Income Inequality, Redistribution and Economic Growth: Statistical Measures and Empirical Evidences 3031248503, 9783031248504

Table of contents :
A Forward By Mohammad Hashem Pesaran
References
Preface to the English Edition
Contents
1 Introduction
2 Inequalities and Economic Inequality
References
3 Economic Inequality
3.1 Measuring Inequality
3.2 State and Evolution of Personal Income Inequality
3.3 Geographical Inequality
References
4 Economic Growth
4.1 Theories of Economic Growth
4.2 Recent Trends in Economic Growth
References
5 Inequality and Growth
5.1 Interpretive Models of the Relationship Between Inequality and Growth
5.2 Some Theoretical Positions on Redistributive Policies
5.3 Some Empirical Evidence
References
6 Inequality of Opportunities
References
7 Recent Trends of Growth and Inequality in a Post-pandemic World
References
8 Summary Remarks
References

Citation preview

SpringerBriefs in Economics Giuseppe Arbia

Income Inequality, Redistribution and Economic Growth Statistical Measures and Empirical Evidences

SpringerBriefs in Economics

SpringerBriefs present concise summaries of cutting-edge research and practical applications across a wide spectrum of fields. Featuring compact volumes of 50 to 125 pages, the series covers a range of content from professional to academic. Typical topics might include: ● A timely report of state-of-the art analytical techniques ● A bridge between new research results, as published in journal articles, and a contextual literature review ● A snapshot of a hot or emerging topic ● An in-depth case study or clinical example ● A presentation of core concepts that students must understand in order to make independent contributions SpringerBriefs in Economics showcase emerging theory, empirical research, and practical application in microeconomics, macroeconomics, economic policy, public finance, econometrics, regional science, and related fields, from a global author community. Briefs are characterized by fast, global electronic dissemination, standard publishing contracts, standardized manuscript preparation and formatting guidelines, and expedited production schedules.

Giuseppe Arbia

Income Inequality, Redistribution and Economic Growth Statistical Measures and Empirical Evidences

Giuseppe Arbia Catholic University of the Sacred Heart Rome, Italy

ISSN 2191-5504 ISSN 2191-5512 (electronic) SpringerBriefs in Economics ISBN 978-3-031-24850-4 ISBN 978-3-031-24851-1 (eBook) https://doi.org/10.1007/978-3-031-24851-1 Translation from the Italian language edition: “Diseguaglianza, redistribuzione e crescita” by Giuseppe Arbia, © The author 2017. Published by Vita e Pensiero. All Rights Reserved. © The Author(s), under exclusive license to Springer Nature Switzerland AG 2023 This work is subject to copyright. All rights are solely and exclusively licensed by the Publisher, whether the whole or part of the material is concerned, specifically the rights of reprinting, reuse of illustrations, recitation, broadcasting, reproduction on microfilms or in any other physical way, and transmission or information storage and retrieval, electronic adaptation, computer software, or by similar or dissimilar methodology now known or hereafter developed. The use of general descriptive names, registered names, trademarks, service marks, etc. in this publication does not imply, even in the absence of a specific statement, that such names are exempt from the relevant protective laws and regulations and therefore free for general use. The publisher, the authors, and the editors are safe to assume that the advice and information in this book are believed to be true and accurate at the date of publication. Neither the publisher nor the authors or the editors give a warranty, expressed or implied, with respect to the material contained herein or for any errors or omissions that may have been made. The publisher remains neutral with regard to jurisdictional claims in published maps and institutional affiliations. This Springer imprint is published by the registered company Springer Nature Switzerland AG The registered company address is: Gewerbestrasse 11, 6330 Cham, Switzerland

A few observation and much reasoning lead to error; many observations and a little reasoning lead to truth Alexis Carrel

To the memory of my friend Stefano Fachin

A Forward By Mohammad Hashem Pesaran

Professor Giuseppe Arbia has produced a highly readable pamphlet on one of the most complex and important problems of our age: How to achieve economic growth with a socially acceptable equitable income distribution. It is generally acknowledged that economic growth is essential for reducing poverty and improving the quality of life, particularly in developing countries. But how can we ensure that technological advances, which are the primary engine of growth, do not lead to increased income and wealth disparities in society. Can this be achieved without discouraging innovation and technological progress? Professor Arbia provides a lucid account of the different forces that govern the relationship between income inequality and economic growth, and the role played by redistributive policies in striking a balance between entrepreneurship and the incentive to innovate and an equitable distribution of income and wealth across the different segments of society. Two economies with the same average rate of output growth could have very different outcomes for poverty and income distribution. Many of the factors behind these differences are discussed and then elaborated later in the book. As emphasized by Professor Arbia, there is no simple relationship between output growth and economic inequality. They could be driven by other common factors such as wars, natural disasters and health pandemics. All such shocks invariably affect output growth adversely but are likely to have positive as well as negative long run impacts on inequality. The same also applies to policy interventions. Not all growth-inducing policies lead to poverty reduction and better employment and job opportunities for the poor. Professor Arbia begins with an overview of the philosophical and political dimensions of inequality with particular emphasis on economic inequality. He takes us on a journey from Adam Smith, Jean Jacques Rousseau and Friedrich Nietzsche to more recent accounts by Norberto Bobbio, Joseph Stiglitz and Mankiw. Challenges involved in measuring inequality are discussed eloquently by reviewing the work of Gini, Dalton, Sen and Atkinson. Using the Gini coefficient, he reviews the empirical evidence on trends in income inequality across advanced (OECD) countries and a number of developing and emerging economies. He documents the wide differences that exist in income inequality even if we confine ourselves to European ix

x

A Forward By Mohammad Hashem Pesaran

countries. Professor Arbia is quite candid about how difficult it is to explain the differences observed between the values of Gini coefficient obtained for Slovenia, Czech Republic and Norway (0.24–0.27) at the low end, and the values obtained for Spain, Latvia and United Kingdom (0.34–0.36) at the high end. These differences are much more pronounced once we also consider countries in Africa and South America. The evidence provided by Prof. Arbia for output growth is equally diverse giving little support for the per capita output convergence predicted in the 1980’s by Robert Barro and a number of other neoclassical empirical economists. Similarly, Professor Arbia finds little evidence in favour of Kuzent’s curve, and the concept of the trickledown hypothesis popularized during the 1970’s and then revived in the U.S. under President Ragan. This leads Professor Arbia naturally to redistributive polices and their short-term and long-term effects on economic growth and inequality, whilst at the same time acknowledging the difficulty of disentangling cause and effect in the relationship between growth and inequality. Professor Arbia’s account reminded me of my own research on income distribution and growth in Iran. In the absence of reliable income data, I used household expenditure surveys that to the regime’s dismay showed a marked upward trend in the degree of economic inequality which was further accentuated by the maximal growth policies adopted by the Shah, itself made possible by substantial rises in oil revenues after the quadrupling of oil prices in 1973/74. See Pesaran (1976) and Pesaran and Gahvary (1978). The rising income inequality was arguably a factor in the February 1979 Revolution that followed, despite the high growth rates achieved prior to the Revolution. In short, Prof. Arbia has managed to produce a succinct and highly readable account of the fundamental economic problems faced by advanced and developing countries alike. It is informative and thought provoking, and provides the reader with the historical background as well as the statistical evidence needed for an independent assessment. November 2022

Hashem Pesaran University of Southern California Los Angeles, USA Trinity College Cambridge, England

References Pesaran, M. H. (1976). Income distribution and its major determinants in Iran. In J.A. Jacqs (ed), Iran: Past, present and future, aspen institute for humanistic studies (pp. 267286). Pesaran, M. H., & Gahvary, F. (1978). Growth and income distribution in Iran. In R. Stone & W. Peterson (eds), Econometric contributions to public policy (pp. 231–248). Macmillan.

Preface to the English Edition

This book represents the translation of an essay of mine published in Italian in 20161 with three additions. First, given the complexity of the topics discussed in the essay, in this English edition I deemed it necessary to include a new Chap. 1 which constitutes a short illustration of the plan of the book and that aims at introducing the reader to the fascinating issues of economic inequality, of economic growth and to the intricate mechanisms that link them. Secondly, in the first edition of the book, the empirical part obviously focused on Italian datasets and was dedicated to describing the national situation and the recent trends of inequality and growth in the country. Furthermore, a substantial part of the discussion was centred on the analysis of the possible policies aiming at reducing inequality without negatively affecting growth in Italy with specific references to the Italian fiscal system. In contrast, being directed to a more international audience, in this English edition, I suppressed those parts, and I presented a more general picture of growth and inequality worldwide leaving apart any comment on policies that are more country-specific. Thirdly, and more substantially, in the years following the publication of the Italian version of this book, the world has been stroked by the Sars-Cov-2 pandemic, which constituted a watershed in all fields of human life: inequality and growth are not exceptions to this rule. Indeed, the shocking effects of the health emergency produced a sharp increase in inequality and a devastating slowdown in economic growth observed all over the world with only a few exceptions. Even if substantive progresses have been made since then, when this book goes to the press, at the end of the year 2022, we are still not entirely out of such an unprecedented health emergency and certainly we are still suffering its economic consequences all over the world. Further instability and economic uncertainty were introduced worldwide by the geopolitical instability following the Ukrainian war that started in February 2022.

1

See Arbia (2016). xi

xii

Preface to the English Edition

Even if this essay is certainly not the most suitable place to comment on these dramatic events, and, moreover, it is still too early for any conclusive considerations about the impact of them on economic growth and inequality, I believe, however, that my readers would probably be disappointed if these topics were completely neglected in the present discussion. For this reason, I introduced them, although very briefly, in Chap. 7 of the book. A more thorough discussion of these topics will probably constitute the material for further studies in the years to come. Rome, Italy December Immaculate Conception 2022

Giuseppe Arbia

Contents

1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

1

2 Inequalities and Economic Inequality . . . . . . . . . . . . . . . . . . . . . . . . . . . . . References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

5 8

3 Economic Inequality . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.1 Measuring Inequality . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.2 State and Evolution of Personal Income Inequality . . . . . . . . . . . . . . . 3.3 Geographical Inequality . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

11 11 14 18 19

4 Economic Growth . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.1 Theories of Economic Growth . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.2 Recent Trends in Economic Growth . . . . . . . . . . . . . . . . . . . . . . . . . . . . References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

21 21 25 28

5 Inequality and Growth . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5.1 Interpretive Models of the Relationship Between Inequality and Growth . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5.2 Some Theoretical Positions on Redistributive Policies . . . . . . . . . . . . 5.3 Some Empirical Evidence . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

31 31 37 44 45

6 Inequality of Opportunities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 47 References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 53 7 Recent Trends of Growth and Inequality in a Post-pandemic World . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 55 References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 58 8 Summary Remarks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 59 References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 62

xiii

Chapter 1

Introduction

The principle of equality among individuals has been a controversial topic for centuries and it was treated from very different viewpoints ranging from social to legal, from cultural to ethical, economic and political. This principle is at the basis of Jean-Jacques Rousseau’s thought and of the Enlightenment principles and it can also be considered at the roots of our current political system of the liberal states. Indeed, starting from the different positions with respect to the idea of equality, the Italian philosophers Norberto Bobbio derives an interesting distinction between right-wing and left-wing in the current political systems and, as a consequence, between the different ways of conceiving public intervention in the society. From a more exquisitely economic point of view, which represents the main focus of this essay, the analysis of inequality in the distribution of income (seen both as inequality among individuals belonging to a certain community and as inequality in the income of the various countries), has represented an exciting topic of discussion fuelled, in more recent years, by the strong economic growth differentials registered between the various countries of the world and by the lack of shared theoretical paradigms which are able to explain them in a plausible way. It has also acquired more interest very recently as a consequence of the health and geo-political crisis in the twenties of the new millennium. In particular, the most recent debate focused on the relationship between income inequality and economic growth and on redistributive mechanisms that could favour the latter. The debate is still open, given the different theoretical positions and the different empirical evidence which provides contrasting elements to support both a direct relationship between the two phenomena (through which a higher income inequality should be expected to encourage economic growth), and an inverse relationship (through which a higher income inequality would, on the contrary, depress economic growth). In this essay we are not interested in discussing the ethical and juridical arguments supporting the achievement of greater economic equality, but rather to analysing the reasons why a greater economic equality could produce a benefit in terms of well-being for the whole community. Going through a historical exam of the evolution of economic inequality and of income growth rates throughput © The Author(s), under exclusive license to Springer Nature Switzerland AG 2023 G. Arbia, Income Inequality, Redistribution and Economic Growth, SpringerBriefs in Economics, https://doi.org/10.1007/978-3-031-24851-1_1

1

2

1 Introduction

the world, we wish to illustrate the complex relationship between them and to outline possible lines of political redistributive interventions. I have done my best to keep the discussion as much as possible at a non-formal level, even at the cost of (maybe sometimes excessive) simplifications, in order to let the subject be accessible to non-specialists in the subject. However, the quote by Alexis Carrel which opens this essay should not fail to suggest to the readers that the method that will be followed in these pages will be more on the empirical-inductive side rather than on the deductive-speculative, and that I will found my conclusions on findings induced by the historically observed empirical data. In doing this, I clearly betray my passion for numbers and for the mathematical formalizations that derives from my statistical quantitative background. On the other hand, however, I can reassure the readers who are going to browse the first pages of this essay in inviting them to read it, that it will not contain any formula nor any mathematical expression. Before entering the discussion, in the remainder of this first chapter, I will very shortly illustrate the plan of the book describing the path that we are going to run across together in order to achieve my aims. Inequality has many facets, and they do not refer only to economics although this represents the main focus of the present book. For this reason, I deem it necessary, before any other considerations, to discuss the topic of inequality in a broader sense together with some of the connected philosophical implications. Indeed, such a preliminary discussion is also relevant because, as we already remarked, the different positions that can be assumed facing the concept of inequality, can be considered at the heart of the distinction between left-wing and right-wing political inclinations with important repercussions on the choices of redistribution policies, a topic which will be extensively treated later in the book. The purpose of drawing such important distinction will be accomplished by Chap. 2. “When you can measure what you are speaking about, and express it in numbers, you know something about it; but when you cannot measure it, when you cannot express it in numbers, your knowledge is of a meagre and unsatisfactory kind. It may be the beginning of knowledge, but you have scarcely, in your thoughts advanced to the stage of science”. This sentence was pronounced at the end of the nineteen century by William Thomson (better known as Lord Kelvin), the famous Irish mathematician responsible for the formulation of the first and the second law of thermodynamics. Kelvin’s celebrated sentence was echoed, a century later, by the following aphorism attributed to Peter Drucker, the Austrian-American economist who is considered the father of the management science: “If you cannot measure it, you cannot manage it”. The previous statements are particularly true when referring to an elusive issue such as inequality and, more specifically, economic inequality: we cannot express any value judgement on it if we do not discuss preliminarily the issue of its measurement. For this reason, Chap. 3 will be devoted to describe how we can measure inequality in the most objective way. Indeed, in the last century this topic has attracted the interest of many statisticians who suggested various indices of inequality whose rationale will be reviewed in this chapter. As we said already, this essay has the ambition of funding its conclusions on empirically justified elements. For this reason, apart from

1 Introduction

3

some theoretical considerations on the nature of inequality indices, the third chapter will also present a snapshot of the current situation of the inequality in the wealth distribution in the different countries and of its most recent trends around the world. The aim is to provide the readers with an objective picture of the current situation at a worldwide level, to give them the elements to build their own opinion on the subject and to understand the discussion which will be reported in the following chapters. Economic growth is the second fascinating topic that we will discuss in this book. Its analysis has engaged for decades economists in the search for possible explanations of the big differentials that are observed around the world. Why some countries in the world experience an economic growth so much sharper than others? And what can be done to foster growth? And what can be done when, conversely, an economic system experiences slow growth or even economic recession? In one sense the job of an economist consists primarily in suggesting to the various governments what actions should be undertaken to contrast recession and stimulate growth, a task that appears to be particularly pressing when this book is printed and when, as a consequence of the Covid-19 pandemics and of the geo-political instability, all countries in the world are facing a dramatic situation also in terms of welfare and economic conditions. The Noble graduate Robert Lucas expressed this vividly when, commenting on the big questions posed by the observed economic growth differentials he said: “The consequences for human welfare involved in questions like these are simply staggering: Once one starts to think about them, it is hard to think about anything else”. It is for this reason that Chap. 4 will be devoted to discuss this issue. Similarly to what was done in Chap. 3, also in this case the presentation will start from some economic-theoretical considerations that are at the basis of the various theories formulated by economists to explain the large differentials in economic growth observed worldwide. It will then move to present a set of empirical data to describe the status, the recent trends and the forecast of economic growth around the world. The core of this essay will be then tackled in Chap. 5 which will be devoted to discussing the complex relationships between economic inequality and economic growth. Here we will report many different economic theories which have been used by the different governments around the world to drive redistributional policies aiming at accelerating the growth of the economic systems. Even if none of the theories presented succeeds to fully explain uniquely and convincingly the direction and the strength of this relationship, nonetheless there are important lessons that we can learn from them. The chapter concludes with the presentation of some empirical evidence about the relationship observed in the various countries in the new millennium. The observed patterns show a circularity of the relationship, pointing out the different result we obtain when we use economic inequality to forecast the growth of one country and when, conversely, we use the stage of development of one country to explain its internal level of economic inequality. Going back to the ideas contained in Rousseau’s in his Discourse on the Origin and Basis of Inequality Among Men, Chap. 6 will be devoted to discussing the distinction that can be drawn between natural inequalities and social inequality leading to the important definition of inequality of opportunities. Here we will show that any

4

1 Introduction

study on the effects of inequality should preliminarily distinguish between these two sources of inequality because their effects on economic growth are rather different and push the economic systems in two different directions. We will also point out the difficulties which are still associated with measuring in an objective way the two components of inequality and, as a consequence, with a correct quantification of the inequality of opportunities. We all know that the recent Sars-Cov-2 pandemic, which was suffered worldwide starting from the first years of the twenties of the new millennium, represented a watershed in all fields of human activity and the study of inequality and growth is not an exception to this rule. Indeed, the shocking effects of the health emergency on the economy were devastating with a general sharp increase of inequality and a worrying slowdown in economic growth observed with few exceptions all over the world. At the time this book is delivered to the press, we are still in the middle of the storm generated by the health emergency. However, even if it is certainly too early for any conclusive considerations, Chap. 7 will nonetheless be devoted to briefly discuss the impact of this shocking event on the subject matter discussed in this essay. Finally, Chap. 8 conclude with some summary considerations.

