Symposium | First Principles: Arguing the Economy

Growth and the Middle Class

By David Madland

Tagged EconomicsJobs

To challenge trickle-down economics, progressives need to develop a compelling story that explains how to generate economic growth. Otherwise we will remain on the defensive about whether our policies can create jobs and opportunity, and we’ll continue debating economic policy on trickle-down’s terms, which is a recipe for failure.

The problems with trickle-down are legion. But—even after producing only relatively weak growth during good times and then causing the Great Recession—trickle-down remains standing. However inadequate trickle-down is as a model for generating economic growth, elected officials fall back on it because they can understand—and sell—the simplistic logic of cutting taxes and regulations to provide incentives to workers, businesses, and investors to be more productive.

To challenge trickle-down effectively, progressives should counter with their own story about economic growth. In that story, it isn’t the rich that lead the way to growth and prosperity. Instead, it is a thriving and vibrant middle class that shows us the path. It may not seem intuitive that the concept of “the middle class” is the opposite of trickle-down and an effective counterargument against it. But it is. To understand why, we must first grasp that current thinking and rhetoric about the middle class is backwards. Politicians typically see the middle class as something to create with the gains of economic growth. But in fact, the opposite is the case: The middle class is the source of economic growth. A strong middle class provides a stable consumer base that drives productive investment. Beyond that, a strong middle class is a key factor in encouraging other national and societal conditions that lead to growth. It is a prerequisite for robust entrepreneurship and innovation, a source of trust that greases social interactions and reduces transaction costs, a bastion of civic engagement that produces better governance, and a promoter of education and other long-term investments.

Progressives often point out that in the middle of the previous century, the United States had both a strong and growing middle class and a strong and growing economy. But this story hasn’t been particularly compelling because we usually haven’t explained why these two facts are linked. Without a clear explanation for how the middle class creates growth, the story is dismissed as nostalgia for a bygone era rather than a convincing case for how the modern, global economy works.

When modern progressives have attempted to articulate a model of economic growth that challenges trickle-down, they have underplayed the centrality of the middle class. Progressives have tended to highlight issues like infrastructure, education, or manufacturing. These are important priorities, but progressives fail to bind them together in an economic narrative centered around the middle class.

In his 1936 book The General Theory of Employment, Interest, and Money, John Maynard Keynes described one of the core connections between the middle class and economic growth: that stable middle class consumption is needed to spur investment. Numerous other foundational thinkers have highlighted other connections. But the modern economics profession has largely missed the boat on the middle class, hampering progressives’ ability to challenge trickle-down. Modern economists have been caught up in free-market ideology, and their training blinds them to many of the channels that help a strong middle class produce growth. Economists are primarily trained to think of individuals as untouched by institutional or social influences, and as a result have largely ignored or discounted the positive role of institutions like government and of “non-economic” behaviors like trust and civic engagement. And modern academic political scientists, sociologists, urban planners, and scientists who study these factors have yet to weave them together into a broad economic theory.

Empirical researchers are increasingly finding that a strong middle class produces higher levels of growth. A 2005 study of economic growth in the 50 states by Ohio State University professor Mark Partridge concluded, “A more vibrant middle class…increased long-run economic growth.” And NYU economist William Easterly’s research on international economic development has found that “relatively homogenous middle-class societies have more income and growth.” But still, the theory of why this is so has not been fully explained.

By culling from canonical economists and modern researchers, we can create a compelling theory of middle-class-led growth. The core mechanisms of middle-class-led growth include stable demand, trust, good governance, and a set of virtuous, forward-looking capitalistic and proto-capitalistic behaviors.

Stable Demand

One of Keynes’s central insights was that consumption needs to be sufficient to dispose of the current output of industry in order to make new investments profitable. Investment drives economic growth, but sufficient overall levels of consumption are needed for the private sector to make those investments. This is why during a recession policy-makers seek to stimulate demand in the hopes of raising consumption to levels that encourage new investments. Unfortunately, too often this is all that is remembered of Keynes. What has largely been forgotten is that Keynes recognized the importance of the middle class in creating sufficient demand to stimulate growth. He argued that extremely unequal distributions of income depress demand and thus reduce growth.

