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Hindering growth

In the seemingly endless back-and-forth over income inequality, the debate typically is framed as a moral question: Is it right that most income goes to a small percentage of the population?

Less frequently is the issue framed in economic terms: Is income inequality hindering growth?

A new study by Standard & Poor’s Financial Services LLC tackles this question head-on, asking, “Would the U.S. economy be better off with a narrower income gap?”

The answer, the study’s author concludes, is yes: “The current level of income inequality in the U.S. is dampening GDP growth at a time when the world’s biggest economy is struggling to recover from the Great Recession and the government is in need of funds to support an aging population.”

Some degree of inequality is inevitable. Indeed, it can be the grease that keeps the economy running effectively, providing motivation to those who want to get ahead. But when the gap between rich and poor becomes excessively wide, it can choke growth.

Large income imbalances “dampen social mobility and produce a less-educated workforce that can’t compete in a changing global economy,” the Standard & Poor’s study notes. “This diminishes future income prospects and potential long-term growth.”

In fact, Standard & Poor’s has reduced its 10-year U.S. growth forecast to a 2.5 percent rate from the 2.8 percent rate it expected five years ago. Similarly, the Congressional Budget Office now predicts inflation-adjusted GDP will grow at an average annual rate of 2.3 percent over the next 25 years, versus 3.1 percent from 1970 to 2007.

The Standard & Poor’s study cautions against attempts to close the income gap that could do more harm than good. But its author says some measure of “rebalancing” and investment in areas such as education, health care and infrastructure could make a big difference.

The challenge is national in scope but evident at the local level too: From 2006 to 2011 in the city of Rochester, the mean household income of the poorest quintile dropped 6 percent while income for the top quintile rose more than 12 percent.

How much faster might the local economy grow with less income inequality?

8/8/14 (c) 2014 Rochester Business Journal. To obtain permission to reprint this article, call 585-546-8303 or email rbj@rbj.net.

One comment

  1. Michael Thornton

    It’s interesting that this issue is actually being acknowledged. Congress ignores it, business executives ignore it, the wealthy ignore it, and the media ignores it, at least until recently. It appears now that the release of Thomas Pikiety’s book and this S&P research that what has been an historical known—income injustice/inequality—leads to a poorer population and a poorer running economy.

    Of course, trying to convince a GOP congress that lifting the poor and middle class and fairly taxing the wealthy is good economic policy flies in the face of their 40 year battle to enforce the destructive trickle down, voodoo economic plan. If you look at the past 40 years since that policy has been enforced, the poor and middle class have greatly lagged the wealthy in most economic indicators and that gap is only widening today.

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