Chapter 2

Inequalities and Economic Inequality

Given the ethical and political implications of the subject we are discussing in this essay, I deem it useful to introduce it starting from the theory, presented more than 20 years ago by the Italian philosopher Norberto Bobbio (1996), on the distinction between right-wing and left-wing. Based on the paradigmatic (and diametrically opposed) ideas of Jean Jacques Rousseau and Friedrich Nietzsche, the philosopher maintains that the various current political inclinations can be explained in terms of the different position they assume on the concept of inequality. Even in a period when the distinction between right and left wings is weakening and blurring in all political systems, these two positions still emerge in the scientific journals and in many political debates (see e.g. Stiglitz, 2012; Mankiw, 2013). In what follows I will do my best to summarize the basic ideas of Bobbio. Following Rousseau’s ideas (1775) Bobbio distinguishes between “natural” inequality and “social” inequality. The former relates to characteristics naturally possessed by each individual (such as height, weight, intelligence) and are inequalities that cannot be eliminated, increased or reduced in any way. The latter concern characteristics acquired by the individual (such as economic conditions, access to political institutions, justice or certain public services) and these can be indeed modified through political interventions. Speaking in terms of social inequality, Jean Jacques Rousseau (1775) argues that all men are equal at the beginning, and it is only the society that replaces the “natural state” of the ancients where all individuals are the same, transforming them and making them different. Friedrich Nietzsche believes exactly the opposite: all men are different in nature and it is only the Society that convinces them that they should be equal through what he calls the religion of compassion. In his famous essay “Also spracht Zaratusta” (Thus spoke Zaratusta; see Nietzsche, 1883–1885) he states: . And in the essay “Beyond Good and Evil” (Nietzsche, 1885): . © The Author(s), under exclusive license to Springer Nature Switzerland AG 2023 G. Arbia, Income Inequality, Redistribution and Economic Growth, SpringerBriefs in Economics, https://doi.org/10.1007/978-3-031-24851-1_2

5

6

2 Inequalities and Economic Inequality

In these two ideas is contained, according to Bobbio (1996), the essence of right and left thinking. Following Rousseau’s ideas, a supporter of the left wing in politics should, therefore, favour those choices and policy measures that encourage the reduction of disparities among individuals tending to reconstruct the original “natural state” in which all individuals have equal access to the goods of the earth. On the contrary, a follower of right-wing thinking should conceive politics as the set of rules aimed at encouraging the free initiatives of all individuals (who are substantially different in skills and abilities) even if they produce a greater inequality. The distinction introduced by Bobbio between right and left clearly echoes in an economic context. This is certainly not the place for an exhaustive discussion of the topic, but for the benefit of those who are reading this essay without a specific technical background, I wish to present two extreme positions that historically (rightly or wrongly) may be considered paradigmatic of two opposite arguments. The subject specialists will forgive me for the excessive simplification that I deem necessary. Following the distinction between right and left wings proposed by Bobbio, on one hand, we find the socialist idea which, in delegitimizing every foundation to the right of property, excludes the possibility of accumulating wealth beyond what is due to all individuals and beyond what it is admissible on the basis of the principle of equality. It is still Rousseau (1775) who helps us to clarify this concept: . This thought is often associated with a famous essay by the anarchist political philosopher Pierre-Joseph Proudhon, (Proudhon, 1840) who owes much of his notoriety to the popular aphorism, contained therein: “property is a theft”. Indeed, Proudhon’s thought is much more articulated than the synthetic formula that made him known to most (even through a famous movie by the italian director Elio Petri, entitled “Property is no loger a theft”, 1973) in that, elsewhere, he makes it clear that property only becomes condemnable when it is realized through the exercise of the power of man over man. As it is explained, for example, by the columnist Sergio Romano (Romano, 2012). Whether or not the origin of this position can be correctly attributed to Proudhon, on the one hand we therefore have a philosophy (from which it derives also a school of thoughts in economics) which states that all men are equal with respect to the fruits of the earth and to their distribution and the purpose of public intervention would therefore be to

2 Inequalities and Economic Inequality

7

smooth out the differences generated by injustice, by the law of the strongest and by human greed. At the other end of this ideal line, which connects the rightmost point of economic thinking with the leftmost, opposed to socialist thinking we can place the liberal thought. Looking again at the paradigmatic example to present the topic in the simplest possible way, this line of thought can be associated with the contribution of the Scottish economist Adam Smith: the first of the so-called classical economists. In the fifth book of his work “An inquiry into the nature and causes of the Wealth of Nations” (Smith, 1776), starting from a mercantilist position, the economist studied what are the forces that determine the wealth of the nations, and suggests what are the most appropriate economic policies and interventions of the State to promote economic growth. Even Adam Smith, like Proudhon, is known to the larger audience for a synthetic sentence about the so-called “Invisible Hand”, through which, in a free market, the pursuit of individual interest would always benefit the common interest. Indeed, the metaphor, often quoted, has an emblematic meaning and a value which is much more limited than the one that (perhaps instrumentally) some people consider. We find it expressed in a sentence in which the economist, countering the tendency to advocate the superiority of the closed economies supported by the mercantilists of the time, states: (Smith, 1776). This metaphor is still often cited in political debates in its most restrictive sense, despite the economists have clarified that an ordering principle (such as the one enunciated by Smith) would achieve the effects described only in the presence of two conditions that are never realized in practice: (i) perfect knowledge of all economic operators about market information (a condition that economists call absence of information asymmetries), and (ii) a situation of perfect competition in which the price is set solely by the matching of supply and demand. In the presence of an invisible hand that transforms individual egoistic efforts into benefits for the whole community, differences in income among the various economic agents should not necessarily be seen as a negative aspect to be mitigated through public intervention, because the creation of differentials of income would still benefit everyone. Mankiw (2013) illustrates very well this position through a suggestive example. Imagine a society characterized by perfect equality where everyone is happy with their role and their income level without any envy towards the others. The government provides public goods (defense, justice, etc.), but has no need to redistribute income among citizens by levying taxes with a progressive criterion: society is perfectly fair and also efficient. This society described by Mankiw is very similar to the island of Utopia of Saint Thomas More (1516) where everything is produced only for consumption and not for the market. Then one day the calm of this egalitarian Utopia is perturbed by the appearance on the scene of a Steve Jobs who introduces an innovative tool like an iPOD or a J. K. Rowling that conquers the public with the adventures of Harry Potter or even by a Steven Spielberg who produces a movie.

8

2 Inequalities and Economic Inequality

When an entrepreneur produces something so innovative, everyone wants to buy the new product, and this creates a pronounced income inequality between the citizen and the innovator. In fact, although the transaction represents a voluntary exchange that makes both buyers and sellers more satisfied (since there is only one producer and many individuals willing to buy his/her product), the distribution of income will quickly become very unequal with the entrepreneur significantly richer than all the others. In this new economic structure the problem would immediately arise if public policy should remain the same as before (since the state of things was initially accepted by everyone and now they are all happier than before), or, alternatively, if political agents should deplore inequality that has been created and put in place its power to go back to the original equality. It is evident from the chosen example what is the answer of Mankiw. It would not make sense for a State to make a redistributive intervention since everybody now is much happier. Therefore, following this second approach, economic policy would have the sole purpose of freeing the market from all impediments and leaving the individuals the freedom to fully develop their own creativity and entrepreneurial skills for the benefit of all. So in this representation, which someone, not mistakenly, could judge excessive and certainly only useful for illustrative purposes, along an hypothetical line of public intervention in economics, we can imagine on the one hand an extreme right-wing position that states the absolute non-necessity of a public redistributive intervention and, on the other hand, an extreme leftist position that considers such public intervention to be absolutely necessary in order to smooth out the differences to lead the society to a perfect egalitarianism. It is necessary to reassure the reader at this point that it is not necessary that she/he takes any position between these two extreme situations (and on all the infinite tones of gray that can be defined between one and the other) to continue going through the present essay. In fact, our aim is to analyze the relationships between inequality and economic growth and whether it is possible to explain the evolution of one on the basis of the other. The aim is also to analyze if there are reasons for redistributive movements of an egalitarian type regardless of the associated ethical and philosophical issues and based merely on issues of a greater efficiency of the economic systems for the benefit of the whole community. This is the purpose that we want to pursue in the next chapters.

References Bobbio, N. (1996). Left and right the significance of a political distinction (A. Cameron, Translated and introduced). Roma: The University of Chicago Press. Translation of the Italian version, Destra e sinistra, Donzelli Editore, 1994. Mankiw, N. G. (2013). Defending the one percent. Journal of Economic Perspectives, 27(3), 21–34. More, T. (1516) Utopia, Reprinted in More: Utopia. Cambridge University Press, 1995. Nietzsche, F. (1883–1885). Also spracht Zarathustra [English translation “Thus Spoke Zarathustra”]. Jiahu Books, 2013.

References

9

Nietzsche, F. (1885). Jenseits von Gut und Böse. [English translation “Beyond Good and Evil”]. Jiahu Books, 2013. Proudhon, P.-J. (1840) Q’est-ce que la propriété ? ou Recherche sur le principe du Droit et du Government [English translation, Proudhon: What is Property? D. R. Kelley, D. R. Kelley, & B. G. Smith, Eds.]. Cambridge: Cambridge University Press, 1994. Romano, S. (2012) on Corriere della sera, 22 gennaio 2012, 35 Rousseau, J.-J. (1775). Discours sur l’origine de l’inégalité parmi les hommes, English edition “Discourse on inequality” (2009) [F. Philp, Trans.]. Oxford World’s Classic. Smith, A. (1776). The wealth of nations: A translation into modern english. Industrial Systems Research, 2015. ISBN 978–0906321706. Stiglitz, J. (2012). The price of inequality: how today’s divides society endangers our future. W. W. Newton and Company.

Chapter 3

Economic Inequality

3.1 Measuring Inequality Having clarified in the first chapter what are the limits and the range of interest of the present essay, in this second chapter we will analyse economic inequality with a specific focus on income inequality among economic agents or among different countries. It should also be clarified right at the beginning that, more generally, we should consider inequality in the distribution of global wealth thus including in the accountability also individual’s assets. However, mainly because of problems related to the collection of reliable data, the literature traditionally focused mainly on income inequality and on its relationship to economic growth. Coherently with the dominant literature we will also follow the same approach. “If you can’t measure it, you can’t improve it” said Lord Kelvin (), echoed more recently by Peter Drucker who stated “If you can’t measure it, you can’t manage it”. In our case, since we want to base our conclusions on empirically grounded facts, first of all we have to deal with the issue of measuring income inequality in the most possible objective way. Economic inequality is an intuitive concept, but at the same time very complex, the measure of which involves a series of difficulties, well known in the economic and statistical literature, to which over the decades a great number of researchers have proposed solutions. In fact, the phenomenon of inequality is not directly observable as it happens with other economic variables such as, for example, income, employment or price levels, which are quantities that, irrespective of an inevitable statistical error, can be measured without ambiguity. Therefore, to move from a theoretical treatment of the concept of “income inequality” to its “statistical” version, it is necessary to define its content in advance and then to build up measures and indicators that can help to grasp its essence in an objective way (internationally accepted to allow crosscountry comparisons) and to describe its temporal dynamics. Intuitively, a measure of inequality reaches its minimum in the case of a perfect equitable distribution of resources when, each individual is endowed with exactly the same amount of income. On the other hand, an intuitive inequality measure should reach its maximum © The Author(s), under exclusive license to Springer Nature Switzerland AG 2023 G. Arbia, Income Inequality, Redistribution and Economic Growth, SpringerBriefs in Economics, https://doi.org/10.1007/978-3-031-24851-1_3

11

12

3 Economic Inequality

when only one individual holds the full amount of disposable income and all others individuals have no income. However, from this intuitive definition it does not follow automatically a specific measure to objectively describe the intermediate cases that are observed in practice. A fundamental contribution to clarify this topic was provided by the Indian economist Amartya Kumar Sen awarded the Nobel Prize for Economics in 1998 for his contributions to the study of the complex relationship between economics and ethics and in particular for the results achieved in the analysis of social choices, in the distribution of well-being between individuals and in the study of poverty. In his essay entitled “On Economic Inequality” (Sen, 1972), the economist distinguishes between “objective” and “normative” measures. The former has the sole purpose of describing the phenomenon, whereas the latter express an ethical judgment and, as a consequence, not necessarily the maximum of distributional equity is achieved when all individuals are endowed with exactly the same amount of income. As a consequence, in this second case, a statistical measure of inequality should not measure an absolute quantity, but should only indicate how much the observed distribution of income is far from an “ideally” desired situation made explicit through a “social welfare function” defined by Bergson and Samuelson as “any order of the set of alternative social states” (Bergson, 1938, Samuelson, 1947). In dealing with measures of inequality, Sen summarizes the many contributions that may be found in the literature and suggests that a good measure of income inequality should satisfy at least four properties namely: (i) anonymity, (ii) invariance, (iii) sensitivity and (iv) a fourth condition that he called the Pigou - Dalton condition (after Pigou, 1912 and Dalton, 1920). The property of anonymity is a minimum condition of coherence which prescribes that a reliable measure of inequality should not be influenced by the name of the income earner and therefore must remain constant if two individuals exchange their own income. The second property, that of invariance, is again a condition of logical coherence which requires that a good indicator of income inequality should not be changed by changing the unit of measurement in which it is calculated. In other words, should income be doubled to all income earners, the inequality index should remain the same. The third property, called sensitivity, prescribes that the inequality measures must be more sensitive to transfers occurring between lower income than to those occurring between higher income. In other words, a transfer of 1 euro from the richest to the second richest individual must have a lower impact on the measure of inequality than the one produced by a transfer of 1 euro from the second poorest individual to the poorest. Finally, the fourth property (Pigou-Dalton condition) prescribes that any transfer from a richer individual to a poorer individual, all other conditions remaining constant, must always produce a decrease in the overall inequality (Sen, 1992). The statistical literature contains several measures which satisfy some of the aforementioned properties. The large number of alternatives proposed is justified by the fact that, however, no measure satisfies them all. Among the objective measures, a first alternative, simple but rather inaccurate, is represented by the difference (or the ratio) between the income of the richest and the income of the poorer. As said, this is rather a rough measure which satisfies only

3.1 Measuring Inequality

13

anonymity, but not the other properties. An extension of this measure, which is also useful for descriptive purposes, is represented by the simple calculation of the ratio between the income held by the 10% of the richest individuals and the income held by the 10% of the poorest individuals. A further objective measure, rather popular in the economic literature, is the one suggested by Theil (1954) based on Shannon’s idea of information entropy (Shannon, 1948) which in turn derived from the second law of thermodynamics. It is based on the comparison between the maximum entropy (i. e. the degree of disorder of a system) and the entropy actually observed. In our case the highest degree of disorder of a system is reached when a single individual holds all the income and therefore Theil’s index can be interpreted as a relative measure of inequality. Despite the existence of a large number of alternative indices, the most popular indicator, considered the gold standard in many official statistics to represent the phenomenon, is the one suggested by the Italian statistician Corrado Gini (Gini, 1912), and subsequently analyzed by Ricci (1916) and by Dalton (1920) among the many others. There are many alternative ways of defining the Gini coefficient; the most intuitive is the following. Compare the income of individuals in a population by taking all pairwise differences in absolute value. Half of the average of these differences (divided by the average income so asto normalize the index between 0 and 1) represents the Gini index. It is again Amartya Sen who comes to help us by providing an intuitive and suggestive interpretation: (Sen, 1972). The Gini coefficient satisfies the anonymity and the invariance property as well as the Pigou-Dalton condition. On the other hand, as far as sensitivity is concerned, it has the distinctive feature of being sensitive only to the relative position of the various individuals in the income ranking (and therefore to income transfers between them) and not to the absolute value of their income. In other words, the index is only sensitive to changes in the different relative position of individuals in the ranking and not to their absolute ranking. However, this feature has not been considered a big limitation in the use of the measure which, over the decades, was established as the standard measurement adopted in official statistical surveys such as those run by the World Bank, by the Organization for Economic Cooperation and Development (OECD) as well as by many other national and supernational (e.g. Eurostat) statistical institutes. As said, in addition to the aforementioned properties, the Gini index satisfies the further property of varying between 0 to 1, assuming a value equal to 0 in the case of perfect equity of income distribution and a value equal to 1 in the case of maximum inequality when we have only one individual in the economy that earns all available income. Before proceeding to an examination of the dynamics of inequality indices around the world, it is useful to recall here, for completeness, some of the normative measures

14

3 Economic Inequality

of inequality. The first, proposed by Dalton (1920), is defined as the relationship between the actual and the desired distribution of income expressed in terms of an explicit social welfare function. A second measure is based, instead, on the idea of equitable distributed equivalent income defined by Champernowne (1952) as the or, as expressed alternatively from Atkinson (1970), . Again, the measure suggested by Atkinson, like the one proposed by Dalton, is based on a comparison between the current and the desired situation through a properly defined social well-being function.

