Consumer Spending and Growth: A Rejoinder

Jared Bernstein is a senior fellow at the Center on Budget and Policy Priorities in Washington and a former chief economist to Vice President Joseph R. Biden Jr.

I see that I have “startled” Casey Mulligan with my post last week, which he has addressed in an interesting post. He contends that contrary to my assertion that there are times when inequality damps middle-class consumer spending at the expense of aggregate growth, it is only investment, never consumption, that determines growth of gross domestic product.

Professor Mulligan writes, “High levels of consumer spending are a consequence of economic growth, not a cause of it.”

Well, sometimes it is and sometimes it isn’t.

I actually tried to be more nuanced in my piece than Professor Mulligan’s critique suggests. I wrote (the important distinction is now in bold):

My point is that the inequality affects growth through many channels. In demand-constrained periods like the present, it weakens consumer spending and growth because the small share of beneficiaries of what growth there is have lower consumption propensities than everybody else. But in debt-driven expansions, inequality appears to play an integral role in terribly damaging bubbles inflated by stagnant incomes, underpriced risk and leveraged consumption.

Note that in the debt-driven case, I offer what I think is pretty interesting evidence of inequality interacting with the debt bubble in ways that actually increased middle-class spending.

So let’s review where Professor Mulligan and I agree and disagree. I’m totally with him on the importance of investment and innovation as fuel for growth, though here, too - as he himself notes - we should be concerned by recent research building compelling and troubling linkages between inequality and inadequate investments in lower-income children.

Where we disagree is how the normal growth dynamics change when the economy is operating with excess slack, particularly in the job market, i.e., times like now. In that case, it is widely accepted - in fact, it’s standard issue in all the economics textbooks Professor Mulligan cites - that Keynesian stimulus can lead to faster growth than would otherwise occur, much of which occurs through more consumer spending, and particularly spending by those on the have-not side of the inequality divide.

As the Nobel laureate Joseph Stiglitz wrote recently about the reasons inequality is impeding an economic recovery:

The most immediate is that our middle class is too weak to support the consumer spending that has historically driven our economic growth. While the top 1 percent of income earners took home 93 percent of the growth in incomes in 2010, the households in the middle - who are most likely to spend their incomes rather than save them and who are, in a sense, the true job creators - have lower household incomes, adjusted for inflation, than they did in 1996.

This is not complicated. All you have to believe is the following:

¶There are people who want to work more but can’t find either jobs or the hours of work they seek; in fact, there are more than 20 million people (over 14 percent) in the current work force who are involuntarily un- or underemployed.

¶Many of them are income-constrained; as per Professor Stiglitz, if they had more income they would spend it. Though the economy has expanded since the second half of 2009, real median household income is down 4.4 percent.The inflation-adjusted stock market is up 60 percent and corporate profits are at a record high relative to national income, so there’s your inequality: the economy’s growing but it’s not reaching the middle on down.

¶If less inequality - or stimulative fiscal or monetary policy - steered more growth to lower-income households, they’d be more likely to spend the extra dollar than a non-income-constrained rich family (see the statistics on this in my earlier post). That’s certainly what the nonpartisan Congressional Budget Office believes (see Table 2) as it applies a G.D.P. growth multiplier that’s more than three times larger for transfer payments to those with lower incomes than tax cuts for the wealthy.

Most economists would consider that logic and evidence a slam dunk linking spending to growth during periods like the present, when high inequality and high unemployment are steering growth away from those with higher consumption propensities. There’s even evidence that investment follows consumer spending at times like this, as companies and their investors need to see customers before they undertake projects, even as interest rates have been historically low (it’s not a coincidence that in the current economy we have both weak demand and corporations that are sitting on large stores of investment capital).

But what about in normal periods when the economy is not demand-constrained? Here Professor Mulligan is on more mainstream ground. When we’re at full employment, most economists would agree that there’s no reason to try to boost one group’s consumption over that of another. There’s no “middle-out growth” in normal times. There’s just growth.

He may be right, but the problem is this: for most of the last few decades - two-thirds of the time by my count - we haven’t been at full employment. There’s been too much slack in the job market, and that may well make the middle-out story operative beyond times like the present.

Finally, and here again Professor Mulligan and I might agree, as I elaborated in my post, that too much inequality leads to financial instability, which is obviously bad for consumption, investment and growth.