To What Extent Are Economic Growth and Inequality Necessarily Compliments Term Paper

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  • Subject: Economics
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economic growth and inequality necessarily compliments?

Economic Growth and Inequality

The relationship between economic growth and economic inequality has been thoroughly studies throughout the decades. Some of the theoreticians in the field claim that economic inequality has a positive effect on economic growth, while others have concluded that the effect is actually a negative one, because of the costs it implies, and a more economically equal situation would be preferable.

However, practice reveals even more complex implications of the phenomenon of economic inequality on economic growth. Several studies have revealed that in poor countries, economic inequality reduces inhibits economic growth, compared to richer countries, where inequality stimulates economic growth.

Economic inequality also has social implications. A high level of inequality usually leads to social cohesion, for example, which may further lead to social pressures on the government, strikes or other social manifestations in certain circumstances.

Although inequality has social, political and cultural implication, the phenomenon is primarily an economic one and this is how it should be analyzed. Its social, political and cultural dimensions practically derive from the economic dimension of inequality.

Economic Growth and Economic Inequality

The evolution of the economy organically assumes a permanent distribution of incomes so that it favors both individual development and community development, as a whole, by creating welfare coordinates and by combining economic aspects with socio-cultural ones. In order to achieve this objective, there are several income and wealth distribution models that can be applied.

In general, specialists consider inequality and poverty motivated by the need for ensuring large incomes for intensive activity, for increased investments and for assuming economic risks, on the one hand, and distributing incomes in accordance with individuals' needs rather than private property an market mechanisms, this way ensuring a minimum level of inequality, on the other hand.

The matter of economic inequality is strongly disputed among economists. Opinions are divided. Income distribution inequality can be considered a positive or a negative phenomenon. Also, economic inequality is considered by some to generate economic growth, and by others to emphasize even more the differences between welfare and poverty.

The effects of economic inequality are numerous. They include: social cohesion, population health, economic welfare, efficient economic distribution, economic incentives, and economic growth.

Not only does economic inequality lead to economic growth, but the phenomenon is extremely beneficial and its elimination is far from being recommended. Even more, the total elimination of economic inequality would "entirely destroy the market economy" (von Mises, 1996).

Economic inequality is expressed by the Gini coefficient. The coefficient expresses the inequality of income distribution or the inequality of wealth distribution. When the Gini coefficient is high, it represents high distribution inequality. A low Gini coefficient represents a more equal distribution. When the Gini coefficient is 0, it means the situation represents perfect equality, when income or wealth is distributed equally to everyone.

The Gini coefficient for the most important countries in the mid 2000s is the following: Australia 0.3, Austria 0.28, Canada 0.27, Denmark 0.2, Finland 0.24, France 0.31, Germany 0.27, Greece 0.33, Ireland 0.28, Italy 0.31, Japan 0.34, Mexico 0.56, the Netherlands 0.24, Norway 0.25, Portugal 0.38, Slovak Republic 0.2, Spain 0.31, Sweden 0.22, Switzerland 0.28, the United Kingdom 0.27, U.S.A. 0.4 (OECD, 2009).

Economic inequality cannot generate economic growth in any circumstances. For example, a very low Gini coefficient of below 0.25 intimidates economic growth because of the costs it implies. Also, a very high Gini coefficient of above 0.4 has a negative influence on economic growth, because of the economic and social phenomena it triggers.

The relationship between economic inequality and economic growth does not manifest in the same manner in each country. In poor countries, economic inequality tends to diminish economic growth, while in richer countries, inequality generates economic growth (Barro, 1999).

As a consequence, "income-equalizing policies might be justified on growth-promotion grounds in poor countries. For richer countries, active income redistribution appears to involve a tradeoff between the benefits of greater equality and a reduction in overall economic growth" (Barro, 1999).

The negative effects of inequality on economic growth include:

Reduced investment opportunities

Diminished borrowers' incentives

Macro-economic volatility

The Kuznets theory is one of the theoretical works that supports the idea of economic inequality being more harmful in poor countries. Results of numerous studies that intended to test this theory do not provide satisfying explanation. This is probably because of the lack of necessary data. The studies were based on cross-country evidence (World Bank, 1996).

The findings of these studies do not support this theory. Only 10% of the countries subjected to these studies that analyzed per capita income variation over a period of 30 years reveal a linear trend. Even more, the studies showed unimportant links between overall growth and economic inequality variations. Also according to these studies, it seems that "periods of growth are associated with an increase of inequality almost as often as with a decrease in inequality. In contrast, we find a strong systematic relationship between overall growth and growth in the income of the poorest quintile" (World Bank, 1996).

As mentioned above, opinions regarding the relationship between economic inequality and economic growth could not more different. Some of specialists' opinions are quite opposite. Findings of various research studies do not clarify the situation either.

For example, although certain studies have pointed that the relationship between inequality and economic growth is a negative one in poor countries, and positive in richer countries, other studies have revealed that this relationship has significant negative implications where democratic countries are concerned (Su, 2001).

The negative effect of inequality on economic growth is explained by different arguments. Therefore, high inequality is supposed to generate increased pressure for redistribution. This income redistribution can be achieved by increasing taxes, which eventually decreases economic growth.

Economic inequality also leads to instability regarding the social and political environment of the country in case. This further has a negative impact on investments, which must be reduced given the circumstances.

Another indirect negative effect of economic inequality regards the human capital, which will not benefit from the same investments as in a more equalized economic situation. Reduced investments in human resources generally attract low work performance, leading to reduced economic growth.

Also, another negative implication of inequality over economic growth consists in the fact that "elasticities of substitution of productive factors of the developed and the developing countries would be larger, causing less aggregate production and slower economic growth in both developed and developing countries" (Su, 2001).

Empirical studies have failed to demonstrate a linier and direct relationship between economic inequality and economic growth. The situation is embraced by several modern theoreticians in the field. Other hypotheses, like that of Kuznets are either partially demonstrated, or dismissed by such empirical studies.

Other results of empirical studies consist in the fact that inequality has a negative influence on markets in the case of developing and transition countries, and a positive influence on markets in developed countries.

Economic inequality is also linked with population growth, which is positively influenced by inequality in developing countries, but negatively in developed countries.

In order to better understand the relationship between economic inequality and economic growth one must take into consideration the causes that generate economic growth. For example, economic growth is generated by the exploitation of the natural resources that the country in case possesses. The most important example for this argument is represented by Saudi Arabia, whose wealth brought by oil exploitation has continuously increased over the decades. This helped the country to begin its development process.

Also in order to increase economic growth a country "can increase the value of existing resources by means of internal improvement, such as by inducing its labor force to work harder or it professionals to concentrate more intensely on existing jobs" (Priest, 2009). In my opinion, this method might be able to help increase economic growth, but clearly not in a substantial manner.

Another economic growth generating factor is innovation. The process of innovation usually leads to progress, which eventually leads to economic growth. Innovation may arise from inequality, but this is probably not one of the most important factors that influence innovation.

The view on economic inequality is different even among politicians. The democrats are oriented towards a more equal economic situation, where everyone should be helped, especially during the financial and economic crisis. This view is strongly contested by the republicans.

The republicans consider that given the circumstances created by the financial crisis, the United States must focus on supporting the overall economy instead of focusing on the individual level. In other words, if the economy is sustained and helped to reach a more stable status, the effects will also be visible on individual level.

However, the opinion about the relationship between economic inequality and economic growth that is embraced by most economists, opinion that is also taught in schools consists in the fact that inequality positively influences economic growth because of the economic incentives it requires.

Specialists that favor the…

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