A few weeks ago, a Ted Talk that was presented by Nick Hanauer did not air, because the content was felt to be too political. What was the talk on? Income inequality. Though income inequality is not really groundbreaking news to anybody, what did make this particular talk quite incendiary (apparently) was the fact that it features a venture capitalist who proclaims that the rich are NOT job creators in the economy.
Republicans in America are particularly upset about higher taxes on the rich, claiming that the rich should be taxed at lower rates, since they will then go on to spend their money, open new businesses and create more jobs. In this way, the benefits received by the wealthy are believed to “trickle down” to the rest of the economy. But is it so?
Well, no. The trickle down theory is not new at all, and we have not seen it actually leading to lower inequality where it has been applied. In fact, Greenwood and Holt (2010) argue that income inequality in America has worsened after Reagan, who was a proponent of the trickle down effect. There does actually exist a negative trickle down effect, where the economy grows, but because wealth is concentrated, instead of income trickling down to the lower classes in a positive way, it influences them in a negative way. For instance, more conspicuous consumption from the 1% at the top places a lot of pressure on the rest to “keep up”, meaning that consumption patterns have to change in order to maintain a certain level of status in your job and community, and this is detrimental to the average, middle-class Joe’s welfare. The more concentrated wealth is, the less investment there is in public goods which are meant to be beneficial for the commons. This is because the wealthy elite oppose higher taxes and are unwilling to pay their share in order to ensure the commons (this is what we see happening with the Tea Party in America). This makes essential goods such as health and education even less affordable to the poor, widening the income gap further. So what, you might argue? Remember that inequality is in itself a market failure in an economy. It distorts the allocation of resources even more than they already are. As Stiglitz points out, young people flood universities in order to study finance, because they believe that this is where the money is and want to be part of the rich elite. What the economy would actually benefit from most, though, is more teachers, researchers and scientists.
Lan and Hegji (2009) find no evidence of a trickle down effect which benefits lower income groups in America. Qureshi (2008) also does not find evidence of this effect in Pakistan. The problem is that economic growth is once again confused with development – we want to argue that we should tax the rich at lower rates so that they can seize opportunities to grow the economy, which in turn will mean higher income and quality of life for other people lower down in the economy, but I have explained in previous posts why this is not so.
As Bill Maher states so very succinctly: “How else do you explain trickle down economics? They’re practically saying – we’re pissing on you.”
References:
Greenwood, D.T. & Holt, P.F. 2010. Growth, inequality and negative trickle down. Journal of Economics Issues, XLIV(2):403-410.
Lan, Y. & Hegji, C. 2009. A new look at the trickle-down effect in the United States economy. Economics Bulletin, 29(3):1743-1748.
Qureshi, M.A. 2008. Challenging trickle-down approach: Modelling and simulation of public expenditure and human development - the case of Pakistan. International Journal of Social Economics, 36(4):269-282.
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