3.2 State and Evolution of Personal Income Inequality To provide a picture of the different patterns of income inequality observed around the world, in this section we will report some results related to the calculation of the Gini index in various countries. Starting with the analysis of the OECD countries for which we avail more reliable official income statistics, Fig. 3.1 shows the level of income inequality in 2018,1 while Fig. 3.2 displays the historical trend in the period ranging from 2000 to 2018. As it is appears from the inspection of Fig. 3.1, income inequality varies a lot among the OECD countries, the lower values being recorded in Slovakia, Czech Republic, Slovenia and Island (below 0.25) and the higher in Mexico, Chile and Costa Rica (above 0.40), followed by Turkey and the United States (just below 0.40). In reading this data, we have to remember that the Gini index varies between 0 and 1. As it can be seen from Fig. 3.2, the OECD countries experienced very different levels and dynamics in the observed period. Some countries, like Colombia, Chile and Mexico, starting from remarkably high levels of the Gini index (around 0.5) experienced a decline in inequality. A similar trend is observed by the Slovak Republic that, starting from around 0.30 in year 2000, now displays the lower value of the index (0.23). In order to better visualize the inequality dynamics, an OECD study (OECD, 2014) focused on increasing inequality over the last 30 years and studied the trends of Gini index between 2007 and 2014 in the OECD countries. The data reported in Fig. 3.3 show that in the period considered, for most of the countries there was an increase in inequality and only 5 countries (Iceland, the Netherlands, Portugal, Latvia and UK) experienced a decrease in the same period. With the aim of extending the study of income inequality to a larger set of countries beyond the OECD member states, we can consider a different dataset provided by the World Bank. However, the reader should keep in mind that the data needed for the calculation of the Gini index are sometimes very difficult to collect, especially in poorer and statistically less advanced societies. Furthermore, the data used to 1

This is the latest year for which we avail data for all OECD countries.

3.2 State and Evolution of Personal Income Inequality

15

Fig. 3.1 Gini’s income inequality index in the OECD countries. Latest year available (2016–2018). Source OECD https://data.oecd.org/inequality/income-inequality.htm

Fig. 3.2 Recent trends of the Gini income inequality index in the OECD countries. 2000–2019. Source OECD https://data.oecd.org/inequality/income-inequality.htm

16

3 Economic Inequality

Fig. 3.3 Variation of the Gini Index (2007–2014/2015) in OECD countries. Source https://www. oecd.org/social/OECD2016-Income-Inequality-Update.pdf

calculate the index are not of the same quality in the different countries due to the different incidence of the phenomenon of tax evasion. For this reason, the conclusions reported here must necessarily be interpreted with a greater caution. In what follows, for the sake of succinctness, we will limit ourselves, to analyse the level of income inequality in the ten countries characterized by the greater inequality and in those characterized by the lower inequality. Table 3.1 shows that at the lowest scale we find (together with the aforementioned Slovenia, Czech Republic and Slovakia observed in the OECD study, see Fig. 3.1) also countries like Belarus, Moldova, Ukraine, United Arab Emirates, Norway, Belgium, and Finland. All of them display values of the Gini coefficient ranging between 0.24 and 0.27. On the contrary, at the highest levels of inequality (with values of the Gini index of about 0.5) we find some south American and African countries, which are areas notoriously often characterized by strong socio-political tensions. Table 3.1 Ranking of the ten countries characterized by the lower and, respectively, higher values of the Gini income inequality index. (Latest year available, 2014–2018). Source https://data.worldb ank.org/indicator/SI.POV.GINI?end=2017&start=1986 Top 10 lower income inequality countries

Top 10 higher income inequality countries

Slovenia

0.24

Dominican Republic

0.43

Czech Republic

0.25

Ecuador

0.45

Slovak Republic

0.25

Mexico

0.45

Belarus

0.25

Paraguay

0.46

Moldova

0.25

Costa Rica

0.48

United Arab Emirates

0.26

Honduras

0.48

Ukraine

0.26

Panama

0.49

Belgium

0.27

Colombia

0.50

Finland

0.27

Angola

0.51

Norway

0.27

Brazil

0.53

3.2 State and Evolution of Personal Income Inequality

17

The analysis shows a clear division of the world between countries characterized by a relatively low income inequality (located essentially in Europe) and countries in the south of the world, which are, on the contrary, characterized by very high disparities in the level of income. This feature appears even more clearly by looking at the map reported in Fig. 3.4 based on different range of time. The aforementioned lower reliability of statistics on inequality in poorer countries probably makes this distinction appear even less marked than it is in reality. Since in this essay we are interested in the links between income inequality and economic growth, in order to anticipate some of the discussion of in this chapter, we conclude this chapter turning our attention to the level of income inequality in a set of countries that recently experienced a rapid economic growth. We will limit ourselves, in particular, to those countries referred in the literature with the acronyms BRICS (Brazil, Russia, India, China and South Africa) and MINT (Mexico, Indonesia, Nigeria and Turkey) a classification that was introduced in the literature by the Goldman Sachs (2007) and by the company Fidelity (O’Neil, 2001; Fraser, 2011). The data reported in Table 3.2 show extremely high levels of the Gini index in Brazil, Mexico and South Africa, while China, India, Indonesia, Nigeria and Russia show lower values that are comparable with the highest values observed in the OECD countries.

Fig. 3.4 World inequality. Source https://data.worldbank.org/indicator/SI.POV.GINI?view=map

18 Table. 3.2 Gini Index in BRICS and MINT countries. Source World Bank. Different years based on the latest year available. https://data.worldb ank.org/indicator/SI.POV. GINI?end=2017&start=1986

3 Economic Inequality B R I C S

Brazil Russia India China South Africa

53,4 (2019) 37,5 (2018) 35,7 (2011) 38,5 (2016) 63 (2014)

M I N T

Mexico Indonesia Nigeria Turkey

45,4 (2018) 38,2 (2019) 35,1 (2018) 41,9 (2019)

3.3 Geographical Inequality There is another aspect of inequality to which it is worth devoting our attention in order to have a more complete picture of the state of economic inequality. It concerns the differences that exist between different countries in the world rather than between individuals in the same country. In fact, it is precisely at this level that the greatest disparities are observed with most of the world’s wealth concentrated only in a few countries, and a marked division between the north and the south of the globe. This is a well-known aspect whose denunciation is at the center of the activity of the major world organizations (such as the United Nations Organization and the World Bank) and of cooperation programs. The World Bank, in particular, has devoted to the problem a specific program called “Poverty and inequality”2 which deals with the study of inequality with a particular concern on transition economies, to regional inequalities within the various countries and to the state of global inequality. Attention to the great disparities in the distribution of income and wealth of the planet also plays a central role in the concerns of the Catholic Church and, in particular, of the papacy of Pope Francis. In one of the latest encyclicals, “Laudato si”, we read: (Pope Francis, 2015, n. 82).3 And again, in a next step, (Pope Francis, 2015, n. 90). 2

https://www.worldbank.org/en/research/brief/poverty-inequality. http://www.vatican.va/content/dam/francesco/pdf/encyclicals/documents/papa-francesco_201 50524_enciclica-laudato-si_en.pdf. 3

References

19

Pope Francis’ concerns are more than motivated by empirical data. With the necessary precautions, a measure of inequality between countries of the world can still be calculated using a Gini type index as we did in the previous section dealing with inequality between individuals (on issues related to the methodology see, e. g., Arbia, 1989). In fact, if we imagine each country as if it were a single individual to whom the average per capita income of the country itself is assigned, we can proceed as for the traditional Gini measure, illustrated in the previous Sect. 2.1, by comparing two to two the per capita income of all countries and recording the absolute differences in these incomes. If we proceed in this direction, the data from the World Bank tell us that the gap between rich and poor countries has also followed the same expansion trend that we have observed within individual countries. Considering, in fact, about 200 countries included in the World Bank archive, the Gini index went from 0.77 in 2000 to 0.81 in 2019. In this virtual representation, in which each country represents an individual, the three richest countries in the year 2000 in terms of per capita income (Principality of Monaco, Liechtenstein and Bermuda) held 11.4% of global income while the 8 richest countries owned 22%. These percentages, already very high, rose respectively to 12% in 2000 (relating to the same three countries) and to 23% in 2019 (our elaboration on World Bank data).4 To further highlight this aspect, we can consider the ratio between the per capita income of the richest country and that of the poorest country. This ratio was 661 in 2000 when a citizen of the Principality of Monaco had an average income 661 times higher than that of a Somali citizen. This ratio rose to 711 in 2019 when the average income in the Principality of Monaco was 711 times higher than the one received in the poorest country (Burundi). If we look at total income instead of per capita, the data is even more evident and impressive. In fact, in 2019 (the last year for which the World Bank publishes reliable data for most countries) about half of all world income (50.3%) was concentrated in the hands of citizens of only 3 countries: 31.6% in the United States, 12.9% in Japan and 5.8% in Germany. In the same year a little less than three quarters of world income (73%) remained concentrated among individuals from only 10 countries (United Kingdom, France, China, Italy, Canada, Mexico and Brazil, plus the above). This evidence is even more shocking if we consider that only 7.8% of the world population resides in the first three countries (respectively 4.5% in the United States, 2% in Japan and 1.3% in Germany) and this percentage stops at 36% when considering the ten richest countries.

References Arbia, G. (1989). Diseguaglianze territoriali. Rassegna Economica, Banco Di Napoli, 3, 569–595. Atkinson, A. B. (1970). On the measurement of inequality. Journal of Economic Theory, 2. 4

http://api.worldbank.org/v2/en/indicator/SP.POP.TOTL?downloadformat=excel.

20

3 Economic Inequality

Bergson, A. (1938). A Reformulation of Certain Aspects of Welfare Economics. Quarterly Journal of Economics, 52(2), 310–334 Champernowne, D. (1952) The Graduation of Income Distribution. Econometrics, 20, 591–614 Dalton, H. (1920). The measurement of inequality of incomes. Economic Journal, 30. Fraser, I. (2011). Fidelity is confident its MINTs won’t suck. In Bloomsbury Information QFINANCE. Gini, C. (1912). Variabilità e mutabilità, Tipografia di Paolo Cuppin, Bologna. Goldman Sachs (2007). BRICS and Beyond, Goldman Sachs Study on BRIC and N11 Nations, November, 23 OECD (2014). Focus on Inequality and Growth, December. O’Neill, J. (2001). Building better global economic BRICs. Global Economics Paper No: 66. Goldman Sachs. Pigou, A. C. (1912). Wealth and welfare. Macmillan. Pope Francis (2015). Praise be to you—Laudato Si’: On care for our common home (Encyclical Letter). San Francisco: Ignacious Press. Ricci, U. (1916). L’indice di variabilità e le curve dei redditi. Roma. Samuelson, P. (1947). Foundations of economic analysis. Harvard University Press. Sen, A. K. (1972). On economic inequality. Oxford University Press. Sen, A. K. (1992). Inequality re-examined. Oxford University Press. Shannon, C. E. (1948). A mathematical theory of communication. Bell System Technical Journal, 27, 379–423. Theil, H. (1954). Economics and information theory. North-Holland.

Chapter 4

Economic Growth

4.1 Theories of Economic Growth In this chapter we will analyze the second important element of our discussion related to the growth of well-being and income. Studies and theories to explain the economic growth of various countries have always been central to the development of economic thought since the aforementioned text by Adam Smith (1776) entitled “On the nature and causes of the wealth of nations”. The 1995 Nobel Prize in Economics, Robert E. Lucas, in commenting on the data relating to the uneven growth recorded in various countries of the world, expresses himself in the following way: < I do not see how one can look at figures like these without seeing them as representing possibilities. Is there some action a government of India could take that would lead the Indian economy to grow like Indonesia’s or Egypt’s? If so, what, exactly? If not, what is it about the’ nature of India’ that makes it so? The consequences for human welfare involved in questions like these are simply staggering: Once one starts to think about them, it is hard to think about anything else. > (Lucas, 1988). Anyone with any interest in economic studies can only agree with Lucas! Despite the long tradition of economic literature, studies relating to the economic growth of nations, however, have only come back to the fore in recent years in an attempt to explain the slowdown and stagnation experienced in this new millennium by many of the more developed countries. Indeed, a certain interest in the so-called “growth theory” seems to come back cyclically through the history of economic thought. In this sense, we can identify three moments of time when economists have dealt more intensely with this problem under the pressure of compelling questions that gradually emerged in the analysis of contingent problems. The first period can be placed between the end of the fifties and the beginning of the sixties, a period when, during the economic boom recorded in many European countries and in the United States following the end of the Second World War, researchers were questioning on the reasons for this growth and on what were the conditions and the economic policy measures that could favor its persistence in the long run. The second moment occurs about 30 years later, between © The Author(s), under exclusive license to Springer Nature Switzerland AG 2023 G. Arbia, Income Inequality, Redistribution and Economic Growth, SpringerBriefs in Economics, https://doi.org/10.1007/978-3-031-24851-1_4

21

22

4 Economic Growth

the 1980s and 1990s, when the major Western economies began their deceleration and the theories that had hitherto been able to explain their economic growth began to be judged unsatisfactory and (above all) not supported by empirical data. Finally, after another thirty years, the third period is the one we are currently experiencing in which, for the first time after World War II, the major economies experience extremely modest growth rates and, in some cases, even a decrease and economists are called to provide new interpretative models and to suggest economic policy strategies to prevent a decline that appears inevitable in many countries. In extreme synthesis, all the theories that over the past decades have tried to explain the economic growth of a country, are based on a mechanism that links the quantity of production to the factors that contribute to its realization. This mechanism is often formalized in a mathematical function called the “production function”. Among these formalization, the most popular is the function introduced by Cobb and Douglas (1928). In its simplest formulation, a production function expresses the production realized in a given moment of time as a function of the productive factor labor (expressed by the number of workers employed, but also by their ability and specialization reflecting the so-called human capital), of the material capital available (the capital factor) and of the technological progress incorporated in the production process. In a pre-industrial economy, the fundamental factor of production was represented by the land and the natural resources of the country and by the work available for their exploitation. As economies evolved from a rural to an industrial structure, the accumulation of capital achieved through fixed investments financed by savings, has increasingly assumed a fundamental role in explaining the economic growth of a country. In these more advanced economies, the presence of skilled workers represents an equally important contribution to economic growth. In this sense, a country can increase its productivity by investing not only in fixed capital (that is machinery, industrial buildings, and so on), but also in the so-called human capital by increasing the expenditure devoted to education, professional training and to the training of specialized personnel. It should be noted that, while investments in material capital are mostly made by the private investor, investments in human capital are usually mainly left to the interventions of the public sector. Finally, a fundamental and growing role in explaining the level of production of a single company and of an entire country, is represented by the so-called technical progress. In his study carried out immediately after the Second World War, Robert Solow proved that the growth in the hourly production which was observed in that period, depended almost exclusively on technological progress (see Solow, 1957). In a later work, Mankiw, Romer and Weil argued that the production function is characterized by equal shares by three elements: Physical capital, human capital and the unskilled labor factor, with one third assigned respectively to each of them (Mankiw et al., 1992). It is evident how a high rate of savings in a country leads to a high rate of investment, which translates into a large amount of fixed capital and, in this way, into a high production. In the same way, a high investment in human capital leads to increasing the potential of a country thus ensuring its economic growth. In contrast with what happened to land and natural resources in the past, however, both physical capital and human

