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Does inequality help growth - or hurt it?

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One of the most urgent questions in economics today is the connection between inequality and growth. That is because one of the big economic facts of our time is the surge in income disparity, particularly between those at the very top and everyone else. The other big fact is the recession set off by the financial crisis and the consequent imperative to jump-start economic growth. Figuring out the relationship between these two tent-pole issues is therefore a good way for economists to spend their time.

There are two main and contradictory ideas about how that relationship might work. One is that inequality is the price of robust economic growth. If the private sector is thriving, the most successful capitalists will be getting very rich. Creating a system that allows - indeed, encourages - the best and the brightest to pull away from everyone else is how you shift your economy into its highest gear.

There is, however, another theory, and it has been winning adherents in the aftermath of the financial crisis. In this view, rising inequality is not a symptom of a fast-growing economy or an incentive that will help create one. Instead, too much income inequality crushes economic growth.

There are different arguments for why that might happen. One is that high income inequality creates an unstable system that is vulnerable to costly booms and busts. Another is that when too much of the income goes to the very top and not enough goes to the middle, spending slumps - how many yachts does a plutocrat need? - putting a brake on growth.

David Howell, a professor of economics at The New School in New York, has written a draft paper for the Center for American Progress, a progressive research group, that investigates the first argument. Howell argues that the United States and Britain have acted over the past three decades on what he calls the laissez-faire theory, that the equation of rising inequality and increasing gross domestic product is correct.

As Howell puts it, "the laissez-faire case for high inequality is grounded in the belief that growth in output and employment depends mainly on strong incentives to work and invest."

Howell tested that view by comparing the United States and Britain to their peers. He asked whether "compared to other rich countries, U.S. income inequality has paid off in relatively high growth." His answer: not particularly. He finds that "there is no simple correlation between our measures of growth and income inequality."

That may come as a surprise to many Americans, who are accustomed to hearing, as Howell explained, "that the U.S. middle class is doing relatively well, at least compared to Europe, because of productivity growth and because we allow higher inequality."

But the reality is that at least some of those allegedly sclerotic European economies, dragged down by their highly redistributive welfare states, have outperformed the United States.

"What we see is Sweden having really good productivity growth by all measures, despite much more modest increases in inequality and starting at a much lower level," he said.

"The U.S. is anywhere from an O.K. to middling performer in the Age of Inequality," Howell said, using his term for our era. But while his work suggests inequality is not needed to get growth, he does not show that inequality actually hurts growth either: "I don't show a strong measurable inverse effect."

Lars Osberg, an economist at Dalhousie University in Nova Scotia, takes on this second argument - the case that inequality, at least beyond a certain point, can stifle growth.

He, too, adopts a comparative lens, looking at Canada, the United States and Mexico.

Osberg argues that a growing chasm between those at the very top and everyone else imperils the overall economy. His worry is financial instability.

"The added savings of the increasingly affluent must be loaned to balance total current expenditure," he writes, "but increasing indebtedness implies financial fragility, periodic financial crises, greater volatility of aggregate income and, as governments respond to mass unemployment with countercyclical fiscal policies, a compounding instability of public finances."

This is a variation of an argument by Raghuram Rajan, a politically center-right professor at the University of Chicago, who has suggested that rising income inequality was one of the drivers of the financial crisis. As income inequality increased, and the incomes of the middle class stagnated, the U.S. government responded by increasing the consumer credit available to the middle class.

In the short term, that was a win-win solution: consumption, and therefore the economy, grew, and the middle class was quiescent because stagnating incomes were masked by increasing consumer debt. But in the medium term that Goldilocks scenario broke down - the middle class consumption bubble, and the Wall Street bubble it helped finance, popped with devastating consequences.

Both Howell and Osberg are skeptical, at best, of the value of rising income inequality as a driver of economic growth. When you put that conclusion together with the arithmetic of democracy - rising income inequality means a majority of voters are on the losing end of the deal - a political backlash seems inevitable.

"Go back to the 1920s or the 1870s and economists were worried about the stability of the capitalist system," Osberg said. "One of the things the 1930s experience teaches us is there are some catastrophic outcomes which can happen."

