We know now that trickle-down economics doesn't really work; the past decade in the United States has seen incomes at the very top soar, while the earnings of the middle class stagnated or declined. But a growing body of academic research is suggesting that this benign force's wicked stepsister, a phenomenon two economists have dubbed "trickle-down consumption," is having a powerful impact on the economy and politics of the United States.
The idea is that income inequality has a significant impact on the 99 per cent: It drives the rest of us to consume more, whether we can afford to or not.
Robert Frank, an economist at Cornell University, has been writing about the subject for nearly two decades. Mr. Frank, co-author of two economics textbooks with Federal Reserve chairman, Ben Bernanke, believes that rising income inequality affects us through what he calls "expenditure cascades." Rising income inequality, he notes, isn't just about the gap between the 99 per cent and the top 1 per cent; it is also about growing differences across the income distribution grid, including at the very top. The result is that all of us see people we think of as our peers earning – and spending – a lot more. As a consequence, we find ourselves spending more, too.
"There has been extraordinary growth in the 1 per cent," Mr. Frank said. "Ordinary people don't want to emulate them, but what happens is that the people who are next to them want to emulate them, and so on. That social cascade ultimately explains why the middle-class home got 50 per cent bigger in the past three decades."
This cascading increase in consumption can have what some of us might consider to be benign effects – everyone working harder and more women entering the work force. But it can also have malign ones. In " Expenditure Cascades," a paper Mr. Frank wrote with Adam Seth Levine and Oege Dijk, the three show that more bankruptcies, a higher divorce rate and longer commutes to work all correlate with increased income inequality.
A draft study by two University of Chicago economists that is attracting a lot of attention supports this view. Marianne Bertrand and Adair Morse coined the term " trickle-down consumption," and in their paper of the same name they find that higher spending, bankruptcy and self-reported financial distress all increase if people live in a community with higher income inequality, compared with one with lower income inequality.
The concepts of "trickle-down consumption" and "expenditure cascades" help to explain one of the great U.S. mysteries of the past decade: Income inequality has been on the rise since the late 1970s, but it is only since the financial crisis that it has gained any real traction in public life. That may be because increased consumption masked growing inequality. Retail therapy meant the 99 per cent didn't notice that the 1 per cent was pulling away.
If you think the American middle class had too much debt before the crisis, and if you buy the notions of expenditure cascades and trickle-down consumption, the bad news is that the cycle may be about to start all over again. Research firm Ipsos MediaCT does a monthly poll of people with a household income of more than $100,000 (U.S.). The February survey, released this week, showed this group is poised to hit the malls.
"We have seen for some time what people call frugal fatigue," said Steve Kraus, chief research and insights officer for Ipsos MediaCT. "Last month it jumped up from about a quarter to a third. They want to revisit the glory days of 2005 or 2006 when they could just buy something nice and treat themselves and not worry about it."
But credit is a lot tighter today than it was before 2008, so how will those who aren't affluent cope when consumption at the top again becomes conspicuous? The alternative to easy credit for the poor is higher taxes for the rich. Surprisingly, Mr. Kraus found that his affluent respondents were willing to pay up. Nearly 60 per cent were in favour of higher taxes for the rich and nearly 40 per cent sympathized with Occupy Wall Street. But households with an income of more than $250,000 are far less supportive of higher taxes and more hostile to the Occupy movement. "When you get to the really high-end folks, you get more of a strident conservative," Mr. Kraus said. "More of a crowd that says, 'Cut spending rather than raising taxes.' "
Consumption may trickle down, but when it comes to the very top, ideas don't climb up.