Unequal, but no drag on economic growth.

Photographer: Andrey Rudakov/Bloomberg

A Bad Case of Piketty Syndrome

Clive Crook is a Bloomberg View columnist and writes editorials on economics, finance and politics. He was chief Washington commentator for the Financial Times, a correspondent and editor for the Economist and a senior editor at the Atlantic. He previously served as an official in the British finance ministry and the Government Economic Service.
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Let's agree, for the sake of argument, that severe inequality is a bad thing in its own right. Does it also act as a drag on the economy? Recent research suggests it does, and calls into question the standard justification for tolerating rising inequality -- namely, that it's the price a society must pay for economic growth and overall prosperity.

In an earlier post I discussed Arthur Okun's classic book on this subject, "Equality and Efficiency: The Big Tradeoff." I defended Okun's view that, as a practical matter, the trade-off is almost impossible to avoid, even though it's true that, in theory, opportunities abound to make society both fairer and more efficient. Last week a new study from the Organization for Economic Cooperation and Development brought fresh evidence to this debate.

The title of this third big OECD volume on inequality captures the main theme: "In It Together: Why Less Inequality Benefits All." It reports that income inequality measured at the country level (as opposed to globally) has been rising almost everywhere for years. It also finds that "income inequality tends to drag down GDP growth" -- a finding you can expect to see cited frequently. On the face of it, measures to reduce inequality will therefore boost growth. In other words, there's no trade-off, and Okun was wrong.

Yet, as the report goes on to explain, it isn't quite so simple.

The OECD states this main finding so that it sits well with the prevailing obsession over inequality (thus guaranteeing that the report will be noticed), yet does so in a way that invites both misunderstanding and, I believe, misdirected effort. I suspect a case of Piketty Syndrome.

QuickTake Income Inequality

The OECD's economists estimate that the increase in income inequality in the two decades after 1985 cut 4.7 percentage points from cumulative economic growth between 1990 and 2010. "The key driver," the report explains, "is the growing gap between lower-income households -- the bottom 40 percent of the distribution -- and the rest of the population." The effects of "bottom inequality" on growth are statistically significant under various assumptions about the underlying relationship. But "top inequality" -- the gap between high incomes and average incomes -- has no statistically significant impact on growth.

The U.S. debate about income inequality is almost exclusively concerned with inequality at the top. The super-rich, it's argued, are taking the bread from everybody else's mouths and corrupting the political process to boot; the net effect is to make everybody else worse off. I don't dismiss those arguments, but the OECD's findings on inequality and growth lend them no support.

Granted, these findings don't link higher top inequality to faster growth, either. This discredits the view that rising top inequality has a redeeming economic purpose. The main thing is simply that when it comes to growth, top inequality doesn't much matter.

Next, one must ask what exactly is happening at the bottom. How does the growing gap between low incomes and average incomes hold back growth? The study ventures some plausible ideas. This one is top of the list:

A main transmission mechanism between inequality and growth is human-capital investment. While there is always a gap in education outcomes across individuals with different socio-economic backgrounds, the gap widens in high-inequality countries as people in disadvantaged households struggle to access quality education. This implies large amounts of wasted potential and lower social mobility.   

The policy agenda this seems to recommend would focus on improving the schools that serve low-income families, and on raising the incomes of the households concerned -- through lower taxes and higher wage subsidies. The study also backs efforts to get more women into the workforce and to enable people to move from irregular or part-time employment to proper jobs.

Well said -- but this isn't what springs most readily to mind, in the U.S. at any rate, when the discussion turns to inequality. That conversation isn't mainly about poverty and low incomes; it's preoccupied with the depredations of the 1 percent.

Maybe a different trade-off is involved here -- a political one. Too few voters appear to care about wasted potential in the lower reaches of the income distribution. Maybe stoking anger over inequality can help, by turning their attention, and that of policy makers, toward those issues. Or maybe, on the contrary, anger over inequality at the top mainly distracts attention from the bigger problem and makes solving it even harder.

I lean to the latter view, but I live in hope.

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.

To contact the author on this story:
Clive Crook at ccrook5@bloomberg.net

To contact the editor on this story:
James Gibney at jgibney5@bloomberg.net