Stalling growth and development – The consequences of inequality
Inequality hinders sustainable economic growth, allows the rich a disproportionate share of political power, and fosters violence and criminality. Unequal societies have lower life expectancies and suffer more from diseases than more equal societies.
Take, for example, a brilliant child living in a Delhi slum, unable to fulfil her potential to become a successful businesswoman because her parents cannot afford to send her to school. Or a child born in rural Zimbabwe who has a much greater chance of dying before the age of three than the child of well educated parents in a wealthy neighbourhood in Harare. Or the staggering discrepancies in educational opportunities between a Swiss child and a child from a South African slum.Many politicians and academics believe unequal opportunities like this are unfair. But why? The World Bank’s World Development Report 2006 ‘Equity and Development’ argues that there is a difference between deserved and undeserved inequalities. Deserved inequalities reflect your efforts, what you have done with the talents you were born with. Undeserved inequalities arise and persist due to circumstances beyond your control. The report concludes that everyone should have equal opportunities and people should be compensated for undeserved inequalities. 1This article looks at unequal opportunities and other consequences of inequality, including criminality, lack of sustained economic growth and democracy, economic crises and political instability. It distinguishes between economic, social and political consequences.
Economic consequences: the IMF changes course
High-level IMF economists Andrew G. Berg and Jonathan D. Ostry recently found that inequality leads not to sustainable economic growth, but interrupted growth of a relatively short duration. “To borrow a marine analogy: a rising tide lifts all boats, and our analysis indicates that helping raise the smallest boats may help keep the tide rising for all craft, big and small.” 2 Berg and Ostry found that longer growth spells are robustly associated with more equality in income distribution. Unequal countries like Nigeria in the 1960s and 1970s and Cameroon in the late 1970s and early 1980s did experience short periods of growth but their economies shrank again in the subsequent decade. The problem is not kick-starting growth but achieving sustainable growth in the long term.This is quite a significant change in the standpoint of the IMF, which was heavily criticized, for example by the anti-globalization movement, for its pro-trickle-down stance. Berg and Ostry seem to turn around the causality of the long dominant trickle-down theory, assigning it to the museum of doctrines that have been proved wrong.Until very recently, however, many economists believed that economic growth would reduce inequality, rather than the other way around. Neoclassical economists believe that when economic growth occurs, the rich spend more on luxury goods, creating jobs for the non-rich. The latter then have more to spend, creating new jobs in, for example, the construction sector, as they can afford better housing. In this way, the wealth of the rich slowly trickles down to the non-rich, leading to the emergence of a middle class as long as there is economic growth. Post-Keynesians like Nicholas Kaldor take the oppostie view, that job creation and the emergence of a middle class depend on investment, which is prior to economic growth. (More on this in the box below.)
Focus on economic growth or investments? The neoclassical versus the post-Keynesian economics debate
Neoclassical economists focus on inequalities in productivity among individuals. They start from the moment when inequalities in talents/endowments have already been distributed. As some individuals are more productive than others, income inequalities are justified. The more productive you are, the more you earn. Neoclassical economists warn against the costs of income redistribution. People need incentives to work hard and to be competitive. That is why inequality is not a bad thing: it helps people to become competitive. This does not mean that neoclassical economists are in favour of unequal opportunities or access to education. Their argumentation simply starts after the distribution of talents/endowments has already taken place. For neoclassical economists, trickle-down occurs as long as people work enough. They earn money they can spend…▶
The neoclassical view was strongly defended by institutions like the World Bank and the IMF until recently (see box on ‘Washington consensus and trickle-down’). And the IMF is not alone in changing its views on inequality and economic growth. The World Bank took a first step in this direction as long ago as its 2006 World Development Report ‘Equity and Development’, already referred to in the introduction. As LSE economist Robert Wade shows, in 2006 it was a struggle to get the topic of the report approved by the Bank’s governing board. 3 The executive directors, who represent member governments, argued that ‘inequality was inherently a political subject that the Bank, as an apolitical organization, should not be talking about’. The board could live with the report’s focus on equity – meaning more equal opportunities to earn income – because it was apolitical. (See ‘How the World Bank, IMF and OECD changed their course’.)Today, however, World Bank economist Martin Ravallion is arguing that poverty hinders economic growth. 4 Although poverty is not the same as inequality, the two are interrelated (see ‘Putting Inequality on the Map‘). Another Bank economist, Branko Milanović 5, is calling for global redistribution to address both poverty and inequality. 6 Milanović is mainly occupied with global inequality rather than inequality within countries, but it is significant that two prominent World Bank economists see inequality as a problem that needs to be addressed. The article ‘Embracing inclusive growth’ will discuss these questions more in-depth.
