Lopsided Growth: Can a Rising Tide Sink Some Boats?

Growing up in Denver in the 1990s, Daniel Murphy — now an assistant professor at the Darden School of Business — witnessed something that nagged him into adulthood: a thriving suburbia marked by growth in jobs, wages and production, juxtaposed against an urban center that continued to struggle. He became aware of skilled nurses leaving clinics that served primarily poor neighborhoods to earn higher wages at plastic surgery or other types of health-service offices catering to wealthier populations. No one could blame them, he thought — and yet, the widening divide between rich and poor was as unmistakable as it was distressing.

Fast forward two decades, and while some[1] say the situation has improved, evidence of disparity still lingers in the wake of the technology-driven growth of the 1990s. A 2016 article by the Associated Press described Denver as a “tale of two cities, all in one place” — a tale that, the article noted, isn’t isolated to Denver. In cities across the nation, there seems to be “an economy on paper that most Americans don’t recognize in their own lives.”[2]

Professor Murphy’s questions of his youth remain poignant today: Is it possible for economic growth to make some people worse off? If so, under what circumstances?

Asymmetric Growth

Seeking answers, he examined data from the Survey of Income and Program Participation — a household-based survey by the U.S. Census Bureau that collects the most extensive information available about the nation’s changes in economic well-being over time. He looked at measures of hardship among “high-skilled” workers (defined as those with a college education) versus “low-skilled” workers (those without a college degree), and how they changed from the mid-1990s to the mid-2000s.[3] His analysis revealed falling living conditions among lower-income households, as well as a sharper disparity in states that experienced the highest per capita growth rates.

His suspicions grew: Was he right that technology-driven economic growth had in fact hurt part of the population? Was a key tenet of trickle-down theory — that all members of society benefit from growth — erroneous in this context?

To find out, Professor Murphy set about developing a model that accounts for economic growth biased toward a certain sector — i.e., growth in which an entire population sector is left out of both the supply and demand sides of growth. Using the model, he examined whether the trickle-down effect could indeed have failed in the face of sector-biased growth of the 1990s.

Discussed in his paper “Welfare Consequences of Asymmetric Growth,” published in the Journal of Economic Behavior and Organization, Professor Murphy’s model shows conditions under which growth can make lower-income households worse off. In particular, if growth favors the labor skills of the rich and the goods/services consumed by the rich (known as the “consumption bundle of the rich”), then growth may disproportionately help the rich while harming the poor.

This, Professor Murphy believes, is exactly what may have happened in the 1990s and early 2000s. Certain IT-intensive industries invested in the technological change of that era. The new technologies complemented skilled (educated) labor and produced goods and services predominantly consumed by those same workers. These industries included:

• Telecommunications and cable networks
• Professional services (especially legal and medical services)
• Certain financial services (e.g., credit intermediation and related activities)
• Air transportation

Thus, even while the economy ballooned during that period, lower-skilled workers found their jobs either replaced by machines, less valuable or even obsolete. The goods and services they consumed were also produced less and less, as they became less profitable in the new IT era. With the advances in technology biased against the consumption bundle of the poor, the well-being of lower-income households fell, despite — or perhaps even because of — overall economic growth.

Real-World Examples

The adverse effects of asymmetric growth are the most salient when the consumption bundles of the rich and the poor are distinct. This situation is especially relevant in the context of local neighborhood services: In highly segregated cities, the poor tend to consume the services provided in their neighborhoods and the rich the services in their neighborhoods.

Imagine an auto repair shop that uses state-of-the-art equipment near a wealthy gated community. Skilled mechanics, who have been trained to use the new equipment, will earn a high return using the new equipment, while low-skilled auto workers repair cars for the poor in less affluent neighborhoods. Since the low-skilled mechanics work with inferior capital equipment, their efficiency/quality remains low, as does their income. Low income implies that demand for goods and services in low-income neighborhoods remains insufficient to attract new investments that would, in turn, increase wages and wealth.

