Saturday, December 13, 2014
For decades, economic policy in Australia - and most other developed countries - has been based on the assumption that there's a trade-off between economic efficiency and fairness (or "equity" as economists prefer to call it).
If governments try to make the distribution of income between households less unequal by, say, using taxes and government spending to redistribute income from rich to poor, or by setting a reasonable minimum wage, it's long been believed, this will make the economy less efficient and so cause it to grow more slowly.
On the other hand, if governments don't do as much to redistribute income away from high-income earners, this will provide stronger incentives for people to work harder, invest and accept risk in the pursuit of greater profits.
This, in turn, will cause the economy to grow faster, leaving us all better off. What's more, the rich have a higher propensity to save, and greater saving will finance additional productive investment.
So, sorry about that, but we have to go easy on high-income earners because this makes the economy work better.
This belief that fairness reduces growth but unfairness fosters it lies behind many of the tax "reforms" we've seen over the years.
The moves to cut the top income tax rate from 67 per cent to 47 per cent, to tax capital gains at half the rate applying to other income, to end the double taxation of dividends and to use introduction of the goods and services tax to increase indirect taxation and cut income tax, are all motivated by the belief this would be better for the economy.
Trouble is, there's been surprisingly little empirical evidence to support this theory - a theory, you'll be surprised to hear, rich people really like (just ask the Business Council).
In recent years, however, the academic tide has turned and researchers are finding increasing evidence that inequality may actually be bad for economic growth. The tide has turned so far it's reached the international economic agencies (though not our econocrats).
Early this year, three researchers at the International Monetary Fund, Jonathan Ostry, Andrew Berg, and Charalambos Tsangarides, published a paper on Redistribution, Inequality and Growth, which found that lower inequality was reliably correlated with faster and longer-lasting economic growth.
What's more, they found that redistribution - the thing economists have long assumed would dampen incentives - seems to have no adverse effect on growth, except perhaps in extreme cases.
"We should be careful not to assume that there is a big trade-off between redistribution and growth. The best available macro-economic data do not support that conclusion," they found.
And now, this week, the Organisation for Economic Co-operation and Development has published a paper by Federico Cingano, Trends in Income Inequality and its Impact on Economic Growth, that comes to similar conclusions.
In most OECD countries, the gap between rich and poor is at its highest in 30 years. In the 1980s, the top 10 per cent of households earnt seven times what the poorest 10 per cent earnt. Today it's 9 1/2 times. (In Oz it's 8 1/2 times.)
Cingano says that doing something about this trend has moved to the top of the policy agenda in many countries.
"This partly due to worries that a persistently unbalanced sharing of the growth dividend will result in social resentment, fuelling populist and protectionist sentiments and leading to political instability," he says.
But another, growing reason for policy-makers' interest in inequality is its possible effect in reducing economic growth and slowing the recovery from the Great Recession.
His econometric comparisons of the performance of OECD countries over the past 30 years confirm earlier findings that increasing income inequality has an adverse effect on later economic growth. In New Zealand, for instance, its total growth over the 20 years to 2010 would have been more than 10 per cent greater had its income disparity not widened as much as it did over the 20 years to 2005.
For both the United States and Britain, their cumulative growth would have been more than 20 per cent greater.
You could argue that just because inequality reduces the rate of economic growth, this doesn't mean government measures to redistribute income will make things better. Those measures could, by reducing economic incentives, make their own contribution to reducing growth.
You could argue it, but you'd get no support from Cingano's analysis of the evidence. "These results suggest that inequality in disposable incomes is bad for growth, and that redistribution is, at worst, neutral to growth," he finds.
But get this: he found that what does most to inhibit growth is an increasing gap between low-income households (the bottom 40 per cent) and the rest of the population.
"In contrast, no evidence is found that those with high incomes pulling away from the rest of the population harm growth," he says.
So the rich attract most envy and resentment, but they're not what inhibits growth. What is it about inequality in the bottom half of the distribution that leads to weaker economic growth in later years?
Cingano finds support for the "human capital accumulation theory", suggesting that lower relative increases in the incomes of families in the bottom half make it harder for them to invest in the education and training that increases the value of their labour and the size of their contribution to growth.
But I've got an idea. Why not get a businessman, say, David Gonski, to propose ways of making sure the socially and economically disadvantaged get a good education?
And why don't we hugely increase university fees? That's bound to make us grow a lot faster.