Income inequality and growth

For several decades, economists have told us that income inequality is a necessary evil. Lonnie Stevans, an associate prof at Hofstra's business school has looked into this again, in Income Ineuality, Net Investment, and the U.S. Capital Stock: Is there an equity-efficiency tradeoff (available on SSRN, here). He asks whether it is really true that a society that "tries too hard at reducing inequality" will have "fewer incentives resulting in diminished productivity and a lower standard of living."

The reasoning about the relationship between inequality and growth (tracing back, for example to A.M. Okun, Equality and Efficiency: The Big Tradeoff (Brookings 1975) is that efficiency costs of trying to redistribute income or regulate the economy are too high--entrepreneurial and "rent-seeking" activity go down, causing a drop in national income affecting everyone, rich and poor alike.  But as empirical evidence seemed to suggest that income inequality was actually bad for growth, market economists went hunting for theories to explain it, such as incomplete markets or credit rationaing.  See e.g., Stiglitz The Distribution of Income and Wealth Among Individuals, Econometica (1969) at 382-397.  Others have suggested that as income inequality increases, support for redistributive policies also increases, resulting in higher tax rates that diminish investment and economic growth.  See e.g., Alesina and Rodrik, Distributive Politics and Economic Growth, 109 Quarterly J. of Econ. 465 (1994).  Of course, reaganomics developed the "trickle down" approach that we followed fairly religiously under the two Bush presidencies--the idea that reducing taxes on the rich will be an incentive to increase net investment, resulting in economic growth.   

So what does Stevan's study show?  here's the conclusion.

It is clear that for over a quarter of a century, the higher the income category, the more income continued to grow and the rich-get-richer pattern has contiued to prvail.  Many have asked why prosperity is not spreading more equally, but when it came to hard policy decision, the resonse has always been that there is a trade-off between equality and growth.  If a country tries too hard to redistribute income, there are fewer entrepreneurs, less capital investment, and a lower standard of living.  According to the results of this study, there is no empirical evidence over the past 30 years in the United States to support such a contention.  In fact, in three of the five inequality measures, increases (decreases) in inequality have had no influence on the U.S. capital stock, net investment and consequently economic growth.  The three remaining inequality measures have had an inverse effect on caital productivity. (bolding in original)

Comments

[r. willis]

at some point we have to consider whether "growth" should be an end in itself. unless growth is built on an unlimited resource, it must somehow be at the expense of someone else.

[LindaMBeale]

Good point. Economists of all stripes seem to take growth as a must-have and then most neglect fairness in thinking about how to go about getting it. Not only do we need to think about the mechanisms we permit for increasing growth, but also we need to consider whether we should (or even can) always increase growth. And this is tied with notions of what is required for a sustainable economy, sustainable democracy, and sustainable resources. How much population growth can the planet sustain, while still affording a decent quality of life?

These are all questions that should be taken seriously, rather than cast aside to place over all the mantra of "growth is good" (a little like the accompanying mantra of "greed is good").

[peter]

Linda,

People aren't equal, therefore, attempting to force income equality is both artificial and futile.

No matter how hard you fight this, there will always be some people who are more athletic, better looking, smarter, more energetic, more honest, more responsible, more charismatic than others.

These people, generally, make more money.

Oh, and I am willing to relinquish my built-in, unearned white male advantage as soon as Shaquille O'Neal stops being tall and Brad Pitt stops being good looking.

[LindaMBeale]

Nobody --certainly not I--ever claimed people were equal. But I do claim that we cannot have a sustainable democracy (not to mention a sustainable environment and economy) if we continue to redistribute upwards. Instead our policies ought to move us towards egalitarianism--we won't get there, but we'll be a lot closer than we'll ever get with the current corporate welfare policies.

[Jack]

The issue isn't income equality. The problem is the grossly disparate distributions of income which arises from an imbalance of power in both the control of the government and the markets.

[LindaMBeale]

well, it is both, actually. The grossly disparate distribution of income creates huge power imbalances. We ought to be moving towards equality (we won't ever get there, of course) rather than away from it. If we remind people that there is nothing inherently good about income inequality, it somehow makes it easier for them to understand the need to interfere with the "normal" distribution patterns which are basically those that have claiming more for themselves and not giving a d___ about anybody else.

[Jack]

When I say that the issue is not income equality I am simply acknowledging that it is unrealistic to expect same. I am emphasising the need to focus on the grossly uneven distribution of income that exists and that the power imbalance that both stems from such an imbalance and also leads to an even greater imbalance
of income distribution.

[LindaMBeale]

ah, then I agree