Economic Progress

How does inequality change innovation?

People carry bags outside a shopping mall on the last day of Christmas shopping in Berlin December 23, 2014.

A new paper looks at who has gained the most from the innovations in consumer products from 2004 to 2013. Image: REUTERS/Hannibal Hanschke

Nick Bunker
Policy Analyst, Washington Center for Equitable Growth
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Economic Progress

When asked why he robbed banks, Willie Sutton reportedly replied, “Because that’s where the money is.” That dictum is apt for more than just bank robbery, though. If you’re running a business, it makes sense to target your efforts and products to large and growing markets. Perhaps that market is large because of the number of people in it or because of the amount of money the people in the market have. The rise of income inequality in the United States—an increase in the relative amount of money some people have—has made some researchers and analysts wonder if this change in potential markets affects innovation. Maybe the rise in inequality has spurred companies into innovating more for households at the top of the income distribution? Well, a new research paper finds such a result.

Share of income earned by top 1%, 1975-2014
Image: VOX EU

The new research comes from a working paper from Harvard University Ph.D. student Xavier Jaravel. The intent of the paper is to look at who has gained the most from the innovations in consumer products from 2004 to 2013. As Jaravel points out, if product innovation has focused more on consumers at the top of the income ladder, then prices will probably end up being lower.

Jaravel got access to scanner data that gives him access not only to data on the prices of goods that individuals buy but also to information about their quality and the incomes of the consumer. What he ends up finding is this: As incomes increased at the top (above $100,000 a year to be exact), more consumer goods targeted toward those consumers entered the market. This increase in the supply of goods ended up driving down the price of these goods. (For those concerned about which way causality is flowing here, Jaravel offers two statistical tests to tease out the causal effect of increases in market size on product innovation and finds that his findings hold in both cases.)

The impact of these price drops is fairly significant. Jaravel finds that the average annual inflation rate over the time period studied for households making more than $100,000 a year was 0.65 percentage points lower than that for those making less than $30,000. As inflation rates go, that’s a fairly significant difference. Over a five-year period, that’s about a 3-percentage-point difference in cumulative inflation.

This finding also has relevance for the amount of inflation-adjusting income inequality in the United States. If products have become relatively cheap for households at the top, then their incomes have actually grown even more than we thought. In other words, inequality has increased more than we previously thought based on research that assumes that all households, rich and poor, face the same inflation rate.

More intriguingly still, if Jaravel’s findings hold up and hold to areas outside of consumer goods, then it means inequality may well shape the path of innovation. Many economists are concerned about the pace of innovation, but maybe we should all be thinking about the beneficiaries of innovation. Sure, innovation may trickle down in some cases (think cell phones), but maybe we might want to see some innovation focused right from the beginning on pressing issues facing a broad swath of the population. What good are cheaper consumer goods if they’re only for a select few?

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