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Home Publications Blogs Beat the Press Krugman versus Stiglitz on Inequality and Economic Growth

Krugman versus Stiglitz on Inequality and Economic Growth

Sunday, 20 January 2013 18:37

Joe Stiglitz had an Opionator piece in the NYT arguing that inequality was bad for growth. Krugman responded by taking issue with a couple of the points raised by Stiglitz: that upward redistribution of income leads to fiscal problems and that upward redistribution of income leads to stagnation.

On the first point, Krugman correctly notes that the tax code is at least marginally progressive. This means that in general upward redistribution of income should increase revenues, the opposite of what Stiglitz claimed. It is possible that Stiglitz was considering the broader tax and transfer picture. This is certainly more ambiguous and could well go the other way.

Suppose we are redistributing 3 percentage points of income (roughly $400 billion a year) from the bottom 20 percent of the income distribution to the top 2 percent. While tax collections will almost certainly go up, we will likely be paying out more money in food stamps, TANF, Medicaid and other means-tested programs. My guess is the net in this story is negative, but I am sure it would depend on exactly who is being hit and who gets the money.

The more important point is whether we may suffer from a lack of consumption if we redistribute from low income people, who Stiglitz argues will spend most of their income, to rich people who he argues will spend a smaller share of their income. Krugman dismisses this assertion, noting the problem that consumption will depend on lifetime income, not temporary income. This would mean that people will always be spending a higher share of their income when their income is low than when it is high. He then turns to the macro picture to see if there is evidence of a rise in the savings rate as income shifted upwards in the last three decades.

The National Income data of course show a decline in savings, but there is a major complication in this story. The stock market began to rise above its historic average ratio to corporate profits in the 1980s and rose way above the historic ratio in the stock bubble in the 1990s. Also, in the 1990s house prices began to rise above their long-term trend level and in the last decade they rose way above their long-term trend.

We know that people spend based in part on their wealth. The increase in stock values relative to income in the 1980s meant that wealth was higher relative to income than would ordinarily be the case. We would expect this to lead to more consumption and a drop in savings. The same is true with the rise in house prices in the 1990s and 2000s. In other words, we did not have a problem of under-consumption because we had bubbles in the stock and housing markets that kept consumption at very high levels.

Does this prove Stiglitz's point? I wouldn't go quite that far, but it does suggest that Krugman's case is not as solid as it may first appear.

There are two other points worth mentioning on the general topic. The standard savings data would overstate private sector savings in the 70s relative to later decades because of the high inflation of that decade. This eroded the real value of government bonds held by the private sector. That meant that the deficits in that decade were smaller than they appeared, but it also meant that private sector savings was lower than the official data indicate.

The other item to keep in mind is that we are not supposed to be worried about insufficient demand in this story in part because the low interest rates that would result would cause the dollar to fall and net exports to rise. This happened a bit in the mid-90s in response to the deficit reduction of at the beginning of the Clinton administration. However things went the other way following Robert Rubin's high dollar policy and the East Asian financial crisis.

This is a longer story, but in the textbook story rich countries like the United States are supposed to be net exporters, sending capital to poor countries. The fact that we have seen the opposite in a big way for the last 15 years is not good.



Seth Ackerman reminds me that comparisons of saving rates only make sense when the economy is near full employment. Otherwise the saving rate will be inflated by virtual of the fact that income is depressed lowering the denominator. The full employment assumption is plausible for the late 80s, mid and late 90s, and near the peak of 00s cycle. It is less plausible for the early and mid 80s, early 90s, and early part of the last decade. Of course for comparison purposes, we would have the same issue with the 70s downturn.

Comments (29)Add Comment
Modeling redistribution and growth
written by Steve Roth, January 20, 2013 7:34
I built a little model of this a while back. See what you think.


Has anyone done a more rigorous model incorporating this type of thinking?
written by urban legend, January 20, 2013 8:10
"Suppose we are redistributing 3 percentage points of income (roughly $400 billion a year) from the bottom 20 percent of the income distribution to the top 2 percent. While tax collections will almost certainly go up, we will likely be paying out more money in food stamps, TANF, Medicaid and other means-tested programs."

This seems to ignore the dynamic effect of taking the money from the lower income people. 3% would virtually wipe out their discretionary income and a presumably high multiplier that flows from spending that income. Their purchases will be for more consumables and ordinary services (movies, restaurants, domestic vacations) more subject to competitive pricing (and therefore lower profit margins, higher percentage for inputs employing people), whereas luxury goods for the wealthy are more likely one-time purchases -- how many yachts or Lamborghinis can one buy? -- and more likely to be diverting spending outside the country.