The investing class and the academic world are focused on those dangers. "Can capitalism survive?" is one of the trendiest conference topics among red-blooded capitalists and left-leaning professors alike. So far, at the ballot box and on the street, this question has not been as salient. That does not mean it will not be in the future - and in ways we cannot predict.

© (c) Copyright Thomson Reuters 2013.

©2021 GPlusMedia Inc.

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So now we are being sold on inequity as a potentially good thing. What utter propagandistic tripe.

The stability of a middle class is the key to creating a positive economy. People with vested interests in maintaining a certain stability in society will create a working economy. The real problem today is the concentration of wealth in a class that does not distribute that wealth. There in is the problem. And the source of such insipid ideas as inequity being good for economics.

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SAN JOSE, Calif One of the most urgent questions in economics today is the connection between inequality and growth.

Let me answer it for you, by paraphrasing Adam Smith, who wrote "The Wealth Of Nations" long long ago.

Inequality = growth

It's not a pressing issue. It's not a mystery. It's not complicated.

Some people are good at somethings, some are good at other things. This is the foundation of an economy based on the division of labor. Some people's skills are worth more than others.

If EVERYBODY had the SAME skills, then there would be NO REASON for exchange. Then we'd all be poor.

That is because one of the big economic facts of our time is the surge in income disparity, particularly between those at the very top and everyone else.

The reason that the rich are getting richer is they are gaming the system in their favor. Crony capitalism, and big government that can be bought is the cause of this problem.

Again, this is not a mystery, and it's not complicated. Only those in favor of big government (and their free handouts) fail to see this clearly.

The other big fact is the recession set off by the financial crisis and the consequent imperative to jump-start economic growth.

The "financial crisis" didn't "set off" the recession. Both are caused by the same thing. Big government, over regulation, over leveraging, and too much fiat currency which lead to a misallocation of resources.

Once again, not mysterious, and not complicated. And again, only those who champion the involvement of big government into every aspect of our lives choose not to see this.

Figuring out the relationship between these two tent-pole issues is therefore a good way for economists to spend their time.

How comforting to know that this economically naive journalist feels compelled to tell economists how they "should" be spending their time.

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Choking hard right now but horse Shiite does that to me. If we are Uber Rich, greedy corporatists seeking only fast ROI are in charge, and we see only from their perspective - then and only then - "throwing part of your population under the bus" so that the other part may prosper becomes a method of choice. On the other hand: A democratically elected, People voted, not corporate money pressure lobbyist elected government, bent on creation a better society for human existence is in power, the greedy ROI worship agenda will fall to second place and Societies wants and needs will come to the front. Canada has a healthy "mix" of these components - both end in disaster, if not moderated by each other in equal proportions.

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gaijinfoMay. 27, 2013 - 10:48AM JST The reason that the rich are getting richer is they are gaming the system in their favor. Crony capitalism, and big government that can be bought is the cause of this problem.

Okay, so you agree that the rich aren't rich because of any inherent merit, they're simply exploiting the system. The rich get richer, the poor get poorer. Or to put it in Jesus' words, "the poor will always be with us", a saying more than 2000 years old.

Again, this is not a mystery, and it's not complicated. Only those in favor of big government (and their free handouts) fail to see this clearly.

... and then you leap to this conclusion. Surely small government would be just as easily (if not easier) to play, and arguably cheaper. Surely the solution to this problem is not to cut down on aid to those who need it, but rather to make sure that the rich pay what is fair in terms of social obligations like taxes, and ensure a little more equality. It is blatantly undemocratic to have a system where votes are bought and sold, but that's where most major democracies are today, and it is ridiculous. When laws and rights are up for sale the system is so broken that thos breaking the system deserve to be executed as traitors.

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What we know from historical data is that a robust and growing economy goes together with a robust and growing middle class. Which one is cause and effect is often debated, but it is probably both because it is a positive feedback loop. On the other hand, shrinking middle classes have always been an indicator of future problems. We should read the signs on the wall.

