Does Income Inequality Cause Decreased Economic Growth?

The income inequality debate never seems to die. Its most recent revival was due to the Organisation for Economic Co-operation and Development (OECD) and its latest report (summary here) on "Trends in Income Inequality and its Impact on Economic Growth." Although the OECD's analysis has more variables, the essential relationship that the OECD establishes is between the Gini coefficient and the GDP growth rate.

What is the Gini coefficient? It is a form of statistical dispersion used to represent the income distribution of a given nation. It has become the gold standard for measuring income inequality. Although it works nicely because it's relatively easy to compare across countries, there are still some flaws with it. One is that it compares income, and not wealth. Two countries with different amounts of wealth can have the same Gini coefficient, which also means that the Gini coefficient says nothing about quality in a given country. The Gini coefficient can produce the same coefficient for two countries with different income distributions because the Lorenz curve can have different curvatures for different countries. Furthermore, the Gini coefficient does not account for utility or economic opportunity.

Much like with the GDP, until we can come up with a better metric, we need to do the best we have. Even if the OECD uses the GDP as the metric for economic success, I still take issue with the temporal comparison because over time, a more developing country is going to experience an overall decline in GDP growth rate with reasons having nothing to do with income inequality. Correlation has suddenly turned into causation, and that fact that the OECD recommends wealth redistribution, a policy that does more than its fair share of harm, based on a correlation that can be easily explained by other factors is most unfortunate. The OECD says that redistribution would work if the government could do so efficiently (OECD, p. 19), which I find to be a highly tenuous assumption.

Although there is enough reason to not to jump to conclusions with the OECD's report, what did the OECD end up finding? The ratio of the income of the richest ten percent to the poorest ten percent increased from 7:1 in the 1980s to 9.5:1. As a result, the OECD's economic analysis suggests that this increased income inequality has had a statistically significant, negative impact on economic growth. Conversely, what the OECD finds that is equally intriguing is that "no evidence is found that those with high incomes pulling away from the rest of the population harms [economic] growth (p. 6)." This is important because the typical income inequality narrative is that the top echelon is gobbling up the resources while the "99 percent" have nothing left.

Looking at the OECD study, the issue is not with the rich getting richer per se, but rather with the poor not having the same level of access to resources in order to develop their human capital. This is especially true when looking at educational attainment for lower-income families (p. 28), which was one of the biggest kvetches of the OECD in this study. If the OECD study is correct, then income inequality only affects those with a lower educational attainment. Those with parents who have medium to high educational attainment are not affected by income inequality (p. 25-26). 

The OECD focuses on the bottom of income distribution, as it well should. Anti-poverty initiatives are not enough, according to the OECD (p. 29), but they might not be enough because the current programs are not sufficient at accomplishing the task at hand. It very well could be because many anti-poverty initiatives are handled by government bureaucracies, which makes me wonder whether the government intervening to reduce income inequality will actually increase economic growth. There are many ways to revive economic growth, and I honestly don't think simply redistributing wealth is going to help. The IMF actually published a report, and showed that at best, redistribution is negligible, but it can also very well make things worse (Ostry et al., 2014, p. 23). There is no need to knock rich people down a peg with poor policy like the wealth tax because by the OECD's own admission, the "one percent" isn't de facto causing the issues at hand. I've discussed education and anti-poverty initiatives in the past, but it should go without saying that we should focus on policies that help make the poor less poor and provide them with the opportunity to access the tools they need to succeed in life. Whatever those policies may end up being, we should improve the quality of education and encourage entrepreneurship instead of going after the ever-intangible and elusive "income inequality."