The wealthy in unequal societies simply do not consume enough to drive a modern economy. The wealthy save more than the middle class and they consume less. This means that when incomes are stagnant or declining for most people, there isn’t enough demand in the economy to encourage productive investment—unless this demand is debt-fueled. But debt-driven consumption can’t last forever; eventually credit stops flowing—often during an economic crash, exacerbated by high levels of consumer debt. And it can take years to recover from deep recessions, slowing growth for long periods.

The lesson is clear: In order to spur sustainable economic growth, the middle class needs to be able to consume. And to do that, they need to see their incomes rise.

Trust

A strong middle class leads to higher levels of trust. When a society is largely middle class, strangers are more willing to try to work with one another in business and in life, and people are more likely to be optimistic and believe that they can control their circumstances. In addition, people feel they share a similar fate and form stronger social bonds. As Tocqueville observed in the early 1800s, Americans, because they were largely middle class and not aristocrats who could conscript others, needed to trust one another enough to work together to achieve common goals.

Studies across U.S. states, of the United States over time, and across countries all find that societies with a strong middle class and low levels of inequality have greater levels of trust of strangers. Trust is based upon the belief that we are all in this together, part of a “moral community,” according to University of Maryland Professor Eric Uslaner. It is difficult to convince people in a highly stratified society that the rich and the poor share common values, much less a common fate.

As John Stuart Mill argued, “The advantage to mankind of being able to trust one another, penetrates into every crevice and cranny of human life: the economical is perhaps the smallest part of it, yet even this is incalculable.” Mill may have thought the impact of trust on economic growth incalculable, but modern researchers have sought to quantify it. One study of U.S. states measured the percentage of state residents who think “most people can be trusted”—ranging from about 10 percent on the low end in Arkansas to more than 60 percent in New Hampshire—and then analyzed the long-term economic growth of those states, controlling for a host of economic and political factors such as initial levels of education and income. It found that “a 10 percentage-point increase in trust increases the growth rate of GDP by 0.5 percentage points” over five years.

Trust reduces transaction costs because less time and resources are spent verifying and policing. And trusting people see the world as full of opportunities. With higher levels of trust, people are more likely to innovate, seek out trade and new technologies, and generally take economically sound risks.

Good Governance

A strong middle class, as thinkers from Aristotle to James Madison to modern political scientists have noted, fosters better governance by helping ensure government is well-run, increasing citizen participation, minimizing factional fighting, and promoting policies for the benefit of all of society rather than special interests. In contrast, economic inequality and a weak middle class make the political system imbalanced and depress the political participation of the non-wealthy, reducing voting, discussion, and interest in public policy. Political scientist Frederick Solt’s 2008 study of advanced countries found that a rise in inequality from low to high levels reduces political discussion by 12 percentage points and voting by 13 percentage points. Since even in relatively equal societies the non-wealthy are less likely to participate in politics than those with greater economic resources, inequality and a weak middle class have a profound impact on who is politically engaged.

And the weakness and withdrawal of the middle class from public life doesn’t just change electoral politics and public policy. It also reduces the basic effectiveness of government. The quality and efficiency of government agencies and services is significantly diminished, studies show, by economic inequality and a weak middle class. In a 2007 article in The Review of Economics and Statistics, economists Alberto Chong and Mark Gradstein developed a theoretical model explaining the relationship between inequality and governance and then empirically tested it, finding that economic inequality has a harmful effect on bureaucratic quality, government stability, and democratic accountability. Moreover, actual corruption in government becomes much more common without a strong middle class. In short, a weak middle class hollows out governing practices and institutions, so that the bureaucracy no longer delivers for its citizens.

But the important connection, the one progressives rarely make, is that these changes in government have an impact on growth. The active engagement of the wealthy, with their disproportionate power to secure public policies to their liking—through lobbying, campaign expenditures, and other means of influence—is likely to cause taxpayer dollars to be wasted. Government money is misspent not just when the wealthy pursue rent-seeking activities—narrow tax breaks, special copyright terms, patent monopolies, giveaways of the broadcast spectrum, and mining and logging rights on public lands for below-market fees, among others—but also when the wealthy shift broad policy away from more efficient alternatives.

