Sample Economics Essays on Income Inequality and Growth

Income Inequality and Growth

Recent years have seen exponential economic growth across different sectors. Naturally, it is the expectation that such growth has rippling effects for different people within such economies. The fact that the said economic growth has not met these expectations, but rather only increased inequality, therefore begs for research and explanation into the relationship between economic growth and inequality. Inclusive growth, which refers to visible economic growth and reciprocal reduced economic inequality, although elusive, remains one of the most important policy agendas for everyone in the economic sector (Kang, 2015). The relationship between growth and inequality is intricate as visible through rising inequalities in the developed world coupled with a dwindling middle-income class. At the same time, developing and emerging economies continue to see widening inequality as a result of their rapid economic growth (Kang, 2015). While the natural expectation is that increased economic growth leads to reduced inequalities, recent trends of economic growth leading to even wider income inequalities debunk this very notion. The inconsistency, hence, calls for a discussion on the effects of growth on inequality and the reverse: effect of inequality on economic growth. The two are therefore the subjects of discussion for this paper.

The relationship between growth and inequality is intricate. The intricacy in the relationship between the two means there is no direct causal link between growth and inequality. Finding the relationship between growth and inequality, therefore, requires consideration of the sources of growth. Consideration of growth here looks at the drivers of the said growth: whether occasioned by productivity or employment (Causa, Hermansen, & Ruiz, 2017). Zeroing in on the type of growth, in this case, helps to point the relationship between such growth and inequality.

On productivity growth and its effect on inequality, DiPietro (2014) argues that there is a negative relationship between the two. DiPietro’s views are in agreement with Causa, Hermansen, and Ruiz (2017) who inform, “Labor productivity growth is found to have contributed to rising market income inequality.” The argument here is that with perennial growth in inequality over the past decades, growth in labor productivity continues to have a negative impact on inequality. Growth in labor (and productivity) becomes an advantage to the upper class, who benefit more with such growth. DiPietro (2014) informs that inequality is necessary for any society, as a driver of productivity. The balance between inequality and productivity is such that to the optimum level of inequality, it is a driver to growth. However, given the recent rise of above-optimal inequality, equality does not necessarily drive productivity, rather stifling it. The increased inequality means that any benefit that accrues from growth in productivity largely benefit the upper class rather than the poor, lower and upper middle class. Moreover, “Beyond the optimal level of inequality, society responds more to money than to the needs of ordinary people. It becomes easier for upper-income groups to buy off the political and judicial system and to tilt the laws and the judicial interpretation of the laws in their favor, so that, the acquisition of income by the wealthy becomes more readily procured by means that no longer contribute to the real production of society” (DiPietro, 2014, p. 4). Growth in productivity (labor), in this case, only benefits the upper class, while at the same time increasing inequality.

While growth productivity exacerbates inequality, growth in employment seems to have the opposite effect.  According to Causa, Hermansen, and Ruiz (2017), growth in employment has an equalizing impact on inequality. Income distribution to lower households due to growth in employment is the main driver of the equalizing effect of employment growth (Causa, Hermansen, & Ruiz, 2017). The argument here is that with an upsurge in employment opportunities, more people have access to an income emanating from the employment. Naturally, income in the hands of the poor and lower middle class means upward economic mobility, which in itself reduces inequality.

Aside from the separation of specific economic sectors of productivity and employment growth, GDP growth also has its effect on inequality. Herman, Ruiz, and Causa (2016) aver that growth in GDP has rippling effects on inequality. For instance, a 1% increase in GDP per capita had the effect of increasing household market incomes by more than 1% for all income groups (Herman, Ruiz & Causa, 2016). The effect is especially visible in OECD countries, where over the years (from the mid-80s to 2012) growth in GDP per capita has found its way to household market incomes. Noteworthy, however, is that even with resulting distribution of growth in GDP per capita across all households, the dividends earned remain largely unequal. As expected, the upper class tend to get more in the GDP per capita growth share in comparison with the poor (Herman, Ruiz & Causa, 2016). This unequal distribution lies in the economic investment of the upper class. Any benefits that come from economic growth, as well as GDP per capita growth, tend to benefit the upper class more than the lower class, essentially widening inequality.

Majumdar and Partridge (2009), on the other hand, posit that economic growth has a negative impact on income inequality given its (economic growth) positive association with higher investment, higher employment-generating activities, and more employment. The combination of the factors leads to greater access to jobs and income to more people. They, however, argue that the intensity of the impact varies between rural and urban areas. For urban areas, they posit that high population density has the potential of increasing job competition, leading to lower job access in comparison with rural areas (Majumdar & Partridge, 2009). Even more is that with an influx of immigrants and their willingness to work for lower wages essentially locks locals out of jobs, which then degenerates to higher inequality levels. At the same time, however, “growth may reduce income inequality in the urban areas because higher population density results in more personal contacts, better networking, and access to information, and hence more opportunities to access more and better jobs” (Majumdar & Partridge, 2009, p. 11). Economic growth, in this case, has both a positive and negative effect on inequality, depending on the level of education and whether the majority of workers are skilled or unskilled.

On the impact of inequality on growth, Bivens (2017) avers that evidence from economists show that the current slow pace of economic growth is a product of constrained aggregate demand. The demand nosedived after the economic recession, which saw many lose their jobs. The result of the Great Recession was less spending by households, businesses, and the government, which have cumulatively led to slow economic growth. Most important in the slowing growth, however, is that while higher disposable income could easily jumpstart the economy to its previous levels, the loss of jobs an increasing inequality have continued to impact negatively on economic growth (Bivens, 2017). Thus, while a few economically endowed individuals favored by economic inequality may make purchases, the fact that the larger majority disadvantaged by inequality do not participate in the economy slows down growth. The potential for growth is, therefore, higher with less inequality than the current levels of heightened pay and wealth inequalities.

