Introduction

Abstract

In a recent survey of 1767 leaders from academia, business, government, and nonprofits, the World Economic Forum’s Global Agenda Council found increasing income inequality to be the top global concern in 2015, followed by increasing joblessness, and lack of leadership across countries (WEF 2015). Inequality indeed matters and there is a rich literature investigating its relationship with economic development. Okun (1975) argues that in pursuing increased economic efficiency, trade-offs in terms of increased inequality may be necessary to facilitate capital accumulation and technological innovation and encourage economic agents to invest in education and health. There is a larger body of literature, however, that highlights the long-term negative effects of increasing income inequality on sustainable and inclusive development. In their study of 174 countries, Berg and Ostry (2011) contend that countries with lower income inequality enjoy higher growth rates in the long run, after controlling for market structure and other institutional factors. Bénabou (1996) also shows that economic growth in countries with high income inequality is slower than economies with lower levels of inequality. It has been further argued that inequality is associated with business recessions and economic crises. For example, income inequality and the ratio of debt to income saw rapid increases before both the Great Depression of the 1930s and the 2007-2008 Great Recession (Kumhof et al. 2015). By increasing concentration of income, inequality can reduce aggregate demand in an economy, leading to recession. This is mainly due to the lower marginal propensity to consume associated with the wealthy in comparison to middle- and lower-income groups (Carvalho and Rezai 2014). In explaining the global financial crisis of 2007-2008, deepening income inequality has indeed been highlighted as a major culprit (see Stiglitz 2012). Inequality affects the poor by reducing their ability to invest in their health and human capital formation (Galor and Moav 2004; Aghion et al. 1999). It also influences social mobility across generations, as children’s future earnings are significantly affected by their parents’ earning profiles (Corak 2013). Finally, it has been shown that inequality damages economic growth through intensifying conflicts and political stability. Increasing inequality reduces the opportunity cost of engaging in conflicts (Lichbach 1989).