Trade-Off between Growth and Inequality.

It has long been thought that you need to have some inequality if you are going to encourage growth. However you can go to extremes, as in the case of Margaret Thatcher, who said that inequality is essential to fostering “the spirit of envy” and hailed greed as a “valuable spur to economic activity”. There is some truth in the matter that without the carrot of financial reward risk taking by entrepreneurs would not be as prevalent as would innovation. This all relates to equity efficiency trade-off where you cannot have both at the optimum level – ie you have an opportunity cost. The Free Exchange column in The Economist discussed this issue.

Negatives of Inequality:
* Damages growth as those on low incomes suffer poor health and low productivity
* Reduces public confidence in growth-boosting policies – eg Free Trade
* A response to the problem of inequality has been to make borrowing easier for lower income groups but when the borrowing ends everyone suffers – Sub-Prime crisis.

Duration of Growth
Some researchers have suggested that getting the economy to grow in the first place is much easier than trying to maintain the levels of growth. When growth does slow down after an initial burst it is usually inequality that is the root of the problem.

Inequality and Redistribution
Further research has tried to separate the effects of inequality and redistribution. Governments tax and spend (fiscal policy) to try and reduce the level of inequality. The chart below shows the difference between 2 measures of income – Market Income and Net Income (after taxes and transfer payments). The difference between the two gives a measure of redistribution. Some notable points:

1. USA – does comparatively little redistribution as its Gini is reduced by approximately 10 points.
2. Sweden – cuts the Gini by 23 points
3. Governments in more unequal countries redistribute more
4. Germany are more unequal than the UK with Market Income but has less inequality when redistribution policies are implemented.
5. Economies that redistribute a lot of lower incomes may have shorter growth periods.
6. If the gap between Market and Net Income is 13 points or more further distribution shrinks growth expansion
7. Inequality more associated with low growth – the higher the Gini Coefficient for net income the slower the growth in income per person.

Gini coef redistribution

One thought on “Trade-Off between Growth and Inequality.

  1. Simon March 25, 2014 / 5:16 pm

    It is an interesting graph. If I was to choose from the list of countries, without looking at the graph, which one I would prefer to live in based on surveys about quality of life in the various countries, I would probably choose Denmark or Sweden. What is interesting is that these countries show, on the graph, the biggest difference between net and market income or the largest levels of redistribution. They do not show, it seems, high levels of income equality. If incomes were highly equal the Gini numbers would be much closer to one. Instead they are all above between 30 and 35 on average.

    All the countries in fact show high levels of income inequality. What is shown by the graph is that the more advanced countries with higher perceived quality of life actually redistribute more of their income. The difference between market and net income.

    Of course the graph does not distinguish between actual income levels but notice that as you move to the right on the graph you move from low income countries to high income countries. This indicates that as income redistribution becomes greater economic prosperity also increases. This is in fact consistent with emerging economic theory and one of the reasons income inequity is such a hot topic.


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