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Saturday, February 17, 2007

Is Inequality Destabilizing?

Robert Shiller looks at the relationship between social unrest and inequality across countries. He argues that how inequality is perceived to arise is an important contributing factor to social problems, and that building trust in economic relationships is the key to overcoming perceptions of inequities:

Inequality and its discontents, by Robert J Shiller, Project Syndicate: Leaders around the world seem to be convinced that inequality and lack of broad participation in economic growth, if allowed to persist, will lead to social discord and even violence. But is inequality the real problem?

As Indian Prime Minister Manmohan Singh put it ..., “Even as absolute poverty may be reduced by growth, inequalities can get sharpened. This can be politically and socially extremely destabilising.” So India must “take steps that reduce social and economic inequalities, without hurting the process of growth and without reducing the incentives for individual enterprise and creativity.” ...

Such arguments have the ring of common sense. If people believe that they will share in overall economic growth, they should be more likely to support social peace. If they do not, unrest will become more likely.

However, social scientists have found it difficult to prove that point. In fact, some statistical analyses of the correlation between inequality and social conflict conclude that there may even be an inverse relationship: societies that are more unequal tend to show less conflict, because the rich are better able to control the poor.

There is some evidence that social unrest follows from inequality. The economists Alberto Alesina and Roberto Perotti have shown that, after controlling for several other factors, high-inequality countries do tend to have more social instability...

Nevertheless, one wonders why the evidence that inequality causes social unrest is not stronger. One part of the problem may be that it is not always inequality per se that causes social discord, but also how inequality is perceived to have come. Unrest may reflect more a sense of betrayal – that others are not living up to their implied promises or are not behaving honourably.

Indeed, a sense of trust in others’ intentions is central to a functioning economy. Lawyers write a lot of contracts, and courts spend a lot of time enforcing them, but these institutions cannot cover everything. Most economic relationships depend on good will, a basic inclination to do the right thing even if no one is checking.

Trustworthiness is hardly universal. But the business world is built on our intuitive knowledge of when we can trust people fairly well and when we can’t trust them much at all. We design contracts around imperfect trustworthiness and construct elaborate institutions that take account of the hills and valleys of human honour. When these function well, we have a general sense that, even though people are not always trustworthy, basic fairness prevails. ...

By contrast, when inequality is perceived as the result of a breakdown in trusting relationships, it can lead to bitterness, and, ultimately, social unrest. This frequently occurs in times of rapid economic change. For example, in a rapidly globalising world, people may have to leave their long-term employers, with whom they have built a sense of trust... In such cases, inequality may be perceived more intensely, for people may link it with the loss of good will.

What Singh, Lula, and other world leaders really seem to want is to strengthen trust and cooperation even amidst a rapidly changing economy. If they succeed in devising policies, laws, and incentives that achieve this, a by-product would likely be a reduction in inequality, which one hopes would reinforce the improved sense of trustworthiness.

If he is saying that rising inequality is the result of solid underlying economic fundamentals, that people are fairly rewarded for their contributions to the economy but rapid economic change obscures this from view generating misperceptions and lack of trust, I don't agree. It is entirely possible that the perceptions of unfairness are justified in many of these countries and that trust will reemerge only when the economic system itself is changed to ensure that government policy, market failures, cronyism, and other departures from solid economic fundamentals are not the source of the unequal distribution of goods and services. Trust follows action.

    Posted by on Saturday, February 17, 2007 at 06:22 AM in Economics, Income Distribution | Permalink  TrackBack (0)  Comments (18)

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