8. Inequality and Economic Growth
Summary (4 min read)
Introduction
- IN 1HE middle of the twentieth century, it came to be believed that 'a rising tide lifts all boats': economic growth would bring increasing wealth and higher living standards to all sections of society.
- At the time, there was some evidence behind that claim.
- The 'rising-tide hypothesis' was equally consistent with a 'trickle-up' theory-give more money to those at the bottom and everyone will benefit; or with a 'build-out from the middle' theory-help those at the centre, and both those above and below will benefit.
- This is partly because the extraordinary growth in top incomes has coincided with an economic slowdown.
- The trickle-down notion-along with its theoretical justification, marginal productivity theory-needs urgent rethinking.
The great rise of inequality
- Let us start by examining the ongoing trends in income and wealth.
- In the past three decades, those at the top have done very well, especially in the Cl The Author 2016.
- The Political Quarterly © The Political Quarterly Publishing Co. Ltd. 2016 Published by John Wiley & Sons Ltd, 9600 Garsinglon Road, Oxford OX4 2DQ, UK aod 350 Main Street, Malden, MA 02148, USA INEQUALITY AND EcoNoMic GROWTH US.
JOSEPH E. STIGLITZ
- Profits of airlines and the value of airline stocks increase, airline CEOs should not get a bonus.
- The design of good compensation schemes that do this has been well understood for more than a third of a century,53 and yet executives in major corporations have almost studiously resisted these insights.
- High unemployment most severely penalises those at the bottom and the middle of the income distribution.
- Higher public investment-in infrastructures, technology and education-would both revive demand and alleviate inequality, and this would boost growth in the long-run and in the short-run.
- If governments ensure equal access to education, then the distribution of wages will reflect the distribution of abilities (including the ability to benefit from education) and the extent to which the education system attempts to compensate for differences in abilities and backgrounds.
A generalised international trend
- While the US has been winning the race to be the most unequal country (at least within developed economies}, much of what has just been described for it has also been going on elsewhere.
- In the past twenty-five to thirty years the Gini index-the widely used measure of income inequality-has increased by roughly 29 per cent in the United States, 17 per cent in Germany, 9 per cent in Canada, 14 per cent in UK, 12 per cent in Italy and 11 per cent in Japan .
- The more countries follow the American economic model, the more the results seem to be consistent with what has occurred in the United States.
- Also disturbing are the patterns that have emerged in transition economies, which at the beginning of their movement to a market economy had low levels of inequality in income and wealth (at least according to available measurements).
- Moreover, recent research by Piketty and his co-authors has found that the importance of inherited wealth has increased in recent decades, at least in the rich countries for which the authors have data.
Explaining inequality
- In the nineteenth century, they strived to explain and either justify or criticise the evident high levels of disparity.
- While exploitation suggests that those at the top get what they get by taking away from those at the bottom, marginal productivity theory suggests that those at the top only get what they add.
- The advocates of this view have gone further: they have suggested that in a competitive market, exploitation (e.g. as a result of monopoly power or discrimination) simply couldn't persist, and that additions to capital would cause wages to increase, so workers would be better off thanks to the savings and innovation of those at the top.
- Since then, the work of Bebchuk, Fried and Grinstein has shown that the huge increase in US executive compensation since 1993 cannot be explained by firm performance or industrial structure and that, instead, it has mainly resulted from flaws in corporate governance, which enabled managers in practice to set their own pay.
The increase in rents34
- Three striking aspects of the evolution of most rich countries in the past thirty-five years are (a) the increase in the wealth-to-income ratio; (b) the 142 INEQUALITY AND EcoNoMic GROWTH stagnation of median wages; and (c) the failure of the return to capital to decline.
- Hence, those with skills would see their wages rise, and those without skills would see them fall.
- As a result, the value of those assets that are able to provide rents to their owners-such as land, houses and some financial claims-is rising proportionately.
- With more wealth put into these assets, there may be less invested in real productive capital.
- Indeed, it is easy for capitalist economies to generate such bubbles (a fact that should be obvious from the historical record,37 but which has also been confirmed in theoretical models.
