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The economy is a positive sum game – We can all get better off

Yesterday, I looked at what is known as the ‘fixed pie’ fallacy in economics. This is the notion that there is a fixed amount of income or wealth in a society and that one person can only increase their income or wealth by taking some income or wealth from someone else. This is a zero sum view of the world; one person can only get better off if someone else gets worse off.

This notion is false. As I explained yesterday, the Gross Domestic Product (GDP) of the United States – the ‘pie’ – has grown by over 8,000% in real terms in the last 200 years. As a result, pretty much all of us live better than even fairly well off people did a century or so ago. We don’t have to obsess about how much of the ‘pie’ someone else has and we don’t have to rely on making someone else poorer to make ourselves richer. The ‘pie’ can get bigger and make us all better off. The economy can be a positive sum game, as it has been for much of the past couple of centuries.

Another way to see this is by looking at the growth of household income of various income groups. If the pie really is fixed and we can only get better off if someone else is getting worse off, then we would expect to see the incomes of the poorest households falling, stagnating, or rising only slowly in states where the incomes of the richest households were rising. Conversely, we would expect to see the incomes of the poorest households rising fastest in states where the incomes of the richest households were falling, stagnating, or rising only slowly.

But that is not what we see in the data. Quite the opposite, in fact.

Figure 1 shows the real terms percentage change in household income for the top earning 5% of households from 2010 to 2017 on the horizontal axis. On the vertical axis, it shows the real terms percentage change in household income for the bottom earning 20% of households over the same period. If the pie is fixed, you would expect to see the line sloping from top left to bottom right. You don’t. It slopes the other way, from bottom left to top right. In other words, on average, states which saw the largest gains in household income for the top 5% also saw the largest gains in household income for the bottom 20%. The rich got richer, but so did the poor. Nobody had to be made worse off because the economy is a positive sum game, not a zero sum one.

Figure 1: Real terms % change in household income, bottom 20% and top 5% of households, 2010-2017

Source: Census Bureau

We shouldn’t infer anything causal from this, at least not without much further work. The increase of the incomes of the top 5% might not be what is driving the increase in the household incomes of the bottom 20%. There might be something else driving both which we are missing. What might that be? But one thing we can say is that making the rich poorer isn’t a way to make the poor richer.

John Phelan is an economist at the Center of the American Experiment. 




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