Inequality & Growth

1. Inequality & Growth Moritz Nagel Lois Hales Charles Leury OleksandrBevz

2. Outline • Hypotheses • Context • Setting • Measures • Causes & Mitigating Factors • Snapshot 2009 • Conceptualization • Debate • Conclusion

3. Hypotheses Inequality has a positive impact on growth 1 Inequality has a negative impact on growth 2

4. Context What are we talking about? • Inequality: all disparities in the distribution of… • Income & assets • Consumption • Opportunity • Social welfare (TRD) • Between who? • Countries • Individuals & groups within countries

5. Context How do we measure inequality? • Datasets • UNU-WIDER World Income Inequality Database, Version 2.0c, May 2008 • Deininger, Klaus and Lyn Squire, "A New Data Set Measuring Income Inequality", The World Bank Economic Review, 10(3): 565-91, 1996. • Gini index • Hoover index • Theil index

6. Context What causes inequality? • Labour market • Education • Computerization/growing technology • Globalization • Sexism • Racism • Culture • Wealth condensation • Development patterns • Personal preference for work and leisure • Etc.

7. Context Mitigating factors • Market driven • Propensity to spend • Unionization • Etc. • Government sponsored • Public education • Progressive taxation • Minimum wage legislation • Nationalization of products

8. Context Snapshot 2009

9. Conceptualization A social welfare measure may present a more revealing picture than income per capita taken by itself. (Sen 1973) SW = income per capita * (1 – GINI)

10. Conceptualization A social welfare measure may present a more revealing picture than income per capita taken by itself. (Sen 1973) Social Welfare, annual average, 1992 - 2007 SW = income per capita * (1 – GINI) (Global Ø (64.8) between 8. and 9. at 2,759)

11. Conceptualization What about Total Relative Deprivation? Social Welfare, annual average, 1992 - 2007 (Global Ø (64.8) between 8. and 9. at 2,759)

12. Conceptualization What about Total Relative Deprivation? TRD = (income per capita – SW) * population Total Relative Deprivation, annual average, 1992 - 2007

13. Conceptualization When we discuss income inequality as Development Economists, we implicitly talk about poverty reduction. Let’s assume that subsistence needs are met, is there global equality of opportunity? Exhibit A: A person's location and her social class account for more than 90% of her position in global income distribution. 60% is explained by location, the rest by social class. Not more than 20% can be attributed to effort. (Milanovic 2007) Exhibit B: While average years of schooling have risen dramatically in the developing world (from 2.1 years in 1950 to 7.1 years in 2010), there are substantial differences in the rates of return to human capital of an additional year of schooling between regions. (Barro and Lee 2010)

14. Conceptualization Source: Barro and Lee 2010, p. 43. Rates of Return to an Additional Year of Schooling

15. Conceptualization Sustainable Growth vs. Equitable Growth? ► There is no such thing as indefinitely sustainable growth in a closed ecosystem as our planet. → Possibility of a growth ceiling (annual or total) due to: - market saturation/ overproduction - eventual lack of resources (e.g. copper, oil, etc.) - pollution/ climate change - …? But: Economic growth is very likely not a zero-sum game.

16. Conceptualization Preliminary conclusions? ► Inequalities can manifest themselves in quite subtle ways in addition to (or as a result of) income inequality. ► It is a qualitative choice whether we talk about equality or equity. While both describe more or less the same phenomenon, their respective vantage points beg to differ. ► The question of whether income inequality fosters or hinders economic growth may miss the target altogether.

17. Conceptualization Simon Kuznets (1955): "How can either the institutional and political framework of the underdeveloped societies or the processes of economic growth and industrialization be modified to favor a sustained rise to higher levels of economic performance and yet avoid the fatally simple remedy of an authoritarian regime that would use the population as cannon-fodder in the fight for economic achievement?"