Over time, the technology can have a bifurcating effect. As new technology continues to complement the abilities of high-skilled mechanics, those better-off, skilled mechanics will increasingly work in the high-end auto shops that serve the rich, while the less-skilled mechanics will disproportionately provide services for the poor. At the aggregate level, two distinct economies can emerge: one in which the high-skilled rich provide services for each other and another in which the poor consume services provided by low-skilled, low-income workers.

The gap widens between the wages, profits and standard of living of the high-skilled mechanic and his clientele (which includes his own, wealthier family), versus those of the low-skilled mechanic and his clientele. Average wages and profits among auto mechanics may rise during this period, but the low-income households can no longer afford the services of high-skilled mechanics, so they effectively face higher quality-adjusted prices. Thus their real wage/income falls. The statistics obscure the full reality of the situation.

Another scenario: New computer technology increases the efficiency of technology-savvy, college-educated workers in the wealth management industry, which causes an increase in pay in this industry for workers with a college degree. Newly minted college graduates, incentivized by the high pay, decide to work in wealth management for high wages, rather than work as health care providers or teachers in low-income communities. The end consequence of the new computer technology is that low-income communities do not benefit from the health/education/etc. services that skilled college graduates might have provided.

Inequalities like these are never completely avoidable in a capitalistic society, and they don’t always cause hardship (real or perceived). For example, just because the rich can afford to consume Starbucks coffee while the poor might drink less-expensive Maxwell House instant coffee doesn’t mean the poor are worse off. Even in the technology world, some products, like cellphones,[4] have benefited the poor and rich alike. A trickle-down effect can and does occur … but not always! And in the case of an industry like health care, inequality does matter. If the rich provide and consume higher-quality medical services, while the poor — especially those in rural areas — receive lower-quality care, the impact can be life-altering.

Policy Implications

As Professor Murphy notes, if only the bottom line — the overall size of the economic “pie” — matters, then asymmetric growth, as long as it’s growth, isn’t concerning. However, if there’s a concern for the welfare of all, rich and poor alike (not to mention everyone in between), then equalizing measures should be put in place when growth is sector-biased. These measures may include government subsidies, accessible education or job-training programs, and/or a progressive taxation system. Steps like these give lower-skilled (and lower-income) workers a chance to retrain and adapt to new labor needs.

More research and data gathering are needed to determine the precise contexts in which economic growth fails to help all parts of a population. The key takeaway from this initial study, Professor Murphy says, is that we should not assume a rising tide lifts all boats. In some cases, as in the technology-fueled growth of the 1990s, it may, instead, tilt the waters disproportionately toward the rich, leaving the poor in shallow waters — or even running them aground.

Daniel Murphy authored “Welfare Consequences of Asymmetric Growth,” which appeared in the Journal of Economic Behavior & Orientation.

[1] For instance, a Brookings Institution report published 27 April 2017, speaks of Denver’s (and other metro cities’) progress in “inclusive growth”: https://www.brookings.edu/blog/the-avenue/2017/04/27/the-surprisingly-short-list-of-u-s-metro-areas-achieving-inclusive-economic-growth/.

[2] Associated Press, “Across U.S., Economic Averages Miss the Big Picture,” Denver Post, 8 June 2016, http://www.denverpost.com/2016/06/08/us-economic-averages-miss-wealth-disparity.

[3] Hardships include things like “not enough to eat” and “unable to meet basic expenses.”

[4] Pew Research Center reported in January 2017 that 92 percent of Americans making less than $30,000 per year own a cellphone of some kind; the percentages for higher-income brackets are 95 percent ($30,000–$49,999), 96 percent ($50,000–$74,999), and 99% ($75,000+). Interestingly, smartphones remain favored toward the rich, with only 64 percent of the lowest bracket owning one, while 93 percent of those who make $75,000+ own one. http://www.pewinternet.org/fact-sheet/mobile/