4.1 Theories of Economic Growth

23

capital be accumulated indefinitely thus can representing an inexhaustible source of economic growth (Barro & Lee, 1993). As mentioned already in the previous section, a first period in which the new theories of growth were developed occured in the late 1950s when countless scholars began to deal with the subject following the innovative ideas developed by the aforementioned American economist Robert Solow (1956) and by the Australian scholar Trevor Swan (1956). These studies earned Solow the Nobel Prize in 1987. This intense phase of studies led to the elaboration of what we now refer to as the neoclassical theory of growth. Solow and Swan’s contribution starts from a model previously independently developed by Roy F. Harrod (1939) and Evsey Domar (1946) and from the innovative ideas of Nicholas Kaldor (1954). It falls within the so-called theories of exogenous growth which believe that growth depends on factors that are determined externally to the economic system (therefore called exogenous) such as, for example, the rate of population growth and the technical progress. The conclusions reached by the Solow—Swan neoclassical theory of growth are that a country’s production growth does not depend on the saving rate of the country itself. Consequently, if two countries have the same population growth rate, the same saving rate and the same production model (incorporated into a specific production function), they will, in the long run, reach the same income level. The second period of popularity of growth theories can be temporally placed between the end of the eighties and the beginning of the nineties when many economists started to consider the neoclassical theories of growth obsolete, unsatisfactory from a theoretical point of view, but, above all, unable to explain the data observed empirically. From a theoretical point of view, indeed, the neoclassical system, affirming that growth depends on technical progress (exogenously determined), is not able to explain what are the factors that contribute to its determination. More realistic, alternative theories started to arise in the late 1980s aiming at explaining the large differentials observed in the growth dynamics in different countries. In contrast with the exogenous growth theories, these new theories started from the fundamental seminal contributions of Paul Romer (1986) and Robert Lucas (1988), and affirm that technological progress, and therefore growth, are not determined by factors that are external to the economy, but, on the contrary, it depends on forces which are generated within the system itself such as the savings rate with particular emphasis on those that are set aside in order to finance investments in human capital. These theories are now known in the literature as the theories of endogenous growth in which growth can therefore be self-sustaining. Thus, in opposition to the theory of exogenous growth in this new interpretative scheme, production can grow indefinitely. The problems related to economic growth have come back to the fore in recent years when all the top economies of the World are experiencing a strong slowdown in growth and in some cases even a reduction (even in the presence of high technological progress) that cannot be explained with the pre-existing theories. At the same time, we wonder what are the factors that have determined the rapid economic growth observed in some countries outside the traditional G7 model. In this sense, some

24

4 Economic Growth

Fig. 4.1 The 10 largest world economies at market exchange rates in 2014 and 2050 according to the forecasts of the Economist Intelligence Unit (Nominal Gross Domestic Product of each country expressed in billions of US dollars)

groups of countries, variously identified through imaginative formulas and acronyms, have attracted the attention of the major economic observers for their high growth rates and for the structural conditions that could bring them, in the short term of a few decades, to obscure the main economic powers. In particular, the economist of the investment bank Goldman Sachs, Jim O’Neil in 2001 drew the specialists’ interest on the four countries that he refers to as the BRIC group (a term coined using the initials of Brazil, Russia, India and China and then changed to BRICS to also include South Africa. See O’Neil, 2001). Subsequently, the financial multinational Fidelity identified a second group of accelerated developing countries, called the group of MINT (Mexico, Indonesia, Nigeria and Turkey. See Fraser, 2011). Finally, Jim O’Neil again pointed out a larger group of 11 countries (for which he coined the term Next Eleven or N-11) which have the potential, together with the BRICS and MINT, to establish themselves as the largest economies at the worldwide level during the twenty-first century. This group includes Bangladesh, Egypt, Indonesia, Iran, Mexico, Nigeria, Pakistan, the Philippines, Turkey, South Korea, and Vietnam. Figure 4.1. shows the forecasts made in 2005 by the Economist1 about the evolution of the world economy in the coming years which would lead to an eclipse of many current leading countries (with Italy and Russia disappearing from the top 10) and their replacement with some of the emerging countries (namely Indonesia and Mexico). In particular China is forecasted to overtake the United States in terms of product as early as 2026 while India would catch up with them in 2050. The recent Covid-19 health emergence would change significantly the picture of the new world and would probably exacerbate even more this tendency. A similar picture emerges in the forecast made by OECD reported in Fig. 4.2. Faced with these scenarios, waiting for a new theory capable of explaining the causes, scholars are currently wondering what are the characteristics of these

1

https://espas.secure.europarl.europa.eu/orbis/sites/default/files/generated/document/en/Long-ter mMacroeconomicForecasts_KeyTrends.pdf.

4.2 Recent Trends in Economic Growth

25

Fig. 4.2 Dynamics of the 5 largest world economies by 2060 according to the forecasts of the OECD (Nominal Gross Domestic Product of each country expressed in millions of US dollars). https://data.oecd.org/gdp/real-gdp-long-term-forecast.htm#indicator-chart

countries that allow such rapid growth at a time when traditional economies are struggling.

4.2 Recent Trends in Economic Growth To help our reader to form an objective idea of the differentials of economic growth in income worldwide, let’s start by examining the data reported in Figs. 4.3 and 4.4 which show the trend of per capita income in the OECD countries over the past forty years. In particular, Fig. 4.3 highlights the behavior of some countries that recorded a growth above the OECD average during the period of observation. Figure 4.4, on the other hand, compares the same trends, but highlighting the BRICS countries, showing values that are still below the OECD average, but moving towards it with an accelerated speed especially in the last fifteen years. Figure 4.5 more clearly shows this tendency with Russia and China in particular rapidly catching up the OECD countries. Turning now consider the long-term trends in income growth, Fig. 4.6 captures the state of growth in OECD countries over the past 20 years. Before moving on to comment on the data, however, I would like to draw the attention of our reader to the different quality of the data used to make international comparisons: A topic already discussed in Chap. 3.2. The picture that emerges is not reassuring for the Group of Eight (G8) —France, Germany, Italy, the United Kingdom, Japan, the United States, Canada, and Russia—, which, with the only exception of Germany, record values below the average and some of the lowest growth rates of all OECD countries.

26

4 Economic Growth

Fig. 4.3 Annual per capita income trend in some OECD countries in the period 1980–2020 (Source OECD. Data expressed in constant US dollars). https://data.oecd.org/gdp/gross-domestic-productgdp.htm

Fig. 4.4 Annual per capita income trend in some OECD and BRIC countries in the period 1980– 2020. The BRIC countries available are highlighted (Source OECD. Data expressed in constant US dollars). https://data.oecd.org/gdp/gross-domestic-product-gdp.htm

(Russia is not an OECD member). In contrast the most accelerated speed of growth is observed in the three Baltic states which more than triplicated their GDP in the period under observation. If we refer, instead, to short-term trends and, in particular, to recent years, we can refer to a wider set of countries through the data collected by the World Bank with the recommendations (already expressed before) about the accuracy of the values

4.2 Recent Trends in Economic Growth

27

Fig. 4.5 US dollar per capita 1990–2020 in BRICS countries Source OECD. https://data.oecd.org/ gdp/gross-domestic-product-gdp.htm

Fig. 4.6 Percentage long-term growth rates of the per capita Gross Domestic Product in the period 2000–2020 for the OECD countries. (Source OECD)

in the statistically less advanced countries where it is often necessary to resort to estimates and approximations. In order to focus only on changes in income and not on demographic dynamics, we have chosen to refer to the growth rates of per capita income rather than to the total income of the country. The growth rate of total income, in fact, is equal to the growth rate of per capita income multiplied by the rate of change of the population. Furthermore, given the fluctuations that can be observed from year to year in growth rates due to statistical evaluations, delays and other inaccuracies, (and also in order to include in our analysis countries for which in some years no observations are available) we have chosen to report the average

28

4 Economic Growth

Fig. 4.7 Percentage growth rates of per capita Gross Domestic Product for a set of countries (average of annual growth rates in the period 2017–2019. Source World Bank)

annual growth rates in the last three (pre-Covid) years available (from 2017 to 2019). These data are reported in Fig. 4.7. Our conclusions can be altered by the possible presence of the so-called growthelsewhere phenomenon, which is observed when the share of growth in countries due to the shift in those countries of production activities already carried out in advanced countries (see Vaciago, 2015). However, the picture that emerges from the examination of Fig. 4.5 is of an evident position of suffering of the Western European countries which recorded only moderate increase (or even a decrease) in per capita income recorded on average in the three years considered. On the other side, on very high growth rates we find countries such as China, Ireland and some Eastern European countries.

References Barro, R. e Lee, J. (1933) International comparisons of educational attainment, NBER. Cobb, C. W., & e Douglas, P.H. (1928). A theory of production. American Economic Review, 18(1), 139–165. Domar, E. (1946). Capital expansion, rate of growth, and employment. Econometrica, 14(2), 137– 147. Fraser, I. (2011). Fidelity is confident its MINTs won’t suck, Bloomsbury Information QFINANCE. Harrod, R. F. (1939). An essay in dynamic theory. The Economic Journal, 49(193), 14–33. Kaldor, N. (1954). The relation of economic growth and cyclical fluctuations. Economic Journal, 64(253), 53–71. Lucas, E. R., Jr. (1988). On the mechanics of economic development. Journal of Monetary Economics, 22, 3–42. Mankiw, N. G., Romer, D. & Weil, D. N. (1992) A contribution to the empirics of economic growth, The Quarterly Journal of Economics, 407–437. O’Neill, J. (2001). Building better global economic BRICs, Global Economics Paper No: 66, Goldman Sachs.

References

29

Romer, J. E. (1986). Increasing returns and long-run growth. Journal of Political Economy, 94(5), 1002–1037. Smith A. (1776) The wealth of the nations. The Wealth of Nations: A Translation into Modern English, Industrial Systems Research, 2015. ISBN 978–0906321706 Solow, R. (1956). A contribution to the theory of economic growth. Quarterly Journal of Economics, 70(1), 65–94. Solow, R. (1957). Technological change and the aggregate production function. Review of Economics and Statistics, 39(3), 312–320. Swan, T. W. (1956). Economic growth and capital accumulation. Economic Record, 32(2), 334–361. Vaciago, G. (2015). Increasing returns and growth in advanced economies: A re-evalauation. Oxford Economic Papers, 27, 187–200.

Chapter 5

Inequality and Growth

5.1 Interpretive Models of the Relationship Between Inequality and Growth After having analyzed separately in the two previous chapters the various theoretical and empirical aspects relating respectively to income inequality and economic growth, this chapter will be devoted to the relationships between these two phenomena and to the redistributive policy considerations that arise looking at them jointly. It should be noticed in advance that the questions related to how inequality arises and how it evolves have represented for centuries by economists a major reason of study. However, despite this, the relationship between inequality and economic growth is still a source of discussion and controversy and far from being fully understood. In an attempt to systematize the various schools of thought, Lundberg and Squire (2003) distinguish two possible lines of thoughts along which, in the literature, researchers have tried to explain the relationships between the two phenomena. A first line of research, deriving from the ideas of Kuznets and Lewis, attempted to identify a formal link between income growth and inequality. The second approach, instead, attempted to find a causal explanation for the observed trends in growth and inequality by treating these two quantities independently of each other. Traditional theories, still largely reported in the most popular economics textbooks, follow the first line of thought and suggest a direct link between inequality and growth while recognizing that the goal of full system efficiency can be partially bartered with the achievement of greater social equity. On the other hand, many development economists have taken different positions in recent years, supporting them with theoretical as well as empirical arguments. As mentioned already, the traditional theory relating to the relationship between inequality and growth derives from the pioneering contribution provided by the economist Kuznets (1955). Kuznets’s idea, which was later developed in a greater detail by Robinson (1962), is based on the movement of the workforce that can be © The Author(s), under exclusive license to Springer Nature Switzerland AG 2023 G. Arbia, Income Inequality, Redistribution and Economic Growth, SpringerBriefs in Economics, https://doi.org/10.1007/978-3-031-24851-1_5

31

32

5 Inequality and Growth

observed looking at the historical evolution of an economy from the agricultural to the industrial sector. A fundamentally agricultural economy, which is typical of less developed countries, usually records a low level of income and a low level of inequality at least in the agricultural sector. The shift of labor and resources from the agricultural sector to the industrial sector entails a growth in both individual income and in the level of inequality with the emergence of small groups of wealthier individuals who obtain larger profits from investments in the industrial sector. However, as the weight of alternative sectors to agriculture (characterized by higher wages and rents) increases, these differences among earners tend to disappear and moreover many of those who entered the most profitable sectors at low income levels will tend to reach higher positions and higher income levels. According to this theory, therefore, a bell-like pattern of inequality should be expected as economic development progresses. While the economy develops, inequality would tend to grow first and then decrease. In line with Kuznets’ thinking, Arthur Okun argued, in the 1970s, that there is a trade-off between the efficiency of a system and equality (Okun, 1975) so that governments should decide where to position by favoring either economic growth or the realization of a more equitable system of distribution of welfare. According to Okun we can use the government tax system to move income from one individual to another, but the system still looks like a “laundry basket” because a certain amount of money will be lost while moving it. This argument, according to Okun, should not imply that we cease to desire the realization of greater equity. However, but, since we are also interested in the efficiency of the system, we must be aware of the laundry basket and stop the losses before the efforts to achieve full equity destroys the efficiency of the entire economic system. Kuznets’ theory and related studies gained considerable popularity in the 1970s also supported by empirical data observed in the United States and in most OECD economies (see, for example, Ahulwalia, 1976; Papanek & Kyn, 1986) although the findings for developing countries were much more ambiguous (Adelman & Morris, 1973; Anand & Kanbur, 1993). In those years, a virtuous circle appeared to have been established in Western economies: the lowest inequality achieved fueled growth, which in turn further reduced inequality. However, the decrease in inequality observed by these economies during the last decades of the last century has experienced an abrupt change of direction with a growth trend in the last 30 years which appeared in clear contradiction with Kuznets’ theory. As a consequence, the theory has been gradually losing its explanatory power (see, for example Anand & Kanbur, 1993) and it was even recently branded by Thomas Piketty as a “fairy tale” which was only useful to reassure world economies with an optimistic forecast in the period of the cold war (Piketty, 2013). In fact, the data we examined during Chap. 3 show how Kuznets’ theory does not seem to present an empirical confirmation in recent years in which, on the contrary, we observe a growing inequality in the most advanced economies and a decreasing inequality in the developing countries. In this sense, some authors (for example Li et al., 1998) have argued that, while Kuznets’ theory can still be used to explain the differences between countries in

5.1 Interpretive Models of the Relationship Between Inequality and Growth

33

a single moment of time, but it is no longer suitable for explaining their temporal evolution in the new global macroeconomic framework that has been established. The view that favors a positive effect on growth due to reduced inequality was supported by a series of empirical studies in the 1990s which showed a negative correlation between the average growth rate and the various measures of inequality. An excellent review of such empirical evidence is contained, for example, in Benabou (1996). Among these, the French economist focuses, in particular, on the case of the differential development recorded by two Asian countries (South Korea and the Philippines) in the last thirty years of the last century. In the 1960s, in fact, these two countries appeared extremely similar in terms of the main macroeconomic indicators (for example, income, employment and investments), but were very different in terms of economic inequality. In fact, in the Philippines there was a much higher level of inequality than that observed in South Korea. The empirical data supporting Benabou’s theory showed that the ratio between the income of the 20% of the richest population divided by the 40% of the poorer population was about twice as much in the Philippines as in Korea. Over the next thirty years, however, South Korea’s income grew 2.5 times faster than that of the Philippines. In spite of what were the dominant theories at the time, therefore, the income of the country characterized by lower income inequality had grown faster. In an attempt to overcome Kuznets’ theories that were gradually losing appeal, over the years many theories have arisen aimed at explaining the effects of inequality on economic growth whose results are however conflicting and whose empirical tests lead to often contrasting results. Also following the crisis of the old theories of growth in the presence of a changed macroeconomic framework, since the 1990s there has been an increased interest in the determinants of economic growth and, among these, on the role of inequality. In general terms, economic growth in the last thirty years has been associated with three phenomena: trade liberalization, technological changes and the birth and development of new organizational forms. The new theories dealt with analyzing the effects of these phenomena on economic growth. The development of endogenous growth theories (see Sect. 4.1) together with the increased availability of internationally comparable data for a large number of countries has allowed the empirical analysis of growth differentials between countries together with their etiology. Together with economists who continue to report a tendency for inequality to generate lower levels of growth (e.g. Perotti, 1996), there are studies that document an inverse relationship (e.g. Li et al., 1998; Forbes, 2000). From the empirical studies carried out in the 1990s, the picture that emerges becomes progressively less ambiguous and suggests that greater inequality mostly has the effect of reducing the growth rate of the economy (see Aghion et al., 1999; Alesina & Rodrick, 1994; Persson & Tabellini, 1994). Todaro (1997) argues that an inverse relationship between inequality and growth is to be expected due to the following four reasons: (i) unproductive investments by the richest individuals, (ii) the low levels of investment in human capital by the poor, (iii) the demand of the poorest mainly oriented towards local markets and (iv) political rejection of the masses.

