Slicing the Economic Pie Differently Better Than Growing It?

Whether it’s better to make the economic pie bigger or make sure its pieces are more evenly distributed has been a long-standing philosophical argument in Washington since at least the Reagan administration and its “rising tide lifts all boats” approach. And the looming debate over whether and how to overhaul the tax system will likely see that call renewed. But a new paper by a Harvard University economics professor argues more equitable pie cutting would be better.

In a May 5 brief for voxeu.org, the policy web portal for the London-based Center for Economic Policy Research, Chetty and his co-authors looked at the percentage of children earning more than their parents, adjusted for inflation, from 1940 to 1980. Using the measure as a proxy for “the American dream,” Chetty and his co-authors found a steady drift downward historically, from 90 percent of children born in 1940 earning more than their parents to only 50 percent of children born in 1980. Mobility was also down in all 50 states, though the brief noted the worst declines centered in the industrial Midwest in states like Illinois and Michigan.

The two main reasons for the lack of mobility? Chetty and his team cited both slower trend growth in Gross Domestic Product as well as a more unequal distribution of economic growth. But changing the latter parameter would have a far more pronounced effect than changing the former. Simulating the current economy where the distributional pattern was the same as in the 1940s would raise mobility to 80 percent from 50 percent. By contrast, raising economic growth to levels seen in the 1940s and 1950s would raise mobility as well, but by a smaller amount—with only 62 percent of children earning more than their parents.

“These findings show that higher growth rates alone are insufficient to restore absolute mobility to the levels experienced in the mid-century U.S. Under the current distribution of GDP, we would need real GDP growth rates above 6 percent per year to return to rates of absolute mobility in the 1940s. Intuitively, because a large fraction of GDP goes to a small fraction of high-income households today, higher GDP growth does not substantially increase the number of children who earn more than their parents,” the paper said. “Of course, this does not mean that GDP growth does not matter: changing the distribution of growth naturally has smaller effects on absolute mobility when there is very little growth to be distributed. The key point is that increasing absolute mobility substantially would require more broad-based economic growth.”