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8. Inequality and Economic Growth

01 Dec 2015-The Political Quarterly (John Wiley & Sons, Ltd)-Vol. 86, pp 134-155

AboutThis article is published in The Political Quarterly.The article was published on 2015-12-01 and is currently open access. It has received 45 citation(s) till now. The article focuses on the topic(s): Income inequality metrics & Income distribution.

Topics: Income inequality metrics (84%), Income distribution (77%), Economic expansion (57%), Inequality (54%)

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.

10 per cent to 21 per cent. The top 0.1 per cent have fared even better. Over the same period, their average real income increased by 281 per cent (from $1,597,080, adjusted for inflation, to $6,087,113) and their share of national

  • 1 Median hourly compensation (adjusted for inflation) increased by only 9 per cent from 1973 to 2014, even though at the same time productivity grew by 72.2 per cent .
  • Year Figure 1: Wages, productivity and average incomes in the US {1973-2014) Notes: (left panel) Data are for average hourly compensation of production/nonsupervisory workers in the private sector and net productivity of the total economy.
  • Facundo Alvaredo, Tony Atkinson, Thomas Piketty, Emmanuel Saez and Gabriel Zucman (right panel) 135.

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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8.
Inequality and Economic Growth
JOSEPH
E.
STIGLITZ
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 liv-
ing standards to all sections of society.
At
the time, there
was
some evidence
behind
that
claim.
In
industrialised countries
in
the 1950s
and
1960s every
group
was
advancing,
and
those
with
lower incomes were rising most rapidly.
In the ensuing economic
and
political debate, this 'rising-tide hypothesis'
evolved into a
much
more specific idea, according to which regressive eco-
nomic policies-policies
that
favour the richer
classes-would
end
up
bene-
fiting everyone. Resources given to the rich
would
inevitably 'trickle
down'
to the rest.
It
is important to clarify
that
this version of old-fashioned
'trickle-down economics'
did
not
follow from the
postwar
evidence. The 'ris-
ing-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.
Today the trend to greater equality of incomes which characterised the
postwar
period has been reversed. Inequality is
now
rising rapidly. Contrary
to the rising-tide hypothesis, the rising tide
has
only lifted the large yachts,
and
many
of the smaller boats have been left dashed
on
the rocks. 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. That theory attempts
both
to
explain
inequality-why
it
occurs-and
to justify
it-why
it
would
be
benefi-
cial for the economy as a whole. This chapter looks critically
at
both
claims.
It
argues
in
favour of alternative explanations of inequality,
with
particular
reference to the theory of rent-seeking
and
to the influence of institutional
and
political factors, which have shaped labour markets
and
patterns of
remuneration.
And
it shows that, far from being either necessary
or
good for
economic growth, excessive inequality tends to lead to weaker economic per-
formance.
In
light of this, it argues for a range of policies
that
would
increase
both
equity
and
economic well-being.
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.
Between 1980
and
2014, the richest 1
per
cent
have
seen their average
real income increase
by
169
per
cent (from $469,403, adjusted for inflation, to
$1,260,508)
and
their share of national income more
than
double, from
10
per
cent to
21
per
cent. The
top
0.1
per
cent have fared
even
better.
Over
the same period, their average real income increased
by
281
per
cent (from
$1,597,080, adjusted for inflation, to $6,087,113)
and
their share
of
national
income almost tripled, from
3.4 to 10.3
per
cent.
1
Over the same thirty-four years,
median
household income
grew
by
only
11
per
cent.
And
this
growth
actually occurred only
in
the very first years of
the period:
by
2014
it
was
only .7
per
cent higher
than
in
1989, after peaking
in
1999.
2
But
even
this underestimates the extent to which those
at
the
bottom
have
suffered-their
incomes
have
only
done
as well as they have because
hours
worked
have
increased. Median hourly compensation (adjusted for
inflation) increased
by
only 9
per
cent from 1973 to 2014,
even
though
at
the
same time productivity
grew
by
72.2
per
cent (Figure
1).
(To
understand
how
significant this divergence of productivity
and
wages is, consider
that
from
1948 to 1973
both
increased
at
the
same
pace,
about
doubling over the per-
iod.)3
And
these statistics underestimate the true deterioration
in
workers'
wages, for education levels have increased (the percentage of Americans
who
are college graduates
has
nearly doubled since 1980, to more
than
30
per
cent),4 so
that
one should have expected a significant increase
in
wage
rates.
In
fact, average real hourly wages for all Americans
with
only a
high
school diploma
have
decreased
in
the
past
three decades.
5
'
6
i 400% - - - Net productivity
, ---
" -
Hourlycompensation
-~
300%
+--
--------
---...-'~
-
-
-
_
'
__
,
--,.-
'
__
,
.,,.-
__
,,
Year
----
1600000
~
-----------
- Top1%Average
l~OOOO
+--
-
'"
_
co
_
me
_
(i
_
ncl
~
.
---~-
.,__,..
-~
capital
gains)
-----
Bottom
90%
1200000
+--
- .-
ve
-
rag
-e
in
-
co
-
me
___
_,__,_
__,___,~
_.,...
(incl.
capital
gains)
e
~
1000000
!S
800000
+--
---
._,.._ _
_,_
____
_
i
~
600000
400000
~~
----------
2000001
------------
--------------------------------------------------
§~§~§§§~~~~~~~~~~~~i~
Year
Figure
1:
Wages, productivity
and
average incomes
in
the
US {1973-2014)
Notes: (left panel) Data are for average hourly compensation of production/nonsupervisory
workers
in
the private sector
and
net
productivity of the total economy.
'Net
productivity' is
the growth of
output
of goods
and
services minus depreciation
per
hour
worked. EPI analysis
of
data
from the
BEA
and
BLS
(see technical appendix for more detailed information).
Sources: Economic Policy Institute (left panel); The World Wealth
and
Income Database.
Facundo Alvaredo, Tony Atkinson, Thomas Piketty, Emmanuel Saez
and
Gabriel Zucman
(right panel)
135