Petersen and Schoof (2015) inform that perfect equality in income across society leads to less intensification of work as there is little incentive. The idea is that increased income inequality stirs more growth-promoting incentives, which then lead to GDP increases (Petersen & Schoof, 2015). The trick is to ensure that income and economic inequality do not surpass their optimum levels. Accordingly, extreme inequality has a great impact on economic growth. Specifically, people do not get the incentive to work in the face of extreme inequality. Put succinctly, “the relationship between economic growth
– measured on the basis of real gross domestic product – and the degree of income inequality assumes an inverted-U trajectory, and that an optimal level of income inequality can be found simply through consideration of the prevailing GDP level” (Petersen & Schoof, 2015, p. 2). Spurring economic growth in this case largely relies on decreasing income inequality.

Empirical evidence points to high-income inequalities as building blocks of economic growth. According to Petersen and Schoof (2015), empirical data showed that due to higher savings propensity of high-income earners, there were higher levels of investment with a positive effect on economic growth. While this is true on some occasions, recent empirical data (Bivens, 2017; Herman, Ruiz & Causa, 2016; Petersen & Schoof, 2015) points to the contrary. The statics, according to Petersen and Schoof (2015) shows that a 10 percent increase in income inequality points to reduced long-term annual growth rate by 0.3% to 0.6%. The negative effect of inequality on economic growth is visible across the board for developed and developed economies, as well as for democratic and non-democratic countries.

Perhaps one of the hardest hit and most important parts of the economy by inequality is human capital. Petersen and Schoof (2015) posit that high levels of income inequality weaken an economy’s production potential, and with it, growth potential. Human capital is especially at risk in such a scenario. Noteworthy is that “If citizens have the feeling that vigorous effort will not pay off, because the largest share of the national income accrues to a small part of the population in any case, then investments in their own human capital in the form of education are not worthwhile” (Petersen & Schoof, 2015, p.5). The fact that human capital and qualitative improvement of human capital as a prerequisite to economic growth, consequently, spell doom for growth for society with high inequality levels. Investment in education as a way of improving the quality of human capital has long-term effects on not only the economy but the society at large. Killing such investment due to high inequality levels, therefore, reduces the quality of current and future human capital, with the potential of causing an economic implosion.

High income inequality is especially a threat to economic growth when citizen’s dissatisfaction reaches points where they want to leave the country. Empirical evidence shows that “young and well-qualified people have the highest degree of cross-border mobility; consequently, this effect threatens the society with a brain drain that reduces the potential for growth” (Petersen & Schoof, p.5). Bernstein (2013) concurs with this assessment adding that a weakened human capital in response to high and rising income inequality has the potential of reducing a country’s long-term growth potential.

The debilitating effects of inequality on economic growth are arguably visible through human capital impairment in participation in the economy. Bernstein (2013) highlights that due to income inequality, many low-income citizens have insufficient access to the health care system.  Inaccessibility or a poor healthcare system for the low-income earners leads to poor health outcomes, high employee turnover, more time spent on sick leaves, and generally poor productivity. All these culminate to poor economic outcomes, unmet economic goals, and generally negative growth.

Although economic growth is a complex entity with a plethora of factors acting it, its relationship with inequality is undeniable. Inequality may not entirely affect economic growth, yet in some ways, it is a factor for consideration. Optimal economic inequality spurs economic growth by providing an incentive for activities that contribute to GDP growth. However, beyond optimal inequality put the economy at a catatonic state, where no incentives exist to spur economic growth. Economic inequality additionally spurs economic growth through savings investment by the upper class. Such investments naturally have an impact on economic growth. It is expected that economic growth has a positive impact on inequality. By providing jobs, disposable income for investment and purchases, economic growth greatly reduces inequality. However, economic growth within a society of inequalities further exacerbates inequality. Only a few (top 1%) usually benefit from extreme economic and income inequality and economic growth. It is therefore important to ensure that inequality remains at manageable levels that help spur and sustain economic growth.

 

References

Bernstein, J. (2013). The Impact of Inequality on Growth. Washington, DC: Center for American Progress

Bivens, J. (2017). Inequality is Slowing US Economic Growth. Economic Policy Institute. Retrieved from https://www.epi.org/publication/secular-stagnation/.

Causa, O., Hermansen, M., & Ruiz, N. (2017). Does growth lead to inequality? It depends. OECD Ecoscope. Retrieved from https://oecdecoscope.blog/2017/01/10/does-growth-lead-to-inequality-it-depends/.

DiPietro, W., R. (2014). Productivity growth and income inequality. Journal of Economics and Development Studies, 2(3), 1-8

Hermansen, M., Ruiz, N., & Causa, O. (2016). The Distribution of the Growth Dividends. Organisation for Economic Co-operation and Development

Kang, J., W. (2015). Interrelation between Growth and Inequality. Mandaluyong: Asian Development Bank

Majumdar, S. & Partridge, M., D. (2009). Impact of Economic Growth on Income Inequality: A Regional Perspective. AAEA and ACCI Joint Annual Meeting, Milwaukee, Wisconsin, July 26-29, 2009

Petersen, T. & Schoof, U. (2015). The Impact of Income Inequality on Economic Growth. Bertelsmann Stiftung