Refuted economic doctrines #5: Trickle down

The idea that policies favorable to the wealthy, such as financial deregulation and favorable tax treatment of capital income, will ultimately benefit everybody has been described, pejoratively, as ‘trickle down’ economics.

The same idea been summed up, more positively, in the aphorism ‘a rising tide lifts all boats’ attributed to John F Kennedy, and a favorite of  Clinton advisers such as Gene Sperling and Robert Rubin. (It should be noted that this phrase is also used in the context of debates over free trade and over the effects of macroeconomic expansion. While it generally implies that we should focus on expanding aggregate income without too much concern over distribution, it is less sharply focused than the ‘trickle down’  pejorative.

Whatever you call it, trickle down economics is one of the casualties of the financial crisis. I’m not the first to point this out, and I’m sure I won’t be the last, but here’s a piece summing up my thoughts.

US experience during the decades of neoliberalism gives little support for this view. In the period since the economic crisis of the early 1970s, US GDP has grown strongly, and the incomes and wealth of the richest Americans has grown spectacularly. 

By contrast, the gains to households in the middle of the income distribution have been much more modest. Between 1973 (the last year of the long postwar expansion) and 2007, median household income rose from $44 000 to just over $50 000, an annual rate of increase of 0.4 per cent. (More on this here and here)

Household size has decreased, mainly due to declining birth rates. The most appropriate measure of household size for the purpose of assessing living standards is the number of “equivalent adults” derived from a formula that takes account of the fact that children cost less to feed and clothe than adults and that two or more adults living together can do so more cheaply than adults in separate households.  The average household contained 1.86 equivalent adults in 1974 and 1.68 equivalent adults in 2007 (my calculations on US census data). Income per equivalent adult rose at an annual rate of 0.7 per cent over this period.

For those at the bottom of the income distribution, there have been no gains at all. Unlike the situation in Australia and other countries where a poverty line is defined in relative terms, as a proportion of average income, the US has a poverty line fixed in real terms, and based on an assessment of a poverty-line standard of living undertaken in 1963. 

The proportion of Americans below this fixed poverty line fell from 25 per cent in the late 1950s to 11 per cent in 1974. Since then it has fluctuated, reaching 12.5 per cent in 2007, a level that is certain to rise as a result of the financial crisis and recession now taking place. Since the poverty line has remained unchanged, this means that the incomes accruing to the poorest 10 per cent of Americans have actually fallen over the last 30 years.

Other measures yield similar conclusions. Median earnings for full-time year-round male workers have not grown since 1974. Women have done a little better, with median earnings for full-time year-round workers rising by about 0.9 per year over this period. 

Overall, the main factors sustaining growth in living standards for American households outside the top 20 per cent have been an increase in the labour force participation of women and a decline in household savings. Over the period since 1999, consumption financed by borrowing against home equity has been the main factor offsetting stagnant or declining median household incomes.

Thus, in statistical terms the US offers little support to the trickle down theory. It is equally important, however, to look at how the theory is supposed to work. The general idea is that, the more highly owners of capital and highly-skilled managers are rewarded, the more productive they will be. This will lead both to the provision of goods and services at lower cost and to higher demand for the services of less-skilled workers who will therefore earn higher wages.

The financial sector is the obvious test case for this theory. Incomes in the financial sector have risen more rapidly than in any other part of the economy, and have played a major role in bidding up the incomes of senior managers and professionals in related fields such as law and accounting.  According to the trickle-down theory, the growth in income accruing to the financial sector benefitted the US population as a whole in three main ways.

First, the facilitation of takeovers, mergers and buyouts by private equity firms offered the opportunity to increase the efficiency with which capital was used, and the productivity of the economy as a whole.

Second, expanded provision of credit to households allowed higher standards of living to be enjoyed, as households could ride out fluctuations in income, bring forward the benefits of future income growth, and draw on the capital gains associated with rising prices for stocks, real estate and other assets.

Finally, there is the classic ‘trickle-down’ effect in which the wealth of the financial sector generates demands for luxury goods and services of all kinds, thereby benefitting workers in general, or at least those in cities with high concentrations of financial centre activity such as London and New York.

The bubble years from the early 1990s to 2007 gave some support to all of these claims. Measured US productivity grew strongly in the 1990s, and moderately in the years after 2000. Household consumption also grew strongly, and inequality in consumption was much less than inequality in income or wealth. And, although income growth was weak for most households, rates of unemployment were low, at least by post-1970 standards for most of this period.

