Thursday, May 10, 2012
Inequality Increases Consumption, by Rich and the Rest
By Kevin Morris
Some economists have begun studying a concept called 'expenditure cascades'. A recent news article in Reuters has referenced a thought-provoking research study by Robert H. Frank, Adam Seth Levine and Oege Dijk. Expenditure cascades, according to the researchers, are the cascading, or successive adoption, of increased spending habits by households of all income levels in an area. The theory is that increased spending by a high income group in an area results in the group just below them to spend more, which results in the income group below that group to spend more, and so on, until it reaches the lowest income group. Frank et al. hypothesize that these expenditure cascades result in decreased saving by lower income groups, and increase unsustainable debt. Their argument questions Milton Friedman's commonly accepted economic theory that no matter the household income, spending rates remain constant and proportional.
In what seems to be a validation of keeping up with the Joneses, Frank and his colleagues use their theory to explain why mainstream economic models have not been able to predict the decline in saving rates amongst lower incomes despite high debt levels. It is clear that this creates an unsustainable economic situation, with high debt levels amongst households leading to the current economic situation in the United States. Amongst other impacts, the authors also point out that increase in income inequality is correlated with increases in bankruptcies, divorce rates and commute distances.
Marianne Bertrand and Adair Morse of the University of Chicago, make a similar argument in a paper on "trickle-down consumption", wherein people who live in communities with higher income inequality are more likely to face higher spending, financial distress, and bankruptcy.
These findings raise the question of what role businesses have had in enabling these trends, through current business practices in compensation, marketing, credit allowance, etc. More importantly, are these trends sustainable? For example, can businesses prosper when debt levels amongst the population are so high?