Misdiagnosing Inequality And The Cause Of Middle-Class Woes

mark w. hendrickson

Responding to Nobel Economist Joseph Stilitz’s Yahoo.com Interview


In an interview posted on Yahoo.com (April 23), Nobel Prize-winning economist Joseph Stiglitz spoke about growing economic inequality and America’s shrinking middle class. Agreed, these are challenging and discouraging times for many, but as has happened before, Mr. Stiglitz provides a faulty explanation.

Stiglitz spoke fondly of the highly progressive tax code and lesser degree of inequality that followed World War II. Like his intellectual comrade, Thomas Piketty, he looks more favorably upon the Great Depression, with its greater poverty but lower measures of inequality, than the 1980s, with its significant improvements in standards of living for the non-rich accompanied by higher measures of inequality.

Stiglitz veers into historical revisionism by asserting that today’s inequalities originated during the Reagan years with its supply-side tax cuts that made the tax code less progressive and allegedly benefited only the rich. I would counter that there is a much more obvious cause for today’s sluggish economic growth and concomitant middle class struggles: Growth in government.

Stiglitz and I agree that standards of living improved after the end of World War II. He, though, implies that this prosperity was due to the more egalitarian progressive tax code of the era, with its top marginal rate of 91 percent. I know of no accepted economic theory that high taxes create prosperity. The real explanation for the post-war boom was that after years of suppressed consumer spending enforced by wartime rationing and the diversion of resources to the war effort, peacetime released a flood of pent-up demand as Americans made up for lost time. The huge decline in federal spending after the war (from 48 percent of GDP during the war down to 15 percent in the late ‘40s) released billions of dollars to the private sector which turbo-boosted a strong economic recovery.

Economic growth was more tepid in the 1950s. There were three mild recessions during the Eisenhower years, helping to tip the 1960 election to the Democrats. President Kennedy’s bequest to the American people was a tax cut that boosted economic growth in the mid-‘60s.

The foundation for today’s malaise was laid in the mid-‘60s when Lyndon Johnson significantly expanded the federal government by waging two expensive wars—the War on Poverty and the Vietnam War—while adding new federal entitlements (Medicare and Medicaid). Richard Nixon and Gerald Ford continued the spending binge, with an early casualty being the dollar’s gold backing, followed by rampant inflation and rising unemployment that made the 1970s a lost decade economically for many Americans.

The economic staglation of the 1970s was routed during Reagan’s presidency. His supply-side policies revived economic growth. For Stiglitz to claim that only the rich benefited from Reagan’s policies is egregiously contra-factual. The poverty rate fell and median incomes and net worth rose. The Reagan recovery (which carried on through the Clinton years with only mild pauses) was a boon to the American people. That being said, the failure of Reagan and the Democratic congress to halt the growth of government and to confine their spending to match government’s tax revenue deserve a share of the blame for our sluggish economy today.

Deficit spending took a welcome breather under President Clinton and a Republican House under Newt Gingrich, but the regulatory state continued to expand its growth-restricting reach on the economy. Then, during the economically disastrous presidencies of George W. Bush and Barack Obama, massive spending (much of it in response to the fallout from the government/Fed-engineered housing bubble and subsequent Wall Street bailout) and increasingly active regulatory agendas have diminished economic growth, thus reducing opportunities for the non-rich to make economic progress.

So here we are today, suffering a record-slow post-recession recovery resulting in fewer opportunities for economic advancement for non-rich Americans. Big Government produced an $18-trillion debt that has impelled the Federal Reserve to suppress interest rates, thereby delaying the needed adjustment of ending the fiscal malpractice of government over-spending and distorting capital markets. This, combined with a suffocating regulatory regime that wars against business has put us in the unusual and worrisome situation of businesses closing at a faster rate than new businesses are opening, thereby shrinking employment opportunities.

The cause of the current economic sluggishness that is “hollowing out” the middle class is Big Government. Repeated economic studies, such as the ones I cited in my book cataloging the errors in Thomas Piketty’s book on inequality, show the negative correlation between government spending and economic growth. Additional evidence is found in the Heritage Foundation’s Index of Economic Freedom, which shows that as Big Government has made our economy less free, growth has slowed.

Joseph Stiglitz’s diagnosis is flat-out wrong when he argues that the middle class is declining because the rich are getting richer. That zero-sum view is atavistic mercantilist nonsense. In a free market, transactions are positive sum, so individuals become wealthy in return for economically benefiting others. It is in the political marketplace where transactions are zero-sum—where wealth that benefits some comes at the expense of others. Indeed, we have a lot of that today in the form of bailouts, subsidies, boondoggles, and other forms of cronyism. If Mr. Stiglitz would oppose those growth-sapping cancers, I’d gladly make common cause with him, but for him to blame the rich instead of government for today’s problems reflects a partisan and ideological bias rather than objective economic analysis.

Because Stiglitz’s diagnosis is wrong, his prescription also is wrong. Raising taxes on the rich won’t improve the economic prospects of the non-rich. Shrinking the burden of government will.

Get your copy of Mark Hendrickson’s excellent: Problems with Piketty: The Flaws and Fallacies in Capital in the Twenty-First Century

Self-Educated American Contributing Editor, Mark Hendrickson, is Adjunct Professor of Economics at Grove City College, where he has taught since 2004. He is also a Fellow for Economic and Social Policy with The Center for Vision & Values, for which he writes regular commentaries. He is a contributing editor of The St. Croix Review, sits on the Council of Scholars of the Commonwealth Foundation, and writes the “No Panaceas” column in the Op/Ed section of Forbes.com. Mark’s published books include: America’s March Toward Communism (1987); The Morality of Capitalism (editor, 1992); Famous But Nameless: Inspiration and Lessons from the Bible’s Anonymous Characters (2011); and God and Man on Wall Street: The Conscience of Capitalism (with Craig Columbus, 2012). Mark Hendrickson’s Archives at Self-Educated American.