MILAN – Rising income
and wealth inequality in many countries around the world has been
a long-term trend for three decades or more. But the attention devoted to it
has increased substantially since the 2008 financial crisis: With slow growth,
rising inequality bites harder.
The “old” theory about inequality was that
redistribution via the tax system weakened incentives and undermined economic
growth. But the relationship between inequality and growth is far more complex
and multi-dimensional than this simple trade-off suggests. Multiple channels of
influence and feedback mechanisms make definitive conclusions difficult.
For example, the United States and China are
the fastest-growing major economies today. Both have similarly high and rising
levels of income inequality. Though one should not conclude from this that
growth and inequality are either unrelated or positively correlated, the
unqualified statement that inequality is bad for growth does not really accord
with the facts.
Moreover, in global terms, inequality has
been falling as developing countries prosper – even though it is increasing within
many developed and developing countries. This may seem counterintuitive, but it
makes sense. The dominant trend in the global economy is the convergence
process that began after World War II. A substantial share of the 85% of the
world’s population living in developing countries experienced sustained rapid
real growth for the first time. This global trend overwhelms that of rising
domestic inequality.
Nonetheless, experience in a wide range of
countries suggests that high and rising levels of inequality, especially
inequality of opportunity, can indeed be detrimental to growth. One reason is
that inequality undercuts the political and social consensus around
growth-oriented strategies and policies. It can lead to gridlock, conflict, or
poor policy choices. The evidence supports the view that the systematic
exclusion of subgroups on any arbitrary basis (for example, ethnicity, race, or
religion) is particularly damaging in this respect.
Intergenerational mobility is a key indicator
of equality of opportunity. Rising inequality of outcomes need not lead to
reduced intergenerational mobility. Whether it does depends heavily on whether
important instruments that support equality of opportunity, principally
education and health care, are universally accessible. For example, if public
education systems start to fail, they are often replaced at the upper end of
the income distribution by a private system, with adverse 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 parts of Africa) often lead to and reinforce unequal political
influence. Rather than seeking to generate inclusive patterns of growth,
policymakers seek to protect the wealth and rent-capturing advantage of the
rich. Generally, this has meant less openness to trade and investment flows,
because they lead to unwanted external competition.
This suggests that all inequality (of
outcomes) should not be viewed in the same way. Inequality based on successful
rent seeking and privileged access to resources and market opportunities is
highly toxic with respect to social cohesion and stability – and hence
growth-oriented policies. In a generally meritocratic environment, outcomes
based on creativity, innovation, or extraordinary talent are usually viewed
benignly and believed to have far less damaging effects.
That is partly why China’s current
“anti-corruption” campaign, for example, is so important. It is not so much
China’s relatively high income inequality, but the social tensions created by
insiders’ privileged access to markets and transactions, that threatens the
Chinese Communist Party’s legitimacy and the effectiveness of its governance.
In the US, how much of the increase in income
inequality over the past three decades reflects technological change and
globalization (both favoring those with higher levels of education and skills),
and how much reflects privileged access to the policymaking process, is a
complex and unsettled question. But it is important to ask for two reasons. First,
the policy responses are different; second, the effects on social cohesion and
the social contract’s credibility are also different.
Rapid growth helps. In a high-growth
environment, with rising incomes for almost everyone, people will accept rising
inequality up to a point, particularly if it occurs in a context that is
substantially meritocratic. But in a low-growth (or, worse, negative-growth)
environment, rapidly rising inequality means that many people are experiencing
no income growth or are losing ground in absolute as well as relative terms.
The consequences of rising income inequality
can tempt policymakers down a dangerous path: the use of debt, sometimes
combined with an asset bubble, to sustain consumption. This arguably occurred
in the 1920s, prior to the Great Depression; it certainly occurred in the US
(and Spain and the United Kingdom) in the decade prior to the 2008 crisis.
A variant, seen in Europe, is the use of
government borrowing to fill a demand and employment gap created by deficient
private domestic and external demand. To the extent that the latter is
associated with productivity and competitiveness problems, and exacerbated by
the common currency, this is an inappropriate policy response.
Similar concerns have been raised about the
rapid increase in debt ratios in China. Perhaps debt seems like the path of
least resistance in dealing with the effects of inequality or slow growth. But
there are better and worse ways to deal with rising inequality. Leverage is one
of the worst.
So where does that leave us? For me, the
high-priority items are fairly clear. In the short run, the top priority is
income support for the poor and the unemployed, who are the immediate victims
of crises and the underlying imbalances and structural problems, which take
time to remove. Second, especially with rising income inequality, universal
access to high-quality public services, particularly education, is crucial.
Inclusion sustains social and political
cohesion – and hence the very growth needed to help mitigate the effects of
rising inequality. There are many ways for economies to fall short of their
growth potential, but underinvestment, especially within the public sector, is
one of the most potent and common.