Washington Consensus and trickle-down
Originally, the term Washington Consensus referred to ten main policy instruments on which Washington-based institutions like the IMF, the World Bank and the US Treasury agreed. These instruments included privatization, deregulation, trade liberalization and fiscal prudence. Latin American countries had to pursue them as a condition to qualify for financial aid from the US and the international institutions to overcome the debt crisis of the 1980s and 1990s. Nowadays, the same conditions are also applied to European countries like Greece to obtain financial support, but the term Washington Consensus…Read more
Growth of a middle class
Although government policies can reduce inequality, high inequality can make it difficult for a middle class to emerge. In El Salvador, for example, elites can buy private education and do not feel the need to invest in a public education system, which is needed to allow the growth of a middle class. As pointed out in ‘Putting Inequality on the Map’, there is a growing middle class in many developing and middle income countries like China, India, Nigeria, Indonesia and Brazil. Although Latin America has the highest inequality levels in the world, a substantial middle class is emerging and inequality has been reduced considerably. That is mainly due to government policies that actively counter inequality with conditional cash transfers. 7 (See ‘Embracing inclusive growth’ for how specific government policies can promote the growth of a middle class in highly unequal countries.)
Inequality and crisis
One economic consequence of income inequality is its role in crises: “Rising income inequality seems to have contributed to the emergence of a credit bubble which eventually burst and triggered the Great Recession [of 2009, NW],” 8 the International Labour Organization concludes in a recent study. This mainly applies to the US and other Western countries with easy credit regulations. Consuming beyond their means is not a problem for the poor in developing countries as they cannot get loans anyway. Easy credit in countries with income inequality can lead to the non-rich consuming beyond their means, resulting in economic bubbles which eventually burst and then lead to crises. As the rich grow richer, they may want to lend their money and the non-rich may develop a desire to keep up with the rich. The non-rich will buy houses with mortgages they cannot repay and cars and luxury goods on credit. This type of economic growth is not sustainable and may exacerbate inequality in the end. It may also endanger the upcoming middle classes when they discover easy credit, as has happened recently in Brazil and Chile. In Brazil, credit outstanding to individuals grew from 6% to 16% of GDP between 2022 and 2012 and repayments are increasingly defaulting. 9
Social consequences: higher incidence of societal and psychological problems
According to epidemiologists Richard Wilkinson and Kate Pickett, industrialized societies with lower income inequality suffer less from physical/psychological diseases, criminality, violence, divorce, obesity and teenage pregnancies. 10 They display a higher degree of trust, less excessive consumption and rising life expectancy. Countries with high income inequality show a higher incidence of societal and psychological problems, not only among the poor, but throughout society as a whole. All segments of the population therefore suffer the negative consequences of income inequality.
