When is economic growth good for the poor?

November 17, 2010

In a good society, the living standards of the least well-off rise over time.

One way to achieve that is rising redistribution: government steadily increases the share of the economy (the GDP) that it transfers to poor households. But there is a limit to this strategy. If the pie doesn’t increase in size, a country can redistribute until everyone has an equal slice but then no further improvement in incomes will be possible. For the absolute incomes of the poor to rise, we need economic growth.

We also need that growth to trickle down to the poor. Does it?

The following charts show what happened in the United States and Sweden from the late 1970s to the mid 2000s. On the vertical axes is the income of households at the tenth percentile of the distribution — near, though not quite at, the bottom. On the horizontal axes is GDP per capita. The data points are years for which there are cross-nationally comparable household income data.

Both countries enjoyed significant economic growth. But in the U.S. the incomes of low-end households didn’t improve much, apart from a brief period in the late 1990s. In Sweden growth was much more helpful to the poor.

In Austria, Belgium, Denmark, Finland, France, Ireland, the Netherlands, Norway, Spain, and the United Kingdom, the pattern during these years resembles Sweden’s. In Australia, Canada, Germany, Italy, and Switzerland it looks more like the American one. (More graphs here.)

What accounts for this difference in the degree to which economic growth has boosted the incomes of the poor? We usually think of trickle down as a process of rising earnings, via more work hours and higher wages. But in almost all of these countries (Ireland and the Netherlands are exceptions) the earnings of low-end households increased little, if at all, over time. Instead, as the next chart shows, it is increases in net government transfers — transfers received minus taxes paid — that tended to drive increases in incomes.

None of these countries significantly increased the share of GDP going to government transfers. What happened is that some nations did more than others to pass the fruits of economic growth on to the poor.

Trickle down via transfers occurs in various ways. In some countries pensions, unemployment compensation, and related benefits are indexed to average wages, so they tend to rise automatically as the economy grows. Increases in other transfers, such as social assistance, require periodic policy updates. The same is true of tax reductions for low-income households.

Should we bemoan the fact that employment and earnings aren’t the key trickle-down mechanism? No. At higher points in the income distribution they do play more of a role. But for the bottom ten percent there are limits to what employment can accomplish. Some people have psychological, cognitive, or physical conditions that limit their earnings capability. Others are constrained by family circumstances. At any given point in time some will be out of work due to structural or cyclical unemployment. And in all rich countries a large and growing number of households are headed by retirees.

Income isn’t a perfect measure of the material well-being of low-end households. We need to supplement it with information on actual living conditions, and researchers and governments now routinely collect such data. Unfortunately, they aren’t available far enough back in time to give us a reliable comparative picture of changes. For that, income remains our best guide. What the income data tell us is that the United States has done less well by its poor than many other affluent nations, because we have failed to keep government supports for the least well-off rising in sync with our GDP.

9 Responses to “When is economic growth good for the poor?”

  1. Max Rockbin Says:

    I think this article fails to distinguish between two separate phenomena: Income mobility and income distribution.
    Do “The Poor” improve their lot? If you look at distributions of income at two different points in time (and different levels of GDP) and in this article, you are examining distributions of income, but NOT whether a particular group of people is better off. For example, if a new group of people, say from Mexico, venture into the United States, and (at least for a while) have lower incomes, that would give the appearance of a more skewed income distribution – but it does not really indicate whether the existing population improved their lot or not. To examine that, you would need more than a spreadsheet or stats software. You’d have to do long term studies and surveys.

  2. Andrew Says:

    actually, I believe that research on this question has been undertaken either by sociologists or economists by comparing the earnings of sons to the earnings of their fathers. The U.S. has very little income mobility for those in the bottom out of the bottom and also little mobility of those in the top out of the top – especially if you compare similar mobility statistics in other rich industrialized countries.

  3. msgnet Says:

    What is happening to the size of households in the US relative to Sweden and other countries? As far as I know, the divorce rates in the US increased markedly after 1960, greatly increasing the number of households.

    I’m also concerned about comparing by default the bottom 10% in different countries. The US has had considerably more immigration and a currently has a wider spread of income distribution than most other countries. I think that makes it difficult for an apples to apples comparison.

  4. Other Peter T Says:

    As Andrew says, the research shows that the US ranks low in income mobility. It’s also not particularly more open to immigrants – both Canada and Australia have more migrants per capita, while Europe bears the brunt of migration from Africa and Eastern Europe.

    A less obvious point is that income transfers are directly political. They really only work where there is a strong political consensus in support (often the result of a recent history of disastrous class war). Historically the Anglo countries have relied on less direct arrangements (tariffs, wage policy, industry and farm support, assisted emigration in the UK case), which have all been undermined by the move to neo-liberalist economic policies.

  5. Ned Cifric Says:

    The increase is there but it is so little that there is hardly any impact. Its a sad world, in which the poor get little or any headway.

  6. Simon Says:

    http://www.nationmaster.com/graph/imm_net_mig_percap-immigration-net-migration-per-capita

    The US does not have more immigration per capita than the comparison group we are interested in here.

  7. ohwilleke Says:

    “What is happening to the size of households in the US relative to Sweden and other countries? As far as I know, the divorce rates in the US increased markedly after 1960, greatly increasing the number of households.”

    Sweden has abandoned the institution of marriage to a greater extent than almost any other society in the world. Unmarried parenthood their is similar in frequency to unmarried parenthood in African-American ghettos in the United States.

    Also, after a surge in divorce rates in the U.S., the trend has changed. College educated Americans are now considerably more likely to get married and more likely to stay married than their parents generation. In contrast, marriage as an institution for working class Americans without college educations is falling apart. Fewer couples are marrying, and those who marry are having great trouble staying married.

    Another significantly changing trendline is the number of children per woman for women of different socio-economic status. For at least the last century or so, higher status women have had fewer children than lower status women. This trend has reversed itself in the last couple of decades and now higher status women have more children. Part of this trend is attributable to high status women who delay childbearing and then have multiples due to the use of fertility drugs. Part of this trend is attributable to wider use of contraceptives by lower status women, a trend that lagged the use of contraceptives in higher status women. Teen pregnancy rates are very near the lowest they have ever been at any time ever in the history of the United States or their pre-immigration ancestors. The high rates of unmarried childbirth in the United States today are largely a function of working class women in their twenties and thirties choosing to have children with men to whom they are not married — often cohabitating, but not always.

  8. cole Says:

    Why do all good things must come from the government? How about adding the $300 billion in charitable giving citizens of the US give each year. A substantial slice goes to the poor. Wouldnt it be more efficient to increase private charitable giving where people are content to do their job for little wage or for nothing instead hiring govt union bureaucrats who siphon much of the money away.
    The immigration discussion is almost laughable if you dont take into account illegals.

  9. human mathematics Says:

    How does LIS data compare to PPP numbers?

    I’m particularly wondering about decrease in food costs and increase in technology / quality of goods for the poorest 10% in the USA.


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