The debate over inequality in America and other advanced nations has both moral and empirical dimensions. Many people believe that income and wealth disparities represent a gross injustice that needs to be remedied by government interventions, even if such interventions damage economic growth. Others have gone a step further, arguing that inequality itself damages growth. But the evidence for this latter argument is much weaker than its proponents think.
In a 2014 study, Manhattan Institute scholar Scott Winship made the commonsense point that inequality in rich countries is very different from inequality in poor countries, and that lumping all countries together can therefore paint a misleading picture of inequality’s effects. Winship found that, “in developed nations, greater inequality tends to accompany stronger economic growth” (emphasis added). He also showed that “cultural, historical, and geographical factors . . . affect living standards far more greatly than does inequality.”
In a more recent study, published last month, economists Daniel Carroll of the Cleveland Fed and Eric Young of the University of Virginia concluded that “inequality is only weakly related to long-run economic growth. What relationship is there tends to be negative rather than positive: income and wealth inequality tend to be lower when the long-run growth rate is zero.”
Even New York Times columnist Paul Krugman, who considers inequality “crucially important for social and political reasons,” has acknowledged that there is “not much evidence” that it does serious harm to growth. If we look at the data from 1985 to 2007, Krugman notes, we see that “the low-inequality northern Europeans have a range of [growth] outcomes not noticeably different from the high-inequality Anglo-Saxons.”
The bottom line, as explained by Financial Times economics editor Chris Giles, is this: “Economic performance varies wildly over time and across countries, yet the evidence suggests inequality explains only a tiny fraction of these differences. Whatever effect the gap between rich and poor might have on growth, other forces dominate, so we should not look to redistribution as the new engine of growth.”
For more on the inequality debate, here’s a link to my IWF policy focus from last December.