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  • Does Inequality Hurt Innovation or Entrepreneurship?

    occupy-dc-11-2-2011

    When you’re fixated on a particular problem, it’s easy to see the problem everywhere. Much of the political left is currently obsessed with income inequality, to the exclusion of job creation, economic mobility, or economic freedom. That means they see the consequences of income inequality in some unlikely places.

    Slate‘s Matthew Yglesias exemplifies the trend by blaming income inequality for skepticism of Google’s investment in a high-end thermostat and smoke-detector brand, Nest. Yglesias wonders who will buy the $250 thermostats. There’s a simple answer: the affluent. Because a luxury-level thermostat is a modest upgrade over a conventional one, most middle-income homeowners will stick to the basics. So Nest’s success probably depends on the top few percent of Americans deciding to spring for a luxury good.

    So if U.S. inequality is rising, does that help or hurt Nest’s prospects? Most likely, it helps Nest, since inequality consists of more families moving away from the average income. Yglesias even concedes this, noting a “booming market for luxury goods.” Nest, then, would do even better if income inequality grew!

    The keys to understanding why growth, inequality, innovation, and entrepreneurship all co-exist in dynamic economies are all around your home. If you live in a typical American household, you own many luxury goods: your cellphone was a luxury in the 1980s, and your car in the 1920s. Even the conventional thermostat that Google hopes you’ll replace was once a luxury. These goods filtered down to mass consumption partly because they became cheaper over time but more importantly because the average American income grew so much over time.

    But most entrepreneurs are not inventing luxury home appliances. So does income inequality worsen innovation and entrepreneurship overall? As it turns out, no. Research finds that countries with low inequality have low entrepreneurship. The Global Entrepreneurship Monitor found that growth, economic freedom, and culture promote entrepreneurship:

    Both opportunity and necessity entrepreneurship were higher in countries where there was greater income inequality and where the adults expected the national economic situation to improve. Opportunity entrepreneurship was higher where there was (a) a reduced national emphasis in manufacturing, (b) less intrusive government regulations, (c) a higher prevalence of informal investors, and (d) a significant level of respect for entrepreneurial activity.

    The research on innovation and inequality mostly finds that rapid innovation leads to higher income inequality, at least in theory. But there is also recent evidence that inequality is part of the economic system most conducive to high innovation.

    Yglesias is right that Nest thermostats won’t become a middle-class appliance until middle-class incomes grow. But growth from redistribution will not deliver a steady stream of customers to inventors, since it merely moves demand around. Dynamic entrepreneurship and innovation are both causes and effects of rising incomes at every level.

    Posted in Economics, Front Page [slideshow_deploy]

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