Until recently it was generally accepted that policies designed to reduce inequality might be morally good, but would cause a reduction in economic growth. This view was popularised by a book by Arthur Okun called Equality and Efficiency: The Big Trade Off.
It’s not difficult to understand why there might be a trade-off, because some degree of inequality is required for a capitalist system to function. Without allowing inequality of wages, the market can’t signal to workers that a particular skill-set is scarce, and so it can’t provide incentives for people to switch from less productive occupations to more productive occupations. One might also think that inequality of wages provides incentives for people to work hard within their existing jobs to get promoted and earn more money. On this view, inequality, like any other signal created by the price mechanism, is required in order for capitalism to function. Policies designed to reduce inequality will therefore cause a reduction in economic efficiency and will lead to a reduction in economic growth. Furthermore, any attempt to ameliorate inequality will lead to higher taxes for the rich, which will drive away the ‘wealth creators’, who will take their skills and money with them.
One response to this argument is to concede that there is a trade-off between equality and efficiency, but argue that social justice is more important than economic growth. After all, economic growth is simply a measure of increasing output, measured in goods and services. Having more goods and services is good, but is not a very good proxy for human happiness. It may be nice to have two cars parked on my driveway rather than one, but it isn’t clear that this is going to make me happier. We might instead think that society should be judged by how it treats those who are less fortunate, in which case the trade-off between equality and efficiency is a price worth paying for a more just society.
The real problem for the argument above, however, is that the evidence simply doesn’t support the view that there is a trade-off between growth and inequality. In fact, there is some evidence that long-term economic growth is higher in more equal societies than in less equal societies. And this evidence doesn’t come from some left-wing economist, it comes from the IMF.
One explanation for this evidence is that inequality produces a massive waste of potential because those at the bottom of the income distribution don’t have access to the same opportunities as those at the top. The resources of any society are scarce and in an unequal society these scarce resources are channelled towards those with money and away from those without. This not only leads to a waste of human potential but it also means that the market produces lots of goods and services that wouldn’t be produced if the market responded equally to people’s desires. In an unequal society, the market produces lots of private jets, luxury yachts and rolex watches, thereby using a large proportion of society’s scarce resources to satisfy the desires of rich people, leaving fewer resources to satisfy the desires of the poor (an outcome that is not only unjust, but is economically inefficient because the overall welfare of society could be increased with a more equal distribution of resources).
When added to the evidence that unequal societies also do a lot worse on a range of other metrics – from homicide rates to the incidence of mental health problems – the argument for focussing on reducing inequality seems unassailable. This is especially true if you believe the work of Thomas Picketty, because – if he’s right – this problem will only get worse as we wade, ever deeper, into a new gilded age.