18. Conceptualization Historical Trajectory of Income Inequality Bourguignon and Morrisson (2002) ► 1820 to 1950: World Gini coefficient rose by 1 percentage point for every decade ► Since 1950: World income distribution continued to worsen (only improving from 1950 to 1960 and showing signs of stability between 1970 and 1992) ► Early 19th century: within-country inequality represented 80% and more of the total (it accounted for only around 40% by 1950) ► 1820 to 1950: extreme poverty rates decreased from 84% to 24%, poverty rates declined from 90% to 51.3%

19. Conceptualization Historical Trajectory of Income Inequality ► Differences in country economic growth rates practically explain all of the increase in world inequality and in the number of poor people. → Richer countries become even richer as poor countries are virtually cut off from economic growth in the first 150 years after the industrial revolution. Conclusion: Income inequality worsened dramatically in the observed period (Gini index by 30%, Theil index by 60%) due to the increase in inequality across countries or World regions. Source: Bourguignon and Morrisson 2002, p. 741.

20. Inequality has a negative impact on growth... How? Why?

21. Negative Impact We begin with some theoretical findings… • Credit-Market Imperfections • inequality of assets and incomes puts some constraints on the investment ability of the poor • Political Economy • greater degree of inequality requires redistribution process and distorts economic decisions • Socio-political Unrest • inequality of wealth and income motivates the poor to engage in crime, riots, and other disruptive activities

22. Negative Impact More hypotheses… • Self-promotion • once there is a gap in distribution in the society, the rich get richer and poor get poorer • Tough on policy makers • high inequality can foster macroeconomic instability and impede efficiency-promoting reforms that require cooperation and trust

23. Negative Impact Moreover… • Inequality is bad for health … • psychological effect • more egalitarian societies enjoy better quality of social relations • homicide and violence are strongly related to income inequality • leads to lower levels of social support, weaker social networks and more domestic conflicts

24. Negative Impact Empirical evidence… • Cramer (2003) • inequality promotes conflicts • Kawachi(2009) • the greater the dispersion of income within a given society, the lower the life expectancy Some 20 papers report that inequality leads to higher mortality, and 2 report the opposite (both of them use the same data)

25. Negative Impact More evidence… • Ezcurra (2007) • examines the regional growth of EU and concludes that it is bad for growth • does not depend on the specific measure used to quantify the degree of income dispersion! • Ravallion (2001) • inequality is bad for start-ups of new business, even though the size of this effect is small • Ravallion (2005) • countries with higher initial inequality experienced lower rates of growth

26. Inequality has a positive impact on growth... How? Why?

27. Positive Impact Propensity to Save/Stimulates Savings • Classical approach: inequality is beneficial to development in the post-industrialization period (Keynes, 1920 & Kaldor, 1957) • The marginal propensity to save of the rich is higher than that of the poor (Kaldor) • Stiglitz (1969): aggregate behaviour is independent of the distribution of wealth • Bourguignon (1981): more unequal economies grow faster

28. Positive Impact Propensity to Invest/Stimulates Investment • Inequality enhances growth due to Investment Indivisibilities (Aghion, Caroli & García-Peñalosa, 1999) • A rise in inequality tends to raise investment Barro (2000)

29. Positive Impact Incentives • Trade-off between productive efficiency and equality is based on incentive considerations (Aghion, Caroli & García-Peñalosa, 1999) • Mirrlees (1971) – incentives boost effort • Okun (1975) – wealth transfer policies reduce incentives • Cornia and Court (2001) – inequality of earnings that rewards effort is likely to be pro-growth

30. Positive Impact Empirical Evidence • Forbes, 2000 – an increase in a country’s level of income inequality has a significant positive relationship with subsequent economic growth. • Li and Zou, 1998 – income inequality is positively, and most of the time significantly, associated with economic growth. • Cornia and Court (2001) – there is an inequality range that is most efficient for growth.

31. Positive Impact The Efficient Inequality Range

32. Conclusion Is inequality a catalyst for growth? What is government’s role, if any, in the reduction of inequality? Thank you for your time and attention!