34

5 Inequality and Growth

Aghion et al. (1999) argue that a greater inequality can reduce the growth rate of the economy and that a redistribution of income among earners can, on the other hand, fuel growth. However, the authors do not come to a conclusion about an equally important question. Indeed, this feedback could generate a virtuous circle through which the redistributive policy reduces inequality which in turn accelerates growth leading, in this way, to a further reduction of inequality. However, it could also produce a vicious circle through which the growth fostered by the lower inequality induces a growth in inequality itself, leading to a situation in which the redistributive effort must be repeated indefinitely in the future. Aghion et al. (1999) analyze in detail the arguments in favor of the two possible schools of thought. Ultimately, the view that some income and wealth inequality would produce a benefit on growth are based essentially on three arguments. The first one is that, following the ideas of Kaldor (1954), what economists call the marginal propensity to save (i.e. the share of each euro of additional income that goes to saving) is higher for the rich than for the poor. Thus, if the growth rate of the Gross National Income is directly related to the proportion of income that is saved and therefore available for investment (see Sect. 4.1), then economies characterized by greater inequality will grow faster than those characterized by a more egalitarian distribution. This argument was formalized by Stigliz (1969) in a model of growth à-la-Solow and then used as a possible explanation also by Bouguignon (1981). The second argument for which inequality can be expected to foster growth relates to the indivisibility of investments. Production investments, especially those that are most innovative, often require high non-repayable initial costs. Consequently, in the absence of a well-functioning stock market, a certain concentration of wealth is required in the hands of a few individuals or families in order to cover these costs and thus undertake an entrepreneurial activity. Thirdly, and finally, the idea that it is impossible to pursue the objectives of production efficiency and economic equity together is based on arguments related to incentives. According to this argument (also supported by Mirrlees, 1971, among the others), in a context where the risk of production depends on the commitment of the employed and economic agents, the strategy of compensating employees with a constant wage that does not depend on their performance will have the obvious effect of discouraging employees themselves from investing their efforts beyond the bare minimum. On the other hand, the opposite strategy of making the wage premium too sensitive to the worker’s performance could likewise be inefficient when the output of production is uncertain and the workers are risk-adverse. Ultimately, the traditional point of view is that a choice must be made between the growth of the economic system and social justice. Following this argument, a redistribution of income would have a direct and an indirect negative effect on growth. On the one hand, it reduces the differences in income and therefore for the above reasons reduces the pace of economic growth. On the other hand, since the redistribution takes place through a system of incentives and tax reduction, the incentives to accumulate wealth through productive investments and entrepreneurial activity would disappear.

5.1 Interpretive Models of the Relationship Between Inequality and Growth

35

The same authors (Aghion et al., 1999) affirm that there are, however, at least as many reasons to support the opposite hypothesis that inequality can have negative effects on growth. The first argument has to do with the fact that greater inequality reduces investment opportunities. The second is that inequality reduces the incentives for economic agents. The third lies in the fact that greater inequality generates uncertainty in the macro-economic framework and in this way would discourage investors. According to Robert Barro (2000), in order to judge the effects of inequality on income, it is necessary to consider four arguments relating, respectively, to (i) the individual saving rate, (ii) the imperfections of the credit market, (iii) some aspects of economic policy and (iv) social stability. As regards the first point, that is the relationship with the individual saving rate, Barro, like other economists linked to the Keynesian tradition, believe that this rate is an increasing function of the individual income level. The higher the income, the more there is a tendency to set aside increasing shares in the form of savings. If this is true, then higher earners will tend to save more of their income which can be used for investment. According to this theory, if in a given country policy measures are taken to redistribute income in favor of the less well-off and therefore to reduce inequality, this will at the same time tend to reduce the amount of national income dedicated to investments and thereby slow down economic growth. However, it should be noted that this theory assumes a closed economy and the absence of direct foreign investment, an assumption which contrasts sharply with the observational reality. The second set of arguments used by Barro can be traced back to imperfections in the credit market and in access to financing opportunities. In the presence of such imperfections, creditors may find it difficult to raise funds to support financial investments. With limited access to credit, the poorest categories of the country could be tempted by investments in human capital that guarantee higher rates of return with less access to credit, thus favoring economic growth. Through this mechanism, a reduction in inequality would lead to an acceleration of the growth rate. However, if the credit market and institutions tend to progress with the development of the economy, then these effects linked to market imperfections will tend to have a higher effect in poorer economies than in richer ones and, in this way, we would come to postulate an adverse effect of inequality on growth. The third set of arguments refers to political economy. Indeed, in an economy characterized by strong economic inequalities, one can expect that the presence of a system of votes based on majorities will push in the direction of a redistribution of incomes towards the less well-off using instruments such as transfers, a progressive taxation system and programs of public expenditure. This transfer system will tend to distort economic investment choices by discouraging the decision to enter the labor market and to invest and, in this way, could lead to a reduction in the rate of growth of the economy. Finally, the effects linked to social stability must be considered. In a country with strong inequalities, the less affluent people can be induced to commit crimes, riots and other disruptive activities threatening the political and economic stability of the country. Threats to stability and property in this situation will tend to reduce internal investments and

36

5 Inequality and Growth

especially the attraction of direct investments from abroad. In this sense, greater inequality will reduce the country’s production efficiency and ultimately its growth. The analysis conducted by Barro (2000) is also based on some empirical arguments. In fact, the economist observed the behavior of 146 countries for which reliable and comparable data of the Gini index and income growth rates were available (Deininger & Squire, 1996). With regard to the growth observed between 1965 and 1975, between 1975 and 1985 and between 1985 and 1995, it is observed that, taking all countries as a whole, the two variables do not show any relationship either positive or negative. However, if we divide the 146 countries into two groups on the basis of their per capita income (taking the value of $2,000 in 1985 as a threshold), for the poorest countries we observe a negative effect of inequality on growth rates while this effect becomes positive for richer countries. According to Barro, this differential effect could be due to the greater constraints in the credit market experienced by the poorer countries and which creates an obstacle to growth. Another Nobel Prize winner, in addition to the many cited so far, has no doubts about the sign of the relationship between inequality and growth: Joseph Stiglitz awarded in 2001 for his contributions to the analysis of markets with asymmetrical information. The arguments put forward by Stiglitz in his volume “the price of inequality” (Stiglitz, 2012) in support of a negative effect of inequality on economic growth are basically four. The first argument refers to the instability that is induced on the market by high inequality. The harmful effects of this instability on growth range from purely economic effects (such as the lower share destined for consumption by individuals with higher incomes) to effects more linked to the social sphere such as the growth of delinquency and crime up to the extreme case of civil war. He ascribes to the high instability induced in the United States by the excessive growth of income inequality also the swelling and subsequent explosion of the first technological bubble (in the 1990s) and of the real estate bubble in the early 2000s. Finally, a final effect of inequality on instability has to do with the increase in risk. Firms, naturally unwilling to risk, demand a higher premium if this risk increases, failing which they simply invest less and thus slow down the process of growth. In this sense, a vicious circle would be established whereby inequality increases instability and, in turn, instability produces greater inequality. The second argument put forward by Stiglitz in support of an inverse relationship between inequality and growth concerns the reduction of public investment. The more unequal the distribution of income, the more reluctant the rich will be to make their money available for common needs related to, for example, health or education, which they have the opportunity to access directly through the private sector. The third argument refers to the decline of social mobility and to the phenomenon that Stiglitz (2012) calls rent seeking. When the equality of opportunities are reduced (e. g. due to a lower possibilities of access to investment in human capital), resources are used inefficiently, slowing growth. In the same direction goes the rent seeking, described as the phenomenon through which an individual tries to obtain a competitive advantage and a profit through the exploitation of the environment, rather than through the conclusion of economic transactions and the production of added value.

5.2 Some Theoretical Positions on Redistributive Policies

37

In this situation, the overall result will be inefficient and at the same time unfair because it is not commensurate with the contribution of the economic agent in terms of adding value. In this sense, many of the high-income earners owe their fortunes not to their high marginal productivity, and therefore to their ability to generate income, but rather to the position rents achieved through lobbying. In these cases A byproduct of efforts to grab a larger slice of the pie is in fact that what remains of it gets smaller (Stiglitz, 2012).

The fourth argument is centered on the idea of motivation. People need motivation to get involved. If they feel they are being treated unfairly, it can become difficult to motivate them and discontent makes workers less productive. The lack of motivation would, in this sense, have contributed to the collapse of the communist system. The case of Bridgestone/Firestone tires, studied by Krüger and Mas (2004) is illuminating. After a year of good profits, the management in charge demanded that an eight-hour shift be changed to a twelve-hour shifts day and night, and that the pay of new hires be reduced by 20 percent. However, the new conditions led to the production of many defective tires, subsequently involved in more than a thousand fatal and non-fatal accidents, until in 2000 Firestone tires were withdrawn from the market (Stiglitz, 2012).

5.2 Some Theoretical Positions on Redistributive Policies In recent years, especially in the United States, it has become increasingly popular the tendency to strongly advocate economic policies aimed at reducing inequality in order to accelerate the growth process of the economy currently in a stagnant phase. These positions attribute the blame for the slower pace of economic growth and stagnation to the increased inequality. This way of thinking presents a vast group of variously distributed supporters including President Barack Obama, the OECD, various movements, and pressure groups (such as Occupy Wall Street), the Nobel laureate Joseph Stiglitz and many others. Proponents of such theories argue in their favor with three classes of arguments. The first argument concerns the absence of true progressiveness in the taxation system. Perhaps the most striking manifestation of this topic, at least in the United States, took place during the 2008 presidential campaign in a fundraising event organized by Hillary Clinton where billionaire Warren E. Buffett stunned audiences by claiming that the rich don’t pay enough taxes and taking his own personal situation as an example. On that occasion, the billionaire claimed that his taxes in the previous year totaled 17.7% of his income while his receptionist had paid about 30% of his income (see Tse, 2007). Following this sensational announcement, in 2011 President Barack Obama proposed what was called “Buffett’s rule”, which required taxpayers with an income exceeding one million dollars to pay at least 30% of their income in federal taxes.

38

5 Inequality and Growth

The same kind of argument could be used in many other countries. For instance, in Italy, the principle of progressivity of taxes (although enshrined in Article 53 of the Italian Constitution), does not materialize in practice with a marginal tax rate that flattens after a threshold that recently fall from 75,000 to 50,000 Euros gross per year. In this way it is excluded from progressivity a number of taxpayers that amounted to about 1 million in 2015 and that collected, at the time, approximately 13% of the total income of the country. The second argument used by the proponents of redistributive policies refers to the fact that the income of the wealthiest individuals does not reflect the contribution they have made to society. In a competitive labor market, in fact, a worker’s wages should be proportional to the additional contribution that the worker provides to production through his work or to his marginal productivity. However, this may be far from the truth for a number of reasons among which a predominant weight is exerted by the aforementioned phenomenon of rent seeking. Although some authors have tried to deny this argument (for example Mankiw, 2013) for the United States, it certainly does not seem groundless if we consider what happens in many countries. A third argument in favor of a reduction in inequality that would stimulate growth is that individuals in the higher income brackets would benefit from physical, legal and social infrastructure provided by the central government in a way that exceeds the lowest income earners and, for this reason should contribute more to their costs. President Obama expressed this concept very clearly in the speech given in Roanoke, Virginia during the presidential campaign in July 2012 (Obama, 2012) in which he states: If you were successful, somebody along the line gave you some help. There was a great teacher somewhere in your life. Somebody helped to create this unbelievable American system that we have that allowed you to thrive. Somebody invested in roads and bridges. If you’ve got a business – you didn’t build that. Somebody else made that happen. The Internet didn’t get invented on its own. Government research created the Internet so that all the companies could make money off the Internet. The point is, is that when we succeed, we succeed because of our individual initiative, but also because we do things together. There are some things, just like fighting fires, we don’t do on our own.

Obama’s words echo those spoken by Joseph Stiglitz. In the aforementioned book “the price of inequality” (Stiglitz, 2012), he states: The government establishes the fundamental rules of the game. Enforces the laws and in general offers the heavy and light infrastructure that allows a society, and an economic system, to function. If the government does not provide roads, ports, education or pure research - or does not provide for someone to do so, or does not at least create the conditions in which someone else could do so - ordinary economic activity cannot flourish (Stiglitz, 2012).

This last argument is evidently based much more on the principle of the benefit received than on the traditional principle of the progressive taxation. In fact, the higher taxes for the income of the richest would be justified by the assertion that a rich individual has obtained his wealth to a large extent because he has used goods and services provided by the public sector and therefore must bear the cost to a greater extent. Indeed, the value of a stable and efficient political system is extremely high,

5.2 Some Theoretical Positions on Redistributive Policies

39

and its failure would plunge the incomes of the rich more than those of the poor. This argument is obviously more relevant in countries where the weight of public spending is high and where the absence of alternative private services (for example in health care) makes the functioning of the public system even more essential to the achievement of economic purposes of the individual agents. To counterbalance this position, Mankiw argues, however, that the burden of public spending on the economy has grown over the years in the United States not because better roads or bridges have been built but only because it has increasingly used its power to take from Peter and pay Paul (Mankiw, 2013).

that is to transfer income without providing a corresponding additional service. In an OECD study appeared in 2014 (OECD, 2014), this issue is addressed by clearly taking the parts of a redistributive policy which does not start from egalitarian considerations, but from a concern in the efficiency of the system. Building on the growth in inequality observed in most member countries (already discussed in Sect. 4.2), the OECD study conducts an exercise through which it estimates what growth could have been in the various countries if inequality had remained constant over the past 30 years. Figure 5.1 shows the rate at which the growth rate of Gross National Product would have grown in 16 OECD countries over the period 1985–2005 if inequality had remained constant at 1985 levels. Growing inequality is estimated to have reduced growth in countries such as Mexico and New Zealand by around 10%, by around 9% in the UK, Finland and Norway and by between 6 and 7% in Italy, in the United States and Sweden giving rise to additional growth only in the case of Spain, France and Ireland. According to this study, for instance, if in Italy were adopted policies aiming at containing the growth of inequality in the distribution of incomes, in the years from 1985 to

Fig. 5.1 Actual growth rate (blue symbol) and theoretical growth rate (blue bar) that would have been observed in 16 OECD countries between 1985 and 2011 if inequality had not worsened over the period, and difference between the two (orange bar). Source OECD (2014)

