For the past several decades, the idea that high levels of inequality were good for the economy dominated political and economic thought. Politicians believed the trickle-down theory that enabling “job creators” to get richer would help us all, and economists provided cover for this line of thinking because they thought there was a tradeoff between growth and equity.
But, as inequality has risen to extreme levels in the United States, the foundations of the economy have weakened, and America is now experiencing the kinds of problems that plague less-developed countries. The United States now must confront high levels of societal distrust that make it hard to do business, governmental favors for privileged elites that distort the economy, and fewer opportunities for children of the middle class and the poor to get ahead—wasting vast quantities of human potential.
Fortunately, a new class of economists and policymakers are now challenging the old, flawed, ideas about inequality. Academics have begun to rethink their views about the decline of the middle class, and progressive politicians are finally starting to openly contest the logic underlying supply-side after years of failing to do so. There is a growing realization that a strong middle class is not merely the result of a strong economy—as was previously thought—but rather a source of America’s economic growth.
The new direction on economic policymaking cannot arrive soon enough, because our economy continues to suffer deeply from a financial crash caused in large part by high levels of inequality. Rebuilding the middle class is critical, as a strong middle class performs four vital functions in the US economy.
First, a strong middle class helps society run relatively smoothly, with higher levels of trust among its citizens. People need to be able to trust one another enough to do business with one another. When there is little trust, the cost of doing business shoots up—or, as economists put it, transaction costs increase.
Second, a strong middle class leads to better governance. A thriving economy depends on a well-functioning government that provides critical services, such as roads and schools, with relatively little corruption. As the middle class has weakened and inequality has risen, the wealthy have gained excessive political power and the middle class has become less civic-minded, leading to a host of governmental dysfunctions.
Third, the middle class is a source of stable consumer demand, which enables businesses to invest in new products and hire additional workers—thereby fueling growth. As consumer demand in the years prior to the Great Recession was based heavily on middle-class debt, the economy was unstable. And now that the middle class is so weak—burdened by stagnant incomes, high debt levels, and underwater mortgages—it can’t consume enough to keep the American economy going.
Finally, a strong middle class creates more human capital. In the modern economy, a skilled, healthy, and entrepreneurial workforce is a driver of economic growth—at least as much as the physical capital of factories and machines. As inequality has risen and the middle class has weakened, America has not developed the full human potential of its middle and working classes.
To have strong and sustainable growth, the economy needs to work for everyone. That’s why we need to focus policy on rebuilding our economy from the middle out.
About the Author: The author’s name is David Madland. David Madland is the author of Hollowed Out: Why the Economy Doesn’t Work Without a Strong Middle Class and the Managing Director for Economic Policy at the Center for American Progress. Follow Madland on Twitter: @DavidMadland