The Middle Class Grows the Economy, Not the Rich

President’s Speech Hints at Alternative Model of Growth

David Madland shows how a strong middle class is the key to higher GDP—not giving more money to the wealthy and hoping it trickles down.

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President Obama gestures while speaking about the economy on December  6, 2011, at Osawatomie High School in Osawatomie, Kansas. The president suggested that the middle class are the key to economic growth. (AP/Charlie Riedel)
President Obama gestures while speaking about the economy on December 6, 2011, at Osawatomie High School in Osawatomie, Kansas. The president suggested that the middle class are the key to economic growth. (AP/Charlie Riedel)

See also: A Strong Middle Class Is Key to Getting Our Economy Moving by Michael Ettlinger, Economic Inequality Is Not Sustainable by Heather Boushey, and 10 Reasons Why Cutting Poverty Is Good for Our Nation by Desmond Brown (CAP Action)

The speech President Barack Obama delivered yesterday on the state of the middle class was a forceful refutation of the failures of supply-side economics. Most promisingly, it reached for an alternative theory of economic growth based on the role of the middle class.

The president is certainly on to something. A weakened middle class doesn’t just hurt those who are losing ground. It hurts all of us by stifling our country’s economic growth, as my Center for American Progress colleagues and I have argued in a number of places. In fact, aspects of the president’s speech closely paralleled an article I wrote on the topic a year ago in Democracy: A Journal of Ideas.

Consider that from 1947 to 1979, when the middle class received 54 percent of the nation’s total income on average, the economy grew at a steady clip of 3.7 percent per year. That was 1 percentage point higher than the 2.7 percent rate it grew at from 1980 to 2010, when the middle class was weakening to its current share of only 46 percent.

A 1 percentage-point difference in annual growth rates is a big deal: Over 30 years, an economy increasing at 2.7 percent annually will grow to about two-and-a-quarter times its original size. One growing at 3.7 percent annually will more than triple.

Further, New York University economist William Easterly’s research on international economic development finds that “relatively homogenous middle-class societies have more income and growth.”

While the president didn’t fully develop the argument for why a strong middle class is good for economic growth, he did articulate some key connections. I expand on those and offer some others below.

How a strong middle class drives economic growth and investment

As the president noted: “When middle-class families can no longer afford to buy the goods and services that businesses are selling, it drags down the entire economy from top to bottom. … that’s why a CEO like Henry Ford made it his mission to pay his workers enough so they could buy the cars they made.”

There are many other connections besides the demand case the president makes: a strong middle class is a prerequisite for robust entrepreneurship and innovation, a source of trust that makes business transactions more efficient, a bulwark against credit booms and busts, and a progenitor of virtuous, forward-looking behaviors, such as valuing education.

Promoting better governance is a key way the middle class grows the economy

Perhaps the most important way a strong middle class boosts economic growth is by creating better governance. The president alluded to this when he argued that inequality distorts our democracy by giving “an outsized voice to the few who can afford high priced lobbyists and unlimited campaign contributions.” This is a problem Theodore Roosevelt also discussed in his speech in Osawatomie, Kansas, a century before.

The middle class promotes efficient and honest delivery of government services, as well as forward-looking public investments—in education and infrastructure, for example—that benefit all of society rather than only special interests. Such good governance sets the stage for economic growth. But when the middle class is weak, government tends to operate poorly as the wealthy use their disproportionate power and influence to secure special favors, wasting taxpayer dollars on narrow tax breaks, bank bailouts, special copyright terms, and giveaways of public resources.

The middle class has a strong interest in promoting foresighted policies and making government work well because their economic fate is more closely tied to the quality of government than that of the wealthy. Quite simply, the middle class depend more on public services than the rich. High-income individuals can more easily opt out of public services because they can readily use private services unavailable to individuals with average income.

Lower-quality public schools, for example, are not as much of a concern for the wealthy because they can more easily afford to send their children to private schools. Even quality roads and bridges are less of an issue when you can take helicopters and private planes.

The wealthy can also more easily opt out of a country’s regulations over specific aspects of their life. They can make investments and banking abroad or even move to another country. In contrast, the middle class is more likely to be forced to make the system generally work. And when the middle class is strong they have the political power to achieve their goals.

But, over the past several decades, America has become less of a middle-class society as the wealthy have captured most of the economy’s gains. The top 1 percent’s share of income rose from 9.12 percent in 1974 to 23.5 percent in 2007, while over this same time period the share of income going to the middle class—defined as the middle 60 percent of the population—fell from 52.2 percent to just 46.9 percent and the share going to the bottom 20 percent stayed roughly flat, declining by less than 1 percentage point.

It should not be surprising that as the rich have pulled away from the middle class, their relative political power has significantly increased compared to the middle class.

This dramatic change in power has distorted our political system. Not only have the rich been able to exert ever more political influence, but the far greater relative power of the rich has caused the middle class to feel less influential and thus vote less often and get involved in politics less frequently. As a result, the views of the middle class now hold less political weight than they used to.

And as America has become less of a middle-class society, we have become less trusting and thus less willing to make investments that others might benefit from. Economic inequality is associated with self-centered attitudes toward government spending, while relative equality is associated with greater support for public goods. People in middle-class societies feel they share a similar fate and thus are more willing to make investments that they may not directly benefit from.

To see how this works, take the case of education spending.

A stronger middle class also invests more in education

Because of the decline of the middle class, education spending is lower than it would be otherwise.

Indeed, four decades ago the United States ranked second among high-income countries in education spending as a share of gross domestic product—the broadest measure of a country’s income level—with only Canada outspending us, according to the World Bank. In 2008, the most recent year data are available, we ranked 11th—and Canada, whose middle class has also shrunk significantly, dropped to 16th, as countries with stronger middle classes like Sweden and New Zealand edged ahead.

In states across the country, a similar dynamic has played out as well. Since the Great Recession began, most states have cut education spending. Yet in those states with a stronger middle class, education spending has not been cut by nearly as much on average. Moreover, of the five states that cut education spending the most, the middle class in four is weaker than the national average. And of the five states that increased education spending the most, four had stronger middle classes than the average.

Indeed, in a report my colleague and I wrote last month that examined educational spending in all 50 states over the past two decades, we found that a weaker middle class is associated with significantly lower levels of education spending, controlling for other factors that affect education spending such as state income levels, the percentage of minorities in a state, and the age distribution of the state.

Specifically, we found that a 1 percentage-point increase in the share of income received by the middle class is associated with an increase of $64 per-pupil spending on K-12 education. Our study suggests that if the middle class received the same share of income as it did in late 1960s—approximately 7 percentage points more—per-pupil spending on education would be about $447 higher today. In a state like Louisiana, the median state in terms of student population, that would translate into $306,138,231 more in education spending.

Putting it all together

In short, a strong middle class is good for economic growth. President Obama’s speech was a critical step toward making this truth a central part of our economic debate. There is still a long way to go until middle-class-led growth replaces supply-side as the dominant view of the economy. But if that goal is achieved, yesterday’s speech by President Obama’s will live in history like Roosevelt’s.

Dr. David Madland is the Director of the American Worker Project at American Progress.

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David Madland

Senior Fellow; Senior Adviser, American Worker Project

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