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Home > Blogs > Anthony Harrington > Can inequality be reduced without harming growth? Part One

Can inequality be reduced without harming growth? Part One

Can inequality be reduced without harming growth? Part One Anthony Harrington

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Back in January 2012 I wrote a blog headed: Why Income Inequality is Killing the US Economy, based on two things: namely the shrinking wage that has been handed out to low-to-middle earners in the US, for the last few decades; and a rattling good speech by the labor economist and former Chairman of the Council of Economic Advisers, Alan Krueger, who has been tracking the growth of inequality in the US for decades. Clearly, as I write this two years and a couple of months later, the US economy hasn't exactly died yet, but income inequality in the US continues to sharpen. How does this impact the economy? Very simply. If circumstances tighten down wages for ordinary folk, they reduce their spending. The rich do not spend sufficiently to compensate for the impact on consumer spending of millions of wage earners becoming more frugal in their ways, and you get a pretty stiff economic headwind.

So how do you combat inequality? The conventional, classical economist's view is that as soon as you start putting in place institutions and taxes aimed at bringing about reasonable living standards for all, along with labor laws that seek to provide workers with a degree of protection from rapacious employers, you introduce rigidities into the labor market which ultimately will have a negative impact on productivity and competitiveness, and other countries who don't have those kinds of rigidities in their labor markets will eat your lunch. In other words, mainstream economists do not particularly like overt efforts to combat inequality and they cite studies which purport to show that the more law you seek to bring to bear to combat inequality, the worse the impact is on your economy.

However, a very interesting 2004 paper, by Dean Baker, Andrew Glyn, David Howell and John Schmitt, took  a close look at the results of mainstream studies on the topic, and concluded that actually, when you come right down to it, there is no overwhelming body of evidence supporting the idea that having unions, a minimum wage and a social safety net necessarily equates to a blight on economic growth (hence the subhead to their paper: The Failure of the Empirical Case for Deregulation, in which "deregulation" means the case for dismantling and reforming union practices, the minimum wage and so forth. Baker et. al. argue that the knee jerk acceptance of the idea that countries with weakening economic performance should straight away set about fundamentally reforming their national labor market institutions, is just quite simply misguided.

What this call for "more flexibility" in labor markets generally means, they point out, is lower wages for part-timers and the less skilled. In other words, the argument against labor market "rigidities" is simply a cover for arguing that the poor should be as poor as circumstances demand, with wages being set by the iron laws of supply and demand. There is a whole economic literature on the subject of what constitutes the "appropriate" distribution of income between wages and profit, and very little of that literature saw China coming! Which brings us back to our starting point, when average surplus income falls and credit dries up, consumer spending takes a mammoth hit and GDP nose-dives.

In a recent opinion piece in the New York Times, the renowned economist Joseph Stiglitz tackles "the growing divide" between the 1 percent and the rest. He comments:

"[W]ith inequality at its highest level since before the Depression, a robust recovery will be difficult [...] inequality stifles, restrains and holds back our growth."

He points out that, in the US, the top 1% of earners took home 93% of the growth in incomes in 2010. Growth in the run up to the boom which ended with the global financial crash of 2008, was reliant on the bottom 80% of wage earners going into debt by consuming on average around 110% of their income, he argues. Stiglitz goes on to cite the International Monetary Fund (IMF) on "the systematic relationship between economic instability and economic inequality", then bemoans the fact that America's politicians do not appear to have grasped this.

So, if inequality is such an evil, and it is hard to argue that the world needs more billionaires at the expense of a further squeeze on ordinary household incomes, then how is it best dealt with? Part Two looks at some current thinking on the potential solutions to inequality.


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Further reading on inequality



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Tags: classical economics , income inequality , Joseph Stiglitz
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  1. fifocoral says:
    Mon May 19 14:22:13 BST 2014

    Great article indeed! Recent IMF study has found that inequality is damaging to economic growth Countries with high levels of inequality suffered lower growth than nations that distributed incomes more evenly.

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