Very little of this is likely to survive the financial crisis. At its peak, the financial sector (finance, insurance and real estate) accounted for around 18 per cent of GDP and a much larger share of GDP growth. With professional and business services included, the total share was over 30 per cent.[1] The finance and business services sector is now contracting, and it is clear that a significant part of the output measured in the bubble years was illusory. Many investments and financial transactions made during this period have already proved disastrous, and many more seem likely to do so in coming years.  In the process, the apparent productivity gains generated through the expansion of the financial sector will be lost.

The failure of the trickle-down approach has been even more severe in relation to consumer finance. The idea that increasing income inequality was unimportant when households could borrow to finance growing consumption was never defensible. The gap between income and consumption had to be filled by a massive increase in debt. With sufficiently optimistic assumptions about social mobility (that low-income households were in that state only temporarily) and asset appreciation (that the stagnation of median incomes would be offset by capital gains on houses and other investments)  these increases in debt could be made to appear manageable, but once asset prices stopped rising they were shown to be unsustainable.

In the US context, these contradictions have been resolved for individual households by a massive increase in financial breakdowns. Until 2005, this mainly took the form of a steady increase in bankruptcy, to the point where Americans were more likely to go bankrupt than to get divorced.  Restrictive reforms introduced at the behest of the credit card industry produced a dramatic drop in bankruptcy (in part, the lagged counterpart a massive upsurge in 2003 and 2004 as people rushed to get in under the old rules). From 2006, onwards, bankruptcy rates resumed their upward trend, reaching 1.1 million per year in 2008

This trend attracted little attention as bankruptcies were rapidly overshadowed by foreclosures on home mortgages. During the boom, when overstretched householders could normally sell at a profit and repay their debts, foreclosures were rare. From 2007 onwards, however, they increased dramatically, initially among low-income ‘subprime’ borrowers but spreading ever more broadly. 2.3 million houses were affected by foreclosure action in 2008. In hard-hit areas of California, more than 5 per cent of houses went into foreclosure in a single year

As in other respects, the longer-run implications of the crisis have yet to be fully comprehended. Even when economic activity recovers, consumer credit will be far more restricted than in past decades. As a result, there will be no escape from the implications of decades of stagnant wages for workers at the median and below.

Politically, the failure of the trickle-down theory seems likely to produce a resurgence of the class-based politics pronounced dead in the era of economic liberalism. The contrast between the enforced austerity of any recovery period, and the massive, and massively unjustified, excesses of the financial elite during the boom period, will produce a political environment where phrases like “malefactors of great wealth” no longer seem quaint and old fashioned. (Just after writing this, I Googled it, and found it as the title of a piece in Time Magazine’s Swampland by Joe Klein, among the most reliable indicators of the political zeitgeist_

fn1. Here I’m measuring the ratio of gross FBS output to gross domestic product, which is the figure most relevant to the argument. The value-added in FRB (which nets out inputs purchased by the FRB sector) is smaller, around 20 per cent, but still indicates a highly financialised economy.

90 thoughts on “Refuted economic doctrines #5: Trickle down

  1. an example of where the supposed trickle is really just pi**ing

    WASHINGTON — Today two senators expressed concern over the recent lobbying blitz by multinational corporations to allow companies with offshore funds to move their money back to the United States at a deeply discounted tax rate. The lobbying effort is advocating a repeat of what was specified in 2004 as a one-time only tax break for corporations with funds offshore, when the American Jobs Creation Act of 2004 provided a one-year repatriation tax holiday that reduced the 35% federal tax rate that U.S. companies normally owe on their foreign earnings to just 5.25%.

  2. “#24 Read the post,then look up “pejorative” in the dictionary.”

    I don’t understand what is pejorative about the term trickle-down – apart from you asserting that it is.

    “People who advocate trickle-down economics don’t generally use the term.”

    Why not? What do they call it? Who are these people? What is the economics and why is it wrong? Who proved it wrong?

    “That doesn’t mean they don’t exist.”

    Name names please. Otherwise you are just asserting.

    “The idea that policies favorable to the wealthy, such as financial deregulation…will ultimately benefit everybody…”.

    That is not the essence of the ideas behind financial deregulation.

    Straw men, straw arguments.

  3. The claim that cutting taxes on the wealthy, deregulating financial markets and similar policies will help everyone is part of the standard view of the US Republican Party, espoused by everyone from George W Bush down. The Club for Growth is the clearest single embodiment of this view, and the commentator who exemplifies it is Larry Kudlow. But I doubt this will help much.

  4. “But I doubt this will help much.”

    It does help. Thankyou.

    However, you have named a political party, a politician, and a lobby group as examples, but only one economist (and part celebrity at that).