Economy is like a game and where you have winners there must be losers. And it has always been the winners who define the rules of the game. When people lose the confidence that they can ever be among the winners, they will start to transgress those rules, be it by criminal behaviour or political upheavals. Therefore there must be a certain redistribution of wealth so that the number of losers does not grow beyond a critical point. Furthermore, there must be a credible perspective that with sufficient effort everyone can be among the winners.

Neither total equality nor total inequality are desirable, as both of them stifle progress and economic growth. There is an optimum somewhere in the "middle" between them. You need some inequality as an incentive, but when you look around the people around you, you will notice that the incentives do not need to be large to drive people to excel. The optimum changes over times, as it depends a lot on non-economic external influences. Thus when we want to keep an economy in balance, we have to change our position from "left" to "right" and viceversa over time. At the moment, we need a certain shift to the left in most countries.

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Inequality of wealth leads to stagnation and greater numbers of people living in poverty. The facts in the US are there for all to see. The middle class in shrinking, poverty is at all time highs and the concentration of wealth in the USA is nearly that in the robber baron days in the 1920s. A 2011 study by the CBO found that the top earning 1 percent of households gained about 275% after federal taxes and income transfers over a period between 1979 and 2007, compared to a gain of just under 40% for the 60 percent in the middle of America's income distribution. And why is this. Reagan and Bush tax cuts for the wealthy which was a massive transfer of wealth from the middle class to the rich in large part. This was justified by the trickle down theory of Laffer which of course is now proven a complete fraud. Why the middle class votes for republicans is just plain insane. You might as well just give the rich your money before the republican politicians figure out how to take it from you and give it to their rich masters. All of this is criminal and unfortunately many vote for their own poverty. They are the real losers.

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OMG, I have a company and earn more than the employees who work for me! The employees who make a lot of money and care for their families and buy houses! I am so evil OMG.

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What sort of inequality are we talking about?

As long as most people are rich enough to enjoy their lives, while others being super-rich, they'll be ok, in spite of occasional grudges about that inequality.

Many people are increasingly worried, because they've seen some evidence that some people work hard but can't live decently in Japan today. This is not the kind of inequality that people will not tolerate.

So, yeah, some types of inequality are bad, while extreme equality doesn't work.

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America is not Sweden. As for income inequality, the top 10% of wage earners in America employ nearly half the population. Were the top earners to earn less, it goes without saying that they would employ less.

It seems that many people have no idea how economics and economies work. Most people seem to think that the rich steal their money from the poor, and hoard it in a cave somewhere.

The majority of millionaires in America are not bankers, stock traders, or executives. The majority of millionaires are small business people. My uncle is a millionaire. He became one by working up to 16 hours a day, 6 days a week for more than 20 years. He never bought a new car, he has never owned a Rolex watch. He started out as a one-man operation, but now he employs 50 people.

My father and grandfather did more or less the same thing, with similar success. There is no "income inequality", but there is a lot of "effort inequality". There are no "haves" and "have nots", there are only "do" or "do nots".

I have been struggling with my own business (it is always a struggle), and I earn a good income from it. It is hard work, but I enjoy it. It's not unlike growing a garden. The idea, the planning, the investment, the cultivation, and the eventual produce are very similar.

I know many people who complain about "how the rich get richer and the poor get poorer". They hate their jobs, and their future prospects, but they don't do anything about the situation. And that is the problem, there are "people who do", and "people who don't". Unfortunately, the latter outnumber the former.

The sad thing is that it doesn't have to be that way. People often reach a "comfort zone" in their careers, they make enough to get by with the effort they put out. That's fine. But, people like this have no right to complain about their situation, or the situation of anyone else. You are responsible for your own life, and whatever situation you find yourself in now is the sum total of all the decisions you have made up until this point, for better or worse.

If you are suffering from "income inequality" then go out and earn some more damn income, don't expect someone else to do it for you. Natural selection applies to people as it does to nature. The smartest and the strongest get first dibs. If you want to escape from "income inequality" , you'd better get smarter and stronger.