33. Bibliography • Barro, Robert J. (2008) “Inequality and Growth Revisited”, Working Paper Series on Regional Economic Integration, No. 11 (January). • Barro, Robert J. (2000) “Inequality and Growth in a Panel of Countries”, Journal of Economic Literature, Vol. 4, No. 3, pp. 5 – 32. • Barro, Robert J. and Jong-Wha Lee. (2010) “A New Data Set of Educational Attainment in the World, 1950 – 2010”, NBER Working Paper, No. 15902 (April). • Becker, G., Philipson, T., Soares, R. (2003) “The Quantity and Quality of Life and the Evolution of World Inequality”, NBER Working Paper, No. 9765 (June). • Bello, Walden. (2006) “The capitalist conjuncture: over-accumulation, financial crises, and the retreat from globalisation”, Third World Quarterly, Vol. 27, No. 8, pp. 1345 – 1367. • Bordon, R. B.; M. Bertram and T. E. Graedel. (2005) “Metal Stocks and Sustainability”, Proceedings of the National Academy of Sciences of the United States of America, Vol. 103, No. 5 (31 January), pp. 1209 – 1214. • Bourguignon, Francois. (1992) “The distributional effects of growth: case studies vs. cross-country regressions”, Delta and World Bank: Paris. • Bourguignon, Francois. (1981) "Pareto-Superiority of Unegalitarian Equilibrian Stiglitz' Model of Wealth Distribution with Convex Savings Function," Econometrica. Vol. 49, No. 6, pp. 1469 - 1475.

34. Bibliography • Bourguignon, Francois and Christian Morrisson. (2006) “Inequality Among World Citizens: 1820 – 1992”, The American Economic Review, Vol. 92, No. 4 (September), pp. 727 – 744. • Chen, S., Ravallion, M. (2001) “How Did the World’s Poorest Fare in the 1990s?”, Review ofIncome and Wealth, Vol. 47, No. 3 (September). • Cornia, Giovanni Andrea and Court, Julius (2001) “Inequality, Growth and Poverty in the Era of Liberalization and Globalization”, Journal of Economic Literature, Vol. 63, No. 32. • Cramer, C. (2003) “Does Inequality Cause Conflict?”, Department of Development Studies, School of Oriental and African Studies, University of London. • Deininger, Klaus and Lyn Squire. (1996) “A New Data Set Measuring Income Inequality”, The World Bank Economic Review, Vol. 10, No. 3, pp. 565 – 591. • Forbes, Kristin J. (2000) “A Reassessment of the Relationship between Inequality and Growth”, Journal of Economic Literature, Vol. 40, No. 15. • Kawachi, I. (1997) “Social Capital, Income Inequality, and Mortality”, American Journal of Public Health. • Kuznets, S. (1955) “Economic Growth and Income Inequality”, The American Economic Review, Vol. 45, No. 1 (March), pp. 1 – 28. • Li, Hongyi, and Heng-Fu Zou. (1998) “Income inequality is not harmful for growth: Theory and evidence” Review of Development Economics, Vol. 2 No. 3, pp. 318 – 333.

35. Bibliography • Milanovic, Branko. (2007) “Where in the world are you? Assessing the importance of circumstance and effort in a world of different mean country incomes and (almost) no migration”, Development Research Group, World Bank. • Mukhopadhaya, Pundarik. (2004) “World Income Inequality data base (WIID) Review”, Journal of Economic Inequality, Vol. 2, pp. 229 – 234. • Okun, Arthur M. (1975) “Equality and Efficiency: The Big Tradeoff”, Washington, D.C. • Philippe Aghion; Eve Caroli; Cecilia García-Peñalosa (1999) “Inequality and Economic Growth: The Perspective of the New Growth Theories”, Journal of Economic Literature, Vol. 37, No. 4. (December), pp. 1615 – 1660. • Ravaillon, M. (2005) “A poverty-inequality trade off?”, Development Research Group, World Bank. • Ravaillon, M. (2005) “Inequality is Bad for the Poor”, Development Research Group, World Bank. • Stark, Oded and J. Edward Taylor (1991) “Migration Incentives, Migration Types: The Role of Relative Deprivation, The Economic Journal, Vol. 101, No. 408 (September), pp. 1163 – 1178. • Stiglitz, Joseph E. (1969) "The Distribution of Income and Wealth Among Individuals”, Econometrica, Vol. 37, No. 3, pp. 382 – 397.

36. Bibliography • Vanhoudt, P. (1998) “An Assessment of the Macroeconomic Determinants of Inequality”, Working Paper Series in Economics and Finance, No. 271 (October). • Wilkinson, R. (1998) “Why inequality is bad for you?” Marxism Today (November/December).