Positive and Negative Inequality

The absence of exclusion maintains cohesion and growth that mitigates inequality.

Rising income and wealth inequality in many countries around the world has been a long-term trend for three decades or more, but since the 2008 financial crisis much more attention has been paid to it. With slow growth, rising inequality hurts more.

The “old” theory of inequality was that redistribution through the tax system weakened incentives and undermined economic growth, but the relationship between inequality and growth is far more complex and multidimensional than that tradeoff suggests. Multiple channels of influence and feedback mechanisms make it difficult to draw conclusions.

For example, the United States and China are currently the fastest growing economies. Both have equally large and rising levels of income inequality. Although one should not conclude from this that growth and inequality are either unrelated or positively correlated, the outright statement that inequality is bad for growth does not really fit the facts.

Furthermore, globally, inequality has been declining as developing countries have prospered, even as it is increasing within many developed and developing countries. It may seem illogical, but it makes sense. The prevailing trend in the world economy is the convergence process that began after the Second World War. The significant 85 percent of the world’s population living in developing countries experienced rapid and sustained real growth for the first time. This global trend exceeds that of the increase in internal inequality.

However, experience in a wide range of countries indicates that high and rising levels of inequality, particularly in terms of opportunity, can indeed be detrimental to growth. One reason is that inequality weakens political and social consensus on growth-oriented strategies and policies. It can lead to deadlock, conflict or poor policy choices. Systematic and arbitrary exclusion of certain subgroups (for example, based on ethnicity, race or religion) has been found to be particularly detrimental in this regard.

Intergenerational mobility is a fundamental indicator of equal opportunities. The increase in inequality of results does not have to lead to a reduction in intergenerational mobility. When this is the case, it depends to a large extent on whether the important instruments that support equal opportunities – mainly education and health care – are universally accessible. For example, if the public education system begins to fail, it is often replaced at the top end of the income distribution by a private system, with negative consequences for intergenerational mobility.

There are other links between inequality and growth. High levels of income and wealth inequality (as in much of South America and certain parts of Africa) often cause—and reinforce—inequality in political influence. Instead of seeking to create inclusive growth patterns, policymakers seek to protect the wealth and rent-seeking advantage of the rich. In general, this attitude has been accompanied by less openness to trade and investment flows, because they entail unwanted foreign competition.

Thus, it does not seem that all inequalities (of outcomes) should be considered in the same way. Inequality based on effective rent-seeking and privileged access to resources and market opportunities is highly toxic for social cohesion and stability and therefore for growth-oriented policies. In a generally meritocratic environment, results based on creativity, innovation, or extraordinary talent are generally welcomed and seen as having much less harmful effects.

That is partly why China’s current “anti-corruption” campaign, for example, is so important. What threatens the legitimacy of the Communist Party of China and the effectiveness of its management is not so much the relatively large income inequality in China as the social tensions created by preferential access to markets and the transactions of those who They have privileged information.

In the US, the question of to what extent the rise in income inequality over the past three decades reflects technical change and globalization (both of which favor those with higher levels of education and skills) and to what extent it reflects access privileged access to the policy-making process is complex and not settled, but it is important to raise it for two reasons. First, the normative reactions are different; secondly, the effects on social cohesion and the credibility of the social contract are also important.

Fast growth helps. In a high-growth environment, with rising incomes for almost everyone, citizens will accept inequality up to a point, particularly if it occurs in a fundamentally meritocratic framework, but in a slow-growth environment (or, worse, still negative), a rapid increase in inequality means that many people are being deprived of it or losing ground in absolute and relative terms.

The consequences of rising income inequality may tempt policymakers down a dangerous path: using debt, sometimes combined with an asset bubble, to maintain consumption. This seems to have been the case in the 1920s, before the “great depression”; This was certainly the case in the US (and Spain and the UK) in the decade before the 2008 crisis.

A variant, typical of Europe, is the use of state indebtedness to fill a gap in demand and employment caused by deficient private internal and external demand. To the extent that the latter is related to productivity and competitiveness problems and exacerbated by the common currency, it is an inappropriate regulatory reaction.

Similar concerns have been raised about China’s rapidly rising debt ratios. Debt may seem like the path of least resistance to address the effects of inequality or slow growth, but there are better and worse ways to address rising inequality. Leverage is one of the worst.

So what should we do? In my opinion, the top priorities are pretty clear. In the short term, the biggest is income support for the poor and unemployed, who are the immediate victims of crises, imbalances and underlying structural problems that take time to clear. Second, particularly in the case of rising income inequality, universal access to high-quality public services, especially education, is of critical importance.

The absence of exclusion maintains political and social cohesion and, therefore, the growth itself necessary to contribute to mitigating the effects of the increase in inequality. Economies fall short of their growth potential in many ways, but underinvestment, particularly within the public sector, is one of the most serious and common.