Thursday, March 28, 2013

Inequality, trickle-down consumption and economic growth

Here is an interesting article at the Washington Post (similar story in the local paper), regarding the effect of inequality on household savings by the middle class. The basic idea is one that we've discussed in class - personal well being may be influenced by the well being of those around you. If your "neighbors" are getting richer and buying more stuff, you may feel poorer and spend more to "catch up". What are some of the macro and micro implications? I can tell you from personal experience that this phenomenon works in reverse too. When we lived abroad, we lived very simply, barely spending any money at all.  There's a lesson here: As your income increases over time, try to maintain at least some of the spending habits that you develop when you have lower income.
Note chart 4 in the article... this looks like a simplified way of reporting the results of a regression model.


  1. I think what many people in the middle class who are trying to keep up with their wealthier friends/neighbors are failing to understand is that those wealthier counterparts did not become wealthier by spending (consumption), but more likely through investment in either physical or human capital. If the people in the middle class want to prolong their wealth, they should invest their money in capital rather than goods and services.

    On the micro level, this may seem like a keeping up with the Jones's situation in which consumption leads to marital problems and a longer drive to work (according to Frank, Levine, and Dijik), but on the macro level this sort of spending can lead to an increase in debt and bankruptcy filings, hurting the nation's economy.

    1. "If the people in the middle class want to prolong their wealth, they should invest their money in capital rather than goods and services."

      Great point. Seems like the older generations knew this, were very thrifty and conscientious of saving. Probably out of necessity and hard life lessons learned.

      Like this old saying i found
      "It is as useful to save money that you already have as it is to earn more."

  2. “'Middle income households would have saved between 2.6 and 3.2 percent more by the mid-2000s had incomes at the top grown at the same rate as median income,' they conclude."

    That's a pretty telling quote. I'd like to see data on how spending has changed since the 60s when it comes to upper-class vs. middle-class.

    According to my awesome, wall-sized chart of the entire US economy (it really is awesome), the typical middle class worker in 1965 made $19.61/hour (in 2011 dollars). In 2011, that had risen to $19.71. By comparison, the typical CEO in 1965 made $490.31, and in 2011 had seen that grow to $5419.97.

    But that's the income side, which everyone knows is screwy. What would be interesting to see is how spending has grown. Has upper- and middle-class expenditures grown at roughly the same rate? Is the lack of middle-class savings a function of trying to "keep up with the Joneses" or a function of income stagnation? Or how much of each?

    My interest lies in behavioral econ, and if it is due to keeping pace with your neighbors, then that seems to lend some credence to the idea that people are not necessarily the rational actors that classic econ makes them out to be. Anybody piling on debt and not saving knows that is no way to maximize utility (even if they don't think in those terms), so the lack of change from that status quo is a sign that we behave in ways well short of our self interest, right?

  3. Reading this article led me to start thinking whether or not this trickle-down effect could occur from government spending as well. While obviously people aren't saying things like , "Oh, the president has a nice plane, why don't I buy one?" government spending on social safety nets and welfare programs could also encourage those who are receiving these aids to spend their money differently.

    One of the more interesting new programs has been providing cell phones for low-income households. While the benefits of this can be seen, why wouldn't this money go into spending on housing or food costs which are basic needs, rather than cell phones which can be seen as luxuries. One thing I'll never forget seeing is a woman with her children at the grocery store purchasing her groceries with food stamps, and then proceeding to load them into a new (maybe 2 years old) escalade with big shiny wheels. Our government, through the massive debt that it has surmounted, also contributes to this idea of spending without grasping an understanding of your means.

  4. This got me thinking to what extent the effect of having interest rates at the lower bound or ZIRP since 2008 may have contributed to the "expenditure cascades" (if at all) in more recent times? My thinking is that there may not be any good incentives for middle and low income households to save anything. Since there is no reward for saving but rather a loss or punishment because there is no meaningful interest paid on account balances, why save? I propose that people in these households might even unknowingly recognize a growing disadvantage of holding cash in there micro world. So they end up buying now rather than paying more for something later (as prices rise).

  5. I think this is the same sad story, people want what they can't have. But people being people decide to spend outside their means to obtain their dreams. This in the end generally leads to their dreams ending in bankruptcy and divorce. I used to spend, not outside my means, but close to it. I didn't save any money and I regret that. I did learn my lesson though and I have been making strides to fix it.
    I think it is just hard for people to understand that, especially when some people think the norm is some reality show. That, I fear, is what society is telling people they need to become and some people believe it.