11/23/2006 12:06 am ET Updated May 25, 2011

Is Income Equality Bad for Economic Growth? No

A brief complaint this Thanksgiving. 'No thanks' to the media who parrot the neoclassical line that to do well for workers means you do poorly by the economy. This week, both the Wall Street Journal and The New York Times ran stories wondering whether more equal wages would undermine economic growth. The agenda of the newly Democratic Congress raises fears among some of the economic establishment that social programs designed to raises wages could staunch the overall growth of GDP.

The economics writers who did these pieces are solid journalists and both provided a rounded version of the issues. But why lead the stories with such concerns? Simon Kuznets and others once raised questions about whether there were stages in which growing inequality was temporarily inevitable. But this is old stuff and it was never meant to apply universally to rich nations.

Some economists, nevertheless, present the notion as if it is indisputable. Rapid growth results in greater income inequality. And, moreover, great equality may be a deterrent to rapid growth. You'd think history spoke with a single voice on this.

But in the U.S., incomes remained remarkably equal in the 1950s and 1960s, the so-called Golden Age of American growth, when the standard of living for all levels of earners about doubled. Wages grew very rapidly. And, remember, it was an age of high taxes and significant public investment in education, R&D, highways, and health.

By contrast, income inequality grew fastest after that, when the GDP itself grew historically slowly, adjusted for cycles. This is the period between the 1970s and mid-1990s. And it was an age of falling tax rates and reduced public investment as a percent of GDP, not to mention restrained regulation and few new social programs.

Rapid economic growth returned only in 1996 under Clinton. For five years or so, income grew for all demographic categories, much as it did in the 1950s and 1960s. Alas, income tax rates were raised just before this period, some might recall, and the earned income tax credit was significantly expanded, thus helping poorer workers.

So, fast growth in the post World War II period in America coincided with income equality, not inequality

Then, what are these fears based on? The widespread influence of a conservative version of neo-classical theory distorts the rhetoric. Goes the theory, taught even by some Ivy League professors: higher wages are a cost to business, restrain profits, and therefore dampen capital investment, which is the source of economic growth. Government social programs are a deadweight lost for the economy.

But there is another view, which is in accord with real economic history. Higher wages and greater equality is a stimulus to growth because it increases buying power--effective demand. Such prospects for more sales spur business to make capital investment, and GDP grows. Yes, wages can get too high, but we're not anywhere near that level. And there is no international evidence that nations with more generous social programs grow slowly.

The anomalous situation is the Bush expansion since 2001. GDP growth has been solid, wages mostly inert, and profits high. No one yet has a good answer for why wages have so badly lagged GDP growth. But capital investment, if solid, has not been as strong as one would have liked.

Can we continue to grow if wages don't start to rise strongly? I doubt it. The good news is that there has finally been an uptick in wages this year.

But let's get over the destructive and remarkably callous notion that what's good for workers--that means almost all of us, by the way--is bad for the economy. I know quite a few economists who will make a cogent argument, based both on theory and on empirical observation, that growth is as often led by rising wages as it is by higher profits, and perhaps more often.

It would be more balanced and far more useful if the nation's serious business journalists sought some of those thinkers out again--especial given the economic history of the U.S. over the last fifty five years.