It seems to me great care and skepticism needs to be applied to national savings data. From the standpoint of the wealthy, the key measure of savings is the change in net worth. In the 90s, the explosion in asset prices meant huge "savings" in the form of net worth increases without regard to how much income was saved in a technical sense.

Also, with relatively small progressivity, why would we assume there would be, even initially before the dynamic effects of the lost income among a mass of lower income people are considered, a net increase in taxes in redistributing the income upwards?
Are U Happy? Happiest in The World - Inequality Matters?
written by James, January 20, 2013 8:19

"What else? They are all borderline socialist states, with generous welfare benefits and lots of redistribution of wealth. Yet they don't let that socialism cross the line into autocracy. Civil liberties are abundant (consider decriminalized drugs and prostitution in the Netherlands). There are few restrictions on the flow of capital or of labor.

So where does the United States rank? It's at 12th place this year, slipping from 10th."

Consumption Collapsed During the Great Recession
written by Paul Mathis, January 20, 2013 8:50
"The Great Recession of 2008–09 was characterized by the most severe year-over-year decline in consumption the United States had experienced since 1945. The consumption slump was both deep and long lived. It took almost 12 quarters for total real personal consumption expenditures (PCE) to go back to its level at the previous peak 4Q07."
- Federal Reserve Bank of Chicago

The consumption deficit in our economy is the reason for out slow recovery and a major cause of that deficit is income inequality in the U.S. Stiglitz is correct.
taxes turn regressive at the very top
written by Jeff Fisher, January 20, 2013 10:10
Our tax system is not progressive over the entire range of income.

Somewhere in the top 1% it turns regressive (see Romney's total tax rates for an example).
written by geraldmcgrew, January 20, 2013 11:01
...the only thing allowing (modest) growth under neoliberal conditions of greater inequality was asset bubbles. Sounds about right.

I guess my next question is whether a new extended period of growth due to yet another asset bubble is still possible. Or is that a Humpty Dumpty that can't be put back together again? I know we're in a (very very slow) recovery, but weren't there modest upturns during the '30s as well as during the milder structural upheaval of the '70s?

That is, unless a new asset bubble can be the basis for an EXTENDED period of growth, it would seem that this recovery is likely to stay too weak and be too temporary to ever get us back to full employment. In which case stuctural changes to the economy might be required for a SUSTAINED period of growth. Is that wrong?
Isn't Stiglitz right?
written by A Populist, January 21, 2013 6:26


I came to your blog to answer this very question.

I can see how (theoretically) the wealthy could spend just as high a percent of their income on consumption - thus maintaining demand, and employment. However, given that the lower classes live hand-to-mouth, this seems absurd. OK, I guess that is not a robust economic argument.

Does "income" capture all of the increases in money available for consumption? If not, is there a better measure which might indicate any tendency for inequality to decrease consumption, employment, or economic activity generally?

What about other factors, such as overseas investment, or increases, transfers, or destruction of wealth not captured by "income"? Will any of those things explain the seeming discrepancy between the common perception that the wealthy can and do consume less of their income, and Krugman's claim that the rich consume just as much of their income as the poor?

Also, can anything be inferred from the difference in CBO multipliers for stimulus given to the wealthy vs the poor? I would think that the high multipliers for UI vs tax cuts is an indicator that transferring funds from the wealthy to the poor, would increase economic activity. Can anything be inferred from this? If not, doesn't it at least raise some questions?

OTOH: What if Krugman is correct? Does inequality affect employment in other ways, such as preventing large numbers of poor and middle class workers from working fewer hours, since they cannot afford to do so?

It still seems bizarre to me that the rich consume just as much of their wealth and income, as do the poor. I know that is not an argument - so I really appreciate your take on this. To me, Krugman seems much to quick to dismiss the idea that the wealthy consume a lower percentage of their income.
Massive Inequality and Democracy Don't Mix
written by Robert Salzberg, January 21, 2013 6:31
The question shouldn't be whether we can have massive inequality and full employment, it's whether we want an economy with massive inequality.

Historically, massive inequality goes hand in hand with oppression which yields feudalism, plantation economies and totalitarianism.

Setting aside the bubble years where fake wealth inflated demand, mass inequality and full employment just haven't happened in Democratic nations unless you count Democracies that had slavery.

If you let massive amounts of wealth accumulate at the top, the net effect is massive numbers of underpaid workers below which eventually creates an unsustainable economy and/or government.

