Macroeconomics

07 July 2015

Equality vs. Growth  

Wealth inequality has long been viewed as primarily a social, rather than macroeconomic, problem.

However, recent reports by the International Monetary Fund (IMF) and Organization for Economic Cooperation and Development (OECD) find that countries with high levels of inequality suffer lower growth than those where income is more evenly distributed.

The IMF report also warns that inequality can make growth more volatile. Controversially, it argues that wealth redistribution can be used to improve equality without damaging economic growth.

That report is the latest in a recent series questioning the validity of the “trickle-down” theory, which argues that wealth creators need low tax rates as an encouragement to invest, but that the benefits will be felt throughout the economy because of increased greater purchasing power and job creation.

IMF research suggests that a focus on reducing poverty is just as important as encouraging entrepreneurship.

While the IMF argues for wealth redistribution through increased taxation, others, such as the OECD, advocate tackling income inequality through a focus on skills and education.

The OECD reports that inequality is a particular drag on wealthy countries with the highest levels of income disparity – notably the UK and US. The researchers estimate that raising living standards for the poorest Britons to the relative level in France would increase UK GDP growth by 0.3% annually for 25 years.

As a number of economists have pointed out, this conclusion seems to be contradicted by recent experience. Greater income equality does not seem to have helped stimulate economic growth in Continental Europe, although that bloc might have fared even worse without it.

Even then, there are exceptions. Denmark, the world’s most egalitarian economy by OECD benchmarks, has witnessed sluggish expansion for the last decade, proving that equality alone is no guarantee of growth.