Good and Bad Inequality

MILAN – Rising income and wealth inequality in many countries around the world has been a long-term trend for three decades or more. But the attention devoted to it has increased substantially since the 2008 financial crisis: With slow growth, rising inequality bites harder.

The “old” theory about inequality was that redistribution via the tax system weakened incentives and undermined economic growth. But the relationship between inequality and growth is far more complex and multi-dimensional than this simple trade-off suggests. Multiple channels of influence and feedback mechanisms make definitive conclusions difficult.

For example, the United States and China are the fastest-growing major economies today. Both have similarly high and rising levels of income inequality. Though one should not conclude from this that growth and inequality are either unrelated or positively correlated, the unqualified statement that inequality is bad for growth does not really accord with the facts.

Moreover, in global terms, inequality has been falling as developing countries prosper – even though it is increasing within many developed and developing countries. This may seem counterintuitive, but it makes sense. The dominant trend in the global economy is the convergence process that began after World War II. A substantial share of the 85% of the world’s population living in developing countries experienced sustained rapid real growth for the first time. This global trend overwhelms that of rising domestic inequality.