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Is Inequality the Convenient Villain or a Misguided Obsession?

Jean-Pierre Chauffour's picture

Inequality is back in the news. In his 2014 State of the Union address, U. S. President Obama lamented that, “after four years of economic growth, corporate profits and stock prices have rarely been higher, and those at the top have never done better.  But average wages have barely budged.  Inequality has deepened.  Upward mobility has stalled.”   At the global scale, Oxfam is making the same point, noting in a recent report that the richest 85 people in the world own the same amount of wealth as the 3.5 billion bottom half of the Earth's population. Perhaps more surprising, the rich and powerful CEOs jetting to Davos earlier this year seemed to finally get it: capitalism cannot survive if income and wealth become concentrated in too few hands. Fighting inequality would therefore not only be the morally correct thing to do, it would also be smart economics.  And this is what a recent Staff Discussion Note from the IMF suggests: “inequality can undermine progress in health and education, cause investment-reducing political and economic instability, and undercut the social consensus required in the face of shocks, and thus tends to reduce the pace and durability of growth.”

While the politics of inequality is straightforward, its economics is more subtle. If we were to double, triple or quadruple everyone’s income tomorrow, millions would be lifted out of poverty, but inequality would actually increase. Should we reject these scenarios out of hand? In other words, is the fundamental issue inequality or is it economic growth?  The IMF seems to suggest the former: “redistribution is overall pro-growth”. Tax, spend and redistribute and the world is likely to be a better place (i.e., more equal and more prosperous). 

Too good to be true?

We should all share the Fund’s concern that they may have picked up the reverse causality. What if it is not inequality that is damaging to economic growth but the lack of economic growth that is damaging to equality?  In a recent book (forthcoming in English), Thomas Piketty, expert on the measurement of inequality, shows that economic growth has generally been a force for equality. Friedman (Benjamin, not Milton) goes further and argues that beyond its material benefits, economic growth may actually improve the citizen's "moral character", his tolerance, generosity, and openness. Could it be that, in recent decades, wealth concentrations in OECD countries (not to discuss their moral character) have been pushed toward Victorian levels because of tumbling rates of economic and population growth and not the other way around? According to Piketty’s “laws of capitalism”, the normal state of the world is one in which the return to capital is persistently both higher and more stable than the rate of economic growth. Accordingly, only periods of high economic growth can sustain improvement in the share of total income going to wages (as opposed to capital) and therefore make societies more equal. If this causality is correct, then redistribution can only be a pale palliative to the more fundamental forces at play. For the World Bank, the big lesson would be that accelerated economic growth—not redistribution—is the key means to achieve and sustain the institution’s twin goals of eliminating extreme poverty by 2030 and boosting shared prosperity, measured as the income of the bottom 40 percent in any given country.  

Of course, broad-brush macroeconomic studies take methodological shortcuts. The measurement of redistribution at the core of the IMF analysis (the difference in the Gini coefficients before and after tax) says little about the actual redistribution efforts, as evidenced by the weak correlation between the proposed measurement of redistribution and actual transfers (e.g. 0.49 in relation to countries’ subsidies and other transfers). To be sure, it’s often the case that large fiscal transfers have little effect on income distribution (the famous Okun's "leaky bucket") or, conversely, that tax and spending measures that are not intended at redistributing income have strong redistribution effects.

Finally, in discussing the possible effect of inequality and redistribution on the duration of the growth spell, the IMF may not have dwelt sufficiently on the source of financing of the redistribution effort—taxation versus indebtedness—and the possible connection between the latter and the redistribution variable. Could the debt-financed redistribution in OECD countries in the last 30 years have had a positive impact on growth (as debt-to-GDP ratios increased from the 20-30% range to above 90% in many countries)? So the “extra” growth was not the result of the redistribution per-se but the additional indebtedness (the year after year multiplier effect) regardless of the nature of expenditures. In other words, if the debt build-up experience of the last 30 years cannot be replicated in countries that are already highly indebted, would a tax-financed redistribution still be pro-growth in the future?

Causes and effects are always difficult to disentangle, as are the concepts of inequality and envy. Digging into the various manifestations of economic inequality—inequality of opportunities vs inequality of outcomes, in-country inequality vs global inequality, “good” inequality vs “bad” inequality—opens a wide research agenda. While the academic conversation continues, the forces that have been able to reduce extreme poverty in the world by more than half since the early 1980s—namely, sustainable accelerated economic growth—should not be derailed.


Submitted by leo on

i strongly believe that an aspect of inequality is deliberated on pasted decision..
but lets leave history to judge itself what Matters is what we do from hence forth.....
in dat spirit... we need 2 supplement d developing world with the technical resources to meet
its potential demand or needs with policies geared towards d 21th century not applying tactics of d 20th century...
we need to make developing countries thinking about long-term productivity growth albeit to establish a productive base..
swf in d developing world need 2 aggressively chase tfp, adapting their economies to the rapidly changing global environment.
making innovation a necessary criteria for swf is needed to bolster growth in ssa

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