During the three decades after World War II, for example, incomes in the United States rose rapidly and at about the same rate — almost 3 percent a year — for people at all income levels. America had an economically vibrant middle class. Roads and bridges were well maintained, and impressive new infrastructure was being built. People were optimistic. By contrast, during the last three decades the economy has grown much more slowly, and our infrastructure has fallen into grave disrepair. Most troubling, all significant income growth has been concentrated at the top of the scale. The share of total income going to the top 1 percent of earners, which stood at 8.9 percent in 1976, rose to 23.5 percent by 2007, but during the same period, the average inflation-adjusted hourly wage declined by more than 7 percent.
Yet many economists are reluctant to confront rising income inequality directly, saying that whether this trend is good or bad requires a value judgment that is best left to philosophers. But that disclaimer rings hollow. Economics, after all, was founded by moral philosophers, and links between the disciplines remain strong. So economists are well positioned to address this question, and the answer is very clear.
Adam Smith, the father of modern economics, was a professor of moral philosophy at the University of Glasgow. His first book, “A Theory of Moral Sentiments,” was published more than 25 years before his celebrated “Wealth of Nations,” which was itself peppered with trenchant moral analysis.
Some moral philosophers address inequality by invoking principles of justice and fairness. But because they have been unable to forge broad agreement about what these abstract principles mean in practice, they’ve made little progress. The more pragmatic cost-benefit approach favored by Smith has proved more fruitful, for it turns out that rising inequality has created enormous losses and few gains, even for its ostensible beneficiaries.
Recent research on psychological well-being has taught us that beyond a certain point, across-the-board spending increases often do little more than raise the bar for what is considered enough. A C.E.O. may think he needs a 30,000-square-foot mansion, for example, just because each of his peers has one. Although they might all be just as happy in more modest dwellings, few would be willing to downsize on their own.
People do not exist in a social vacuum. Community norms define clear expectations about what people should spend on interview suits and birthday parties. Rising inequality has thus spawned a multitude of “expenditure cascades,” whose first step is increased spending by top earners.
