More Equality, More Growth?

More equal societies almost always do better. This was the sub-title of Richard Wilkinson and Kate Pickett’s important 2009 book, The Spirit Level, in which they demonstrate the correlation between lower income inequality and better societal outcomes across eleven different dimensions both among US states and across a wide range of advanced economies.

More equal societies, they found, tend to have better physical and mental health, more trust and social mobility, less obesity and violence, and lower incidence of incarceration and teenage pregnancy. Echoing JK Galbraith’s famous contrast between ‘private affluence and public squalor’, the first part of Wilkinson and Pickett’s book is titled ‘material success, social failure’.

The implication, that there is a necessary trade-off between more equality and lower economic growth, is one that has long held sway with mainstream economists and right-wing politicians. Increasingly, however, the economics profession – if not yet the right-wing politicians! – are coming around to the idea that while a certain amount of inequality may be necessary to underpin economic dynamism – so there are incentives for hard work and innovation – too much inequality actually undermines economic growth.

Nobel laureate, former World Bank Chief Economist and Professor at Columbia University, Joseph Stiglitz has been to the forefront in making this argument in recent years, his 2012 book on The Price of Inequality setting out in detail not only why the economic pie is being shared increasingly unfairly, but also why this phenomenon acts as a brake on the rate at which the pie expands. Less equality means less growth.

Stiglitz makes four central points: 1) income and wealth have become concentrated in the hands of those that are more likely to save than consume, 2) those with less scope to save have less scope to invest in their education or setting up a business, 3) tax breaks for high earners undermine the capacity of governments to invest in the infrastructure and public services on which thriving economies depend, and 4) increasing inequality render more severe and frequent the boom-bust cycles that make our economies more volatile and vulnerable.

Just last month, three researchers at the traditional bastion of economic orthodoxy that is the IMF added their voice to a gradually emerging consensus. Looking at redistribution and inequality across a range of countries, they found that lower inequality after taxes and transfers is linked to stronger and more durable growth while redistribution itself has a benign impact on growth. So not only does more inequality mean more growth, but the taxes and transfers needed to achieve greater equality themselves have no discernable negative effect on the growth rate.

When the global great and the good gathered for their annual shindig in Davos, Switzerland earlier this year, they flagged income inequality as the ‘top global risk’, because it undermines the quality of democracy and leads to social unrest. It is maybe going too far to suggest that there is an emerging political consensus that inequality is a problem in need of a solution, but what is certainly clear is that there remains no consensus on what a solution should look like.

Taxes and transfers will necessarily have a role to play in redistribution, but there is also a need to look beyond pure income inequality. Income – or GDP – are only relevant to the extent that they allow us to achieve personal – or national – well-being. So, while Wilkinson and Pickett may have found a strong correlation between income equality and well-being outcomes, it is important to realise that equalizing income is not the same as equalizing well-being.

Progressive taxation and well-designed welfare payments are important, but investment in quality infrastructure and public services are a critical component of the equation to underpin more dynamic economies and more cohesive societies. Ultimately, a combination of policies that target reductions in income equality and improvements in well-being outcomes can leave everyone better off.

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