In moderation, redistribution seems to have benign effects
By R.A.
INEQUALITY sits at the top of the political agenda in many countries around the world. Hillary Clinton, the leading Democratic candidate to succeed Barack Obama as president of the United States, made inequality the centrepiece of a major campaign speech on June 14th. On June 18th Pope Francis will deliver an encyclical, a high-level Vatican pronouncement, which is expected to address the problem of global inequality, among other issues. And on June 15th economists at the IMF released a study assessing the causes and consequences of rising inequality. The authors reckon that while inequality could cause all sorts of problems, governments should be especially concerned about its effects on growth. They estimate that a one percentage point increase in the income share of the top 20% will drag down growth by 0.08 percentage points over five years, while a rise in the income share of the bottom 20% actually boosts growth. But how does inequality affect economic growth rates?
How to tax the rich
Economists say that some inequality is needed to propel growth. Without the carrot of large financial rewards, risky entrepreneurship and innovation would grind to a halt. In 1975 Arthur Okun, an American economist, argued that societies cannot have both perfect equality and perfect efficiency, but must choose how much of one to sacrifice for the other. While most economists continue to hold that view, the recent rise in inequality has prompted a new look at its economic costs. Inequality could impair growth if those with low incomes suffer poor health and low productivity as a result, or if, as evidence suggests, the poor struggle to finance investments in education. Inequality could also threaten public confidence in growth-boosting policies like free trade, says Dani Rodrik of the Institute for Advanced Study in Princeton.
More recent work suggests that inequality could lead to economic or financial instability. In a 2010 book Raghuram Rajan, now governor of the Reserve Bank of India, argued that governments often respond to inequality by easing the flow of credit to poorer households. Other recent research suggests American households borrowed heavily prior to the crisis to prop up their consumption. But for this rise in household debt, consumption would have stagnated as a result of poor wage growth. Economic eminences such as Ben Bernanke and Larry Summers argue that inequality may also contribute to the world's "savings glut", since the rich are less likely to spend an additional dollar than the poor. As savings pile up, interest rates fall, boosting asset prices, encouraging borrowing and making it more difficult for central banks to manage the economy.
Crafting a response to rising inequality is tricky, however. Some of the negative impact of inequality on growth can be blamed on poor government policies in highly unequal countries. In Latin America, for instance, populist pressure for excessive state economic control seems to shorten the average duration of growth spells. Yet in moderation, redistribution seems to have benign effects—perhaps by reducing dependence on risky borrowing among poorer households. Over the past generation or two inequality has risen most in places where progressive policies, such as high top tax-rates, have been weakened. A little more redistribution now might improve the quality and quantity of economic growth—and reduce the demand for more aggressive state interventions later.
