Wednesday, August 6, 2014

Inequality dampens economic recovery

A report shows that high inequality contributes to slow down growth and therefore matters for policy makers. The interest of that research is not that it brings new advances into the study of inequality - . The authors of that report are economists of Standard & Poor"s, the rating agency which provides information and analysis for investors in financial markets. This is a recognition that unequal income distribution represents a major risk and not an asset for an economy which seeks to recover from a deep crisis.

The S&P economists write : "Our review of the data, as well as a wealth of research on this matter, leads us to conclude that the current level of income inequality in the US is dampening GDP growth, at a time when the world's biggest economy is struggling to recover from the Great recession and the government is in need of funds to support an aging population". 

The analysis which underpins that conclusion is quite straightforward. The wealthy tend to save more as a share of their income, as a growing part of the national income goes to the top-income group. As a result, there is a contraction of demand for goods and services to support strong growth. The income gap has been bridged with debt which fed a boom-bust cycle of financial crises. Therefore, high inequality becomes self reinforcing, as the wealthy use their resources to influence the political system toward policies that help maintain that privileged situation, such as low tax rates or low estate taxes and underinvestment on education and infrastructures. 

These ideas are not new, going back originally to John Maynard Keynes' theory and  recent work made by Thomas Piketty and Atif Mian and Amir Soufi. The novelty is that they go mainstream, beyond the academic debate on economic inequality and the left wing circles. But the policy prescriptions of the authors of that report are poor trying to avoid discussions about taxation and the social welfare system and focusing only on the need for higher investment in education as a key driver for growth.    

This is unfortunately just part off the problem. Tackling inequality requires bold measures, including redistribution of income and job creating investment plans to boost  sustainable growth. 

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