"Lucas vs. Lucas: On Inequality and Growth"

This is from Marshall Jevons at The Bayesian Heresy. It's an IMF paper by Juan-Carlos Cordoba and Genevieve Verdier looking at the impact of inequality on social welfare. Let me start with the abstract:

Summary: Lucas (2004) asserts that "Of the tendencies that are harmful to sound economics, the most seductive, and in my opinion the most poisonous, is to focus on questions of distribution... The potential for improving the lives of poor people by finding different ways of distributing current production is nothing compared to the apparently limitless potential of increasing production." In this paper we evaluate this claim using an extended version of Lucas' (1987) welfare-evaluation framework. Surprisingly, we find that the welfare costs of inequality outweigh the benefits of growth in most cases. These calculations support the case for a research agenda that treats not only growth but also inequality as a priority.

And here's the conclusion to the paper from Marshall Jevons:

Lucas vs. Lucas: On Inequality and Growth By Marshall Jevons: The conclusion from the working paper Lucas vs. Lucas: On Inequality and Growth:

"Children who are otherwise identical will start their lives with vast differences in resources and opportunities, depending on which country and which family they are born in. How much consumption and economic growth would a newborn child be willing to give up in order to avoid these birth lotteries? Lucas (2004) suggests that this child would give up very little, because even if the child is born poor, economic growth would help him or her overcome poverty.

Our findings in this paper show that, on the contrary, the child may be willing to give up all growth, in order to avoid birthplace risk, and a large fraction of growth, if not all, in order to avoid family risk. The critical elements for our results are time discounting and risk aversion. Both factors downplay the role of growth for welfare, while risk aversion enhances the benefits of more equal outcomes. A third key factor is the size of the risk involved at birth, which is enormous.

The contribution of this paper is to quantify the social cost of inequality under the most standard assumptions made in macroeconomic theory. Our results suggest that societies could greatly benefit from reducing inequality. They also suggest the existence of a “big tradeoff” between inequality and efficiency, as described by Okun (1975), and help to explain why societies may not always find it best to adopt growth-enhancing institutions, particularly when inequality is large and those institutions may foster further inequality.

Societies commonly face major choices between equality on one hand and efficiency and growth on the other. The degree of progressivity of the tax system, for example, reveals a society’s willingness to trade equality for efficiency. Other examples are trade liberalization and labor market reforms, which are often regarded as beneficial for economic efficiency but detrimental to equality. Similarly, the extent of law enforcement, illustrated for example in efforts to crack down on tax evasion or informal markets, is influenced by distributional concerns at the expense of efficiency and growth. Migration policies are also strongly influenced by this tradeoff. Any correct evaluation of the institutional and policy choices made by different societies requires a proper assessment of the welfare implications of these choices, and in particular, a careful weighing of the welfare gains from efficiency and growth against the welfare costs of more inequality. Our results suggest that inequality concerns are of the utmost importance and should be explicitly considered in any aggregate evaluation of institutions.

Public discussions of the costs of inequality and the value of redistributive policies are often framed in political rather than academic terms and can lead to mistaken impressions of their effects on social welfare.16 We believe that our work provides an important first step in objectively evaluating the costs of inequality in a well-understood welfare framework.

A necessary caveat in interpreting our results is that we have not fully specified the microfoundations of the technological restrictions for inequality, growth, and consumption levels.

We postulate a reduced-form technology, and calibrate it using natural experiments rather than cross-country regressions. Some estimates of the inequality-growth tradeoff appear in the empirical literature on inequality and growth, but there is still no consensus on this relationship. Since most countries seem to share the same long-run growth rate, we suspect that the main tradeoff is not between inequality and growth, but between inequality and consumption levels. In future research, we hope to improve our measurement of these technological constraints using panel data for inequality and consumption levels.

Finally, our exercise suggests that the following is the proper ranking of issues in macroeconomics from the point of view of their potential social welfare impact: cross-country inequality, within-country inequality, economic growth, and business cycles."

Comments

[dale]

"Public discussions of the costs of inequality and the value of redistributive policies are often framed in political rather than academic terms and can lead to mistaken impressions of their effects on social welfare."

I would argue just the opposite. It's the political discussions of inequality and redistributive policies that lead us away from one-sided, abstract, and overly academic economic theorizing.

Not that economists don't have a lot to add to the conversation. But it's in the moral and political realms that the realities of inequality will be shown in their full effect.

There is an important article in the New Republic, http://www.tnr.com/doc.mhtml?i=w070129&s=plumer013007
Purchasing Power by Bradford Plumer, that gives a much more reality based perspective on the dangers of economic inequality in terms of our democratic process.

