Since the 1970s, economic orthodoxy has suggested that inequality might be the price worth paying for economic growth. Following a new report from the International Monetary Fund (IMF), the evidence is mounting to the contrary.
Previous studies have found that inequality is linked to lower levels of growth, but the argument has been that the treatment, rather than the disease, was to blame. In other words, countries suffering social inequity are more likely to follow redistributive policies and these policies are more harmful to growth than inequality itself.
It remains a persuasive argument. The coalition government in 2013 cut taxes on income over £150,000 from 50% to 45% following claims that this might create disincentives for entrepreneurs to create wealth.
However, Joseph Stiglitz, among others, has argued that inequality may cause greater economic volatility and, in fact, drag down economic growth. The IMF report provides further evidence to support the Stiglitz view while also providing a clear guide to the complex relationships between inequality, redistribution and growth.
One of the key points is that not all redistributive policies were created equal. They vary in type and effectiveness, and some prove very positive, directly, for economic growth. For example, taxes on activities which have negative consequences – such as excessive financial risk-taking by the rich – can prove very beneficial, as can measures such as cash transfers which support social investment.
The Financial Transactions Tax (FTT), partly designed to rein in the more speculative and risky activities of investment banks, highlights how divisive the redistribution debate can become.
The FTT was approved by EU finance ministers last year – albeit with the UK, Luxembourg and the Czech Republic abstaining. It is estimated that the levy could raise as much as €35 billion (£29 billion) a year for the 11 countries that have signed up to it. However, opponents warn that investment banks might leave the countries where the tax exists – and research by London Economics published in February suggested that household savings will lose value in countries where they are invested in financial assets such as shares or bonds (Germany in particular). Anti-poverty campaigners who support the tax argue that most transactions do not benefit savers but, instead, generate commission and charges for the banks.
One clear example of “good” redistribution, the IMF report argues, is social investment in education and health. The authors say that such investment helps to provide strong and productive workers for the economy. Investment in training can also help improve the skills-base of the economy and so drive up wages and growth. The idea of a “social investment state” to replace a welfare state based on “handouts” rather than “hand-ups” has been popular on all sides of the political spectrum since the 1990s.
It has also re-emerged in the UK with Labour Party leader Ed Miliband’s support for “pre-distribution” rather than (or alongside) redistribution. Spending on education, training and health is also more politically popular than spending on social security benefits. But when cuts to benefit levels for those out of work lead to longer and longer queues at food banks in countries such as the UK, we need to stop and consider people’s current needs, not just their potential as workers in the future.
Perhaps the crucial finding in the IMF report is that redistributive policies had generally positive impacts on economic growth, with only a very few examples of negative impacts. Of course, you can have bad redistributive policies much as you can any other kind. But redistribution is, overall, good for growth. The best available macroeconomic evidence suggests that there is no trade-off between equality and growth or between redistribution and growth.
Where’s the wealth?
The IMF research is extremely helpful and authoritative but it is surprising that the report focuses solely on income inequality. No mention is made of wealth inequality, for example, even though we know that wealth inequality is far more pervasive than income inequality.
In the UK in 2008/10, whereas those at the (top) 90th percentile for income or earnings received four times as much as those at the (bottom) 10th percentile, the ratio for wealth was 77 times. Issues of wealth inequality have received far less attention than income inequality, partly due to lack of robust data, but wealth inequality, although closely related to income inequality, may also cause social, political and economic problems, independent of income inequality. One way of addressing wealth inequality could be through wealth taxation, particularly wealth transfer taxes such as inheritance tax. These would certainly fall within the scope of “good” redistributive policies as they tax unearned income. Revenue raised from such taxes could be used to support social investment policies and/or reduce taxes on earned income for those on low and middle incomes.
The IMF report also discusses economic growth in an entirely positive way. This is not surprising given where most countries’ economies are at the moment. The UK’s recent return to growth has been greeted with almost unanimous relief, if also with some debate about what the real cause has been, how sustainable it is and who will really benefit from it. This last point is important because over the last few decades, the share of growth accounted for by wages has dropped relative to the capital, and the wage share has gone to the top rather than workers in the middle.
Thus the growth that we have experienced has fuelled inequality and this may be part of the reason why the economy went into freefall in 2007/8 and growth was reversed. Governments need to promote growth which benefits the majority rather than the few. And the consequences of growth for environmental sustainability also need to be considered, alongside a renewed focus on well-being as opposed to simple economic outcomes.