Economic growth and inequality: necessary complements or competing forces?

¶ … 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

Political rejection expressed by the masses

As mentioned above, the lack of data regarding the variables that affect economic inequality, economic growth, and the relationship between them is responsible for the lack of concrete, clear, definitive findings. Other specialists in the field accuse other circumstances for the lack of such clear evidence. For example, the periods of time subjected to the study are not long enough for certain theories to be verified, although some of them are based on data of three decades or even more.

Conclusions

It is almost impossible to draw a clear conclusion that would characterize the relationship between economic inequality and economic growth, or to establish a unique trend followed by this phenomenon. One thing is for sure, and that is the causality relationship between inequality and economic growth.

However, it is obvious that economic inequality can have negative or positive, direct or indirect effects on economic growth, and it also affects both developing and developed countries.

Also, there is a very clear distinction between old theories in the field and new, modern ones. Initial theories state that inequality generates economic growth. The theory is embraced by the republicans. They consider that inequality would help stabilize the economy in the financial and economic crisis and it would also help sustain the economy in the future. However, such theories are only partially supported or not supported at all by empirical findings.

Modern theories agree upon the fact that a more equal economic situation would be more favorable for macro economies. The theory is supported by the democrats. Their opinion is based on the idea that it is better to help everyone in these circumstances generated by the financial crisis in order to diminish the income inequality between individuals.

The empirical studies in the field have revealed a certain relationship between economic inequality and economic growth, but the findings did not reveal any pattern followed by this relationship. The causality relationship between inequality and economic growth reacts differently in each country, in accordance with the circumstances that compose the macro environment that characterizes each country.

Some of the empirical studies have revealed the fact that inequality has a negative impact on poor countries and a positive impact on richer countries. The results of these studies vary in accordance with the countries taken into consideration when establishing the country panel. This also proves that the relationship between inequality and economic growth does not manifest in the same manner in each country.

Reference list:

1. Von Mises, Ludwig (1996). Human Action: A Treatise of Economics. Chapter XXXV The Welfare Principle vs. The Market Principle. Ludwig von Mises Institute. Retrieved April 3, 2009 from http://www.mises.org/humanaction/chap35sec3.asp.

2. Gini coefficient (2009). Organization for Economic Cooperation and Development. Retrieved April 3, 2009 from http://stats.oecd.org/WBOS/Index.aspx?QueryId=11353.

3. Barro, R.J. (1999). Inequality and Growth in a Panel of Countries. Harvard University. Retrieved April 3, 2009 from http://www.economics.harvard.edu/faculty/barro/files/p_inequalitygrw.pdf.

4. Economic Growth and Income Inequality: Reexamining the Links (1996). The World Bank. Retrieved April 3, 2009 from http://www.worldbank.org/fandd/english/0397/articles/0140397.htm.

5. Su, Q. (2001). Economic inequality and economic growth. Humboldt University, Berlin. Retrieved April 4, 2009 from http://www2.wiwi.hu-berlin.de/institute/im/publikdl/2001-inequality.pdf.

6. Priest, G.L. (2009). Poverty, Inequality, and Economic Growth -- Simple Principles. Yale Law School. Retrieved April 4, 2009 from http://islandia.law.yale.edu/sela/priese.pdf.

7. Aghion, P. et al. (1999). Inequality and Economic Growth: The Perspective of the New Growth Theories. Journal of Economic Literature. Retrieved April 4, 2009.