« Paul Krugman: The Competition Myth | Main | SOTU: Obama Won't Endorse Raising Retirement Age or Reducing Social Security Benefits »

Monday, January 24, 2011

Why Does Inequality Matter?

The Economist asks:

What's the correct way to think about the rise of the global super-rich? Is there any reason to be concerned about recent changes in the income distribution, in America, across rich countries, or globally? Is there reason to believe that inequality contributes to financial or economic instability?

Here's is my response, which echoes some of my comments in a recent column, along with others (all responses, more are likely to follow):

Lead Articles:  The rich and the rest, Does rising inequality matter—and if so why?, and Did inequality cause the financial crisis?.

Here's what I said:

Why Does Inequality Matter?: Inequality has attained levels rivaling those of the Gilded Age, and if it continues to grow—and there's nothing to indicate that it won't—it could reach the point where it becomes morally intolerable. In addition, there is evidence that social ills grow as inequality widens. And high levels of inequality can also have negative effects on the economy.
We know that a society with perfect equality does not grow at the fastest possible rate. When everyone gets an equal share of income, people lose the incentive to try and get ahead of others. We also know that a society where one person has almost everything while everyone else struggles to survive—the most unequal distribution of income imaginable—will not grow at the fastest possible rate either. Thus, the growth-maximising level of inequality must lie somewhere between these two extremes (one reason for declining economic growth beyond some critical level of inequality may be due, at least in part, to the political problems and loss of opportunity that come with high levels of inequality that Daron Acemoglu discusses in his guest contribution).
We may be near or even past the level of inequality where growth begins falling. The evidence on this is highly uncertain, so it’s difficult to say. But a few more decades like the last few could make the difference, so why take a chance?
But how do we help those who are falling farther and farther behind?
As Lane Kenworthy notes, when we look at how inequality has changed in various rich nations over the last several decades, "it turns out that there is no relationship between changes in income inequality and changes in the absolute incomes of low-end households. The reason is that income growth for poor households has come almost entirely via increases in net government transfers." Thus, nations where lower income households have fared better are also the nations where income transfers have been the highest.
One hope for turning this around in the future is education, but even if we can fix the problems in our educational system—something we've devoted considerable effort to already without much to show for it—it may only slow rather than reverse the growth in inequality. Unfortunately, we won't know the answer until we actually improve education, then wait to see how our better educated young fare when they graduate, a process that will take decades. It will do little to alleviate existing levels of inequality.
For these reasons, I am increasingly of the view that redistribution of income is the only answer to our inequality problem.
But won't such policies lower economic growth? No. Given the present, elevated level of inequality, a reduction is unlikely to have much of an impact on incentives that are important for economic growth.
If we want to preserve a growing and socially healthy economy, and avoid moving to points on the inequality curve curve associated with lower growth, then we will need to do much more redistribution of income than we have done over the last several decades. That means the wealthy will no longer get it all, or at least almost all; they will be asked to share economic growth with the workers who helped to bring it about, workers who ought to be rewarded for their growing productivity.
We can expect considerable protest when the wealthy are asked to give up a portion of the growth that has been flowing exclusively to them for so long, and we’ll hear every reason you can think of and a few more as to why redistributive polices are bad for jobs and bad for America more generally. But sharing economic gains among all those who had a hand in creating them is the right thing to do. For the foreseeable future, redistributive polices appear to be the only way to ensure that workers receive their share of the growing economic pie.

    Posted by on Monday, January 24, 2011 at 10:08 AM in Economics, Income Distribution | Permalink  Comments (40)


    Feed You can follow this conversation by subscribing to the comment feed for this post.