The foresighted and efficient government that comes from having a strong middle class creates favorable conditions for growth, while wasteful, corrupt, and unfair policies are a significant hindrance. A strong middle class helps ensure that government works well, fostering favorable conditions for the economy to prosper.

Capitalist Values

Being middle class in a middle-class society—where most people have adequate financial resources and stability, but not enough to allow for a life of leisure—fosters attitudes and behaviors that are essential to building a healthy capitalist system. Middle-class parents raise their children to value work and education because they understand their children will be dependent upon work, not capital, for most of their income. They convey to their children the principle that if you work hard within the system and follow the rules, you will get ahead. They pass down the patience necessary for children to pursue an education, career, or entrepreneurial activity, and they have the economic means to sustain that patience and plan for the long term.

While the connection between upbringing and environment and a person’s economic productivity can be taken too far, there is no doubt that some behaviors, achievements, and attitudes that promote economic growth come directly from a middle-class environment. Conversely, these positive orientations can be undone by extreme levels of economic inequality, as, for example, David Callahan emphasizes in The Cheating Culture, which explains how the rise in white-collar crime and ethical misconduct (for example, expense account fraud) among employees on the lower tiers of the business world has been fueled by rising economic inequality, which has broken down social norms and made cheating more rewarding.

Members of the middle class set goals and strive to achieve them. A 2010 Department of Commerce report on what it means to be middle class in America today finds, “One characteristic that stands out in the literature on the middle class is that middle-class families emphasize their expectations about the future: this means they work hard, plan ahead, and expect to save in order to attain those goals.”

Students—whether poor or middle class—who go to schools where the majority are middle class have much better outcomes. They score better on tests, graduate high school and complete college at higher rates, and have more successful careers. Researchers find that this is not only because of the direct involvement of middle-class parents who, for example, make sure teachers are good and schools have adequate resources, but also because middle-class kids have positive attitudes toward achievement and engage in productive behaviors such as regularly attending class and doing homework. And in middle-class schools, these attitudes and behaviors dominate.

People who are raised middle class are also much more likely to become entrepreneurs. A Kauffman Foundation report finds that 72 percent of entrepreneurs come from middle-class backgrounds—a vast overrepresentation given that only 44 percent of the public meet their measure of middle class. In short, a healthy middle class is a necessary precondition for the propagation of a healthy capitalism.

Crafting a Progressive Economic Argument

Because of trickle-down’s dominance, progressives are still on the defensive about the tax and social policies essential to our economic vision: progressive taxation, the minimum wage, strong unions, and family leave, to name just a few. The usual progressive argument goes: These policies do not kill jobs. But progressives need to make a stronger case and argue: These policies are essential to creating and sustaining the middle class and thus fueling future growth.

For one theory to supplant another, progressives need to be not just loud and clear about the flaws in the old theory, but to advance vigorously a compelling alternative. The reality is that during the roughly 30-year period of trickle-down’s ascendance, the economy enjoyed only relatively weak growth, followed by the most disastrous economic crisis since the Great Depression. People are beginning to question whether the constant cutting of taxes and regulations really does produce unrivaled growth. But this is not a sign of victory for progressives, merely an opportunity to push an alternative theory.

Progressives need to seize this opportunity by putting forward their own theory: that a strong middle class is the key to economic growth. Leaders in academia, government, and policy-making circles need to take up this charge. Political standard-bearers have to synthesize the message of middle-class-led growth and popularize it, just as Roosevelt did with Keynesian economics and Reagan did with trickle-down. For progressives to win arguments about the economy, Americans need to understand that a strong middle class leads to economic growth, and not the other way around.

From the Symposium

First Principles: Arguing the Economy

No debate is more fundamental in politics than economics. Its the sun; everything else revolves around it. This debate has never been more important than it is today. As the economy slowly rouses itself from its long slumber, its vital...

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David Madland is the director of the American Worker Project at the Center for American Progress. He has written articles, books, op-eds, and commentaries on a range of economic issues, primarily focused on jobs, retirement, and public opinion.

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