“We can either have democracy in this country or we can have great wealth concentrated in the hands of a few, but we can’t have both.”

–Louis Brandeis
U.S. Supreme Court Justice (1856-1941)
Define "Savings" please Prof Krugman
written by Lrellok, January 21, 2013 10:06
In my view, Prof Krugman needs to stop trunkating his graphs. Lets look at the earlier part of his graph, from 1950 until 1980, then falls sharply until 2000. Krugman focuses only on the time since 2000, but lets look at the rest hear. During the 50's and 60's, inequality was falling, or at least not increasing, as wages rose relative to GDP. However, in the late 70's, wages stopped rising at the same rate as GDP. Prof Krugmans graph clearly shows that during this period, savings was falling. Thus, inequality seems to produce a falling in aggregate savings, while equality produces a rise. Instead of starting with the assumption that inequality should produce a rise in savings, lets start with the observable relationship between savings and inequality, and try explaining that.
When a median income family wishes to save money, they generally find a generic vehicle (a passbook account, CD or 401k, depending on the length of time). THey have less money to save, and might need access to it quickly, so exotic vehicles requiring large time commitments are not attractive to median income households. But for wealthy households with large amounts of money, these vehicles are quite attractive.
Which brings us to my question at the top; What sorts of "vehicles" are being counted in "savings"? Are repossessed homes (held off market, there are currently 7 million)? How about bars of gold, that has been big for a while? I remember something about using proven mineral reserves as a sort of savings a while back, where you would buy a mine with ore still in it, wait for the mineral to increase, then sell the mine. Is this counted as savings?
It is entirly possible in my mind that the well to do are using items normally counted as "consumables" as savings vehicles. However, this obstructs capital circulation in the market, as the value is now trapped in the vehicle. You will remember the articles about companies sitting on trillions in cash during the start of the recession. If you stuff your matttress full of cash, does that count as "Savings" as Prof Krugman is using the term, and if not, why are we not presuming this is what the rich are doing, since it is widely reported that it is exactly what they are doing?
written by skeptonomist, January 21, 2013 10:51
Apparently Krugman thinks that GDP could be just as great if most of it were devoted to making yachts and other luxury items for plutocrats. This is just not the way modern economies work - they are based on mass consumption. Even leaving fairness aside, the way to expand the economy is to make products for everyone, not just for a few.

He also ignores the way inequality leads to non-productive speculation and other useless financial activity. When the few have all the money, and there is no demand because of low wages and unemployment, that money is not used productively.

Maybe Krugman's post was a defense of monetary policy, which by its nature is a supply-side tool, injecting money for "job creators" to use as they think fit, not as society needs.
written by skeptonomist, January 21, 2013 11:22
The real problem of inequality is more political than strictly economic - something that Dean has emphasized for a long time. If demand is low, private investors have little incentive to invest because they do not see immediate advantage (sorry, they don't really believe in Say's law). In econo-speak, this is a liquidity trap. The Keynesian solution is to take the investment decisions away from the free market temporarily - have the government make them according to the needs of society, rather than the benefit of the people who have the potential investment funds. The more money plutocrats have, the more political power they have to prevent this - they don't want government taking over the economic decisions, even temporarily. Surely Krugman would agree that this is a major problem with inequality.

In depressions, the free-market system has broken down. It does not make sense to restrict thinking to what happens in that system under ideal circumstances.
Krugman's response
written by Peter K., January 21, 2013 11:26

"Dean Baker makes a couple of very good points, one on saving, one on the budget. I pointed out that saving seems to have declined, not increased, as inequality rose; Dean points out that sharply rising asset prices might be the explanation. Fair enough, although I think the burden of proof is on the other side: if your claim is that inequality causes a persistent shortage of consumer demand, you should find the actual strength of consumer demand problematic.

Dean also makes a terrific point about inequality and the budget: while taking from the poor and giving to the rich probably increases revenues, it also increases spending on means-tested programs, so the budget effect may be negative after all. Indeed: I should have remembered that the highest effective marginal tax rates in our system fall on low-income working families (pdf), who lose benefits as their incomes go up. I doubt that even so the effect can be large, but it’s always a good idea to remember that we have a tax-and-transfer system, not just a tax system.

