Line of Inquiry: Amir Sufi on How Income Inequality Is Holding Back the US Economy

Amir Sufi: So I’ve been studying and researching economics for 20 years. And one of the lessons I’ve learned over that time is that the economy is really kind of like an ecosystem. And like any ecosystem, if there’s a big, persistent shock to that system, it can throw the entire system out of balance and make the economy work less well for everyone.

So that was really where we started with this research is thinking about the rise in income inequality as a shock to the overall economy that’s really pushed the system out of balance. So the rise in income inequality is something that’s very well-documented, well-researched. It’s pretty stunning in terms of its size.

So if you think of, say, the top 10 percent of the income distribution, they’re now making about 10 percentage points more of total income today than they did in, say, the 1960s and ’70s. So, that’s a really big change. And of course it’s influenced academic research, but it’s influenced far more than academic research. It’s the subject of political campaigns. It’s even the subject of cultural phenomenon like books and movies. So we’re certainly not the first to be thinking about income inequality.

When people start to think about income inequality and why it’s problematic, oftentimes the first place they go to is an issue of fairness. And I think that makes a lot of sense. People think, well, it’s unfair that some people are earning way more money than others while some people are just struggling, scraping to get by. And, of course, I have a lot of sympathy for that issue of fairness.

What we’re trying to do in this research, though, is to point out that income inequality is more than just an issue of fairness, that, in fact, income inequality is a structural challenge to the overall economy that keeps the economy from functioning at its full capacity. It really is a problem that needs to be addressed so that we can maximize the potential of the economy for everyone involved.

In a recent research paper that we’ve done, we show that people in the top 10 percent of the income distribution tend to save between 20 and 30 cents of every dollar they make. If you look at the bottom 50 percent of the income distribution, they basically don’t save anything. They basically consume almost everything they make. They spend almost the full dollar that they make when we’re thinking about that $1. If you look at the 50th to 90th percentile of the distribution, they tend to save between, say, 5 and 10 cents on the dollar. So we’re talking about differences in saving rates across the distribution that are really quite enormous.

And so, when you have this large increase in the share of income earned by the top 10 percent of the income distribution, you then basically have an influx of savings that’s coming into the financial system that was not there before. And we call that rise in savings from high-income households the saving glut of the rich. And that’s one of the main research papers that we’ve written on this topic.

It’s an interesting question about: What happens to those savings? In national accounting, those savings have to go somewhere. If the rich save more of their money and it goes into productive investment by businesses, it can be in good for the economy. We can get more output, more income. It can actually act as a counterweight and help median- and lower-income households earn more because they’ll have better equipment at work, better computers, better buildings to go work in. And so, that would be great.

Unfortunately, that’s not happening at all. If anything, private business investment as a share of income has actually been falling. So for every $1 earned by the economy, less of it is actually going into productive investment.

The second thing that can happen with the saving glut of the rich is that it could go overseas. So we could send that money to Africa, to East Asia, to South Asia, to Latin America. We could send that money overseas again to invest, or to potentially let households overseas consume or borrow out of it. And that, again, would be a pretty good outcome, but that, again, is not what’s happening. If anything, the US household sector is actually borrowing more from abroad. They’re not sending more money overseas.

So that really leaves only one margin left, which is somebody in the domestic economy is gonna have to borrow more if those savings are coming into the financial system. And there’s really only two entities that can borrow more if the top 10 percent are saving more: the government or the bottom 90 percent of the income distribution. And our research shows that, in fact, both the bottom 90 percent and the government have been borrowing much more over this period, since basically the 1980s, where the saving glut of the rich has arisen.

So from basically 1983 to about 2007, it was mainly the bottom 90 percent of the income distribution borrowing more and more and more. After the Great Recession, it became more difficult for households in the bottom 90 percent to borrow. And so, as a result, the government basically started borrowing more and more. So you have to take a step back and you have to ask yourself, why is it that the government’s borrowing more? Why is it that the bottom 90 percent of the income distribution is borrowing more? And we point directly to the saving glut of the rich as a potential cause.

So if there’s more money coming into the financial system by the top 1 percent, by the top 10 percent, that money has to go somewhere. If it’s not gonna go into investment, if it’s not going overseas, then really the government and the bottom 90 percent almost has to borrow more out of it. It’s just basic accounting identity. And the financial system has to offer borrowing at cheaper terms in order to get those funds out to somebody.

And, again, we wish businesses borrowed at those cheap interest rates and invested in productive activity, but that’s not what’s happening. What’s happening instead is you’re being asked to borrow more against your home equity. You’re being asked to take more on your credit cards. People are borrowing more in order to get an education. And all of that is, in our view, a natural outcome of the saving glut of the rich.

At the end of the day, one question we might have is: What’s the problem with it? Should we care? Should we care that people in the bottom 90 percent and the government have to borrow more and more because the top 10 percent are earning more and saving more?

At some point, you reach debt levels that are so high that the financial system becomes unwilling to provide more debt financing. That’s kind of what happened after the Great Recession. It became much harder to get a mortgage. It became harder to get a credit card. And when you reach that level where you cannot get the bottom 90 percent to borrow more, at that point, you really can run into long-term stagnation issues in which just not enough money is being spent because the rich are saving so much, the bottom 90 percent can’t borrow anymore. And then you enter in what we call a debt trap. That’s characterized by very high debt levels, very low interest rates, and lackluster output. And that’s exactly where we’ve been the last 10 years.

I think the first thing we need to do is to recognize the structural problem of income inequality, that it’s more than just an issue of fairness and distribution. It is an issue that the macroeconomy is being challenged by, and as such, we need to treat it as a serious macroeconomic problem. It means tackling income inequality by trying to raise the productivity of the working force through better education, through better bargaining power. It may involve thinking carefully about tax policy. But I think, at a high level, it’s important to realize that income inequality is more than just a distribution or fairness issue. It really is an issue that’s holding back the entire economy.

Another solution to this problem is for the government to step in and to use those savings in a productive way. And I think most people think about infrastructure investment—building better roads, bridges, schools—and that could be a very productive use of those savings.

Given these arguments, it’s probably not surprising that tax policy is on the forefront of the policy agenda to potentially try to reduce these negative effects of inequality. There’s been discussions of wealth taxes, of raising the taxes on the top 1 percent. And I think, given these arguments, there is a lot of justification for investigating those policies further. What I think we need more than anything else is buy-in by people who are at the very top of the income distribution to get them to understand that really the economy could operate at a much higher level if we were to have a more even distribution of the income.

And at the end of the day, if the economy continues to go on this path, just like an ecosystem that’s experienced a large shock, eventually the ecosystem will not be able to adjust and could potentially collapse. That’s of course not in anybody’s interest. And so by that, I hope we can all get together and think constructively about solutions.