Issue #20, Spring 2011

Growth and the Middle Class

First Principles: Arguing the Economy

To read the other essays in the “First Principles: Arguing the Economy” symposium, click here.

To challenge trickle-down economics, progressives need to develop a compelling story that explains how to generate economic growth. Otherwise we will remain on the defensive about whether our policies can create jobs and opportunity, and we’ll continue debating economic policy on trickle-down’s terms, which is a recipe for failure.

The problems with trickle-down are legion. But—even after producing only relatively weak growth during good times and then causing the Great Recession—trickle-down remains standing. However inadequate trickle-down is as a model for generating economic growth, elected officials fall back on it because they can understand—and sell—the simplistic logic of cutting taxes and regulations to provide incentives to workers, businesses, and investors to be more productive.

To challenge trickle-down effectively, progressives should counter with their own story about economic growth. In that story, it isn’t the rich that lead the way to growth and prosperity. Instead, it is a thriving and vibrant middle class that shows us the path. It may not seem intuitive that the concept of “the middle class” is the opposite of trickle-down and an effective counterargument against it. But it is. To understand why, we must first grasp that current thinking and rhetoric about the middle class is backwards. Politicians typically see the middle class as something to create with the gains of economic growth. But in fact, the opposite is the case: The middle class is the source of economic growth. A strong middle class provides a stable consumer base that drives productive investment. Beyond that, a strong middle class is a key factor in encouraging other national and societal conditions that lead to growth. It is a prerequisite for robust entrepreneurship and innovation, a source of trust that greases social interactions and reduces transaction costs, a bastion of civic engagement that produces better governance, and a promoter of education and other long-term investments.

Progressives often point out that in the middle of the previous century, the United States had both a strong and growing middle class and a strong and growing economy. But this story hasn’t been particularly compelling because we usually haven’t explained why these two facts are linked. Without a clear explanation for how the middle class creates growth, the story is dismissed as nostalgia for a bygone era rather than a convincing case for how the modern, global economy works.

When modern progressives have attempted to articulate a model of economic growth that challenges trickle-down, they have underplayed the centrality of the middle class. Progressives have tended to highlight issues like infrastructure, education, or manufacturing. These are important priorities, but progressives fail to bind them together in an economic narrative centered around the middle class.

In his 1936 book The General Theory of Employment, Interest, and Money, John Maynard Keynes described one of the core connections between the middle class and economic growth: that stable middle class consumption is needed to spur investment. Numerous other foundational thinkers have highlighted other connections. But the modern economics profession has largely missed the boat on the middle class, hampering progressives’ ability to challenge trickle-down. Modern economists have been caught up in free-market ideology, and their training blinds them to many of the channels that help a strong middle class produce growth. Economists are primarily trained to think of individuals as untouched by institutional or social influences, and as a result have largely ignored or discounted the positive role of institutions like government and of “non-economic” behaviors like trust and civic engagement. And modern academic political scientists, sociologists, urban planners, and scientists who study these factors have yet to weave them together into a broad economic theory.

Empirical researchers are increasingly finding that a strong middle class produces higher levels of growth. A 2005 study of economic growth in the 50 states by Ohio State University professor Mark Partridge concluded, “A more vibrant middle class…increased long-run economic growth.” And NYU economist William Easterly’s research on international economic development has found that “relatively homogenous middle-class societies have more income and growth.” But still, the theory of why this is so has not been fully explained.

By culling from canonical economists and modern researchers, we can create a compelling theory of middle-class-led growth. The core mechanisms of middle-class-led growth include stable demand, trust, good governance, and a set of virtuous, forward-looking capitalistic and proto-capitalistic behaviors.

Stable Demand

One of Keynes’s central insights was that consumption needs to be sufficient to dispose of the current output of industry in order to make new investments profitable. Investment drives economic growth, but sufficient overall levels of consumption are needed for the private sector to make those investments. This is why during a recession policy-makers seek to stimulate demand in the hopes of raising consumption to levels that encourage new investments. Unfortunately, too often this is all that is remembered of Keynes. What has largely been forgotten is that Keynes recognized the importance of the middle class in creating sufficient demand to stimulate growth. He argued that extremely unequal distributions of income depress demand and thus reduce growth.