The Spirit Level Controversy
In The Spirit Level (2009) epidemiologists Richard Wilkinson and Kate Pickett argue why more equal societies almost always do better than more unequal ones. They claim that inequality is the root cause of physical/psychological diseases, criminality, violence, divorce, obesity and teenage pregnancies. Notably, they also argue that inequality makes everybody worse off, not only the poorest, and leads to stress and status fear. The Spirit Level was received enthusiastically…Read more
Homicide rates are almost four times higher in both industrialized and non-industrialized countries with high levels of income inequality than in more equal societies. 11 In urban areas like Cape Town or New York, the type of crime depends on the wealth of the neighbourhood, with homicide and sexual crimes mainly occurring in the poorest districts and more property crime in rich districts. 12 This seems to indicate that crime is related to poverty and not necessarily to inequality. Economist Morgan Kelly, however, found that inequality has a strong effect on violent crimes like murder and rape but not on property crime. Kelly also discovered that poverty and police activity have significant effects on property crime but little on violent crime. Property crime can be seen as economically driven (people act criminally if it is rewarding) while violent crime can be explained by ‘strain theories’ (crime occurs when social structures pressure people to commit crime) or social disorganization theories (crime occurs when social control mechanisms are weakened). 13Although there has been some research on the social effects of inequality in developing and middle income countries, it tends to focus on the effects of the inequalities of an intermediate variable (see box on intermediate variables), for example the impact of the caste system on people in the lowest castes and the casteless (dalit’s). Poor people are overrepresented in India’s lowest caste: “Not surprisingly, we find at the bottom of the caste system individuals and social groups in disproportionate numbers, mired in poverty.” 14 Because of the caste system “birth seems to determine health, education, employment, social and economic outcomes”. 15 Whether caste-based inequality has the same consequences for society as a whole as Wilkinson and Pickett claim income inequality has in industrialized countries, remains unclear. As sociologists Kathryn Neckerman and Florencia Torche state: “To date, research on the consequences of inequality has neglected the developing world.” 16
Intermediate variables explained
Inequality may have a direct influence on access to power, but more often it has an impact through intermediate variables. These are variables (Y) through which another variable (X) exerts influence on yet another variable (Z). Take, for example, the relationship between high temperatures and headache. A high temperature may give you a headache (direct relationship), but it is more likely is that a high temperature (X) makes you sweat and lose a lot of body moisture. If you then don’t drink enough water to replenish it, you may get a headache. The intermediate variable (Y) through which the high temperature contributes…Read more
Wellbeing, human development and happiness
Generally speaking, although high inequality makes people unhappy, inequality only really starts obstructing happiness when absolute poverty has already been reduced. The World Happiness Report (co-authored by economist Jeffrey Sachs of Columbia University’s Earth Institute) describes how the poor report rising satisfaction as their incomes increase. If you live in a Belgrade Roma settlement made from cardboard and blankets, with rats nibbling at your baby, you will be much happier if you have more dinars per day to spend, no longer have to wander the streets at night to collect trash and can afford a safer house and better food for your children.Happiness is not only about absolute income, but also about how income is divided. Although average household income in the US has doubled since 1962, Americans are not happier now as they consider wealth to be unfairly distributed. According to psychologists Shigehiro Oishi, Selin Kesebir and Ed Diener, a high level of inequality makes Americans unhappy. Their research on American happiness between 1972 and 2012 links this to people’s sense of trust and fairness. 17 Affluence, however, also brings its problems, including obesity and shopping addictions. A rising income does not always make people happier: “While higher income may raise happiness to some extent, the quest for higher income may actually reduce one’s happiness,” the World Happiness Report finds. 18 Furthermore, everybody may get richer, but inequality remains the same.Wellbeing or the quality of life are influenced by many other factors than income and income distribution. The UN Human Development Index, based on the work of economist and philosopher Amartya Sen, uses life expectancy, education and income indices to provide a much broader view of the quality of life than income inequality only. Bhutan’s Gross National Happiness Index measures health, education, good governance, psychological wellbeing, ecological diversity, cultural diversity, community vitality, time use and living standards.
