument of supply-side economics is that both zero percent and 100 percent tax rates would produce no revenue. A revenue-maximizing tax rate avoids both the high and low extremes.

The same argument can be applied to inequality. As Jonathan Rauch wrote, “At both extremes of inequality—either perfect inequality, where a single person receives all the income, or perfect equality, where rewards and incentives cannot exist—an economy won’t function.”

So how much inequality is too much? While the exact number may be impossible to calculate, our history contains strong evidence that we already on the high side of the curve. The share of income going to the top 1 percent of earners has reached its highest level since just before the Great Depression.

Most of that build-up of inequality has happened since the late 1970s. Over the past three decades, incomes for the bottom 90 percent of households have risen only slightly, while the incomes of the top 1 percent have soared. Likewise in Oklahoma, poor and middle-class families have seen little income growth since the late 1970s, with nearly all of the gains going to the wealthiest households.

2) Extreme inequality slows overall growth.

Those who defend extreme inequality rely on the essential premise that a larger share of the pie going to the wealthiest doesn’t matter, because their contributions make the whole pie grow enough that everyone benefits.

That may sound plausible in theory, but if we look at the real experience in the U.S. and other countries, the premise fall apart. A study by economists at the International Monetary Fund found that across numerous countries, more inequality was correlated with shorter periods of growth and thus, less growth over time. The effect they found was quite strong — a 10 percentile decrease in inequality increased the expected length of a growth spell by 50 percent. Numerous other studies have found similar results.

Part of the reason is that the most prosperous economies are propelled by strong, middle-class consumer demand. The supply matters too – we need investment capital and lenders willing to provide it – but there needs to be a balance. In today’s economy, corporate profits as a percentage of GPD are at record highs as wages have fallen to record lows. The high profits mean we have no shortage of investment capital, but we do have a shortage of demand for the goods and services that those  investments create. The wealthiest have more money than useful things to do with it, while poor and middle-class workers with stagnant wages can’t afford to buy.

3) Extreme inequality creates instability.

So extreme inequality leaves us with huge amounts of capital without enough useful new businesses to invest it in. At the same time, millions of regular people must borrow to maintain their purchasing power.

We’ve recently seen what happens next. To take advantage of the excess capital, the financial industry invented or greatly expanded the use of risky investment vehicles – like subprime mortgages and mortgage-backed derivatives. To compensate for stagnating incomes, ordinary homebuyers went into heavy debt. When this housing and credit bubble popped in 2008, the whole economy fell apart.

Thus extreme inequality promotes a cycle of bubbles and busts. It is no coincidence that inequality ramped up before the Great Recession, just as it did before the Great Depression. Inequality was a major cause of the U.S. financial crisis.

4) Extreme inequality reduces productivity.

The greatest asset of any economy is the people in it, but extreme inequality is causing our human capital to deteriorate. As wages for the poor and middle-class stagnate, those at the bottom have a harder time obtaining an education, suffer worse health outcomes, and are more likely to end up incarcerated.

Businesses in Oklahoma already face a large projected shortage of skilled workers, and research shows that it’s harder to get ahead in Oklahoman than most other states. We are losing the talents and potential productivity of those who aren’t contributing what they might have with better opportunities.

Extreme inequality is harming our human capital, hampering the consumer demand needed to fuel sustainable growth, and creating a painful cycle of bubbles and busts.  It is a major threat to our state’s future prosperity. As this recent OK Policy report outlining an equity agenda for Oklahoma argued:

Wealth, income, and asset disparities keep too many Oklahomans financially vulnerable to shifting economic winds and unable to save and build assets for a prosperous future for their families. … Taking steps to ensure that all Oklahomans fully participate in the economic mainstream will benefit everyone.

We may continue to debate the best way to address this problem, but we must stop denying that it exists. The growth of inequality is bad for business and bad for all Oklahomans.