This week, my ECONS102 class has been covering poverty and inequality (along with social security and predistribution/redistribution). Today in class we covered some of the negative things about inequality - mostly a laundry list of the ways in which higher inequality might create negative externalities.
One of the negative externalities is that higher inequality might inhibit economic growth. This one is contentious, and certainly not settled in the empirical literature, although there are some good theoretical reasons to expect the relationship to exist (for example, see the mechanisms discussed in this post). You can also illustrate the expected relationship narratively, as I did in class. Something like this:
Imagine you are about to start a race, and it's a race that you really want to win. How hard would you try if you found out just before the race started than some other runners were being given a two-lap head start? Now, haw hard would you try if you found out that you were being given a two-lap head start over everyone else?
In both cases, the incentives to work hard (and run fast) are reduced for most people (although one student today did perceptively point out that in the first case, you either try much harder, or not at all). Now, as I said, despite the attractiveness of this narrative, the empirical evidence is inconsistent in its support. So, I was interested to read this 2018 article by Mauro Costantini (Brunel University London) and Antonio Paradiso (Ca' Foscari University), published in the journal Economics Letters (sorry, I don't see an ungated version online). They use US annual state-level data covering the period from 1960 to 2015, and plot the relationship between GDP per capita and income inequality (measured by the Gini coefficient). The relationship is clearly shown in their Figure 1, Panel A:
The results are interesting, implying that increasing GDP per capita was associated with lower income inequality at low levels of GDP per capita, then the relationship reversed, and finally reversed again at the highest levels of GDP per capita. They refer to this relationship as 'S-shaped', and also find a similar looking relationship when controlling for expenditure on health care per capita, or expenditure on welfare per capita.
This research is far from the last word on this topic, but perhaps it might go some way towards explaining the inconsistent relationships shown in the rest of the literature so far?
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