The wealthy in unequal societies simply do not consume enough to drive a modern economy. The wealthy save more than the middle class and they consume less. This means that when incomes are stagnant or declining for most people, there isn’t enough demand in the economy to encourage productive investment—unless this demand is debt-fueled. But debt-driven consumption can’t last forever; eventually credit stops flowing—often during an economic crash, exacerbated by high levels of consumer debt. And it can take years to recover from deep recessions, slowing growth for long periods.

The lesson is clear: In order to spur sustainable economic growth, the middle class needs to be able to consume. And to do that, they need to see their incomes rise.

Trust

A strong middle class leads to higher levels of trust. When a society is largely middle class, strangers are more willing to try to work with one another in business and in life, and people are more likely to be optimistic and believe that they can control their circumstances. In addition, people feel they share a similar fate and form stronger social bonds. As Tocqueville observed in the early 1800s, Americans, because they were largely middle class and not aristocrats who could conscript others, needed to trust one another enough to work together to achieve common goals.

Studies across U.S. states, of the United States over time, and across countries all find that societies with a strong middle class and low levels of inequality have greater levels of trust of strangers. Trust is based upon the belief that we are all in this together, part of a “moral community,” according to University of Maryland Professor Eric Uslaner. It is difficult to convince people in a highly stratified society that the rich and the poor share common values, much less a common fate.

As John Stuart Mill argued, “The advantage to mankind of being able to trust one another, penetrates into every crevice and cranny of human life: the economical is perhaps the smallest part of it, yet even this is incalculable.” Mill may have thought the impact of trust on economic growth incalculable, but modern researchers have sought to quantify it. One study of U.S. states measured the percentage of state residents who think “most people can be trusted”—ranging from about 10 percent on the low end in Arkansas to more than 60 percent in New Hampshire—and then analyzed the long-term economic growth of those states, controlling for a host of economic and political factors such as initial levels of education and income. It found that “a 10 percentage-point increase in trust increases the growth rate of GDP by 0.5 percentage points” over five years.

Trust reduces transaction costs because less time and resources are spent verifying and policing. And trusting people see the world as full of opportunities. With higher levels of trust, people are more likely to innovate, seek out trade and new technologies, and generally take economically sound risks.

Good Governance

A strong middle class, as thinkers from Aristotle to James Madison to modern political scientists have noted, fosters better governance by helping ensure government is well-run, increasing citizen participation, minimizing factional fighting, and promoting policies for the benefit of all of society rather than special interests. In contrast, economic inequality and a weak middle class make the political system imbalanced and depress the political participation of the non-wealthy, reducing voting, discussion, and interest in public policy. Political scientist Frederick Solt’s 2008 study of advanced countries found that a rise in inequality from low to high levels reduces political discussion by 12 percentage points and voting by 13 percentage points. Since even in relatively equal societies the non-wealthy are less likely to participate in politics than those with greater economic resources, inequality and a weak middle class have a profound impact on who is politically engaged.

And the weakness and withdrawal of the middle class from public life doesn’t just change electoral politics and public policy. It also reduces the basic effectiveness of government. The quality and efficiency of government agencies and services is significantly diminished, studies show, by economic inequality and a weak middle class. In a 2007 article in The Review of Economics and Statistics, economists Alberto Chong and Mark Gradstein developed a theoretical model explaining the relationship between inequality and governance and then empirically tested it, finding that economic inequality has a harmful effect on bureaucratic quality, government stability, and democratic accountability. Moreover, actual corruption in government becomes much more common without a strong middle class. In short, a weak middle class hollows out governing practices and institutions, so that the bureaucracy no longer delivers for its citizens.

But the important connection, the one progressives rarely make, is that these changes in government have an impact on growth. The active engagement of the wealthy, with their disproportionate power to secure public policies to their liking—through lobbying, campaign expenditures, and other means of influence—is likely to cause taxpayer dollars to be wasted. Government money is misspent not just when the wealthy pursue rent-seeking activities—narrow tax breaks, special copyright terms, patent monopolies, giveaways of the broadcast spectrum, and mining and logging rights on public lands for below-market fees, among others—but also when the wealthy shift broad policy away from more efficient alternatives.