So, interesting stuff — and it’s good to be having a real discussion about these issues. I still think that we need to fight inequality for long-run reasons, and that trying to shoehorn the post-financial-crisis weakness into the same framework just weakens our credibility. But it’s not a big deal."
jeezum, can't you economists ever agree on basic stuff
written by ezra abrams, January 21, 2013 11:37
here you have two nobel prize winners (stiglitz and krugman) who can't agree on what would seem to be a basic fact, for which one would expect copious empirical data (total consumption vs income distribution)

what the HE** do you economist do all day ???
Why the heck don't you have data ???

And why on earth would any intelligent person (which presumably includes stiglitz) publish an article without having his factual ducks ina row ?????

A week or so ago, on the blog noahopinion, noah asked why the avg american has a low opinion of economists...
well this sort of sandbox dont' step over that line type of public argument has to be a big reason
As inequality rises, a larger fraction of consumption will go to luxury goods, which are not mass produced.
This means that investment in the mass production/hi tech sector will fall, making us less competitive with the rest of the world.

I think also that economist don't realize that we have a glut of savings; we don't need to save more money for investment - talk to any VC; the problem is not raising money - it is easy to raise money - the problem is finding places to spend it; there is more money then good ideas.
written by Steve Roth, January 21, 2013 12:49
Dean, instead of just modeling this in our heads with words, and you, Krugman, and Stiglitz do in this discussion, I'd really love to see convincing simulation models that might give us some more quantitative feel for these effects. Ones that weren't created by amateur econocranks like me.

Any leads?
I've read this twice & still don't quite understand it
written by watermelonpunch, January 21, 2013 2:14
@ ezra abrams:
A week or so ago, on the blog noahopinion, noah asked why the avg american has a low opinion of economists...

When it comes to this particular topic, I think the answer is much more simple than you suspect.

I'm completely unable to understand the exact arguments at issue here. I feel like half the paragraphs on this page are written in a different language.
Why not look at the tax multipliers?
written by Antiderivative, January 21, 2013 2:44
Tax multipliers are usually always higher for lower income people than higher income people, clearly showing that lower income people will spend more as their income increases than higher income people.

Perhaps I am not looking at this properly?
Haven't we seen this somewhere before?
written by Perplexed, January 21, 2013 3:03
"The more important point is whether we may suffer from a lack of consumption if we redistribute from low income people, who Stiglitz argues will spend most of their income, to rich people who he argues will spend a smaller share of their income."

Isn't this exactly what Keynes was telling us with his marginal propensity to consume arguments? Did we ever really understand this or just give up trying to?

How is this impacted by our oligarch's spending & investing their income overseas?
What happens to economics when the evidence can't be forced to fit the old models?
written by Perplexed, January 21, 2013 3:24

What textbook?
written by Min, January 21, 2013 4:18
"in the textbook story rich countries like the United States are supposed to be net exporters, sending capital to poor countries."

So in the global village, instead of the rich people (countries) buying stuff from the poorer people, the rich are supposed to sell more to the poor than the other way around? Then how do the poor afford to buy stuff from the rich? Well maybe they are required to borrow money from the rich so that they can buy stuff from the rich? (Yes, I know, they are supposed to buy tools from the rich so that they can be more productive.) But in real life what happens? In real life their creditors take them over.

What is the name of the textbook? Debt Peonage Made Easy?
written by urban legend, January 21, 2013 6:40
Hasn't a higher marginal propensity to spend for people of lower income been the staple, almost by definition, of progressive economics? Apart from what seems like massive historical evidence that there is no tradeoff between inequality and growth -- the 90s, the Depression years, the postwar years, Northern Europe since the 90s -- isn't the logical proof of it that marginal utility of expenditure declines as income increases? Income that is barely a blip for the discretionary income of the wealthy -- the loss of which will have little if any effect on standard of living -- will be determinative in the discretionary income for the middle class and lower income people.
Did you say models by amateur econocranks?
written by Eric L, January 21, 2013 6:55
Dean, instead of just modeling this in our heads with words, and you, Krugman, and Stiglitz do in this discussion, I'd really love to see convincing simulation models that might give us some more quantitative feel for these effects. Ones that weren't created by amateur econocranks like me.

What about amateur econocranks like me?


Note also Geoff Willis's similar model (accompanied by a much more thorough paper) that I link to in my comment, as well as my comment. Our models are pretty similar and involve consumers consuming out of savings, rather than out of income, which will result in consumption reflecting long term income as per Milton Friedman's objection. While this trivial model produces very realistic distributions of wealth, inequality does not come anywhere close to observed values unless you assume the poor spend their money more quickly than the rich, which is one reason I suspect Stiglitz is right.
What does Krugman think he's demonstrated?
written by Eric L, January 21, 2013 7:27
I don't get how Krugman's data is supposed to support his case. Why is he looking at overall savings rather than savings among the rich? I don't see why we should expect savings among the rich to have increased by more than savings among the middle class decreased. Any number of things could drive the overall trend, like the things mentioned in the post, I would add that the trade deficit and the influx of foreign capital that goes with it have lowered returns and discouraged saving among rich and poor, but that doesn't mean the rich aren't saving more. I'd also note that Milton Friedman's objection about people having good years and bad years was much more applicable in his day than today; very few of the 1% are people just having an exceptionally good year.