40

5 Inequality and Growth

2005 we would have recorded a growth of per-capita income of 15% compared to the observed growth of only 8% (see Fig. 5.1). It should be noted that the OECD study stops in 2011 and does not take into account the most recent dynamics in the hypothesis that these will exert their effects in future years. The study also notes that the negative impact on growth due to increased income inequality does not stop at the growth in the number of people in the group that makes up the poorest 10% of the population, but also extends to the group of individuals that make up 40% of the poorest individuals. In this sense, redistributive policies should aim not only at reducing poverty, but also at increasing incomes in the lower and middle classes of the social scale. However, in suggesting a set of redistributive policies based on the reshaping of taxes for the benefit of the less well-off and on a system of benefits, the OECD also warns that, while redistributive policies do not slow down growth, not all of them necessarily produce growth. Indeed, policies misdirected to income earners and not focused on the most effective tools, could lead to a loss of resources and generate further inefficiency. The World Bank also enlisted in this line of thinking when it states that: Economic growth is essential for poverty reduction, but the extent to which it is “pro-poor”, that is, the speed with which growth improves the quality of life of the poor, varies widely. To ensure that growth actually provides significant poverty reduction, governments need the resources and tools to fully grasp the extent of poverty in their countries, to analyze the forces behind growth and poverty, and to develop policies to ensure that the poor benefit more than proportionally from growth. These resources include tools that offer an accurate and multidimensional measure of poverty, a detailed factual understanding of the conditions and characteristics of the poor, an accurate reading of how different engines of growth affect the poor, and the role of initial conditions in determining these effects. (World Bank, 2015)

Such arguments attract, as has been said, many supporters. For example, from the online columns of the site ‘www.inequality.org’, the Australian sociologist Babones (2013), supports the same views of Obama and of the OECD, but explicitly referring to Marxist-type positions. According to this author, in fact, the stage of stagnation in which most of the contemporary Western economies currently find themselves is nothing but the historical development already foreseen by Karl Marx in ‘The Capital’ (Marx, 1867). According to Marxist theory, in fact, the development of capitalism would have led to a growing inequality of incomes and would eventually collapse as a consequence of it. In fact, according to his theory, inequality would have grown indefinitely in the capitalist system to the point where workers could no longer afford to purchase the goods produced. Without customers, the capitalist economy would have started to stagnate until its collapse. The countermeasure for this author is very clear even if difficult to implement. Starting from the consideration that since 1973 there has been a huge transfer from the 90% of the poorest individuals to the 0.1% of the richest individuals, the solution consists in asking these privileged people to contribute with a higher rate in order to return part of the enormous profits made and use those sums to raise minimum wages and increase public education. In most of the works and studies cited so far in this chapter, despite the different theoretical positions and conflicting observational data, it has been taken for granted

5.2 Some Theoretical Positions on Redistributive Policies

41

that there is a functional link (whether direct or inverse) between inequality and economic growth. In more recent years there has been an attempt to approach the problem in a different and more realistic way, taking into account aspects that have remained in the shadows in the previous literature. Most of these arguments concern the criticism that can be made to this approach that it minimizes the role of other factors that may instead be extremely relevant. Indeed, specialists are aware that, even where significant statistical regularities are found in the relationship between two variables, this is not necessarily due to a cause-effect link between them. In fact, not only this could be due to situations of spurious correlation and pure chance concomitances, but also, we can observe a wide variety of much more complex causal mechanisms, ranging from the presence of hidden contributing causes, to joint effects, to causal chains and others (see on the subject the interesting volume by Pearl, 2009). In the present case, the observation of an empirical relationship between inequality and growth does not necessarily imply a cause-and-effect link between them (moreover of an uncertain sign), but could be due to the fact that both variables are joint effects of other factors not considered in the analysis. This alternative approach, in addition to being more realistic, is also more useful from the point of view of evaluating the effects of economic policies because policy makers often find themselves in the need to evaluate the balance of the impacts of their choices on both growth and inequality. Following this approach, supported by a series of empirical data, Lundberg and Squire (2003) show that the determinants of growth and inequality are largely the same. In such conditions, the policy maker in search of greater equity runs the risk of involuntarily slowing down growth with her choices if she uses the wrong tools. For example, the authors suggest that increasing the degree of openness of the economy with the aim of stimulating growth could lead to nefarious effects on inequality. However, they suggest that both objectives of equity and efficiency can be pursued by implementing, for example, a more equitable distribution of land or by increasing public spending on human capital formation through education and specialized training. Pagano’s contribution (2004) fully captures the spirit of this approach by using the only tool currently available in statistics to verify the existence of cause-effect links between variables. Such a tool is based on the concept of predictability of one variable on the basis of another, a concept called Granger-causality from the name of the Nobel laureate Clive Granger who first introduced it (Granger, 1969). In very simplified terms, if through the observation of one variable it is possible to predict the trend of a second variable, then the first one Granger-causes the second. Based on the observation of empirical data provided by the World Bank relating to 137 countries observed in the period from 1950 to 1999 (Dollar & Kraay, 2002), Pagano comes to the interesting conclusion that there is a strong relationship between inequality and economic growth, but through a much more complex circular mechanism than the simple direct cause-effect link of one variable on the other. Indeed, looking at the observational data, an increase in the rhythm of economic growth produces a greater inequality of income, but a growth in inequality slows down the growth itself. The circle that would be established is a vicious one with the economy

42

5 Inequality and Growth

going to contraction and collapse in the absence of public rebalancing measures. As already remarked by Barro (2000), the author also observes how the effects could be different in rich and poor countries. In fact, in poor countries there would be a negative cause-effect relationship between inequality and growth (i. e. inequality reduces growth), while this effect could be of the opposite sign in rich countries. In addition, the causal approach used by Pagano also verifies the opposite relationship. In this sense, if we verify empirically the cause-effect mechanism in which growth is the cause of inequality and not vice versa, in poor countries growth would seem to reduce inequality while it would increase it in richer countries. An out-of-the-box contribution to the debate surrounding the relationship between inequality and growth came recently from Piketty (2013). Piketty’s analysis distances itself from most of the literature examined so far for at least two reasons. In the first place, while all the studies examined so far have dealt with analyzing our recent history, the French economist is interested in long-term dynamics and in an analysis that he himself describes as “economic-historical”, by taking into consideration the secular dynamics of growth and inequality to learn useful lessons from history that could suggest possible future scenarios and a wide-ranging theory. Secondly, instead of considering income as an aggregate, both from the distributional point of view and its temporal growth, its approach is based on a clear distinction between labor income and capital income, two components that in the economist’s view follow very different dynamics. The suggested decomposition is especially useful when referring to a measure of inequality. Indeed, the data examined by Piketty show that the Gini indices associated with labor income usually vary between 0.2 and 0.4, while the same indices relating to capital ownership are much higher ranging from 0.6 to 0.9 in different countries or in different eras. The observed values refer to the total income that originates from these two components. In fact, as we have seen with only few remarkable exceptions, these are placed, on average, between the two previously reported values with fluctuations in the range between 0.3 and 0.5. In the nearly one thousand pages of his now famous book “Capital in the 21st Century”, Piketty (2013) exposes a theory which is rather simple in its essence. The French economist, in fact, starts from the observation that the rate of return on capital (seen in the form of profits, dividends, interest, rents and any other capital income) has historically always exceeded the annual growth rate of labor income, except for a relatively short period between the two world wars of the last century. In these conditions the entrepreneur tends to turn into a rentier. Once established, the capital reproduces itself and grows faster than the product. He states: The assets inherited from the past are recapitalized faster than the progress of the production process and income. Therefore, for those who inherit assets from the past, it is enough to save even a limited amount of income from their capital for the latter to grow faster than economic growth as a whole. Under these conditions it is almost inevitable that the assets received as an inheritance largely prevail over the assets accumulated over the course of a working life, and that the concentration of capital reaches very high levels, potentially incompatible with the meritocratic values and the principles of social justice that constitute the foundation of our modern democratic societies. […] The process of accumulation and distribution of assets contains in itself factors so powerful as to push towards divergence, or at least towards an extremely high level of inequality.

5.2 Some Theoretical Positions on Redistributive Policies

43

and this is not due to market imperfections, but rather the more the market is “perfect” in the sense that economists give to this adjective, the more likely it is that inequality will occur (Piketty, 2013).

This mechanism would have led to the growing inequality observed in the United States in recent decades (see Fig. 5.2) by blocking the purchasing power of the popular and middle classes, accentuating their inclination towards increasing debt and making the American financial system more fragile. Faced with an unstoppable growing inequality (because it is self-sustained by the differential between capital and labor income) and with a decline that also appears inevitable, the only way to regain control of capitalism would be, according to Piketty, a progressive annual tax on capital, together with the attempt to encourage the growth of income by investing what is obtained from the growing tax burden in training, knowledge, and non-polluting technologies.

80% Iceland Ireland

60%

GROWTH 2010-2018

40% USA

20%

0% 15

20

25

30

35

40

45

Turkey

-20%

Greece

-40%

GINI 2010

Fig. 5.2 Inequality and economic growth of per capita income of OECD countries. Source OECD

44

5 Inequality and Growth

5.3 Some Empirical Evidence Consistent with the approach that we have followed in the previous chapters, we report below, at the end of this chapter, some empirical data that can help the readers to form their own idea about the relationship between income inequality and economic growth. The analysis is conducted without claiming to subject relational hypotheses to a rigorous statistical test and even less to a causality test, but for purely descriptive purposes. If we first want to verify the existence of a relationship between inequality and growth, it is reasonable to assume that the possible effects of inequality on economic development and on economic growth do not occur instantaneously, but are instead distributed over time. For this reason, in analyzing the OECD countries, in Fig. 5.2 we have reported on the vertical axis the growth of per capita income observed over a rather long period of time from 2010 to 2018 and on the horizontal axis the inequality index of Gini recorded at the beginning of that period (2010). The analysis of Fig. 4.7 shows the anomalous behavior of some countries which have exceptionally high values of the Gini index (Turkey), of the growth rate or of both (Iceland and Ireland) or both (the United States of America). For all the other OECD countries, on the other hand, the graph shows a decreasing trend of the cloud of points, thus indicating that high rates of inequality at the beginning of the period are associated with low levels of growth in per capita income and, vice versa, high values of Gini index are associated with low levels of the growth rate. Even with the cautions already said about the danger of fallacious causal conclusions (and with the arbitrariness of the period considered), this seems to indicate that growing inequality was in some way responsible for the slowdown in growth over the period of time considered, at least in the OECD countries. Starting from the observations made in the previous paragraph, however, we are also interested in seeing if the observed data are compatible with a mechanism in which it is the growth observed in a certain moment of time that exerts an effect on inequality. To achieve this aim, Fig. 5.3 reports on the horizontal axis the growth rate of per capita income in a certain interval of time (years 2010–2013) and on the vertical axis the Gini index observed after five years (2018). For the same reasons expressed in Sect. 2.2, the growth rate is calculated as the average annual rate in the three initial years (2010–2013). In this second case, the trend underlying Fig. 5.3 is substantially constant, indicating that the growth rate at the beginning of the period would not seem to have an effect, over the period of time considered, on the levels of inequality observed at the end of the period. For instance Greece, Portugal, Canada and Switzerland experience the same level of inequality albeit with very different levels of economic growth.

References

45 45 USA Turkey

40

35 Canada

GINI 2018

Switzerland Portugal Greece

30

25

20

15 -8%

-6%

-4%

-2%

0%

2%

4%

6%

8%

10%

12%

GROWTH 2010-2013

Fig. 5.3 Growth and per capita income inequality of OECD countries. Source OECD

References Adelman, I., & Morris, C. T. (1973). Economic growth and social equity in developing countries. Stanford University Press. Aghion, P., Caroli, E., & Garzia-Penaloza, C. (1999). Inequality and growth: The perspective of the new growth theories. Journal of Economic Literature, 37(4), 1615–1660. Ahulwalia, M. (1976). Income distribution and development. American Economic Review, 66(5), 128–135. Alesina, A., & Rodrik, D. (1994). Distributive politics and economic growth. Quarterly Journal of Economics, 109(2), 465–490. Anand, S., & Kanbur, S. M. (1993). The Kuznets process and the inequality-development relationship. Journal of Development Economics, 40, 25–72. Babones, S. (2013). Inequality and growth. www.inequality.ord, 19 maggio 2013. Barro, R. (2000). Inequality and growth in a panel of countries. Journal of Economic Growth, 5, 5–32. Benabou, R. (1996). Inequality and growth, NBER. Macroeconomic Annual, 11, 11–74. Bouguignon, F. (1981). Pareto-superiority of unegualitarian equilibria in Stiglitz’ model of wealth distribution with convex saving function. Econometrica, 49(6), 1469–1475. Deininger, K., & Squire, L. (1996). New data set measuring income inequality. World Bank Economic Review, 10, 565–591. Dollar, D., & Kraay, A. (2002). Growth is good for the poor. Journal of Economic Growth, 7, 195–225. Forbes, K. (2000). A reassessment of the relationship between inequality and growth. The American Economic Review, 90(4), 879–887.

46

5 Inequality and Growth

Granger, C. W. J. (1969). Investigating causal relations by econometric models and cross-spectral methods. Econometrica, 37(3), 424–438. Kaldor, N. (1954). The relation of economic growth and cyclical fluctuations. Economic Journal, 64(253), 53–71. Krüger, A. B., & Mas, A. (2004). Strikes, scabs, and tread separations: Labour strife and the production of defective Bridgestone/Firestone tires. Journal of Political Economy, CXII(2), 253– 289. Kuznets, S. (1955). Economic growth and income inequality. American Economic Review, 45, 1–28. Li, H., Squire, L., & Zou, H. (1998). Income inequality is not harmful for growth: Theory and evidence. Review of Development Economics, 2, 318–334. Lundberg, M., & Squire, L. (2003). The simultaneous evolution of growth and inequality. The Economic Journal, 113, 326–344. Mankiw, N. G. (2013). Defending the one percent. Journal of Economic Perspectives, 27(3), 21–34. Marx, K. (1867) Capital: a critique of political economy, English translation, Pacific Publishing Studio (2010). Mirrlees, J. A. (1971). An exploration in the theory of optimal income taxation. Review of Economic Studies, 38(2), 175–208. Obama, B. (2012). Remarks by the President at a Campaign event in Roanoke, Virginia. July 13, http://www.whitehouse.gov/the-press-office/2012/07/13/remarks-president-campaignevent-roanoke-virginia Okun, A. (1975). Equality and efficiency: The big trade-off . Brooking Institution. Pagano, P. (2004) An empirical investigation of the relationship between inequality and growth. Bank of Italy, Discussion papers, 536. Papanek, G., & Klymn, O. (1986). The effect of income distribution on development, the growth rate and economic strategy. Journal of Development Economics, 23(1), 55–65. Pearl, J. (2009). Causality: Models, reasoning and inference, (seconda edizione). Cambridge University Press. Perotti, R. (1996). Growth, income distribution and democracy: What the data say. Journal of Economic Growth, 1(2), 149–187. Persson, T., & Tabellini, G. (1994). Is inequality harmful for growth? American Economic Review, 84(3), 600–621. Piketty, T. (2013). Le Capital au XXIe siècle, Éditions du Seuil, Paris, 2013. English edition, [Capital in the Twenty-First Century, 2014]. Harvard University Press. ISBN 978-0674430006. Robinson, J. (1962). Essays in the theory of economic growth. Macmillan. Stiglitz, J. E. (1969). The distribution of income and wealth among individuals. Econometrica, 37(3), 382–397. Stiglitz, J. (2012). The price of inequality: How today’s divides society endangers our future. W. W. Newton and Company. Todaro, M. P. (1997). Economic development. Longman. Tse, T. M. (2007). Buffett slams tax system disparities, Washington Post, June 27. World Bank. (2015). http://econ.worldbank.org/WBSITE/EXTERNAL/EXTDEC/EXTRES EARCH/EXTPROGRAMS/EXTPOVRES/0„contentMDK:20318302~menuPK:477901~pag ePK:64168182~piPK:64168060~theSitePK:477894,00.html

Chapter 6

Inequality of Opportunities

In the debate on the cause-effect relationship between inequality and growth and on the political actions to be adopted to pursue both the objectives of equity and efficiency of the economic system, it is necessary at this point to introduce an important distinction between inequality in the distribution of income and wealth and inequality of opportunities (Romer & Trannoy, 2015). This is a fundamental aspect neglected up to now. If, in fact, there can be doubts and controversial arguments regarding the natural causes of inequality and, in the economic sphere, about the sign of the relationship between inequality and economic growth (extensively documented in Chap. 5), probably few could argue against the fact that the failure of policies aimed at obtaining a substantial equality of the opportunities offered to the individual, is not only unfair, but also doomed to produce inefficiencies in the production system and, in this way, a slowdown in growth. Using the terminology introduced by Rousseau, political actions should translate into interventions aimed at the reduction of “social inequalities” alone, thus leaving “natural inequalities” (and therefore the associated differentials in individuals’ productivity) to produce income differences. In this sense, there would no longer be policies labeled as “right-wing” or “left-wings”, but only policies that are concerned on the dimensional growth of the pie to be shared and not just on the increase of some slices destined to a portion of the population to the detriment of another. Indeed, even an author who is traditionally placed on the right-wing such as the economist Greg Mankiw, who was formerly the president of the group of economic advisers to the presidency of GW Bush, states that: If individuals are prevented from following certain paths in life regardless of their ability, then it will be impossible for them to contribute fully to the growth of the economic pie. More specifically, if young people from less well-off families are prevented from continuing their education due to financial constraints, they do not accumulate the optimum amount of human capital. The outcome of this under-investment will be both unfair and inefficient (Mankiw, 2013).

