Tuesday, 4 March 2014

Does raising all boats lift the tide?

So long one believes that incentives matter, it stands to reason that economies need at least a little inequality to grow. One if could do just as well financially not innovating and not risk-taking as innovating and risk-taking, then there would probably be quite a lot less of both, with undesirable consequences for output. But growth can often result in yawning gaps between the incomes of most working people and those doing best in a society, which raises the question: does a highly unequal distribution of income ultimately do more to undermine growth than sustain it?

At some extreme that is unquestionably the case. An economy in which a small group of elite capture all income is almost certainly not going to be among the world's top growth performers. But at more normal market distributions of income, does inequality hurt growth?

For a long time there hasn't been much consensus on the subject within economics. The starting point for many in the profession has until very recently been the work of Arthur Okun, who suggested that the welfare-maximising policy in a society might well be one that involves some redistribution, but policy-makers should be under no illusions about the growth consequences of that redistribution. But the notion of a strict trade-off between the two has been questioned by recent economic work, including research by economists at the IMF,...Continue reading

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