Paul Ryan and the Theory of Income Inequality

Paul Ryan, R-WI, is a conservative philosopher and theoretician of the first rank and it's a real challenge to get the best of him intellectually. He makes a very strong defense of US income inequality using the following theoretical framework.

Neoliberalism and free-market fundamentalism lead to income inequality. Rewarding people in the upper income distribution increases economic growth. Growth generates jobs. Jobs then reduce income inequality. In the economics profession, the role of income inequality in creating economic development is called a Kuznets process (or Kuznets curve) named for the economist Simon Kuznets who studied the empirical foundations of economic growth.

The Pew Economic Mobility Project makes a little different analysis, exploring the link between economic mobility and income inequality (you can read the executive summary of their report here). The video below provides a quick summary of their research.

The theory underlying the PEW mobility research can be summarized with the following directed graph.
Economic growth creates absolute mobility (in terms of the video, everyone is moving up the income escalator). However, economic growth under certain conditions (neoliberalism) blocks individuals from moving up the escalator as they enter on the bottom (relative mobility). In the view of the PEW researchers, the lack of relative mobility is "destroying the American Dream." The result is the type of class conflict that Paul Ryan accuses Democrats of inflaming.

Clearly, Rep. Ryan sees neoliberalism creating absolute mobility and endorses the rise in income inequality (declining relative mobility) because he thinks it feeds back to create growth. In a globalized world system, however, growth may not feedback to the benefit of the working and middle classes.

What seems evident from the late 2000 Financial Crisis is that income inequality leads to the concentration of cash looking for a high-rate of return. Financialization leads to the risky investments necessary to provide high rates of return. Risky investments eventually create a financial crisis which, to some extent, reduces income inequality. The extent of the reduction, however, still leaves the majority of high and low income individuals at the same place in the income distribution.

Rep. Ryan does not mention the financial crisis (and neither does the Pew Center video). However, both the Great Depression and the 2000 Financial Crisis both occurred at secular peaks in US income inequality. The conjuncture of high inequality and financial crisis must be more than a coincidence.

In the audio above, economist Greg Mankiw's gives his explanation of the growth in US income inequality. He does bring the late 2000 Financial Crisis into his discussion.