The trouble with blaming economic inequality for many of our economic ills is that the theory doesn’t fit the facts. One theory is that growing inequality caused many low- and middle-income Americans to over-borrow so they could keep up with wealthier Americans.
This borrowing allegedly led to the credit bubble and the Great Recession. The recovery has been plodding — the theory continues — because so many strapped households don’t earn enough to dig their way out of debt. A skewed income distribution is at the core of our problems.
It’s a seductive argument because hardly anyone champions today’s extreme inequality. But that doesn’t settle the issue. As I pointed out in a recent column, blaming inequality for the credit bubble fails a rudimentary test of logic.
Even if most Americans were aware of growing inequality a decade ago — doubtful, because the subject is highly technical and wasn’t widely discussed — it doesn’t follow that they could automatically borrow whatever they wanted. The crucial link between credit growth and the economic collapse stemmed more from the enthusiasm of lenders than from the eagerness of borrowers.
Now it turns out that the economic evidence doesn’t vindicate the theory either. It’s true that Americans took on more debt in the 2000s. But what isn’t true is that borrowing was driven by growing inequality — a need by poorer Americans “to keep up with the Joneses.” If this had been the case, cities, counties and states where inequality was greatest would have experienced the largest increases in debt among lower-income households. A just-released study from the National Bureau of Economic Research (NBER), a scholarly group, concludes that this didn’t happen.
“Our main finding is that low-income households in high-inequality regions borrowed relatively less than similar households in low-inequality regions,” report the economists.
If people’s main motive in borrowing was “catching up,” then debt increases should have been greatest in areas where there was the most catching up to do. Just the opposite occurred.
The study — NBER working paper 19850 — was done by economists Olivier Coibion of the University of Texas, Marianna Kudlyak of the Federal Reserve Bank of Richmond and Yuriy Gorodnichenko and John Mondragon of the University of California, Berkeley. They examined household debt, income and inequality on a geographic basis through several large databases that cover home mortgages, auto loans, student loans and credit card debt.
Inequality is highest, they say, in the South, California and the Pacific Northwest. It’s lower in the Midwest.
From 2001 to 2008, the debt of low-income borrowers in areas with less economic inequality rose about 15 percent relative to similar borrowers in areas with higher inequality, the study finds.
Lenders lent less to low-income borrowers in high-inequality areas, the study says, because they were more skeptical that they’d be repaid.
No one denies Americans’ recent borrowing binge. But the explanation is not that the added loan demand reflected a spontaneous reaction to stagnant living standards that lenders met by providing whatever borrowers wanted.
The actual story is the reverse: Lenders relaxed credit standards, and borrowers took advantage of the easier access to loans.
The debate over why credit standards were relaxed — was it greed by bankers pursuing fees, or misguided government policies promoting home buying, or a false sense that the economy was more stable? — still rages.
It is the right debate, as opposed to a politically convenient focus on inequality.
© 2014 Washington Post Writers Group