Debunking the middle class
Game theory suggests that in the final sum of things, democratic politics is mostly about wooing the median voter, i.e. the individual or demographic whose inclusion will bring your coalition to 50.1 percent of the vote. Thus it comes as no surprise that in America, where the median voter is a middle-class voter, election-year rhetoric tends to focus on fetishizing those of moderate income.
2012 is no exception. If you watched the Democratic National Convention last Thursday, you probably heard Joe Biden utter these lines:
“Barack and I are about growing this economy from the middle out. … When you do it that way, everybody does well … because the middle class have money in their pockets. They can go out and purchase things that make the economy grow — and not only is sort of the American way, it’s also economically the best way to grow a country.”
The cult of the middle class doesn’t just count Democrats as members. I’m sure in the weeks to come, Mitt Romney and Paul Ryan will wax rhapsodically about whatever semi-professionals and middle managers they can claim familial relations with, as much as Biden deployed stories of his used-car salesman father to heap more worship on Middle America. But Biden’s convention appearance added a new and dangerous element to the middle-class mythology that deserves a thorough and immediate debunking.
Specifically, Biden put forward a two-part theory — first, that giving more money to the middle class was the best way to raise consumption, and second, that increasing consumption was the key to growing an economy.
The first part of Biden’s claim is false as a matter of record. The U.S. Panel Study of Income Dynamics shows that it is the poor, not the middle class, who save the least and consume the greatest fraction of their income. If raising consumption is the goal of economic policy, as is often the case in Keynesian stimulus, aiming transfer payments at the middle class is not the best approach. And looking at the data, it isn’t even the case that targeting economic stimulus toward the middle class would perform much better than spreading it across America equally. In the words of Paul Krugman, “There’s no obvious reason why consumer demand can’t be sustained by the spending of the upper class — $200 dinners and luxury hotels create jobs, the same way that fast food dinners and Motel 6s do.”
The second part of Biden’s claim confuses a short-term economic phenomenon, increasing consumption in a recession to combat the paradox of thrift, for a long-term formula for economic growth. Were it the case that economic growth hinged on low savings rates and large middle classes, it’s doubtful that China’s growth rate over the past two decades would have so greatly outpaced the United States’.
The generous interpretation of Biden is that he meant his comments only as a matter of short-term policy, a way to recover from shortfalls in aggregate demand and no more. But a more realistic reading is that he believes a permanent policy of taxing the rich to give to the middle class is a viable method for increasing economic growth, merely on the basis that the middle class consumes more and saves less as a fraction of its total income. Nothing could be further from the truth.
The simple way to think of things is this: in any given year, society has a limited pool of resources available to it. These resources include everything from physical and human capital (factories, equipment, education), to natural resources (iron ore, oil, natural gas), to the man-hours of our laborers. And faced with this scarcity, society is forced to choose what fraction of its resources to put toward the production of consumer goods, and what fraction will be put toward increasing its stock of resources in the next year. As the national savings rate increases, more of our resources are directed toward building factories, educating students, and otherwise improving our capacity to produce, but at the expense of present consumption. When the savings rate declines, the opposite happens — there is more to enjoy in the immediate present, but next year, because less savings meant fewer resources given to students, construction companies, and the like, there will be fewer college graduates, factories, and so on.
If we saved all of our income, we’d have the largest possible economy, but we’d never be spending any of it on ourselves — we would build more and more factories and train more and more workers until we got to the point we were only building new factories at the rate the existing ones depreciated, only educating the next generation fast enough to replace those departing. And if we saved none of our income (which is roughly what has happened over the past decade), we would spend everything on ourselves, but not have much to spend. The ideal savings rate, the so-called “Golden Rule Savings Rate” where steady-state consumption is maximized, lies somewhere in the middle.
Some economic growth comes naturally. As the population grows, so does our supply of labor. As technology improves, so does the rate at which we convert our available resources into goods. But much of economic growth is due to changes in savings rates, the transition from a low-savings equilibrium to a high-savings equilibrium. Though much credit should be given to improving institutions and diffusion of technology, most of today’s economic success stories from the developing world can be explained as a simple matter of capital formation — as they devoted more and more of what they had toward the future, the future grew brighter.
There’s no reason the United States can’t enjoy this same success story. It is universally recognized that our savings rate is below the golden rule rate. And so, while in the short run we may suffer from a paradox of thrift, in the long run we suffer from a paradox of extravagance — the more we try to raise our consumption, the lower our total consumption is.
For a democrat like Joe Biden, who wishes to increase government consumption, raise taxes on private saving, and transfer wealth from those who would save to those who would continue our long spending binge, it would be convenient if voters bought his notion that these policies were a path to prosperity. For the middle class voter hoping to actually experience some prosperity, it would be better if they ignored Joe Biden.