Conference Paper: Should Policymakers Care Whether Inequality Is Helpful or Harmful For Growth? (October 12-13, 2017)

Abstract

The view that inequality is harmful for growth is gaining currency among policymakers around the world. In the strongest form of this argument, high levels of inequality can make sustained growth impossible or even cause recessions. In a weaker form, lower levels of inequality are good for growth. Among policymakers this view has almost entirely supplanted the traditional economic view that there was a tradeoff between inequality and growth and that greater inequality might be the price to be paid for higher levels of growth. This paper is not a fresh attempt to assess the empirical evidence on inequality and growth or a survey of the existing literature. Instead this paper addresses the question of whether policymakers should even be interested in this question in its traditional form, answering with a resounding no for three reasons. First, although more recent papers have reached the conclusion that exogenously higher levels of inequality result in lower longer-run growth rates, a number of studies have found more nuanced and complicated results, the magnitude and importance of inequality is not so high that it deserves a special place as an explanatory variable, and in general cross-country growth regressions are inherently limited in their ability to make definitive and robust causal claims. Second, and more importantly, with few notable recent exceptions, the literature is about the impact of inequality on growth not the impact of policies to reduce inequality on growth. The former is of interest to social scientists and historians but it is the latter that is relevant for policymakers. Third, and fundamentally, the question itself is mis-specified, at least from the perspective of policymakers. From a normative perspective most policymakers do not care about the average of incomes in the economy—which is the left-hand side variable posed in most of this literature—which accords equal weight to $1 added to the income of a poor person or a billionaire. Most social welfare functions would place more weight on the bottom than on the