The role of institutions and politics
- The large influence of rent-seeking in the rise of top incomes undermines the marginal productivity theory of income distribution.
- Weak unions and asymmetric globalisation, where capital is free to move while labour is much less so, are thus likely to have contributed significantly to the great surge of inequality.
- Unions' inability to protect workers against the threat of job loss by the moving of jobs abroad has contributed to weakening the power of unions.
- Central bank policies focusing on inflation have almost certainly been a further factor contributing to the growing inequality and the weakening of workers' bargaining power.
- The discrimination takes many forms-in housing markets, in financial markets (at least one of America's large banks had to pay a very large fine for its discriminatory practices in the run-up to the crisis) and in labour markets.
The price of inequality
- The evidence is thus unsupportive of explanations of inequality solely focused on marginal productivity.
- A first justification for the claim that inequality is necessary for growth focuses on the role of savings and investment in promoting growth, and is based on the observation that those at the top save, while those at the bottom typically spend all of their earnings.
- The only way to generate savings required for longterm growth is thus to ensure sufficient income for the rich.
- This argument is particularly inapposite today, where the problem is, to use Bernanke's term, a global savings glut.
- The government can tax the income of the rich, and use the funds to finance either private or public investment; such policies reduce inequalities in consumption and disposable income, and lead to increased national savings (appropriately measured).
Reversing inequality
- A wide range of policies can help reduce inequality.
- The rules of the game play a large role in determining market distribution-in preventing discrimination, in creating bargaining rights for workers, in curbing monopolies and the powers of CEOs to exploit firms' other stakeholders and the financial sector to exploit the rest of society.
- Now they must be rewritten once again, to reduce inequality and strengthen the economy, for instance, by discouraging the short-termism that has become rampant in the financial and corporate sector.
- 51 Reforms include more support for education, including pre-school; increasing the minimum wage; strengthening earned-income tax credits; strengthening the voice of workers in the workplace, including through unions; and more effective enforcement of anti-discrimination laws.
- Executives should not be rewarded for improvements in a firm's stock market performance in which they play no part.
57 More precisely, these are the estimated costs ('tax expenditures') associated
- See Congressional Budget Office, The Distribution of Major Tax Expenditures in the Individual Income Tax System, May 2013, p. 31, http:/ I cbo.gov I sites/ default/ files/ cbofiles/ attachments/TaxExpenditures_ One-Column.pdf (accessed 22 December 2015).
- This figure includes the effects of the 'step-up of basis at death' provision, which reduces the taxes that heirs pay on capital gains.
- Not including this provision, the ten-year budgetary cost of preferential treatment for capital gains and dividends is $1.34 trillion.
- 58 See J. E. Stiglitz, Reforming Taxation to Promote Growth and Equity, Roosevelt Institute White Paper, May 2014, http:/ /rooseveltinstitute.org/sites/all/files/ Stiglitz_Reforming_Taxation_ White_Paper_Roosevelt_Institute.pdf (accessed 22 December 2015).
- 59 The Commission's report was released in 2009, and published as J. Stiglitz, A. Sen and J. P. Fitoussi, Mismeasuring The authors Lives, New York, The New Press, 2010.
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Cites background from "8. Inequality and Economic Growth"
...‘Across the OECD, since 1985 the Gini coefficient has increased in 17 of 22 countries for which data are available, often dramatically’ (Stiglitz, 2015: 139)....
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22 citations
Cites background or methods from "8. Inequality and Economic Growth"
...…work offers an innovative contribution to the recent body of literature on the causes and consequences of the increasing levels of income and wealth inequality in advanced financialised economies over the last three decades (e.g. Atkinson et al., 2011; Piketty, 2014; Stiglitz, 2012, 2015a, 2016a)....
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...Through the mechanisms of our model, we provide a formal description of the functioning of what Stiglitz (2015b) previously labelled as a rent-seeking or exploitation rent economy, i.e. an economic system in which the ultimate goal of credit creation is not the financing of productive activities…...
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