Swift economic growth increases inequality, this is just something that we’ve observed time and again. But we also have to know that inequality itself causes economic growth. We don’t really have solutions, we just have trade-offs
Inequality has been increasing in Bangladesh even as economic growth accelerates. There are those who consider this to be a significant problem, and then there are development economists who simply state that this is normal.
Swift economic growth increases inequality, this is just something that we’ve observed time and again. But we also have to know that inequality itself causes economic growth.
This is not to say that any level of inequality is just fine, of course not. But it is to insist that, as with most things in economics, we don’t really have solutions, we just have trade-offs.
Almost all of the desirable things we could have – say, greater equality, or more economic growth – also have undesirable effects. The trick is therefore to find the right balance, not to simply decry the existence of one or other of those things we’d rather not have.
So it is with this relationship between economic growth and inequality, something that the Centre for Policy Dialogue, who brought this to our attention, need to consider.
The most important consideration here being, why does the inequality arise?
It’s possible, and most of human history was filled with this, that the people with all the weapons just take vast amounts from the general population. Some few are therefore very rich, the masses are entirely poor.
In a more modern sense we call this “rent seeking.” Gaining some position through the law, bribery, violence, however, which enables one to take some portion of another’s production. Said rent seeking is regarded by all economists as a very bad thing indeed and we really should be trying to root it out. For example, the government shouldn’t insist that one or other person or company has a legal monopoly on the provision of something.
However, inequality can arise from an entirely different source. If some people are more productive than others then they will gain more income for their labour – that’s what higher productivity means.
That’s an inequality of course. But we also like rising productivity. That’s what makes us all richer, the very thing which produces economic growth. So, if inequality arises from that difference in productivity then we should be just fine with it, applaud it even.
A recent academic paper has explored this in the dim and distant past. It’s well known that hunter-gatherer societies are markedly equal by our own standards. While there are many explanations given for this, the reality is that if no one has much, then there can’t be much inequality of possessions nor incomes. It is the arrival of agriculture that leads to the existence of significant inequality.
The research looked at the size of houses over time. We can look at our present world and note that richer people tend to have larger houses. It’s a reasonable enough guess that people in the far past, 6,000 and 8,000 years ago, who lived in larger houses were wealthier than those who lived in smaller ones. So, look at the variance in house sizes in agricultural digs and see how unequal the societies were.
It existed, that inequality. The link was also to increased productivity. Those early farmers who used draught animals to plough, sow, reap their land also got more in crops from their land.
Further, they were able to farm more land in this more efficient manner. They were thus richer. The increased productivity of using animals made those who used them richer, increased inequality as against those who didn’t.
This is good in this first stage, there is more food being grown, the society is richer, fewer children starve and so on. But there’s a second effect too. If you see that this new fangled method of framing makes them richer then you’re going to try to adopt this new fangled method yourself.
And you too will become richer as a result of your own increased productivity. Which is the real way that the right cause of inequality increases economic growth.
The rise in productivity from a new technology – a n entirely reasonable description of the use of animals in agriculture – leads to that technology being copied, and productivity thus rising more generally across the population and economy. Everyone gets richer as a result of the copying of that thing which made the first group richer.
There’s a huge importance of this to our modern political policy. We are bombarded with the insistence that inequality in and of itself is a bad thing. This is not so – it depends upon how and why the inequality arises.
That which comes from rent seeking is indeed something we should expunge from our economy. That which comes from rising productivity is something to encourage. For it is the thing which makes us all richer over time.
Thus, we cannot insist that we must reduce inequality itself. As, sadly, all too many do.
For imagine a society in which there was no inequality at all? All gain the same income no matter what it is that they do to gain it. In such a case, then, no one would exert themselves to gain more, would they? Because exertion wouldn’t lead to gaining more.
Further, it’s not even possible for us to determine that there’s a right amount of inequality that we should put up with for the sake of growth. Because it matters how it arises, as above.
Two economies with the same amount of inequality, in one arising from rent seeking, in the other from productivity enhancements, would have very different futures. One would remain however rich or poor it was, the other would become substantially richer over time.
The correct answer is thus not to worry about the inequality itself at all, but only about how it arises. Or, as a practical guide to economic policy, eliminate the opportunities for rent seeking and then put up with whatever level of inequality results from advancing productivity and invention.
Not that anyone is ever going to do this, most especially any politician with votes to win from the poorer among us, but that would still be the correct answer.
Tim Worstall is a Senior Fellow at the Adam Smith Institute in London.