One interpretation of Krugman is that he thinks Stiglitz's case depends on consumer demand having been weak pre-crash due to inequality, and he's showing it wasn't. But why wasn't it weak? Because middle class consumption grew even as incomes were stagnant, thanks to rising levels of debt. But that can't work forever; only so many loans make sense even when you're willing to make them at near zero rates of interest, so the consumption has dropped. Krugman says in theory we could all be employed as yacht builders, but just because the wealthy could demand more doesn't mean they have any more reason to do so than they did pre-crash. There's no theoretical or empirical reason to expect them to exactly replace the demand that the middle class is no longer providing.
Aggregate Democracy
written by Union Member, January 21, 2013 7:34

"Suppose we are redistributing 3 percentage points of income (roughly $400 billion a year) from the bottom 20 percent of the income distribution to the top 2 percent."

Real Consumption: With income distribution trends such as this won't - and doesn't - the 2 percent go out and buy 100 United States Senators, Members of Congress, and the 50 State Houses? What share of total aggregate demand is total government spending?

Reason there are 4 million people out of work for more than a year is that working people can't afford to contribute to political campaigns.

overvalued dollar drives savings down
written by Joe Emersberger, January 21, 2013 8:35
To reiterate a point Dean made about the trade deficit.

A high trade deficit (resulting fro an overvalued dollar) will tend to drive down savings. People will import way more (save less) than they otherwise would.

Remember that identity Dean told us to burn into our minds

(X-m) = (S-I) + (T-G)

It explains why comparing the savings rate in two eras (one where you have a record trade deficit and another where you do not) is also going to lead you astray.

And the Winner is ......
written by Glen, January 22, 2013 9:34
In the battle of Krugman vs. Stiglitz the winner is......

Dean Baker.
Marginally Progressive?
written by FoonTheElder, January 23, 2013 9:21
The only part of the tax code that is marginally progressive is the federal income tax. Practically all other taxes are regressive.

That is why when ALL taxes are taken as a percentage of ALL income, the top 1% pay less of a percent than the next 19% and not much more than the 60% after that.

Mitt Romney pays less of a percentage of his taxable (not total) income in income taxes and social security than the bottom 20% ($13,000 per yr. avg.) pays in all taxes.

Really want to understand
written by Steve Roth, January 23, 2013 12:55
Krugman, Drum, Baker, all poo-poo the marginal-propensity-to-spend-from-income/wealth argument.

None of you has explained why it doesn't make sense. When I run the numbers (in an admittedly limited model) I find that downward redistribution makes the pie bigger (faster), and that no redistribution either direction results in the smallest pie. Please! I want to understand what's wrong with this thinking, arithmetic, analysis.
written by Jay, January 23, 2013 10:50
I think Krugman made a big mistake by not considering the effect of inequality on economic growth. I think the economic plight of the black community is a perfect example that has been extrapolated to the economy at large while their unemployment has increased to 14%.

I understand there is a lack of demand but to say that the lack of that demand is not due to plutocratic practices is irresponsible. We don't have the stimulus that he keeps harping about precisely because of economic inequality that has constrained policy making for deficit spending to undermine the function of government for selfish motives.

Also, I am leery of anyone that ignores the stock and housing bubbles that lead to a level of consumption that hid the lack of income growth, transfer of expensive training costs to employees during a "skills" shortage, and erosion of employee benefits over the past 20-30 years.

I understand the importance of the liquidity trap theory but things weren't so great for everyone back in 2000 either. Considering that most people are commoners not jet setters, it's a safe bet a substantial number of people are not consuming as much as they would historically due to a simple lack of money not want. How can an economy that is built on 70% consumer spending be efficient when there is so much income stratification that most people are discouraged from pursing any form of risk that requires more than a year's commitment?
Interfluidity takes on Krugman
written by Eric L, January 24, 2013 10:37

Steve Waldman take on Krugman here:


Quite frankly I don't see what if anything remains of Krugman's argument.

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About Beat the Press

Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.