Thought of the week – Trickle me, Elmo

But, ironically, it seems that trickle-down economics wasn’t just a vacuous concept, it may literally be an upside-down concept of what is really going on in an economy. According to this paper, what really happens in the economy is trickling up, not down.

Imagine a situation where the government introduces a fiscal stimulus like the Covid stimulus plans enacted in most countries in 2020 and 2021. This government spending effectively puts money into people’s pockets and they can choose to spend it or save it. One important thing to realise is that the lower the income of a person who gets a stimulus cheque, the more likely it is this person will spend the money instead of saving it. Savings rates for higher-income households far exceed those of lower-income households. And this is not because the poor don’t know how to handle money, but because the poor simply can’t afford to save. They have essentially zero disposable income, and thus every bit of extra income needs to be spent on purchases of essential goods.

But what happens when poorer households spend their money? Companies that sell consumer goods make more money and their share prices rise. This not only boosts economic growth, it also increases the savings of shareholders. And shareholders are mostly found in the top 50% of the population by income. The higher up the income ladder you go, the more savings people hold in shares and the more their savings increase as poor people spend their extra income. In the end, money spent by the poor trickles up to the rich and enhances their savings, thus creating more inequality in an economy.