Economic Growth Is the Answer
While rising inequality – a problem that the data suggest is real but overstated – has moved to the center of public debate, the key issue is that living standards are not improving fast enough among those who are falling behind. It is this fact that is fueling much of the political tension across advanced economies today.
STANFORD – December is usually a time for looking back on the past year and forward to the year ahead. In 2019, we have witnessed rising political extremism (on both the left and right) and polarization, increased government instability, and growing tensions between central and subnational governments. Each trend will continue in 2020. Almost everywhere one looks, there is a growing gap between what people demand of governments and what governments can deliver. The reasons vary, but a significant underlying cause explains many of the grievances: sluggish economic growth.
While rising inequality – a problem that the data suggest is real but overstated – has moved to the center of public debate, the key issue is that living standards are not improving fast enough among those who are falling behind. In the United States, the policies being proposed to address this issue include much higher marginal income-tax rates, a large tax on wealth, and massive new entitlements and subsidies, implying larger deficits and far more government control of the economy. Unfortunately, this policy mix promises to reduce, not increase, living standards. To expand the economic pie, allowing people and firms to interact freely in markets is a much better option than relying on government planners or bureaucrats. The government’s role should be limited to setting and enforcing fair rules of the game.
In the US, per capita after-tax income is 50% higher than that of the Scandinavian social democracies, which fund their welfare states through high regressive consumption taxes on the middle class. Unwilling to accept that reality, commentators on the left claim that inequality itself is the cause of slow growth. Noting that the wealthy tend to save a greater proportion of their income, they argue that more downward redistribution would boost consumption and therefore growth.