What's happening at the
Thursday 24 Aug 2017 | 17:31 | SYDNEY
Thursday 24 Aug 2017 | 17:31 | SYDNEY

Growth and equality: No trade-off necessary



16 December 2014 08:19

It has long been a central tenet of conventional economic wisdom that there is a trade-off between growth and equality: if governments redistribute resources from the rich to the poor, growth will be slower. Even recognising this, many economists still favour redistribution, for broad social reasons.

Arthur Okun provided the clearest enunciation of this conventional wisdom in 1975, talking in terms of the 'Big Tradeoff' between equality and efficiency. Okun put himself in the middle of the spectrum of opinion, still ready to implement redistribution while acknowledging that the transfer from rich to poor was done with a 'leaky bucket'. 

At the other end of the spectrum were Milton Friedman and the Chicago School. In the three decades between Okun's book and the 2008 financial crisis, the weight of economic opinion shifted decisively towards market-based systems (helped by the collapse of the USSR and the acceptance of markets in socialist economies such as China and Vietnam). Part of the argument was in terms of the greater saving and investing propensities of the well-off, needed to drive growth. Entrepreneurs should get the benefit of their efforts, both to encourage them and to reward them for their contribution to society.

The keenest free-market proponents argued that the rich ought to get a bigger slice of the economic pie in order to reward their entrepreneurship while the poor should have a smaller share in order to encourage them to try harder.

More recently, this whole logic has been challenged.

A recent IMF paper suggests there may not, in fact, be a trade-off between equality and growth. And a new OECD study finds that the poor could make a far greater contribution to growth if they had more resources to give them better education and opportunities. Moreover, income transfers don't seem to damage incentives.

These revisionist arguments come at a time when the old causal linkages are coming into question. In the development debate, getting more savings seemed central to encouraging growth, but we are now in a world where there seems to be a glut of savings in both developed economies (Japan and Germany) and emerging economies (China). We also observe the wealthy not spending just on productive investment but on mansions in the Hamptons and unproductive bling. Downton Abbey doesn't look like a paragon of efficiency. As income distribution has swung in favour of the rich, concerns about secular stagnation have been revived. 

In any case, leaving the facts and the causative linkages to one side, the zeitgeist has shifted. You don't need to have actually read Piketty's 700-page tome on income distribution or to have joined the Occupy Wall Street demonstrators in Zuccotti Park to know that the tide of public opinion is running against the 'one percent' (or more pointedly the 0.01%) who have dominated income increases in recent decades. The debacle of the Global Financial Crisis has to be an important part of the story. Did those Masters of the Universe need their huge bonuses to incentivise them to mess things up so badly? Would the IMF and the OECD (both long-standing free-market fellow-travelers and boosters) be fostering this kind of revolutionary research if public opinion had not become disillusioned with the 'magic of the market'?

For practical policy-makers, this change of rhetoric may not be so radical. Sensible economists have long known that incentives for entrepreneurship are one of the keys to growth, while wondering just how much incentive you need to get people to do things that they want to do anyway. They know that as growth gets underway, some will benefit much more than others. They also know that resources spent on giving some kind of equality of opportunity (especially in education) are vital to tap the full spectrum of talent in the population. They know that minimal levels of health care, working conditions and wages are needed to make society function smoothly. They know that there are some components of growth (like infrastructure) that the private sector doesn't provide in sufficient quantity. 

The proper debate is down at the detailed level, not the sort of pontificating broad-brush generalisations of the free-market ideologues. Arthur Okun's trade-off is still relevant, but we still have to work on how to make the bucket less leaky. The OECD work, in particular, is helping to get the focus where it should be, on these microeconomic issues.

Photo by Flickr user Colin Jagoe.

You may also be interested in...