© The Author(s), under exclusive license to Springer Nature Switzerland AG 2023 G. Arbia, Income Inequality, Redistribution and Economic Growth, SpringerBriefs in Economics, https://doi.org/10.1007/978-3-031-24851-1_6

47

48

6 Inequality of Opportunities

Equality of opportunities is therefore an objective to be pursued regardless of the different political inclinations. Several economists have expressed themselves in this direction. For example, John Roemer and Alain Trannoy (2015) consider the inequality that arises from the free choices of each one to be acceptable, but they suggest, instead, that we need to fight against the inequality that depends on external circumstances related to social factors that are beyond the individual’s control. Alan Krüger, President Obama’s economic advisor, also points out that in the presence of high social mobility there would be less concern about the general level of inequality (Krüger, 2012). The definition of a measure of the degree of equality in opportunities presents greater methodological problems than those discussed in Chap. 3 regarding the calculation of income inequality and these problems are still largely unsolved. Stiglitz proposes to measure this aspect through the intergenerational transmission of income: If America were truly the land of opportunity, the chances of success—let’s say climbing the top 10% of the social ladder—of someone born poor to a family with less education, should be the same as those born into a wealthy, highly educated and socially well connected family (Stiglitz, 2012). Other authors, founding on the intergenerational mobility model of Becker and Tomes (1979), have suggested the use of the so-called intergenerational elasticity whose calculation, like the measure suggested by Stiglitz, is based on the parent–child correlation in personal income (on this topic see also, e.g., Cappellari & Leonardi, 2015). Such definitions would therefore lead to the use of a statistical measure of correlation between parental income and children’s income as an indicator of equal opportunities. In a world of equal opportunity, an individual’s income should not be correlated with that of his or her parents. A strong positive correlation, conversely, indicates the failure of the equality of opportunities. Stiglitz states that the USA is not a land of equal opportunities because there we observe a high correlation between parental income and the income of children. Empirical results are observed in this direction also in Italy where, on the contrary, substantial social immobility is experienced. The sociologist Schizzerotto (2012) remarks: For almost the entire twentieth century, Italy has recorded rather high rates of upward mobility […] the phenomenon derives mainly from the upward shift of the employment structure, in turn linked to economic growth. But when the latter failed in the mid-nineties, the expansion of middle and senior social positions also ceased. He also notes that in Italy: Almost one third of those born in the period 1970–1984 found themselves, at their first job, in a lower social class than that of their father and that less than a sixth of them managed to improve their position with respect to that of origin (ISTAT, 2012). See also on the subject Schizzerotto & Marzardo, 2008). Some studies that have proposed to estimate the intergenerational elasticity (for example Checchi et al., 1999) confirm Schizzerotto’s conclusions and suggest that in Italy this mobility is very low and similar to that observed in the United States (see Cappellari & Leonardi, 2015 for some comparative results in a number of countries).

6 Inequality of Opportunities

49

While agreeing with the approach suggested by Stiglitz, Mankiw (2013) observes that the positive correlation between parental and child incomes could be a distorted measure of inequality of opportunity as the intergenerational transmission of income has many causes that do not have to do with it. For example, parents and children share genes and DNA, a situation that would generate generational persistence even in a world of perfect equality of opportunities. The IQ, for example, has a high level of inheritance and, as a consequence, brighter parents have more often brighter children and this generally tends to produce similar levels of income. Other characteristics linked to success and income have strong hereditary characteristics (such as, for example, self-control, ability to concentrate, ability to synthesize, property of language and exposure) and are also influenced by the example of parents and from imitative effects. A measure of equality of opportunity should therefore consider the correlation between parental income and children’s income, conditional on all these disturbing factors. The statistical methodology presents many possible measures that are suitable for this purpose. However, the exam of new objective measures of inequality in opportunities (although very exciting from a research point of view) would take us away from the limits that we have imposed on ourselves in the present discussion and it is left, perhaps, to some future work together with the analysis of the related empirical findings. In the present chapter, however, we will focus on some aspects which irrefutably are in contradiction with the principle of equal opportunities and therefore (for what has been said before), are doomed to slow down the growth of a country. The first of these aspects concerns the opportunities for access to education and therefore to the training of human capital. It has been observed in several stages during this discussion how investment in human capital represents one of the fundamental elements in determining the growth of a country. The importance of this element has been emphasized with insistence and authority recently by the Governor of the Bank of Italy Ignazio Visco who dedicated various public and written interventions to the subject (Visco, 2009, 2011). In particular, in his book “Investing in knowledge” (Visco, 2009) the Governor starts from the analysis of the great changes of our time, identifying the great evolutionary phenomena that have affected all the countries of the world (globalization, new technologies, upheavals demographic and climatic ones) which can only be addressed and governed through interventions on the level of human capital. The crises of the last years linked to the pandemic emergency and to the geopolitical instability have only further sharpened the situation and accelerated the need for political intervention. Recognizing that investing in education, human capital and knowledge is today an essential factor in productivity and economic growth, Visco also affirms that. The improvement of human capital cannot […] be separated from decisive interventions on schools and university (Visco, 2009). Visco goes beyond a simple analysis of the problem and suggests some possible lines of action. Among these, a fundamental role is assigned to the enhancement of merit. At the level of access to studies, an enhancement of merit would imply.

50

6 Inequality of Opportunities

Higher levels of school fees (corresponding to the cost of ‘investing’ in human capital) accompanied by a large number of scholarships for the most deserving and for the less well-off (Visco, 2009). This intervention would first of all favor greater equality of opportunities, enhance the intellectual potential of a country, improve efficiency and promote growth by reducing inequality. The conclusions are that in the current framework. It seems crucial to continue in the direction of giving increasing weight in public funding to the evaluation of research quality. At the same time, awareness of the costs and prospective returns of investing in more advanced levels of education must be encouraged, seeking more efficient forms both for its functioning […] and for the removal of the constraints that prevent effective equality of access to students (Visco, 2009). A similar argument is exposed in the study by the OECD Department of Economics (Oliveira-Martins et al., 2007). Political measures that increase the equality of investment opportunities in human capital would therefore necessarily have positive effects both on income inequality and on economic growth. A second aspect that deserves attention concerns the progressiveness of taxes with a specific focus on inheritance tax. In the United States, the inheritance tax is considered a form of intergenerational redistribution that is indispensable to avoid that, in the long run, wealth remains confined into the hands of a few families with disastrous consequences for the entire economy as well as for democracy. This form of taxation is sustained on the basis of one of the founding principles of US society, namely the merit of the person. The appeal signed by a group of American billionaires (including Warren Buffett and Bill Gates) generated a big discussion in the US. They took a stand in support of an increase in inheritance tax rates under the banner “United for a fair economy1 ”. Observing how they themselves owe a large part of their fortunes to public spending on schools, infrastructure and health, they state in the appeal: We believe it is right to impose a significant inheritance tax on large estates as they pass to the next generation. We believe it is morally and economically fair and that an inheritance tax promotes democracy by slowing down the concentration of wealth and power (Fair Economy, 2012). This statement follows Warren Buffett’s utterances in November 2007 when, during a hearing at the US Senate Finance Committee in Washington, he introduced his report with these words: Dynastic wealth, the enemy of democracy, is gaining space. Equality of opportunity is declining. A significant and progressive inheritance tax is needed to curb the movement that from a democracy is leading us to plutocracy. This topic has recently become very hot. In 2020, the New York Times published Donald Trump’s tax returns showing that legally he did not pay any income tax in ten of the last fifteen years. More recent years, the New York investigative journalism company ProPublica (https://www.propublica.org/), released data from the American Internal Revenue Service concerning the income of the 25 richest individuals in the 1

https://www.faireconomy.org/.

6 Inequality of Opportunities

51

US, some of them with assets that exceeded 1 hundred billion dollars, like, e. g., among them Elon Musk of Tesla, Jeff Bezos of Amazon, Warren Buffett of Berkshire Hathaway and Mark Zuckerberg of Meta. In the article (Eisinger et al, 2021) we read: At the end of 2018, the 25 billionaires held 1.1 trillion dollars. It would take 14.3 million US wage municipalities to achieve the same amount of wealth. The payment of the federal tax on the personal income of the ultra-rich 25 in 2018 was 1.9 billion. The payment for the 14.3 million common employees was 143 billion. As a matter of fact, the middle class population paid 75 times higher income tax than billionaires. In the same article it is stressed that the dramatic increase in the value of the wealth held by the richest individuals was not followed by an increase in their contribution to the Federal Treasury. For example, Bezos legally did not pay any income taxes in 2007 and 2011. Furthermore, while his assets grew by 127 billion in the years between 2006 and 2018, the founder of Amazon paid income taxes of 1.4 billion with a real tax rate of only 1.4%. Similarly, Buffett, in the years between 2014 and 2018 increased his shares by 24.3 billion, but experienced a true tax rate of only 0.1% (Eisinger et al, 2021). Eisinger et al. (2021) also explain why these very rich people do not have to pay taxes. The reason is quite obvious. Zuckerberg (Facebbok-Meda), Larry Ellison (Oracle’s) or Larry Page (Google) receive an annual wages of one dollar. Bezos receives a middle-class salary of about $ 80,000 a year. Thus all the prosperity of these billionaires is concentrated in the form of assets that grow with the increase in the value of the shares, and, as such, are not taxable for the US law. These very wealthy people usually do not to pay themselves taxable dividends, but often pledge their shares to banks to obtain loans that lead to a lifestyle commensurate with their wealth. In 2021 Elon Musk obtained a $ 57.7 billion-backed loan from his Tesla stock to finance his Bel Air mansion, two personal planes and more. Ellison pledged $ 10 billion in Oracle stock in 2014, and so do many others. Capital gains and inheritance taxes are never paid in the US. The former are set to zero upon the death of the owner and the inheritance tax can be legally circumvented by putting the money in a “trust” for philanthropic purposes. Saez and Zucman (2021) calculated that US billionaires currently own $4.25 Trillion, of which a large share ($2.7 Trillion) are represented by gains on which they haven’t paid any tax upon. The two authors also calculated that during Covid19 health emergency, billionaires untaxed gains have further increased by $1.25 Trillion. On this basis, they propose to impose a one-time tax on the stock of billionaires’ unrealized gains at the ordinary tax rate a policy measure that could raise approximately $1 trillion. The authors claim that this policy would produce several positive effects and not a single drawback. It would be a one-time tax of gains that have already been accumulated, thus it would not create adverse economic incentives; it would be an extra burden only on few billionaires who were going to avoid taxes on their gains; and finally it would be imposed only on less than 1,000 billionaires, so it would be feasible feasible. A similar situation to the United States occurs in many other countries. In Italy, for example, the Italian tax system is only mildly progressive, with rates ranging

52

6 Inequality of Opportunities

between about 40% of individual income for the poorest (up to 25,000 euros per year), and just over 50% for individuals with income over 65,000 euros. However, the system becomes even regressive for 5% of the richest taxpayers: exceeding e 90,000, the effective tax rate begins to decrease, falling to 36% for the top 0.1%, with average annual incomes greater than e 1 million. as shown by Guzzardi et al (2022). In order to better clarify the terms of the discussion taking place in the United States, it should be noted that the inheritance tax, after the progressive strong reduction of the rates desired by George W. Bush between 2001 and 2006, was reinstated starting from 2006 for the hereditary assets exceeding 2 million dollars with progressive rates ranging from 18 to 40%. The minimum threshold has grown over the years, currently reaching 5,3 million. In the UK the inheritance tax rate is 40% for inheritances over £ 325,000, but it is only charged on the part of the assets that’s above the threshold. In Germany the rate ranges from 7 to 50% for inheritances exceeding a certain threshold. The threshold ranges from EUR 20,000 to EUR 500,000, depending on the relationship between the decedent and the beneficiary and the value of the net inheritance. In the Netherlands the rates vary a lot depending on the relationship with the decedent. Indeed, in 2021 the rates were 10% on inheritance below e126,723, and 20% on any inheritance above the threshold for spouse/partner and children; 18% below e126,723 and 36% above for grandchildren and 30% below e126,723 and 40% above for all other beneficiaries. In France, the tax is progressive with seven rates ranging from 5 to 45% for direct descendants and up to 60% for other heirs without any exempt share. In Spain, progressive rates are adopted which range from 7.65 to 36.5% divided into different brackets of hereditary assets. In Italy the hereditary tax was totally abolished in 2001, reinstated in 2006 and currently establishes rates ranging from a minimum of 4% on the amount exceeding 1 million Euros for direct descendant to a maximum of 8% for strangers without any exemption. These rates exclude any form of progressiveness and are placed at much lower levels than the other European partners. An increase in inheritance taxes was also recently requested from Italy by the International Monetary Fund. Eyrand (2014) notes that Italy currently draws 520 million euros from inheritance taxes, equal to 0.03% of the Gross Domestic Product and 1% of the total tax revenue. The study concludes by suggesting the adoption of a progressive increase in the rates of inheritance tax to improve social solidarity. The adoption of a progressive rate would allow Italy to achieve a more ambitious equality of opportunities (Eyrand, 2014). Similar trends are observed elsewhere in Europe, as it is the case in Austria, Norway, Portugal, Sweden, Slovakia, Estonia which have completely abolished this tax. Elsewhere in the world no inheritance tax is imposed for instance in Hong Kong, Singapore, Macao, Mexico, Canada, New Zealand and Australia. Eyrand’s views appear to be officially shared by the International Monetary Fund. In the 2103 country report, for example, we read. The increase in inheritance tax should be considered to generate savings and make the tax system more progressive (IMF, 2013). Of the same opinion is Piketty who in an interview (Piketty, 2014) argues that.

References

53

The inheritance tax is a residual tax and it is a tax that cannot penalize income. If it is done properly the children inherit something they did not have before. Therefore, even if it is a tax, it does not penalize consumption. And he also states that: Italy, in this sense, is a singular exception. […] I believe that Italy must pose the problem of progressive taxation on inheritances, which keeps them low for small ones and which makes them grow as the amounts increase (Piketty, 2014). Investments in human capital and the scarce progressiveness of taxes are two of the key elements on which to draw attention if the goal of a greater level of equality of opportunities is pursued. As it is natural, different positions can be taken on the subject which in turn can suggest different policy measures. However, it is necessary to recognize how the achievement of this goal is of fundamental importance in order to boost growth, especially in the period of strong economic contraction that we are experiencing in recent years.

References Becker, G. S., & e Tomes, N. (1979). An equilibrium theory of the distribution of income and intergenerational mobility. Journal of Political Economy, 87(6), 1153–1189. Cappellari, L. e Leonardi, M. (2015) Disuguaglianza e mobilità dei redditi, in pepi de caleo e brucchi luchino, Manuale di Economia del Lavoro, il Mulino 2015 Checchi, D., Ichino, A., & e Rustichini, A. (1999). More equal but less mobile? education financing and intergenerational mobility in Italy and in the US. Journal of Public Economics, 74(3), 351– 393. Fair Economy (2012) United for a fair economy statement, http://www.faireconomy.org/ Eisinger, J., Ernsthausen, J & Kiel, P. (2021) The Secret IRS Files: Trove of never-before-seen records reveal how the wealthiest avoid income tax, June 8, 2021, 5 a.m. EDT, ProPublica. Eyrand, L. (2014) Reforming capital taxation in Italy, International Monetary Fund, Working Paper, 14/6. Guzzardi, D. , Palagi, E., Roventini, A. & Santoro, A. (2022) Reconstructing income inequality in italy: new evidence and tax policy implications from distributional national accounts, lem working paper series, 2022/06. IMF (International Monetary Fund) (2013) International monetary fund country report no. 13/298, settembre 2013. ISTAT (2012) Rapporto ISTAT 2012, La situazione del paese, Roma. Krüger, A. B. (2012) The rise and consequences of inequality in the United States, www.whitehous e.gov. Mankiw, N. G. (2013). Defending the one percent. Journal of Economic Perspectives, 27(3), 21–34. Oliveire-Martins, J., Boarini, R., Strauss, H., de Maisonneuve, C. e Saadi, C. (2007) The policy determinants of investment in higher education, OECD Economic Department, Working Paper, 576. Piketty,T. (2014) Vogliamo crescere ? tassiamo I grandi patrimoni, Interview, Linkiesta, http:// www.linkiesta.it/intervista-piketty. Romer, J. E. e Trannoy, A. (2015) Equality of opportunity, in Atkinson, A. B., Bourguignon, e F. (Eds.), Handbook of Income Distribution, 2, Amsterdam, Elsevier, 217–300. Saez, E. and Zucman, G. (2021) How to Get $1 Trillion from 1000 Billionaires: Tax their Gains Now, https://eml.berkeley.edu/~saez/SZ21-billionaire-tax.pdf

54

6 Inequality of Opportunities

Schizzerotto, A. & Marzadro S. (2008) Social mobility in italy since the beginning of the twentieth century, rivista di politica economica, Settembre-ottobre 2008, 1-40. Schizzerotto, A. (2012) Mobilità sociale: in Italia è ferma, “la voce.info”, 24 maggio. Stiglitz, J. (2012) The price of inequality: how today’s divides society endangers our future, W. W. Newton and Company. Visco, I. (2009) Investire in conoscenza: crescita economica e competenze per il XXI secolo, il Mulino. Visco, I. (2011) Il capitale umano per il XXI secolo, Il Mulino, LX, 453.

