Paul Krugman: Easing income inequality need not hurt growth

Recent studies on redistribution can change the debate

People line up for a food giveaway programme at MacArthur Park in Los Angeles, California, recently. Disposable income in the US and Britain is much more unequally distributed than in France, Germany or Scandinavia. Photograph: Reuters

People line up for a food giveaway programme at MacArthur Park in Los Angeles, California, recently. Disposable income in the US and Britain is much more unequally distributed than in France, Germany or Scandinavia. Photograph: Reuters

Tue, Mar 11, 2014, 01:00

Most people, if pressed on the subject, would probably agree that extreme income inequality is a bad thing, although a fair number of conservatives believe that the whole subject of income distribution should be banned from public discourse. (Rick Santorum, the former US senator and presidential candidate, wants to ban the term “middle class,” which he says is “class-envy, leftist language”. Who knew?) But what can be done about it?

The standard answer in American politics is: “Not much.” Almost 40 years ago, Arthur Okun, chief economic adviser to president Lyndon Johnson, published a classic book titled Equality and Efficiency: The Big Tradeoff, arguing that redistributing income from the rich to the poor takes a toll on economic growth.

Redistribution
Okun’s book set the terms for almost all the debate that followed: liberals might argue that the efficiency costs of redistribution were small, while conservatives argued that they were large, but everybody knew that doing anything to reduce inequality would have at least some negative effect on gross domestic product.

But it appears that what everyone knew isn’t true. Taking action to reduce the extreme inequality of 21st-century America would probably increase, not reduce, economic growth.

Let’s start with the evidence.

It’s widely known that income inequality varies a great deal among advanced countries. In particular, disposable income in the United States and Britain is much more unequally distributed than it is in France, Germany or Scandinavia.

It is less well known that this difference is primarily
the result of government policies.

Data assembled by the Luxembourg Income Study (with which I will be associated starting this summer) show that primary income – income from wages, salaries, assets, and so on – is very unequally distributed in almost all countries.

But taxes and transfers (aid in cash or kind) reduce this underlying inequality to varying degrees: some but not a lot in America, much more in many other countries.

Studies
So does reducing inequality through redistribution hurt economic growth? Not according to two landmark studies by economists at the International Monetary Fund, which is hardly a leftist organisation.

The first study looked at the historical relationship between inequality and growth, and found that nations with relatively low income inequality do better at achieving sustained economic growth as opposed to occasional “spurts”.

The second, released last month, looked directly at the effect of income redistribution, and found that “redistribution appears generally benign in terms of its impact on growth”.

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