Inequality, Economic Growth, Sarah Illingworth, Impolitikal

Sarah Illingworth on why inequality undermines economic growth

Some measure of income and wealth inequality has long been considered an inevitable, even desirable characteristic of capitalism. It’s argued that inequality motivates individuals to work hard, and with ambition – which is conducive not only to economic growth, but also to innovation. Early economic theory claimed that in the initial stages of a country’s development inequality rises, along with growth, and then declines of its own accord, the market working to correct it. It’s become apparent, however, that reduced inequality is not an inevitable outcome of the free market model. From academics to protestors to the OECD, disproportionately high levels of inequality in the ‘free world’ are increasingly being acknowledged as a concerning reality.

GDP is typically taken as the chief measure of a country’s developmental progress, but – contrary to the mantra of trickle-down economics – it has become clear that the benefits of such growth do not automatically extend to all members of a given group. If a disproportionate level of a country’s wealth is allowed to become concentrated in the hands of a small percentage of the population, the broader, negative effects can be vast. As well as having major implications for social wellbeing generally speaking, income and wealth inequality can affect the ability of people in low- and middle-income groups to save and engage in the kind of economic activity that could potentially improve their lot, let alone engage in consumption. This not only serves to reproduce inequality, it can be detrimental to overall economic growth in the long-term, and is as such symptomatic of market inefficiency, even failure.

While high levels of inequality are typically associated with low- and middle-income countries, they aren’t uncommon in the so-called advanced economies, particularly the United States. Much has been made of the wealth gap in the US, but I will go there again. 14.5% of Americans (45.3 million) live below the poverty line, and the country has one of the highest levels of inequality in the so-called developed world. It also has one of the most disproportionate splits of wealth, with more than 20% of the country’s total wealth belonging to 0.1% of the population. These levels were heightened by the economic downturn of the 2000s, but had been rising steadily since the late-1970s. Although growth in terms of GDP may appear to have stabilised after the recession of the mid-2000s, in reality most of that wealth has gone to the already wealthy.

While the Great Recession provided an opportunity to address the growing chasm between the rich and poor in the US, for example through the reintroduction of stronger progressive taxation policies, and regulations on a financial sector that completely abused the freedom it had been awarded via deregulation, the US government instead chose to bail out the sector without introducing any significant checks that would address predatory lending practices and speculation, and minimise the risk of another similar crisis taking place. Many economies in both the so-called developed and developing worlds are modelled to some extent on that of the US, or at the very least feel some degree of pressure from them to persist with a neoliberal, free market version of capitalism. I believe this makes it even more important that the very high levels of poverty and inequality within the US, and the market inefficiency they represent, aren’t swept under the carpet. Allowing the financial sector to return to business as usual after it caused so much harm to so many people – and this applies not only in the United States, but globally – is not only shortsighted, it’s criminal.

The US economy is simply not as egalitarian as it used to be, and the housing bubble of the early 2000s made this unavoidably clear. Many middle-income families who were enabled to purchase homes with the help of lending services that have since been shown to be highly speculative, subsequently lost them – and their entire life savings – when the bubble burst. The spike in unemployment levels that followed compounded this, helping to trigger the Global Financial Crisis of the mid-2000s and leaving many middle-income Americans (still) in a very vulnerable financial position. In contrast, the tiny group that control a massive portion of the country’s wealth remain relatively well-served by the US government, who have kept taxation rates generally low for the wealthiest Americans since the deregulation of the financial markets in the 1980s. The qualification for this was that so-doing would create conditions optimal for growth, and that the benefits enjoyed by the savvy, hard-working super-wealthy would trickle down to the poor. In reality, speculation and instability has characterised the financial system since, and wealth and job security has decreased markedly for those in the middle- and low-income brackets.

Contrary to the rags-to-riches narrative that used to make the US so appealing, the reality for many Americans today is that those born into poverty are likely to remain there, or at the very least struggle to exit, and those born into wealth are likely to remain there too. Social and intergenerational mobility has been found to strongly depend on a child’s parents’ income levels, and the level to which their parents are willing and able to invest into their education and general wellbeing. Compounding this, student debt has become one of the US’ biggest liabilities. The US is considered most definitely to be a developed nation, and is one of the strongest advocates of the free market model – yet it has allowed its poverty and inequality levels to become some of the highest in the OECD. Rather than minimise inequality, the unchecked market has fostered conditions in which those who are already financially insecure are able to be further disadvantaged, and those that were relatively financially secure to join their number.

I focus on the US here, but the narrative is similar in many other so-called developed economies.  Of course, it’s not only developed nations that exhibit high levels of poverty and inequality – there are many low-income countries in which extreme poverty coexists with extreme wealth – but I focus on the West because there is so often a smugness about how successful we have been at development. Industrialisation and globalisation have brought a lot of benefits, and yes many of those benefits have been enjoyed around the world, but they have tended to be experienced by relatively small groups. And these processes also have their dark side. The heightened vulnerability of poorer nations, and the poor within nations, to climate change and the poverty that has fuelled the intensity of the current Ebola outbreak are two examples of the challenges high levels of inequality can present not only for those already at the margins, but a globalised world more generally.

I believe strongly that people who have a chance to educate, and to adapt to new technologies; that are physically healthy, and have the present security of knowing they will be cared for in the future (e.g. through retirement provisions), are not only likely to have a greater sense of wellbeing, they are also more likely to be economically productive and engaged. The success of social protection programmes in China, South America and Latin America in both reducing poverty and facilitating economic growth, for example, shown that redistributive policies can pay off. If countries like the US continue to exacerbate the wealth gap by promoting the private sector while allowing low-income groups – both within their borders and beyond – to shoulder even greater financial burdens, the long-term costs of inequality will be far higher than the costs associated with recharting the course right now.

Inequality isn’t a new phenomenon, but it’s real. And its current levels, both within countries and between them, are damaging not only to people, they’re damaging to economic stability and growth – which is in turn damaging to people, and that’s why I care about it. But whether you take an ethical perspective, or are interested purely in the bottom line, surely investing in good infrastructure, clean energy and quality education and healthcare for all is less of a nightmare than negotiating the consequences of miserly choices in these areas at a later date. It may not be possible, or even desirable, for everyone to earn or own exactly the same, but in many countries the gap between high-income and middle- and low- income groups is currently too extreme, and obscene, to be sustainable in the long run.

Sarah Illingworth is a freelance journalist and Editor at Impolitikal. She has an MSc in Poverty & Development from the University of Manchester. Read more by Sarah.