Do you enjoy riding on roller coasters? Do you like rising, screaming, and then suddenly plummeting, never quite knowing exactly what scary sensation lurks around the next bend?
Many folks crave that sort of experience. Many others don’t. And if you fall in the latter category, you don’t have to worry about roller coasters — because you have a choice. You can choose not to ride. You can avoid all the precipitous ups and downs.
Over recent years, in the United States, we’ve lived the angst of this reality. In fact, we still haven’t fully recovered from the Great Recession. In our modern market economies, we have no such choice. Ups and downs — booms and busts — come with the territory.
Why not? A global team of economists recently took the time to ponder that question. And their answer revolves around a key choice that — even in a market economy — we can make. We can choose to be more equal. The more equal an economy, the less severe and long-lasting economic downturns will be.
How does inequality make downturns worse? The Great Recession offers a telling case study, and the new research from Stockholm University’s Kurt Mitman, the University of Pennsylvania’s Dirk Krueger, and the University of Minnesota’s Fabrizio Perri walks us through it.
In 2007, the year the Great Recession officially began, the United States was experiencing its highest level of household economic inequality since the 1930s. America’s poorest 40 percent of households had more debts than assets. Taken together, these households essentially held 0 percent of the nation’s wealth.
The richest 20 percent of households, by contrast, held 82.7 percent of America’s wealth.
Household income figures told that same basic inequality story. The bottom two fifths of households were taking in 19.9 percent of national income. The top one fifth was pulling down over double that share, 41.2 percent.
But the story changes a bit when we look at consumption. The richest fifth may have had over 80 percent of the nation’s wealth. But their personal spending made up only 37.2 percent of what the nation consumed.
The poorest two fifths of households, on the other hand, may have had zero wealth. But they did have income, and they were spending almost all that income, month after month, on the goods and services they needed to get by. Their personal spending accounted for nearly a quarter of the nation’s total consumption, 23.7 percent.
All these consumption numbers matter. In an economic downturn, consumption levels determine how rapidly and how well an economy will recover. If people aren’t spending, businesses aren’t going to be hiring.
So what happened after the Great Recession hit? People with little or no wealth started spending less. Households in the bottom fifth decreased their spending at twice the rate of households in the top fifth.
In their new research, economists Mitman, Krueger, and Perri take pains to emphasize why exactly poorer people spend less when an economy goes south. The reason that at first glance might appear to be the most obvious — that poorer households in hard times simply have less income to spend — turns out not to be the key driver.
Yes, low-wealth households that have lost jobs and paychecks will spend less when hard times hit. But low-wealth households that have not lost jobs and paychecks will also spend less. They’ll spend less because they don’t have the resources, as Mitman, Krueger, and Perri put it, “to self-insure against idiosyncratic risk.”
In other words, low-wealth households don’t have enough cash available to tide them over if they lose a paycheck. So these households, once hard times arrive, “drastically reduce their expenditure rates, even if their income has not dropped yet.”
The more low-wealth households in a society, the more devastating the impact of these spending reductions on the economy as a whole, the longer downturns linger.
If, on the other hand, we had a more equal distribution of wealth in the United States, more households would be able to keep spending at the onset of a downturn. The rough times would end sooner.
So what should we do? Short-term, we ought to be doing our best to give poor households more income security. Our woefully inadequate system of unemployment insurance needs a total makeover. Families need to see that the loss of a job will not mean a devastating loss of income.
And in the longer term? We simply need to become more equal. We need a total makeover of the policy decisions — on everything from taxes and trade to labor rights and business regulation — that have left the distribution of household wealth in the United States so incredibly top-heavy.