More Inequality for More Growth?

PARIS – In a recent commentary, “Is Inequality Inhibiting Growth?”, Raghuram Rajan argues that income inequality, which has been on the rise since the 1970’s, can be explained in two ways. Progressive economists blame pro-rich policies. The “alternative” explanation (or, more accurately, the conservative view) focuses on skill-biased technological progress.

According to Rajan, while both explanations maintain that inequality led to excessive debt, causing the global economic crisis, only the “alternative” explanation accounts for European countries that maintained more egalitarian policies, despite low productivity. According to this view, Germany’s economic strength stems from the structural reforms – entailing fewer worker protections, limited wage increases, and reduced pensions – that were implemented to contend with historically high unemployment following reunification.

Now Southern Europe should implement similar reforms, Rajan argues, and accept the resulting increase in inequality, in order to avoid sliding into an “egalitarian decline” like Japan.

But Rajan’s analysis is problematic for three reasons. First, he establishes a largely artificial contrast between the two explanations of inequality’s causes. In fact, a progressive economist would be unlikely to deny that globalization and technological progress have increased income inequality – albeit to a lesser extent than Rajan believes. Likewise, a conservative economist would probably concede that pro-rich policies have fueled inequality (including in Europe, where the marginal income- and corporate-tax rates dropped dramatically almost everywhere).