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For those who can't grasp how "inequality" helps growth, I will explain. When most people find themselves in a difficult situation, they apply their minds or their strength to get themselves out of it. "Necessity is the mother of invention", it is said. If I want to live in a nice home, drive a nice car, or travel to interesting places, it is necessary that I have enough income to pay for these things.

If I have little money or education, I have three options. I can become a criminal, and steal the things I want. I can go "on the dole" and try to collect state benefits. Or, I can find a way to educate myself, and learn a profession which will pay me enough to afford the lifestyle I want. As expected, more than a few choose the first and second options, but most people choose the third option.

The problem with having a large middle class which wants or needs for little is that it does little. It has few hardships to overcome, and few goals to aspire to. If you want an example, you can look at Japan. Japan has become a stangnant and unproductive country with a grim future. Compare the Japan of now to the Japan of 60 years ago, when the large cities were destroyed, there was no infrastructure, and poverty was widespread. Necessity required that people work hard, and they did. The economy exploded, and became one of tne strongest in the world. The following generations have grown up in comfort, without ever having to face the hardships or hard work of the wartime generation. This has made them uninspired, unproductive, and weak.

My family gave me little besides a healthy body and good advice. The things I have now I have earned on my own. Nobody has given me anything, so I have found a way to give to myself. To those of you who work for someone else, where would you be working had the founder of your company simply hadn't bothered to found it? Every business or company where nearly every peron in the world works was started by someone who did more than they had to, in order to make a better life for themselves. And in making a better life for themselves, they have made life better for the rest of us.

Rather than complain about inequality, you should follow the example of those who have worked hard to succeed, and make yourslf equal to them.

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sangetsu03May. 28, 2013 - 09:56AM JST America is not Sweden. As for income inequality, the top 10% of wage earners in America employ nearly half the population. Were the top earners to earn less, it goes without saying that they would employ less.

I just love this sort of illogic that gets trotted out everytime this issue comes up.

When it comes to taking blame the top 10% point their fingers firmly at the corporation and say, "Whoa there!!! Limited liability y'all !! I'm just a stockholder !!!".

When it comes to taking credit they say, "Yup! All the credit goes to me!"

The fact is that with corporations as separate entities it doesn't matter whether they're owned by a million middle-class people or ten super-rich billionaires. The jobs are still there, because they have nothing to do with the billionaires at all, they're seperate entities created by companies. This is WHY companies are structured that way, so that when some billionaire dies the entire company doesn't stop operating.

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Economy is like a game and where you have winners there must be losers.

Not really, not according to classical economics. It is only a zero-sum game when the economy is not growing. As long as there is growth it is not zero sum. It is said that in fact we are all net beneficiaries of a growing economy. This is one reason for the fixation on growth. And it is the justification the rich use for measures that are believed to maximise growth, even to the point of redistributing income their way, such as with corporate welfare and tax cuts. This is usually the result of being able to unduly influence policy in their favour. Throw in a few myths like social mobility - though the UK and the USA are both weak here - based on will to succeed and, bingo, we have the ideology taking shape.

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The fact is that with corporations as separate entities it doesn't matter whether they're owned by a million middle-class people or ten super-rich billionaires. The jobs are still there, because they have nothing to do with the billionaires at all, they're seperate entities created by companies. This is WHY companies are structured that way, so that when some billionaire dies the entire company doesn't stop operating.

Except that the vast majority of businesses in America are not large corporations or companies. They are mostly mom-and-pop operations whose owners have scraped, saved, and put in countless hours to get going. Many of these shops are franchises of large companies, but they are owned by your friends and neighbors. These are the places which employ most Americans. Increased taxes on the top wage earners affects more small business owners than they do bankers or corporate CEO's.

Here in Japan the situation is quite different, the corporations are large-scale conglomerates, and they have their fingers in everybody's pie. They control the national bureaucracy, which is a permanent body which is more responsible for the current mess Japan is in than the inept elected politicians, who have as much real power as convenience store clerks.

Doesn't anyone know anything?

