Equality and growth – no conflict?

“To lay a factual foundation to the argument for raising the American income floor, we need to sweep away the remnants of an older view that policies cannot promote both equality and growth. The older view assumed an “efficiency-equity trade-off.” If such were true, then nothing could be done to foster economic growth without the collateral damage of greater inequality, or greater equality without the collateral damage of less growth.

History does not confirm such a trade-off. To remember why, first consider a simple point about the political process…A dominant historical outcome has been that vested interests have blocked initiatives that would promote growth and/or equality. A conspicuous example is the suppression of mass public schooling – an investment that clearly promotes both equality and growth. Our second consideration comes from the numbers: history does not record any correlation – negative or positive – between income equalization and economic growth, either in our new American history over the past 360 years or world history over the past 150 years. The correlation does not emerge, regardless of whether “growth” means the GDP per capita growth rate or its absolute level, and regardless of whether “equalization” means the share of social spending in GDP, some measure of policy-induced redistribution, the level of pre-fisc income inequality before taxes and transfers, or even the rate of change in any of these.

Economists have explored the effects on income per capita growth of three kinds of egalitarian variables: tax-based social spending and its composition; fiscal redistribution, measured by the gap between pre- and post-fisc inequality; and the greater equality of pre-fisc incomes before taxes and transfers. An empirical literature using contemporary world evidence finds that the growth effect of equalizing incomes is not significant. History agrees. American experience does not reveal any clear effect on GDP of greater tax-based social spending or more progressive redistribution from rich to poor. Indeed, recent analyses suggest that greater pre-fisc equality has a positive effect on growth. This result supports the argument that egalitarian investments in human capital simultaneously achieve more equality and more growth. While these statistical results can be and have been debated, they do not support any claim that equalizing incomes must lower growth. American income history offers no support either.

If there were any fulcrum at which historical insight might be applied to move inequality, it would be political…no nation has used up all its political opportunities for leveling income without harming economic growth. Improving education, taxing large inheritances, and taming financial instability with regulatory vigilance – the opportunities are there, like hundred dollar bills lying on the sidewalk. Of course, the fact that they are still lying there testifies to the political difficulty of bending over to pick them up.”

Peter H. Lindert and Jeffrey G. Williamson (2016), Unequal Gains – American Growth and Inequality since 1700, Princeton University Press, p.261-2.

There are influential theoretical arguments in economics supporting policies which promote growth by, on the one hand, increasing and, on the other, reducing inequality. The above conclusion to Lindert and Williamson’s comprehensive historical study of American growth and inequality is either ambivalent to or in support of a positive relationship between reduced inequality, certainly at its current level in many countries, and faster growth.

Their argument is that the forces generating inequality are largely exogenous (they come from outside the economic system), and so can be altered through policy without harming growth.

Clearly there are limits to this. Perfect equality of incomes and wealth would destroy the incentives required for economic activity. Ever-increasing inequality could also lead to the sort of social division and political instability which would be destructive of the status quo. Neither extreme is sustainable.

From a macroeconomic perspective, greater inequality can promote or reduce growth, depending on the economic context. If productive investment is constrained by a lack of savings, redistributing income and wealth to those economic agents who tend to save a larger share of their income, such as the wealthier members of society or firms, would provide the resources for that investment by increasing the economy’s savings rate. In this situation, greater inequality can boost growth.

This is an argument often associated with Marxist thinking and the central notion of the rate of profit or surplus in providing the resources and motivation for new investment. Growth is “profit-led”.

By contrast, if productive investment is constrained by a lack of consumption spending, then redistribution to those who consume a larger share of their income, normally the poorer members of society, will boost consumption and stimulate investment. In this case, reducing inequality can boost growth, while policies which increase it will lower growth.

This latter argument finds support in Keynesian and post-Keynesian thinking, so that spending for consumption helps drive investment spending. Growth is held back by “under-consumption” and is “wage-led”. If this is the case, then a strong argument can be made for win-win progressive policies which boost household incomes and wages and reduce inequality while raising growth.

Inequality shapes and is shaped by both economic and political forces. There is perhaps “plenty to play for” in terms of policies which promote greater social justice under capitalism, without undermining its foundations. In today’s climate, they are surely essential to sustaining those foundations.

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