What is the actual relationship between economic inequality and growth? it would be nice to have a precise formula that could tell us the best level of inequality for economic growth, but economic theories disagree on the effects that inequality should have on growth (apart from the fact the research in this area started out with the question of how growth has affected inequality), so there is a clear need for actual empirical data.
The best summary I’ve found on this topic is the article
and its accompanying paper.
It summarizes its findings this way:
studies that look at the longer-term growth implications find that inequality adversely affects growth rates and the duration of periods of growth, while those that focus on short term growth find that inequality is not harmful and may be associated with faster growth. Furthermore, studies that look at the impact of inequality on differ-ent levels of the income distribution have found that inequality is particularly bad for the income growth of those not at the top.
Though that summary is a bit imprecise, and preceding conclusion provides a more detailed account:
Economists Daniel Halter and Josef Zweimuller of the University of Zurich, and Manuel Oechslin of the University of Bern identified methodological differences in the papers that find a positive relationship between inequality and growth and those that find a negative relationship. Specifically, those papers that examine inequality’s effect on growth over time within countries tend to find a positive relationship but those that use cross-sectional comparisons find a negative relationship. These results imply that a study’s methodological choices will determine which effects dominate the results and that there are different effects related to inequality driving short-term and long-term patterns in growth. They posit that the time-difference methods are detecting short-term positive effects to growth, while the cross-sectional methods pick up the long-term negative effects for growth when there is persistently high or growing inequality.
That kind of conclusion is confusing since it’s not obvious why different methodologies should yield different results. Also, consistent short-term behaviour over time should translate into a long-term behaviour of the same kind. In fact, a more recent study has found a positive correlation between inequality and growth by analyzing the development of 10-year averages over time. How that result can be interpreted to mean that inquality is still bad in the long-term is not clear, but there are clearly issues with methodology with any studies on this topic.
One Forbes article summarizes a presumed negative long-term effect that high inequality has had on the OECD countries:
Even the OECD agrees with that general conclusion.
Does that mean that there is currently a stronger consensus for the idea that economic inequality hurts growth in the long run? However, this consensus doesn’t seem to be unanimous. That’s probably a sign for the situation being more complicated than we expect it to be. Perhaps we need to develop finer measurements for inequality, to find out what’s really happening.
Nevertheless, let’s just assume that we have a level of inequality that’s a bit too high, and that the economy would profit from reducing it. But how should inequality be reduced? This is where multiplier effects come into play, which measure the effectiveness of redistribution policies. It turns out that the multiplier effects for direct cash grants are particularly high, especially if the recipients are very poor. This would mean that a UBI would be a comparatively effective way of spending money for reducing inequality and boosting the economy at the same time, as the following article demonstrates:
But where should that money come from? Let’s assume that we care about growth a lot, then we should use ways of taxation that don’t impede that growth excessively. The article “What Is The Evidence on Taxes and Growth” claims that there is a clear hierarchy of taxes when it comes to their negative effects on growth, with the latter being less harmful:
- Corporate income taxes
- Personal income taxes
- Consumption taxes
- Corporate property taxes
- Personal property taxes
This suggests that a shift from income taxes towards property taxes would be quite beneficial to the economy, in particular, if the tax money was used for expenditures with high multiplier effects, like an unconditional basic income. Such a transition would defintely be hard, since taxing property is generally more challenging than taxing income. An interesting exception to that rule would be a Land Value Tax because people can’t hide their ownership of land by putting it into a safe in a tax haven. Economists generally agree that a LVT would be pretty close to optimal, but the idea is mostly ignored by politicians.
The order of “badness” of taxes is at least mildly consistent with the idea that inequality hurts the economy. The inequality of personal property is the highest, so this fits the idea that taxing personal income would both reduce inequality and hurt growth the least. Using a LVT would probably even have better effects, while also being more practical. But in that case the question remains what to do about shares of corporations and other investments that aren’t captured by a LVT.
What’s still missing is information on the optimal levels of
- taxation
- inequality
- height of a universal basic income
apart from the question that it’s not clear what we should optimize those values for? Growth? Progress? Wellbeing? And how should we measure those?
Anyhow, the main focus should be to first get a more solid understanding of the relationship between economic inequality and growth, even if the latter doesn’t happen to be exactly what we want or need. Are there perhaps any economic computer models that could shed some new light on this question?
Probably…But here the author contradicts himself: