Is Inequality Bad for Growth? [opinion]

Inequality has received a lot of attention lately, particularly in two arenas where it had not previously received as much: public debate and the International Monetary Fund (IMF). A major driver is the observation that income inequality has now returned to the extreme levels of the Gilded Age.

The share of income held by the top one percent of the global economy rose from eight percent in 1980 to 19pc in 2012 – a level last seen in 1928, and probably the highest among aanced countries. The share held by the top 0.1pc raised from two percent to almost nine percent currently – a level last seen in 1916.

And mobility remains as low as ever. Inequality has increased in many other parts of the world as well. The major exceptions are Latin America, where it has always been very high and remains so, and parts of continental Europe, where it remains relatively low.

The current discussion goes beyond the starting point that we should be concerned about the distribution of the pie, not just about the total size. It tends to focus on one of several extra ‘wrinkles’ – aerse effects of inequality beyond the obvious one of the welfare of those with lower income.

One such wrinkle is the hypothesis that inequality is bad for overall economic growth – for example, in times of inadequate demand, as the rich save more than others. Another is that inequality leads to volatility and instability – for example, that it may have been responsible for the sub-prime mortgage crisis of 2007 and hence the global financial crisis of 2008. A third is the proposition that inequality translates into envy and unhappiness.

Someone who would have been happy at a given income is unhappy if he discovers that others are getting more. One persuasive version of this latter claim holds that top executives demand and receive outlandish compensation not because they value so much the money itself, but because they compete with each other for status.

And yet another concern appears to trump even the first three. Because there is so much money in politics, the rich succeed in getting governments to adopt policies that favour them as a class.

The system often goes under the name of oligarchy. It generates extra handwringing because of the notion that it is self-perpetuating.

The first three concerns have the consolation that they might, at some stage, be self-correcting – at least in a democracy. After all, the upper one percent does not have many votes. Under oligarchy, however, the concentration of economic and political power is self-reinforcing.

Each of these four concerns carries a big element of truth. To do any one of them justice would require delving into the details.

Jeffery Frankel He Is a Professor of Economics At Harvard University, United States

The relationship between growth and inequality has two faces. Examples could elucidate this.

The one-time land redistribution that took place in northeast Asian countries after World War II was probably good for growth. In contrast, a system where the hard-working, thrifty and entrepreneurial fear that they will not be allowed to keep much of the fruits of their efforts is bad for growth.

On the other hand, inequality may cause volatility. For instance, programs meant to help the poor by facilitating housing loans that they cannot afford are bad for them and for financial stability, not good.

But what is wrong with working from the premise that poverty in particular and inequality in general are undesirable for its own sake, other things equal?

I question the rationale for writing opinion columns that focus overwhelmingly on the political-economy dangers of the wealth of the upper one percent. Yes, those dangers are important, but how useful is it to pursue the argument?

Most voters believe that inequality matters in addition to total national income. This is true even recognising that the poor are less heavily represented among those who vote.

Even among the upper one percent, approximately two-thirds believe that differences in income are too large and support progressive taxation.

The problem is that they often vote for politicians who enact laws inconsistent with those goals. For example, ten years ago someone hoodwinked the median voter – most of whom themselves leave negligible estates – into believing that to protect small family-owned farms it was necessary to eliminate taxes on five million dollar estates.

In other words, the problem is not that the median voter is unwilling to trade off any growth in return for more equality. The problem is that the political process produces outcomes that deliver both less growth and less equality than we could get under the optimal trade-off.

Some of the most sensible measures to facilitate growth and reduce inequality include the elimination of payroll taxes for low-income workers and cutting deductions for high-income taxpayers. Some further policies that may promote overall economic growth, while reducing inequality, include universal pre-school education and universal healthcare – especially if these programs are financed out of efficiency-enhancing measures.

In developing countries, measures that tax, subsidise or price-regulate food and energy tend to be highly inefficient tools for improving the income distribution, and frequently even have the opposite effect. A disproportionately small share of social spending goes to the poorest 40pc of the population.

Of the 400-plus billion dollars that countries spend on fossil fuel subsidies each year, far less than 20pc of the benefits go to the poorest 20pc of the population. Conditional cash transfers, on the other hand, have proven highly effective – they reach the poor and promote education and health.

How to nudge the political process towards delivering better policies?

Some believe that the appropriate strategy is to sound the alarm about inequality and oligarchy. However, the argument against oligarchy is not a perfect fit with the reality.

The anti-oligarchy logic on inequality is that the rich have too much money, which they use to get the politicians elected and the bills passed that will favour them, the rich.

But how is that money weapon used?

Politicians need money so badly for only one reason – to get elected. They buy aertising to persuade people to vote for them.

Hypothetically, if we could persuade people to stop watching the aertisements, it would solve the problem. More constructively, if we could persuade the poor to vote, it might solve the problem.

Source : Addis Fortune

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