Inequality and Economy

Joseph Stiglitz's longish OpEd on Inequality Holding Back the Recovery seems to be the big thing on a lot of progressive blogs.  Krugman responded with a light "but" (and then responded to responders).

First: Krugman is right, of course, in that economics is not a morality play and we can [theoretically] have an economy with full employment that features a handful of super rich and the rest of us as peons.  But...and there had to be a "but"...that result is a weaker economy than one with less inequality, even if it does feature full employment.

Second: if reducing inequality would increase the rate of recovery (Atrios' point, which Krugman agreed with).  Is that not the definition of inequality holding back the recovery?  If we are on a 2% growth trend with current inequality, but we would be on a 4% growth trend if we could put in place programs reducing inequality then inequality is slowing growth and hampering recovery.

Back to point the first...

In an extreme vision of the economy that Krugman postulates, with the very wealthy on top, and the vast majority of the rest of us engaged in activities that support their lifestyles, we are pretty clearly stuck in a bad situation.  People with enormous potential born to the lower caste are pretty much doomed to that fate, and society as a whole is worse off for that.  You get less innovation, exploration, culture and many other things that make for great societies.  In that situation you also foment crime, disease and rebellion (though how much and of which type depends pretty heavily on government and policing).  It is a dystopic vision, not because the economy is not recovered (again, it could be at full employment), but because it has stagnated on a grander scale.