Chapter 7

Recent Trends of Growth and Inequality in a Post-pandemic World

In the moment when this book is printed, we are still facing the big emergency of the Sars-CoV-2 pandemic whose effects on the economy (as well as on all other aspects of human lives) were devastating. Further instability and economic uncertainty were created worldwide by the geopolitical instability following the Ukrainian war started in February 2022. Even if this essay is certainly not the most suitable place to comment on these dramatic events, and, moreover, it is still too early for any conclusive considerations about the impact of them on economic growth and inequality, we believe, however, that our readers would probably be disappointed if these topics were completely neglected in the present discussion. For this reason, we deem it necessary to discuss them, although very briefly, in this last section of our book. The shocking effects on inequality of the health emergency linked with the worldwide diffusion of the Sar-Cov-2 virus have been the focus of interest in many papers published in the last two years, whose results are yet not conclusive. For instance, Esseau-Thomas et al. (2022) showed that the number of deaths per inhabitant had a significant positive effect on the increase of Gini coefficient of inequality. On the other hand, Chen et al. (2021) investigated the effects of the Covid19 pandemics on income by studying the relationship between a measure of pandemics uncertainty (called the World Pandemic Discussion Index, WPDI) and the post-tax Gini coefficient. The empirical results indicate that the WPDI is negatively related to income inequality in 107 non-OECD countries, but, conversely, positively associated with income inequality in 34 OECD economies. Adarov (2022) showed that the COVID-19 pandemic exacerbated global income inequality, up to the point of reversing the positive effects of decline recorded in the previous two decades. Weak recoveries in emerging market and developing economies are expected to further increase between-country inequality. Within-country income inequality is also estimated to have increased somewhat in emerging market and developing economies because of severe job and income losses among lower-income population groups as a consequence of the pandemic. Furthermore, the rising of inflation, and the disruptions in education related to Covid could further increase within-country inequality in the medium and long run. Studying the effects of pandemics on income inequality © The Author(s), under exclusive license to Springer Nature Switzerland AG 2023 G. Arbia, Income Inequality, Redistribution and Economic Growth, SpringerBriefs in Economics, https://doi.org/10.1007/978-3-031-24851-1_7

55

56

7 Recent Trends of Growth and Inequality in a Post-pandemic World

Table 7.1 Gini index recent post-pandemic trends

Country name

2019

2020

Gini index trend 2019–2020

Armenia

29.9

25.2

−4.7

Brazil

53.5

48.9

−4.6

Dominican Republic

41.9

39.6

−2.3

Paraguay

45.7

43.5

−2.2

Russian Federation

37.7

36

−1.7

Georgia

35.9

34.5

−1.4

45.4

−1.3

Mexico Ukraine

26.6

25.6

−1

Belarus

25.3

24.4

−0.9

Kyrgyz Republic

29.7

29

−0.7

Argentina

42.9

42.3

−0.6

Indonesia

37

37

0

Thailand

34.9

35

0.1

Chile

44.9

0.5

Uruguay

39.7

40.2

0.5

Costa Rica

48.2

49.3

1.1

Ecuador

45.7

47.3

1.6

Bolivia

41.6

43.6

2

Peru

41.6

43.8

2.2

Colombia

51.3

54.2

2.9

Source https://data.worldbank.org/indicator/NY.GDP.PCAP.CD

from an historical point of view, Sayed and Peng (2021) concluded that the effects of COVID-19 on inequality cannot yet be well identified due to some contrasting evidences. In fact, from one side a typical characteristics of the COVID-19 pandemic is that the fatalities are concentrated in older age groups. Therefore, from this point of view, we should not expect neither labor scarcity nor a decline in productivity, hence no systematic negative effects on inequality. However, we should also expect a reduction in consumption and savings and a raise in unemployment rates and in public debt, which in the medium run could produce a negative effect on income inequality. In terms of empirical data available to support these theoretical considerations, when this book is printed the World Bank released the Gini index 2020 updates for only 20 countries. These data are reported in Table 7.1. The evidences are contrasting. Eleven countries recorded a reduction of inequality in the first post-Covid year, whereas the remaining countries reported an increase with a significant increase (more than 2 percentage points) in some south American countries like Bolivia, Peru and Colombia. It is a noticeable that there is only one OECD country that recorded a reduction of the inequality (Mexico).

7 Recent Trends of Growth and Inequality in a Post-pandemic World

57

Fig. 7.1 Post-Covid (2019–2020) trend of per capita GDP in a set of countries. Source https://data. worldbank.org/indicator/NY.GDP.PCAP.CD

Even if the data are still largely insufficient to draw any definite conclusions, it is however clear that reversing the worldwide increase in income inequality will require exceptional policy measures to reduce between-country and within-country inequality, underpinned by support from the global community. Turning now to examine the effects of the last years’ uncertainty on economic growth, (initially already documented in Sect. 4.2), we considered the per-capita GDP trend in the period 2019–2020 in a list of countries in the world. The evidence is rather clear. Most of the countries in the World bank database (154 countries out of 198, amounting to 77%) experienced a decline in the per capita GDP, while only the remaining 23% recorded an increase. Figure 7.1 reports the annual 2019–2020 growth of per capita GDP for the same set of countries already considered in Fig. 4.7. The graph shows a decrease or only a moderate increase for all countries with the only remarkable exception of Ireland that recorded a growth of more than 5%. The ten worst performing countries in the World bank database are reported in Table 7.2 which shows that Macao and Lybia observed a dramatic decrease of more than 50% in only one year! Among the 44 countries in the dataset that recorded a growth in the per-capita GDP from 2019 and 2020, it is remarkable the fact that only 8 of them are OECD countries (Poland, Finland, Israel, Sweden, Switzerland, Denmark, Luxembourg and Ireland) with only three of them (Switzerland, Luxembourg and Ireland) reporting an increase greater than 1%. Indeed, after decelerating between 2017 and 2019, the global economic growth collapsed in 2020 under the impact of the COVID-19 pandemic, with the GDP falling sharply in all economies under the effects of the lockdown measures and of the related enterprise closures. The International Monetary Fund (IMF, 2020a, 2020b) projected that the global economy, after a growth of 2.8% in 2019, would fall down by 4.4% in 2020, with a steeper decline in advanced economies than in emerging economies. However the long run effects are still difficult to imagine. The IMF warns that the

58 Table 7.2 Ten worst performing countries in the world in terms of the per-capita income in 2019–2020

7 Recent Trends of Growth and Inequality in a Post-pandemic World Countries

Per-capita income trend 2019–2020

Macao SAR, China

−54.3

Libya

−51.9

Lebanon

−38.7

Angola

−36.8

Maldives

−34.4

Seychelles

−33.7

Iraq

−30.7

Suriname

−28.3

Bahamas, The

−25.5

Zambia

−24.6

Source https://data.worldbank.org/indicator/NY.GDP.PCAP.CD

diverse impacts on low-income households will be particularly acute, frustrating the small progresses obtained in the last decades in the reduction of worldwide inequality (IMF, 2020a).

References Adarov, A. (2022). Global income inequality and the COVID-19 pandemic in three charts World bank blogs, February 07, 2022. Chen, T., Gozgor, G., & Koo, C. K. (2021). Pandemics and income inequality: What do the data tell for the globalization era? Public Health. https://doi.org/10.3389/fpubh.2021.674729 Esseau-Thomas, C., Galarraga, O., & Khalifa, S. (2022). Epidemics, pandemics and income inequality. Health Economics Review, 12, 7. IMF (International Monetary Fund). (2020a). World economic outlook update, October 2020a: A long and difficult ascent. Washington, DC. IMF (International Monetary Fund). (2020b). Fiscal monitor database of country fiscal measures in response to the COVID-19 pandemic. Available at: https://www.imf.org/en/Topics/imf-and-cov id19/Fiscal-Policies-Database-in-Responseto-COVID-19 Sayed, A., & Peng, B. (2021). Pandemics and income inequality: a historical review. SN Business & Economics, 1, 4:54. https://doi.org/10.1007/s43546-021-00059-4

Chapter 8

Summary Remarks

In this work, we have set ourselves the goal of studying the complex relationship between inequality and economic growth and the redistributive phenomena related to this relationship. Contrary to what happens in the exact sciences, where theoretical hypotheses of general rules can be replicated through experiments to verify their truthfulness, in economics and in social studies the desire to identify universal laws of behavior is almost invariably doomed to be disappointed and we must be satisfied, in the best of the cases, with approximations that are valid only for certain geographically and temporally delimited situations. The relationship between inequality and growth that we have discussed in the previous pages is no exception. In fact, we have seen how it depends on a large number of factors such as the geographical area of observation, the historical period, the wealth of a country and its evolutionary stage, just to enumerate a few. Discounted of this transience, which is inherent in every conclusion in the economic field, the most convincing arguments that we analyzed in Chap. 6 go in the direction of a circular mechanism of causation. In a nutshell, high levels of per capita income growth seem often to lead to the worsening of the concentration of income in the hands of a few earners and, therefore, to a greater inequality. However, this mechanism should not be interpreted as the possibility that growth and inequality can coexist for a long time because high levels of inequality establish an opposite cause-effect mechanism which tends to slow down growth. In the absence of redistributive interventions, this can trigger a spiral which, in the mature phases of the economy, can lead to the implosion of the economic system. This regressive spiral can only be stopped with a decisive redistributive intervention. To clarify the scope of this intervention and its room for maneuver, it is useful to return to reflect on the meaning of income inequalities as we did at the beginning of this essay. In this sense, a fundamental distinction is that which is at the root of the causes of the differences between the various economic agents. Indeed, income differentials between individuals can be traced back to two distinct factors which have diametrically opposite implications. © The Author(s), under exclusive license to Springer Nature Switzerland AG 2023 G. Arbia, Income Inequality, Redistribution and Economic Growth, SpringerBriefs in Economics, https://doi.org/10.1007/978-3-031-24851-1_8

59

60

8 Summary Remarks

Referring to the Rousseauian categories, it can be said that they may be due to natural and social differences. The natural differences between individuals, for example in their intelligence quotient, in their interpersonal skills, in their manual skills, etc., in fact, lead to a different productivity of labor which, according to neoclassical principles, translates into wage differentials and therefore into income inequality. However, this inequality is a “good” inequality as it is associated with factors that stimulate economic growth. Who can disagree with Mankiw (2013) when, in the example given in Chap. 3, he states that the arrival of a brilliant entrepreneur on the perfect (and also very boring) island of Utopia where everyone has the same income, is positive for everyone? And who can object to the fact that from his arrival and from his entrepreneurial activity all the inhabitants of the island benefit both directly from the satisfaction deriving from the innovation introduced, and indirectly from the demand for work that it generates? However, in an uncontrolled system, the innovator (and increasingly his/her descendants not necessarily endowed with the same natural qualities) would gradually benefit from competitive advantages, position rents and barriers to entry which, in the long run, could generate income differentials based no longer on natural, but rather on social inequalities. This second type of inequality that can be observed is a “bad” inequality which is destined to slow down rather than accelerate economic development. The relative weight and internal tensions of these two components of the same phenomenon are affected by the evolutionary stage of the economy, the system of rules and a set of many other factors. They may underlie the different and sometimes conflicting results documented in Chap. 5. A study that I would like to do (and that perhaps one day I will do) concerns the possibility of decomposing Gini’s income inequality indicator into two components due to natural differences and social differences between individuals, perhaps referring to Stiglitz’s suggestions on intergenerational correlation between parents’ income and children’s income. If this decomposition were to be achieved, we would observe that inequality in incomes due to natural causes can only have a beneficial effect on economic development and growth, through the mechanism of incentives, since some individuals will produce more than others because of their innate abilities. On the contrary, the presence of social inequality can only curb growth through an infinity of different mechanisms, be them the Stiglitz’s rent seeking or Piketty’s self-reproduction of capital or the credit market failures and social stability invoked by Barro. It is the dichotomy between income inequality and inequality of opportunity that we have already dealt with in Chap. 6. Economic policies that aim a greater system efficiency and growth should therefore favor the first type of inequality (for example with the incentive of merit) and repress the second type decisively. In recent years many countries around the world and specifically many OECD countries, are experiencing high and growing levels of inequality together with alarming low growth rates in per capita income. Given the relationship between the two variables widely discussed in this essay, this can lead to a further contraction of the economy until its collapse. If you accept the point of view previously expressed, the recipes available to prevent this from happening are extremely simple in their

8 Summary Remarks

61

substance and destined to achieve your goals if we are willing to wait patiently for their effects. Summarizing what has already been argued above, the measures to be taken should concern at least three fields of intervention. First of all, the realization of a substantial progressivity of income tax especially at the higher levels accompanied by a downward revision of the tax rate curve so as not to reach the super rates introduced by Harold Wilson in the 1960s in the UK and stigmatized with irony in George Harrison’s famous song ‘Taxman’ Harrison in which the Beatles sang: There is one for you, nineteen for me… should 5% appear too little, be thankful I don’t take it all (Beatles, 1966).

Secondly, the introduction of progressivity also in inheritance tax currently characterized by very low rates in many countries. Contrary to the tax on income deriving from work and capital, among other things, inheritance tax implies an increase in revenue without the risk of inducing negative effects on either consumption or investment. Finally, the additional revenue deriving from the introduction of progressivity in the inheritance tax could be used in part for the increase in public investment, especially in human capital and scientific research which, as we have seen, represent two of the main engines of growth. Such policy measures, if taken jointly, would certainly benefit economic growth to the advantage of all social components, also those that are initially disadvantaged. At the same time, they would go towards achieving a redistribution of income in a more egalitarian sense which, as we have seen, could further stimulate growth as well as achieve a social objective. Human societies have always alternated on the world historical stage as a result of natural events, demographics, inventions or wars through which some cultures have imposed themselves and others have disappeared. This is the phase we are experiencing. The major changes in terms of economic development analyzed in Chap. 4 are the effects of such shocking events as mentioned in Chap. 6. Information relating to many OECD countries, if read in an objective and disenchanted way, are extremely alarming and require a decisive intervention in public action with returns that will necessarily be delayed over time. It is not essentially an ethical problem of the fight against poverty and social solidarity on which one can have different positions and to which one can decide to devote different resources according to each one’s political inclinations. It is instead a problem of survival of a system that disregards these inclinations. The battle on this front is extremely difficult and requires decision, time, and patience, but if it is not fought, we are already resigned to giving way to other civilizations and to occupy only an important place in the history books. In that moment there will no longer be any discussion on wealth and poverty, nor of inequality, nor of right-wing and left-wing thinking.

62

8 Summary Remarks

References Arbia, G. (2016). Diseguaglianza, redistribuzione e crescita. Vita e Pensiero. Beatles. (1966). Taxman. In: Revolver. EMI Parlophone. Champerowne, D. (1952). The graduation of income distribution. Econometrica, 20. Gini, C. (1912). Variabilità e mutabilità, Bologna. Partial English translation Cerani, L and Verme, P (2012) The origin of the Gini index: Extracts from Variabilità and Mutabilità (1912) by. The Journal of Economic Inequality, 10, 421–443. Mankiw, N. G. (2013). Defending the one percent. Journal of Economic Perspectives, 27(3), 21–34. OCSE. (2014). Focus on inequality and growth. December 2014. Petri, E. (1973). Property is no longer a theft. Movie distributed by Titanus. Sachs, G. (2007). BRICS and beyond—Goldman Sachs study of BRIC and N11 nations, 23.