The foresighted and efficient government that comes from having a strong middle class creates favorable conditions for growth, while wasteful, corrupt, and unfair policies are a significant hindrance. A strong middle class helps ensure that government works well, fostering favorable conditions for the economy to prosper.

Capitalist Values

Being middle class in a middle-class society—where most people have adequate financial resources and stability, but not enough to allow for a life of leisure—fosters attitudes and behaviors that are essential to building a healthy capitalist system. Middle-class parents raise their children to value work and education because they understand their children will be dependent upon work, not capital, for most of their income. They convey to their children the principle that if you work hard within the system and follow the rules, you will get ahead. They pass down the patience necessary for children to pursue an education, career, or entrepreneurial activity, and they have the economic means to sustain that patience and plan for the long term.

While the connection between upbringing and environment and a person’s economic productivity can be taken too far, there is no doubt that some behaviors, achievements, and attitudes that promote economic growth come directly from a middle-class environment. Conversely, these positive orientations can be undone by extreme levels of economic inequality, as, for example, David Callahan emphasizes in The Cheating Culture, which explains how the rise in white-collar crime and ethical misconduct (for example, expense account fraud) among employees on the lower tiers of the business world has been fueled by rising economic inequality, which has broken down social norms and made cheating more rewarding.

Members of the middle class set goals and strive to achieve them. A 2010 Department of Commerce report on what it means to be middle class in America today finds, “One characteristic that stands out in the literature on the middle class is that middle-class families emphasize their expectations about the future: this means they work hard, plan ahead, and expect to save in order to attain those goals.”

Students—whether poor or middle class—who go to schools where the majority are middle class have much better outcomes. They score better on tests, graduate high school and complete college at higher rates, and have more successful careers. Researchers find that this is not only because of the direct involvement of middle-class parents who, for example, make sure teachers are good and schools have adequate resources, but also because middle-class kids have positive attitudes toward achievement and engage in productive behaviors such as regularly attending class and doing homework. And in middle-class schools, these attitudes and behaviors dominate.

People who are raised middle class are also much more likely to become entrepreneurs. A Kauffman Foundation report finds that 72 percent of entrepreneurs come from middle-class backgrounds—a vast overrepresentation given that only 44 percent of the public meet their measure of middle class. In short, a healthy middle class is a necessary precondition for the propagation of a healthy capitalism.

Crafting a Progressive Economic Argument

Because of trickle-down’s dominance, progressives are still on the defensive about the tax and social policies essential to our economic vision: progressive taxation, the minimum wage, strong unions, and family leave, to name just a few. The usual progressive argument goes: These policies do not kill jobs. But progressives need to make a stronger case and argue: These policies are essential to creating and sustaining the middle class and thus fueling future growth.

For one theory to supplant another, progressives need to be not just loud and clear about the flaws in the old theory, but to advance vigorously a compelling alternative. The reality is that during the roughly 30-year period of trickle-down’s ascendance, the economy enjoyed only relatively weak growth, followed by the most disastrous economic crisis since the Great Depression. People are beginning to question whether the constant cutting of taxes and regulations really does produce unrivaled growth. But this is not a sign of victory for progressives, merely an opportunity to push an alternative theory.

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Issue #20, Spring 2011
 
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Paco:

The clearest argument against trickle-down economic theories would seem to be our recent experience with bank bail-outs.

On the theory that the bloated, over-stuffed banks were absolutely vital to our economy and had to be bailed out and saved despite their irresponsible gambling led us to handing a $trillion over to them.

Not to worry! Surely this money would trickle down to the rest of us. So did it trickle down? So did it trickle down?

Not at all! It got distributed to bank executives. Some got invested overseas and some went into commodity speculation, driving up our prices for gasoline and food.

Why did it not get invested here? Because the USA is not where the big growth potential is and it is not where the risks are low.

The US government has dis-invested its infrastructure for the last thirty years and it has encouraged its businesses to leave. Why would anyone invest in this country if its own government will not.

May 11, 2011, 9:38 AM
Darrell Watson:

Though the article makes a convincing argument for a vibrant middle class, it does not state specific economic policies to achieve said goal. The person, whether democrat or republican who can articulate such an economic policy will win in a landslide.

