Why Income Inequality Hurts Economic Growth? There’s a continuing debate as to the broader impact of income inequality. Some claim that while it hurts those who experience it, there’s not a wider effect. On the other side of the issue are the theories that with more concentration of wealth in fewer hands, there’s an impact on the economy overall.
According to a new study from the Organization for Economic Co-operation and Development, the latter are right. There is and has been a reduction of economic growth because of the growing concentration of income among a smaller portion of the global population.
According to the OECD, the gap between the richest and poorest in most member countries is at its highest in the last 30 years. In addition, a broader measure of inequality called the Gini constant (0 when everyone has the same income and 1 when a single person has all income) has been on the rise. The U.S. is at the top of the scale except for Mexico, which has by far the worst income inequality of the OECD states.
The new OECD analysis found a “negative and statistically significant” correlation between income inequality and economic growth. Specifically, the 3 Gini point rise in inequality that was the average for OECD states over the last 20 years meant 0.35 percent less economic growth per year for the same time, or a total 8.5 percent GDP loss in that period. Here’s a graph that shows the hit various national economies have taken as a result, along with an explanation of the impact.
“Rising inequality is estimated to have knocked more than 10 percentage points off growth in Mexico and New Zealand, nearly 9 points in the United Kingdom, Finland and Norway and between 6 and 7 points in the United States, Italy and Sweden. On the other hand, greater equality prior to the crisis helped increase GDP per capita in Spain, France and Ireland”.
Even at 6 points, that would be a 0.3 percent hit to U.S. GDP every year for the last 20.
The inequality problem is not one of the poorest of the poor in a country. It’s the bottom 40 percent by income, according to the OECD study, which makes sense if you consider the rationale behind why inequality can hurt an economy.
Growth happens when lots of people spend money. In the U.S., for example, the small number of people at the top of the economic ladder can’t consume and spend at the rate that the broader population can. And the distribution of income means that there are many more in the bottom 40 percent by income than there are in the top 40 percent by income. Unless a policy addresses lower incomes, and not just official poverty, it won’t succeed in helping the economy.
The OECD said that certain types of income redistribution — specifically, high-value services like good education and healthcare — increase, and not decrease, economic growth if effectively targeted without inefficiency and waste.