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sangetsu03May. 28, 2013 - 05:14PM JST Except that the vast majority of businesses in America are not large corporations or companies. They are mostly mom-and-pop operations whose owners have scraped, saved, and put in countless hours to get going. Many of these shops are franchises of large companies, but they are owned by your friends and neighbors. These are the places which employ most Americans. Increased taxes on the top wage earners affects more small business owners than they do bankers or corporate CEO's.

Umm... mom and pop operations that are barely scraping by aren't owned by millionaires, because if they were then "the vast majority" of business owners would be millionaires. Since this isn't the case your logic falls apart. Higher tax rates for top earners pretty much hits corporate CEOs and bankers ONLY. Trying to make out that it affect mom and pop stores barely scraping a profit is... ridiculous.

Here in Japan the situation is quite different, the corporations are large-scale conglomerates, and they have their fingers in everybody's pie. They control the national bureaucracy, which is a permanent body which is more responsible for the current mess Japan is in than the inept elected politicians, who have as much real power as convenience store clerks.

And yet Japan is a more equal society by every single measure than the U.S. Look up gini-coefficient. Then come back when you know something.

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@sangetsu03

My family gave me little besides a healthy body and good advice. The things I have now I have earned on my own. Nobody has given me anything, so I have found a way to give to myself. ... Rather than complain about inequality, you should follow the example of those who have worked hard to succeed, and make yourslf equal to them.

I understand the benefit of believing your argument, as it allows you to think about how great you are, but it falls down when you consider that people who achieve great things in science, technology and medicine tend to come from middle-class backgrounds in societies where they can get an education. Those kind of people trigger economic growth, I mean think about the invention of the Web as one example. Without providing access to a decent education, which is under threat considering how expensive its becoming, we miss out on so much potential. Rags to riches stories are great and all but its not the kind of world we should be aiming for, and complaining about inequality is something we should all do, considering how much of it there is.

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Inequality eventually spurs profound change.

Not all will welcome it. The creed that I follow teaches that the first now will later be last.

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In he long run extreme inequality of wealth leads to bad things (breakdown of society, wars, etc.) Not to condemn all who have made a fortune, but many who have, have done it with a un-level playing field, by exploiting people, etc. It is not as simple as many make it seem, as some really do create wealth with innovation, yet others are those merely hold control of land and other capital assets (the problem is when this becomes an increasingly inherited amount). And the worst lobby politicians to socialize their costs/ losses to the general working person (taxpayer).

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I am wondering if anyone on the forum has read much about the early late-19th/early 20th century economic philosopher, Henry George.

George devoted his life to studying the reasons for inequality, laying out his findings in his work Progress and Poverty. He came up with an extremely simple "single-tax" system to address it that has never been tried.

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Inequality itself doesn't matters. What matters is the median. If the median standard of living rises, inequality isn't really an issue.

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@Yabits,

Many should read his ideas.

@ Deplore I might agree, but the exacerbating inequality will at some point lower the real median as well (although not perhaps the nominal median ).

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Inequality may help growth but the fruits of that growth will then be unequally distributed.

Case in point, a sneaker brand moves offshore uses sweatshop labor. It plows the savings into marketing, increases sales, climbs on the stock market and the CEO gets a fat bonus for cutting costs and earning the company money. It also finds a few legal loopholes and offshore tax havens to save even more money. But the laid off workers get nothing and the sweatshop laborers don't see a cent of the multi-million dollar bonuses at the top. The CEO pats herself on the back for being such a great free-market thinker when all she did was lay off honest workers so she could pay someone else less, and dodge her corporate responsibility to pay tax.

Yes that company 'grew' and helped the stock market 'grow' but there were losers as well as winners. The sweatshop workers got a job they might not have had, the CEO got a fat bonus, but a bunch of other people got laid off and will suffer terribly for that 'growth'. The IRS gets less money and there's less to go around for necessary govt programs like education and health. They didn't 'grow' out of this.

Growth should not be a target for its own sake. It has sto actually benefit everyone, not just those at the top.

It takes a village to raise a child; it takes a society to raise a billionaire. Nobody got there on their own. Gates and Buffet recognize this and like to give back to the world that made them rich.

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