JOSEPH
E.
STIGLITZ
In
the first three years of the so-called recovery from the Great Recession
of
2008-2009-in
other words, since the
US
economy returned to
growth-
fully
91
per
cent of the gains
in
income
went
to the top 1
per
cent. By 2014,
the rest of the income distribution
had
experienced a
bit
more of a boost,
but
even accounting for that,
58
per
cent of the gains
in
total income have
gone to the top 1
per
cent since 2009. (During that period, the income of the
bottom
99
per
cent has
grown
by
just 4
per
cent.
)7
Presidents Bush
and
Obama
both
tried a trickle-down
strategy-giving
large amounts of money
to the banks
and
the bankers. The idea
was
simple:
by
saving the banks
and
bankers, all
would
benefit. The banks
would
restart lending. The wealthy
would
create more jobs. This strategy,
it
was
argued,
would
be
far more
efficacious
than
helping homeowners, businesses
or
workers directly. The
US
Treasury typically
demands
that
when
money is given to developing
countries, conditions
be
imposed
on
them to ensure
not
only
that
the money
is
used
well,
but
also
that
the country adopts economic policies
that
(accord-
ing to the Treasury's economic theories) will lead to growth. But
no
condi-
tions were imposed
on
the
banks-not
even, for example, requirements
that
they lend more
or
stop abusive practices. The rescue worked
in
enriching
those
at
the top;
but
the benefits
did
not
trickle
down
to the rest of the
economy.
The Federal Reserve, too, tried trickle-down economics. One of the
main
channels
by
which quantitative easing
was
supposed to rekindle growth
was
by
leading to higher stock market prices, which
would
generate higher
wealth for the very rich,
who
would
then
spend
some of that, which
in
turn
would
benefit the rest.
As Yeva Nersisyan
and
Randall Wray argue
in
their chapter
in
this vol-
ume,
both
the Fed
and
the Administration could have tried policies
that
more directly benefited the rest of the economy: helping homeowners, lend-
ing to small
and
medium-sized enterprises
and
fixing the broken credit
channel. These trickle-down policies were relatively ineffective----one reason
why
seven years after the
US
slipped into recession, the economy
was
still
not
back to health.
Wealth is even more concentrated
than
income-by
one estimate more
than
ten
times so. The wealthiest 1
per
cent of Americans hold 41.8
per
cent
of the country's wealth; the top
0.1
per
cent alone control more
than
22
per
cent of total wealth.
8
Just one example of the extremes of wealth
in
America is the Walton family: the six heirs to the Walmart empire command
a wealth of $145 billion, which is equivalent to the
net
worth
of 1,782,020
average American families.
9
Wealth inequality too is
on
the upswing. For the four decades before the
Great Recession, the rich were getting wealthier
at
a more rapid pace
than
everyone else. Between 1978
and
2013 the share of wealth
owned
by
the top
1
per
cent rose dramatically, from less
than
25
per
cent to its current level
above
40
per
cent; the share of the top 10
per
cent from about two-thirds to
well over three-quarters.
10
By
2010, the crisis
had
depleted some of the
136