    So are we mainly refering to political rhetoric rather than economic doctrine?

    I looked up Lawrence Kudlow on Wikipedia (i had not heard of him – wonder how many of your readers have?) Quoting the section on his economic and political views:

    “Kudlow opposes estate taxes, as well as taxes on dividends and capital gains. He also advocates that employees be compelled to make greater contributions to their pension and medical costs, suggesting that these expenses are an undue burden on corporations and defends high executive compensation as a manifestation of market forces and opposes most forms of government regulation. In general, he describes himself as a ‘supply-side’ economist, arguing that reducing taxes will increase governmental revenue through expansion of the overall economy. He has also advocated wide ownership of stocks and frequently speaks of a broad “investor class” that includes most Americans. He is a harsh critic of corporate corruption such as that at Enron and Worldcom.”

    Contradicting his support for small government, he is a supporter of the massive state intervention in Iraq.

    But now i want to take you up on another point. To quote from this post –

    “US experience during the decades of neoliberalism gives little support for this view [of trickle-down economics].”

    What exactly defined the past few decades as neoliberal? Was it the level of govt. spending as a portion of GDP, either absolutely or relative to the previous few decades? Was it the amount or ‘strength’ of govt. regulations? Privatisation perhaps?

    Lets look at some numbers for the U.S….

    U.S. Federal Register total pages:

    From Wikipedia:

    “The Federal Register is the main source for the U.S. federal government agencies:

    * Proposed new rules and regulations;
    * Final rules;
    * Changes to existing rules; and
    * Notices of meetings and adjudicatory proceedings.”

    U.S. Govt. spending history 1902-2010

    I cannot see any trend towards smaller government in these numbers. So what is more neoliberal about the post mid-1970’s period than the post WW2-pre mid 1970’s period, other than some of the rhetoric?

  5. On your first point, “trickle down” is a doctrine about economics rather than a hypothesis debated, in that specific form, by economists, although lots of economic analysis has implications for the claim.

    On your second point, it’s true, and I’ve pointed out on many occasions, that neoliberals failed to stop the growth of the public sector. That doesn’t mean they didn’t try, quite strenuously. The problem is that the natural tendency of economic development is in the direction of more of the services, governments typically finance or provide.

  6. Ok, so “trickle-down” is a framework for analysing economic theories. Fine. But doesn’t that leave you with the problem of “projection” – imparting meaning, substance or intent to theories or policy proscriptions, that are not implied or intended (or fully so) by their authors? Or less formally, won’t the trickle-down framework result in a tendency to see and hear what you want or expect to see?

    Why not deal with the economics directly? – its not like the Laffer Curve is Rocket Science!

    So the neoliberals tried but failed to stop the growth of the public sector, owing (as you believe) to the natural tendency towards bigger government. Does this tendency have a natural limit? Does this tendency include the push in the United States for higher home ownership levels (“the ownership society”), via the strengthening of the Community Reinvestment Act and pressure on Fannie Mae and Freddie Mac to extend their purchasing of morgage securities, particularly of sub-prime and Alt-A securities? Or the ultra-low interest rates that fueled the boom that this intervention precipitated?

    In your linked post, one reply refers to Webers belief that “rising social progress and incomes will lead to expanding government to ensure stability, protection and social welfare”. Does the pressure on governments to provide greater and greater levels of stability, protection and welfare result in debarcles like Iraq and Afganistan? I think it might.

    Btw, the link to the Oz was broken. Perhaps it was to this article by Friedman?

  7. Another way of looking at it would be to ask how much would Warren Buffet have to spend in order for the Trickle Down theory to make sense?

    When you have $62 billion in spare change simply buying the odd yacht just won’t cut it, for that you would have to “…buy a private jet, pack it full of rare breed poodles and smash it into the side of a mountain. Every. Single. Day.”

    Even then he would have change left over 😉

  8. It’s true that luxury items create jobs. But so does school construction, mass transit and healthcare.

  9. The next issue then is what about children who are neglected – or more generally, how do you ensure equal access to resources for children – who are obviously not in a position to guarantee that for themselves.
    Similarly for people with profound disabilities – how do you ensure decent opportunity for people with disabilities? Similarly, how do you ensure decent medical treatment for children born with correctable disabling conditions but whose parents lack the resources to have the problem corrected.
    There is an obvious history here with hip dysplasia which is simply corrected in most cases where resourcing is available.

  10. Dear Mr. Quiggin, Can you refer me to some web address where I can get a complete set of your nine economic doctrines refuted? I can find 5 and 9. You could email them to me as well, at Thanks, David

Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s