Jan 31, 2012, 7:32 PM
Dave Higgins:

If progressives want to successfully connect with voters, they need to get beyond academic analyses and economic policies. They need instead to come up with a foundational explanation of how the world works - and therefore how we should address the problems we face.

In this particular case, explaining why the well-being of the middle class is important needs to be rooted in more than a bunch of statistics. It needs to be rooted in a clear understanding of how the world works.

We are living in confusing and uncertain times. For most people, this is very troubling. The appeal of conservatives and their arguments is their simplicity: "Things are messed up because of liberals & foreigners who are trying to change us. All we need to do is go back to the way things were."

Progressives need to come up with a simple framework for their ideas that provides an alternative understanding of the way things are, which can provide a foundation for their ideas as well as a rationale for voters to support them.

Here's an example of what I'm talking about:

http://quantumsenseblog.com/2012/02/20/the-job-creator-myth/

Feb 23, 2012, 4:50 PM
fairleft:

Well-done, but with such an emphasis on the need for a prosperous middle class, you surely should define that term. Do you mean a middle class as distinguished from the working class? A middle class that excludes the working poor? Redistribution of income from the wealthy to the rest of us is one of the key pro-growth ideas, and I hope in your thinking 'rest of us' = 'middle class'.

Jan 13, 2013, 2:18 AM
George DeMarse:


For a discussion of the "goals" of progressives, see Drew Westin and "The Political Brain," and George Lakoff and "The Political Mind." Both of these books provide a "master narrative" of progressive policies.
Basically they include the general principles of: the merits of collective decision making to solve problems rather than individual action, a progressive taxation system to fund government programs, the need to help the weakest members of society, appeal to science in social policy, the teaching of civic pride, etc.

The Sage of Wake Forest

Jan 13, 2013, 1:20 PM
Lehel:

Thanks for the interesting post. The one thing lacking is the discussion on how the middle-class grew in America in the first place. If you can make a strong argument for how past progressive policies enabled the development of a large middle class in America, you'd be set. But, until then, you are at a loss for an argument that it was a free-market that allowed for the rise of the middle class, and progressive policies only serve to keep people dependent on the government, rather than learning how to save, invest and grow on their own merits.

Jan 14, 2013, 5:30 PM
George DeMarse:


Well that would be easy. Progressive policies "made the middle class."

In the gilded age, wealth was almost exclusively reserved for the top 2 or 3 percent of the population--industrialists, inherited wealth, etc. There was barely a "middle class" to speak of--mostly poor and unlanded gentry.

With the advent of the "progressive era," the the progressive income tax and other policies that redistributed some wealth and created some economic security enabled a middle class to be born and sustain itself.

The middle class became more stable and grew with the advent of unionization later on when more wealth was "negotiated" toward the middle and away from the top. This enable a large middle class to "consume more" a grow the economy.

That would be the answer to your question on "how" progressive policies created a middle class. And the reason we need more of these policies today to sustain it.

Jan 21, 2013, 11:21 AM
Thron:

Trickle down has two paths. One is based on progressive principles where government taxes and trickles down tax dollars through favoritism, K-Street pressure, ideology, crony capitalism, campaign contributions and entitlements. The other is free market capitalism where free individuals free from government manipulation based progressive principles build wealth through their innovation, ability to tolerate risk, education and drive by a combination of greed and deed. These individuals create wealth through a job rather than government handout. They compete on quality and cost until government pollutes their industy with crony capitalism where failure is rewarded and excellence dies. Those with a moral compass will be more motivated by deed but still victims of progressive principles. Those driven by power and materialism will favor greed and collaborate with progressives in government for special treatment. The difference is progressivism has NEVER created a vibrant middleclass because its leaders see the masses as helpless victims and themselves as an more caring, educated aristocracy more capable of manipulating their weaknesses to the politically correct path. Unionized public education is a monument to progressivism where progressive disciples described as teachers have devolved K-12 education to 25th in the World from number one in 1960. It is trickle-down progressivism that is driving the US economy, education and culture today, not free market trickle-down. You have misdiagnosed the problem because it is the solution you are advocating.

Feb 14, 2013, 8:25 AM

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