Krugman v Stiglitz on what’s holding back the recovery

Two of the leading economists in the world disagree over whether inequality hampers the economic recovery.

It relates primarily to the US where the top 1% has captured 95% of the income gained since the financial crisis. Since 2009, the top 1% of incomes grew by 31.4% while the bottom 99% saw their incomes rise by only 0.4%, according to a study from the University of California at Berkeley.

The main cause of the slow recovery is certainly worth knowing.

I sat down with two of the most eminent economists in the world, Nobel Laureates Paul Krugman and Joseph Stiglitz, who disagree over the issue.

Stiglitz maintains that those sorts of inequality figures are the main impediments to economic growth. The rich pay less tax, so higher inequality depresses tax receipts. Also, most importantly, the poor consume more of their income than the rich.

This lower "marginal propensity to consume" of the rich was originally pointed out by John Maynard Keynes.

Rich v poor?

In other words, poorer people have less disposable income, and spend more of it on necessities such as food.

Richer people tend to spend proportionately less of their income since they have more money to spend.

It implies that raising incomes for the poor would generate proportionately more consumption.

But, Krugman says that he hasn't seen evidence that the rich "under-consume".

In one sense, of course, the rich spend more absolutely than the poor. If the poor spend 20% of, say, £10,000 of income, then that would add £2,000 to the economy. If the rich spend 3% of £100,000, then that would add £3,000.

Slow recovery

Krugman's point is that this comparison is a static one: if you took two people at a point in time with two different levels of income, then that's what they are doing.

But, if you were raise the income of, say, the poor person, then it's harder to know how their spending would change. Stiglitz maintains that there is a large body of evidence that supports his position.

Stiglitz and Krugman may disagree over how important inequality is to the slow recovery. But they agree that high levels of income inequality are clearly a problem for economic as well as social reasons.

They also agree that most governments have not got it right in terms of the balance of austerity and growth, and don't see the crisis-affected economies of the US, Britain and eurozone getting back to more normal rates of growth anytime soon.

For the rest of us trying to understand why this recovery is so slow five years on from the crisis, it's worth having these debates, since the answer could provide guidance on what needs to be done.

For the full interviews with Paul Krugman and Joseph Stiglitz, tune into Talking Business with Linda Yueh on Friday. Details of when to watch are at: www.bbc.co.uk/talkingbusiness.