INEQUALITY
AND
EcoNoMic
GROWTH
richest Americans' wealth because of the decline
in
stock prices,
but
many
Americans also
had
had
their wealth almost entirely
wiped
out
as their
homes lost value. After the crisis, the average wealthiest 1
per
cent of house-
holds still
had
165 times the wealth of the average American
in
the bottom
90
per
cent-more
than
double the ratio of thirty years
ago.11
In
the years of
'recovery', as stock market values rebounded (in
part
as a result of the Fed's
lopsided efforts to resuscitate the economy
through
increasing the balance
sheet of the rich}, the rich have regained
much
of the wealth
that
they
had
lost; the same
did
not
happen
to the rest of the country.
12
Inequality plays
out
along ethnic lines
in
ways
that
should
be
disturbing
for a country
that
had
begun
to see itself as having
won
out
against racism.
Between 2005
and
2009, a
huge
number
of Americans
saw
their wealth dras-
tically decrease. The
net
worth
of the typical white American household
was
down
substantially, to $113,149
in
2009, a
16
per
cent loss of wealth from
2005. But the recession
was
much
worse for other groups. The typical
African American household lost
53
per
cent of its
wealth-putting
its assets
at
a mere 5
per
cent of the
median
white American's. The typical Hispanic
household lost
66
per
cent of its wealth.
13
Probably the most invidious aspect of America's inequality is that of
opportunities:
in
the
US
a
young
person's life prospects
depend
heavily
on
the income
and
education of his or her parents, even more
than
in
other
advanced countries.
14
The 'American
dream'
is largely a myth.
A
number
of studies have noted the
link
between inequality of outcomes
and
inequality of opportunities.
15
When
there are large inequalities of
income, those
at
the top can
buy
for their offspring privileges
not
available to
others,
and
they often come to believe
that
it is their right
and
obligation to
do
so. And, of course, without equality of opportunity those
born
in
the bot-
tom of the distribution are likely to
end
up
there: inequalities of outcomes
perpetuate themselves.
This is deeply troubling: given
our
low level of equal-
ity of opportunity
and
our
high level of inequality of income
and
wealth,
it
is
possible
that
the future will
be
even worse,
with
still further increases
in
inequality of outcome
and
still further decreases
in
equality of opportunity.
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 (Figure
2).
16
The more countries follow the American
economic model, the more the results seem to
be
consistent
with
what
has
occurred
in
the United States. The UK has
now
achieved the second highest
level of inequality among the countries of Western Europe
and
North
137


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