Say It Loud: Inequality is Bad for Everyone

22 Dec 2014 | Sarah Treuhaft
Say It Loud: Inequality is Bad for Everyone
Above: (Graph courtesy of the Organisation for Economic Co-operation and Development OECD)

Cross-posted from Rooflines

There is an invisible culprit in the great scandal of inequality in America: your Econ. 101 textbook.

Go ahead, dig it out from that storage chest, and undoubtedly you’ll read that inequality, while we might not like it, is good for economic growth and progress. This idea has undergirded decades of policymaking, and is still widely accepted by the public and elected officials making decisions about whether and how to invest in housing, transportation, education and the other elements of healthy, thriving communities.

To make real strides toward an equitable economy, the paradigm must shift. Thankfully, a slew of new research is adding up to a serious takedown. And now it’s time for practitioners, advocates, and policymakers to apply this new economic thinking to gain broader support for strategies to build more inclusive communities.

Two economists figure prominently in the textbook story about inequality and growth: Simon Kuznets and Arthur Okun. In the 1940s, Kuznets' theory of inequality and economic growth cast inequality as an inevitable growing pain of the development process. He said that as countries develop, inequality rises, but it then falls as growth takes off and standards of living rise. A few decades later, Okun, President Johnson’s chief economic advisor, released Equality and Efficiency: The Big Tradeoff. In it, he described how inequality creates positive incentives for people to work and invest, and made the case that policies to address inequality, while they might be socially desirable, will take a toll on economic growth.

For decades, these theories—perfectly aligned with ideas about trickle-down economic growth—dominated the field of economics and set the terms of policy debates. Yes, policymakers have the tools to do something about inequality, but it will cost us in growth. Better to invest in growth at the top that would eventually lift up those at the bottom.

Now a new consensus is emerging. Over the past several years, economists from mainstream institutions like the IMF, the OECD, even Morgan Stanley and Standard & Poor's are looking at the latest data and finding that inequality, far from promoting growth, has a dampening effect on it. And policies to increase equity and inclusion are not only the better moral choice—they are necessary to bring about growth that is robust, sustained, and shared.

The latest contribution comes from an OECD working paper released this month (full study here). Crunching the numbers on inequality and growth across 31 developed OECD countries, economist Federico Cingano found that rising inequality has a “negative and statistically significant impact on subsequent growth.” According to his analysis, GDP growth in the United States would have been 7 percentage points higher between 1990 and 2010 if inequality hadn’t increased.

Cingano also looked into what type of inequality mattered for economic growth: inequality at the top or inequality at the bottom? He found it was the widening gap between the poor and lower middle class (households in the bottom 40 percent of the income distribution) and everyone else that had the biggest negative impact on growth. In contrast, and countering the general focus on the 1 percent pulling away from the rest, the growth of incomes at the very top had no impact on growth.

The reason why inequality at the bottom stunted overall growth? Unequal educational opportunities. Children of parents with low educational levels do progressively worse in terms of educational attainment and skills as inequality levels rise, while inequality has no impact on the education of children from more educated families.

Instead of an equity-growth tradeoff, the analysis found that reducing inequality is a win-win all around. “Policies to reduce income inequalities should not only be pursued to improve social outcomes but also to sustain long-term growth,” writes Cingano. He warns that focusing on growth alone, without thinking about who gains from it, could undermine growth in the long run.

Policy-wise, the paper advocates more equitable tax policies to ensure the benefits of growth are broadly shared (echoing a recent IMF study that said redistributive policies, when designed well, can be growth-enhancing). It also recommends policies to increase educational access and opportunity for low-income children and broad social investments to increase access to services, skills development, health care, and child care for low-income and vulnerable lower middle-class households.

This OECD analysis adds to the mounting evidence base that suggests it is time to rewrite those textbooks. But paradigms shift slowly, and the academic debate will no doubt continue. So, it is up to us doers to put this new knowledge about economics to work, and there is no time to waste. The crisis of inequality shows no sign of abating, and it is placing all of our communities at risk. So say it more and say it loudly as you promote strategies for racial and economic inclusion: inequality is bad for everyone.