On Tuesday, Standard & Poor’s released a new research report entitled, “How Increasing Income Inequality Is Dampening U.S. Economic Growth, and Possible Ways to Change the Tide.” Despite its much-discussed conclusions, the report is fraught with flaws. Like many discussions of inequality, it describes a number of real economic problems related to growth and opportunity but fails to persuasively connect them to income inequality, assuming much of what it purports to demonstrate.
Much of the report is dedicated to describing inequality of educational outcomes between rich and poor children—inequalities it says will lead to diminished economic growth and declining economic mobility. Like many before it, S&P cites the research of Staford University sociologist Sean Reardon, who analyzed a number of questionably comparable studies with test scores measured at different ages. Reardon’s now-famous chart connects the data points from these studies with neatly-smoothed trend lines to argue that the test score gap between rich and poor children is growing.
Set aside the obvious point that the parental income gap between children is correlated with countless other inequalities—in parental skills and values, family structures, social networks, neighborhood resources—and that any of those gaps could be driving the pattern Reardon shows. In a recurring pattern, S&P fails to note important research that directly addresses and overturns the Reardon result. University of Chicago professor Eric Nielsen carefully addresses the measurement issues in treating test scores as indicators of achievement and finds that the achievement gap between rich and poor children has narrowed over time.
Not only does S&P fail to establish that child inequalities are due to income inequality, it claims against the totality of the evidence that “income imbalances tend to dampen social mobility.” Despite repeated attempts by the Obama Administration and others over the past three years to link income inequality and social mobility, the case today is in tatters. Correlation does not imply causation, but even the correlation between inequality and mobility across countries, across American labor markets, and over time within the United States is minimal, in doubt, or both. Most devastatingly for S&P, the evidence indicates that mobility has changed little in decades despite income concentration rising. (Inequality between the poor and middle class, meanwhile, hasn’t grown since the 1980s.)
A feature of the S&P report is its parroting of arguments routinely made by others arguing that inequality is the defining challenge of our time. Predictably, the report cites research from the International Monetary Fund relating inequality to economic growth across countries. One of these papers is largely confined to developing countries, where the relationship between inequality and growth is irrelevant to the rich, democratic, redistributive nations of Europe and the former British Empire.
The other is more inclusive but relies on correlations of the sort that have proved so fragile in the case of the inequality-mobility link. A basic problem with this research is that developed and developing countries are so fundamentally different they ought to be analyzed separately. Scholars who have done so, including Christopher Jencks and Lane Kenworthy, find that changes in inequality either have no correlation with economic growth or that increasing inequality raises growth. Even the Center for American Progress, the progenitor of the new Washington Center for Equitable Growth, has conceded the ambiguity of the research in multiplereports.
Just as predictably, S&P cites Michael Kumhof and Romain Ranciere to argue that inequality caused the “massive, systemic financial [crashes]” in 1929 and 2008, with no mention of the paper by Michael Bordo and Christopher Meissner debunking their research. Rising inequality tends to occur at the same time as credit bubbles, but it is the bubbles themselves that lead to crises, as their careful research shows.
Just as predictably, the S&P report cites research arguing that because the rich are less likely to spend additional income, rising income concentration saps consumer demand and hurts growth. But this research fails to acknowledge that investing income rather than spending it would be expected to increase economic growth in the medium to long run.
Along the way, S&P gets a lot else wrong too:
•The report exaggerates the decline in the value of the minimum wage by using a cost-of-living adjustment widely known to overstate inflation. It neglects to note that the fraction of workers making the minimum wage has fallen significantly while the tenth percentile of hourly wages has risen slightly over time.
•The report cites French economist Thomas Piketty to argue that inherited wealth has grown in importance over time, but Piketty’s data are for France, and Lena Edlund and Wojciech Kopczuk of Columbia University present evidence that inherited wealth is actually becoming less important in the United States.
•The report says that taxes and transfers have done little to reduce inequality in the United States even though Congressional Budget Office data show that inequality is 25 percent lower after redistribution than before.
•It says that benefits for “programs that largely benefit the poor were also reduced,” after 1979 but they have grown sizably.
Overall, the S&P report on inequality lacks empirical backbone. S&P chief economist Beth Ann Bovino stated, "One of the reasons that could explain this pace of very slow growth is higher income inequality. And that also might also explain what happened that led up to the great recession." Yes, but so could many other factors. Like many inequality spot-lighters before, S&P raises a number of important economic challenges, but with barely a thread of a connection to income inequality established. Worst of all, the inequality spot-lighters appear to have cocooned themselves to the point where they are unaware of the holes in their arguments or the countervailing evidence.
Scott Winship is the Walter B. Wriston Fellow at the Manhattan Institute for Policy Research. You can follow him on Twitter here.
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Read more on this topic:
Inequality as a Barrier to Growth? Invented Out of Thin Air
Income Inequality in America: Fact and Fiction
Is Wealth Inequality Rising? (On Paul Krugman's Ambiguity Denial)
