At a time when there’s much talk about the 99 percent versus the 1 percent, it’s worth noting that most economists believe some income inequality is not only a good thing but also necessary for strong and sustained economic growth. But they differ widely on how much is good and when or if inequality becomes harmful.
A century ago, income was distributed very unequally in our country. The highest-income households got many times the income of the poorer ones. From the end of the Great Depression to the mid-1970s, it became more equal.
Now, it is moving sharply back in the other direction, and we are returning to a degree of inequality not seen in decades. Most of the increased national income over the past 20 years has gone to the highest-income 20 percent of the population and an unprecedented share of that to the top 1 percent.
Some economists, myself included, think such growing inequality is one of the most important issues of the day. But surveys of the general public show less concern.
Charles Lane, a Washington Post editorial writer, recently laid out the argument against government action to reduce inequality. He cited a Gallup poll in which 52 percent of Americans said the gap between rich and poor was “an acceptable part of our economic system,” while 45 percent said the gap “needs to be fixed” as evidence that we worry less about inequality than we used to.
But his argument largely rested on “Equality and Efficiency: the Big Tradeoff,” a short but influential book written by Arthur Okun in 1975. Okun was a Yale prof and moderate Republican Keynesian who served in the Nixon administration.
Okun’s argument, shared with other economists, starts with the premise that a free-market economy with minimal government intervention is the most efficient way of transforming economic resources into goods and services to meet people’s needs. The specific role of unequal rewards is that they provide an incentive for individuals to work harder, take risks and innovate. If everyone ends up with the same income, regardless of ability, effort and risk, there is little reason to put yourself out.
Nearly any economist would agree with this general argument. The vital question of just how much inequality one needs to provide such incentives is open to debate, however.
In Okun’s day, one heard many anecdotal arguments about the growth-inequality trade-off. Countries like Brazil, Mexico and Iran then had rapid economic growth. They also had highly unequal income distribution. Hence, some argued, the second was causing the first.
It was equally true, however, that these countries with unequal income distribution tended to be poor. If one simply ended the stupidest economic policies in such countries, they achieved rapid growth of their gross domestic product on a percentage basis. That is mostly what happened in China in the decade after 1978.
Similarly, one can find cases where decreases in inequality were accompanied by stagnant growth. Lane cites the example of Greece, which had the greatest reduction in inequality of any European Union country after 1985 but lackluster growth.
But U.S. economic growth was faster when incomes were more equal, after World War II and has decreased as inequality has increased. France has more equal income distribution than we do and much more government intervention in free markets, but output per hour worked is just as high there as here. The Asian tiger economies of South Korea, Taiwan, Hong Kong and Singapore had less unequal income distribution than once fast-growing countries like Iran or Brazil, and their growth turned out to be both faster and far longer-lasting.
This is an area where political views will always dominate empirical research. If you are a liberal, however, understand that some level of inequality may be necessary for incentives to growth. If you are a conservative, understand that the reasons for growth are complex and that in many situations, inequality can hinder rather than promote growth.
Economist Edward Lotterman teaches and writes in St. Paul, Minn. Write him at ed@edlotterman.com.