Then there is the work of social epidemiologists like Marmot and Wilkinson that illuminate the real life and death consequences of inequality.

[William Smith]

I have to disagree with Dale on the article's importance. Lucas is one of economics' most vocal opponents of government intervention in the market and yet his own analytical framework shows that government intervention in the form of wealth transfer, both cross and intra-country, are more beneficial than harmful to long-term economic growth.
There is something very much to be said about taking the weapons of an opponent and turning them on that opponent.

[dale]

It's not that I disagree with the thrust of the article as expressed in the summary, it's more that I think the full costs of inequality will be understood as much or more from a moral, medical and political POV than from an academic economic POV.

[dale]

And obviously, the actual struggles for a more egalitarian society will take place on the moral and political fields, informed by economics and other academic studies.

[anne]

"Public discussions of the costs of inequality and the value of redistributive policies are often framed in political rather than academic terms and can lead to mistaken impressions of their effects on social welfare."

Among the stranger of passages I have read in a while, but eventually I will understand with my seance-like abilities calling forth the ghosts of English past. Wooooo.

[ken melvin]

All must serve sound economics.

[marcel]

Oxymoron alert, oxymoron alert: There is an important article in the New Republic.

[Real Person from the Real World]

I gather that one thing being said is that a society that provides a better start for its poorer citizens, means a better outcome for everyone. No argument there. Redistributive priciples, that is something else. Gov't crack down on tax cheats.... does that include states that want you to confess on your state income tax, that you bought books from Amazon online, and didn't pay sales tax? It's alright for big business to import labor to take jobs, or open factories out of the country where labor is cheap, but it is NOT alright for joe sixpack to try to avoid sales tax legally.

[Lafayette]

dale: "But it's in the moral and political realms that the realities of inequality will be shown in their full effect."

I have to agree. Trying to "prove" that inequality is bad for economic performance will get us nowhere.

Look what it took for blacks to obtain economic freedom in the US ... years of struggle. And, all the while it was patently obvious that giving blacks a chance to perform actively in the economy only betters every participant.

If Americans cannot feel a moral obligation towards the poor, then they have no basis to have a moral indignation of the concentration of wealth in a very small percentage of their fellow countrymen. In fact, perhaps most have no moral indignation whatsoever of the disproportionate accumulation of capital in the US.

Maybe that indignation will come with time, especially after the incompetence of the plutocratic elite in Washington during this present administration.

One can only hope. But, frankly, I doubt Americans are generally astute enough to formulate a moral imperative and then act to see it implemented politically. Let's remember that Johnson's Great Society was intended to do away with poverty. It didn't.

I suspect that most people look upon poverty as simply a natural occurrence in a deeply competitive society, where the winners take all and the losers can go to hell.

Which is what losers do. Poverty is hell on earth.

[Lafayette]

"It's alright for big business to import labor to take jobs, or open factories out of the country where labor is cheap, but it is NOT alright for joe sixpack to try to avoid sales tax legally."

What in heaven's name is this analogy?

There is NO law preventing outsourcing and there never will be. And, why should the internet be a way to avoid state income tax?

Your mixing apples and pickles to make a point that doesn't stick.

[Lafayette]

"Public discussions of the costs of inequality and the value of redistributive policies are often framed in political rather than academic terms and can lead to mistaken impressions of their effects on social welfare."

In a European context, the heavy state investment in not only infrastructural reconstruction after WW2 but social subsidies in housing and education bore fruit where expected.

There was a colossal shift upwards in income distribution from the lower to middle-class. Few Europeans, who have experienced this shift, would dispute the point. Neither would they care to think that their children should also not benefit from the public largesse as regards education (free tuition up to university) ... the prime economic escalator.

Europe and America (demographically and economically similar, today) would differ in only one characteristic, but an important one. Mobility is conducive to labour efficiency and there for personal income. In Europe, this factor is substantially lower than in America.

I suspect that it probably reflects the reason for the great disparity presently income levels between the two regions (the US and the EU).

As a matter of legal formality, for instance, in France before dislocating for "economic purposes", some employers offer currently employees to dislocate with the jobs to parts of Eastern Europe. The conditions, particularly pay, are so ridiculous that employees refuse categorically to accept them - so the go on the dole at home.

[I.O.Kitov]

The influence of inequality on economic growth is more political than economic question. If to accurately calculate Gini coefficient for personal incomes in the USA as published by the US Census Bureau for the period since 1947, one can find that there has been no change in inequality as described by this Gini coefficient. So, real (and nominal) economic growth in the USA is not too much sensitive to inequality.
For details:
http://www.ecineq.org/milano/WP/ECINEQ2007-67.pdf