The need for trickle up economics and the fall of trickle down.

Throughout this year, we have seen breaking headlines on mostly negative stuff. With the market crash due to Brexit, to the rampant bigoted rhetoric of US presidential candidate Donald Trump. It was really pleasing and refreshing when the annual US census Bureau report came out in support of Obama’s fiscal policies. I do not write this, to praise Obama but to focus more on the concept of Trickle up economics, which many a times policy makers have tended to ignore.

The recent evidence from the US:

The annual US Census Bureau report on income, poverty and health insurance showed strong progress on three fronts: rapid growth in the incomes of ordinary families — median income rose a remarkable 5.2 percent. This is a substantial decline in the poverty rate (The report says that, “The 1.2 percentage point decrease in the poverty rate from 2014 to 2015 represents the largest annual percentage point drop in poverty since 1999.”) ; and a significant further rise in health insurance coverage after 2014’s gains.

Since Obama’s re-election, he has presided over a significant rise in taxes on high incomes. Now, the top one percent is now paying about the same share of its income in federal taxes as it did in 1979, before Ronald Reagan began the era of big tax cuts for the rich. And some of the increased tax take is being used to subsidise health insurance for middle- and lower-income families.

The Theory of Trickle Up

The main idea behind the trickle up economics comes from the concept of the multiplier effect. This, in effect, means how much of income is spent on consumption goes on to create more consumption and hence leads to more economic growth than the value of the income itself. An example is a better of explaining it:

So suppose you have a college student named Rishabh. Assuming his sources of income are modest (i.e. from part-time work and  or a student loan) and he is not able to save much. Hence, an individual like Rishabh would spend most of his income on consumption. This consumption would further provide lead to more activity in sectors such as retail, entertainment, and food. So, if Rishabh spends $100 on something, this $100 would have a larger than effect than $100 itself!

Now let’s talk about a fictitious millionaire names Richard. If Richard earns $1 Million, then it will mostly be the case that Richard would save a decent amount of this money. This unspent money would be beneficial for Richard as he is gaining interest on it, but for the economy as a whole it is kind-off useless.

This is one of the reasons why in many countries the Taxes are progressive. So that the people with less income have more money to spend on things and the people with large sums give money which would in turn be used on people and projects which would grow the economy.

Trickle Down
Maybe trickle down was not funny for some

But what happened to trickle down?

The main concept behind the trickle down argument goes something like this: If rich people are given more money they would then generate more economic activity through investment and employment generation. Many conservative governments believe in this concept. Especially the Regan and Thatcher Administrations put their faith in this philosophy.

Research suggests that the income gap has grown massively, especially in between the top 1% of the world rich. A research by Oxfam reports that in 2014 the top 1% held about 48% of the world’s wealth and they expect this figure to rise to 54% by 2020.

The middle incomes have been squeezed. This all seemed to be going on for too long but the recent ramifications, in which we see the growth of anti-establishment voice, show that this cannot go on as it has been, without having some major political and economic costs. More, though, it is argued that increasing inequality may instead now be damaging to the growth and middle incomes, through a vivid variety of channels. These costs include fueling household debt and real estate bubbles; reducing aggregate demand; undermining capital investment; reducing the capacity of middle and lower income households to invest in education and skills; reinforcing barriers to socio-economic mobility so more fail to reach their full productive potential; further entrenching the power of existing elites to protect their economic interests including rent-seeking, increasing barriers to entry and stifling innovation. This could in turn, exacerbate pressures for protectionism and restriction of immigration, and undermining the political and legal institutions and social trust that are now recognised as key to growth. (Stiglitz 2012, 2015)

Raghuram Rajan, the former head of India’s central bank and University of Chicago professor, argued in his influential book Fault Lines that rising inequality in the US created tremendous pressures on politicians to make cheap credit available to the low paid.

Finally, the following quote of Pope Francis sums up the fall in belief people are having on trickle-down economics: “The promise was that when the glass was full, it would overflow,  benefiting the poor,” Francis said. “What happens instead is that when  the glass is full, it magically gets bigger, but nothing ever comes out  for the poor.”

“The promise was that when the glass was full, it would overflow,  benefiting the poor,” Francis said. “What happens instead is that when  the glass is full, it magically gets bigger, but nothing ever comes out  for the poor.”

Going ahead

The results of this US policy experiment are in and they’re not bad. They could have been better if the stimulus should have been bigger and more sustained.

Following on this, the battle for trickle up economics is not won. There is more that needs to be done. There should be a more push for fiscal measures all across the developed world targeting the poorest sections of the economy at least. In the words of Franklin Roosevelt from three-quarters of a century ago, seem almost relevant in our present era of rising economic inequality. “The test of our progress is not whether we add more to the abundance of those who have much,” Roosevelt said. “It is whether we provide enough for those who have little.”

“The test of our progress is not whether we add more to the abundance of those who have much,” Roosevelt said. “It is whether we provide enough for those who have little.” – Franklin Roosevelt

Thanks to Snake Oil Magazine for the picture

References:

Stiglitz. J.E., The Price of Inequality: How Today’s Divided Society Endangers Our Future, W.W. Norton, New York, 2012.

———, The Great Divide: Unequal Societies and What We Can Do About Them, W.W. Norton, New York, 2015.

Also, See The Origins of Inequality by Stiglitz

 

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