Economics by The Economist

Author:The Economist
Language: eng
Format: epub
Publisher: PublicAffairs

January 2014

Redistribution: inequality v growth

Up to a point, redistributing income to fight inequality can lift growth

ON THE CAMPAIGN TRAIL in 2008 Barack Obama stumbled into a memorable encounter with Joe “the Plumber” Wurzelbacher. Explaining the logic of a proposal to raise taxes on the rich, Mr Obama mused that “when you spread the wealth around, it’s good for everybody”. The soundbite, soon an attack-ad mainstay, failed to derail the Obama campaign. But the disagreement between Joe the Plumber and Barack the Senator still trips up governments around the world: is there a trade-off between economic growth and redistribution?

Some inequality is needed to propel growth, economists reckon. 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 and 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. It could threaten public confidence in growth-boosting policies like free trade, reckons Dani Rodrik of the Institute for Advanced Study in Princeton. Or it could sow the seeds of crisis. 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. When the borrowing binge ends everyone suffers.

Pinning down the precise relationship between growth and inequality is a challenge. Some studies reckon inequality is mildly bad for growth. Others suggest the relationship changes as poor countries grow rich, while still others reckon it is the trend in inequality rather than its level that matters.

FIG 8.2 A little off the top

Gini index based on: net income market income

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