Political consequences: representational inequality
In societies with high income inequality the rich often have the most political power. Economists like Joseph Stiglitz, Jacob S. Hacker and Paul Krugman argue that inequality not only “violates moral values, but that it also interacts with a money-driven political system to grant excessive power to the most affluent”. 19 The powerful misuse their power to obtain lower taxes and government-¬protected market share. According to Stiglitz, regulatory authorities are heavily influenced by money. 20Existing inequality undoubtedly reinforces the political influence of the rich and their institutions. The disproportionate weight of wealthy people in US political life has been the subject of significant research, most notably by the American Political Science Association’s (APSA) Task Force on Inequality and American Democracy. The Task Force concludes that: “public officials […] are much more responsive to the privileged than to average citizens and the less affluent”. 21 This ‘representational inequality’ in the USA has been verified by academics including Princeton professor Martin Gilens, who concludes that in terms of federal government policy, the affluent are far better represented than the poor. 22One of the oldest and best established insights of political science is the importance of a “relatively equal distribution of economic resources across citizens” 23 for a stable democracy. From Aristotle to de Tocqueville, from founding father James Madison to political scientist Robert Dahl, there is general agreement that democratic regimes depend on relatively high equality. Higher levels of inequality tend to lower the political engagement of citizens. Because the rich have a disproportionate share of influence, the non-rich feel that their views no longer matter and withdraw from politics.
Focus on economic growth or investments?
Neoclassical economists focus on inequalities in productivity among individuals. They start from the moment when inequalities in productivity have already been distributed. As some individuals are more productive than others, income inequalities are justified. The more productive you are, the more you earn. Neoclassical economists do not wish to disturb the distribution of productivity by income redistribution. People need incentives to work hard and be competitive. That is why inequality is not a bad thing: it helps people to become competitive. This does not mean that neoclassical economists are in favour of unequal opportunities…Read more
Quality of institutions
High inequality has harmful effects on the quality of institutions. There is widespread evidence that “greater economic inequality makes transitions to stable democratic regimes much less likely to occur”. 24 In the aftermath of the mass privatization in post-Soviet Russia, for example, a small group of entrepreneurs got rich very quick, acquired political power and used it tor their own benefit. That was bad for bureaucratic quality, government stability, democratic accountability and corruption. 25Although bad institutions can cause inequality, a study by economists Alberto Chong and Mark Gradstein covering a sample of 121 developed and developing countries found that inequality determines the quality of institutions more than the other way around. 26 The two reinforce each other, however: high inequality will make institutions worse, and bad institutions will augment inequality. 27A high level of equality is thus good for democracy and for the quality of democratic institutions. The same applies to having a substantial middle class (for more on this, see Putting Inequality on the Map). Some sociologists and political scientists, including Max Weber, Seymour Martin Lipsett and Samuel Huntington, attribute certain values to a middle class. Middle-class people value hard work and are thrifty. They value political stability, so they demand quality institutions. And they demand good education as it gives people the opportunity to climb the social ladder; countries with a large middle class therefore often have a good system of public education. The middle-classtheory also has its critics. Lipsett himself famously described German fascism as a middle-class movement, 28 while political scientist Ergun Özbudun describes the Turkish pro-Islamic Welfare Party and the ultranationalist Nationalist Action Party as typical middle class movements. “[They] are stronger in small- and medium-size towns and among the downwardly mobile self-employed middle classes as well as among the recent rural migrants to the big cities. In fact, the Welfare Party’s rising appeal in the 1990s combined a defense of Islamic values with that of the interests of small businessmen and merchants of Anatolia as opposed to the big business interests concentrated in major cities.” 29
Social change and unrest
Inequality plays a role in the social change and unrest. According to UNRISD, it was one of the underlying causes of the Arab Spring: “While locally speciﬁc factors underpin the recent uprisings in Tunisia, Egypt, Syria and neighbouring countries, high rates of unemployment, precarious livelihoods and repressive state practices are common sources of discontent that feed popular unrest.” 30 This claim does, however, need to be qualified. There was rather low inequality and little overt unrest in pre-1978 China and in the Soviet bloc before 1989. Although repression had much to do with that, the lack of large differences in wealth was also significant and uprisings occurred anyway. Revolutions can probably be better explained by rising expectations than growing disparities. 31 Inequality may, however, play a role in interplay with ‘collective humiliation/collective dignity’ – the “ability to go without shame”. The sometimes volcanic power to mobilize people – for example in the Movimento Sem Terras (the Brazilian Landless Workers Movement) and probably also the Arab Spring – might stem from that interplay. 32 This would mean there is no direct causal relation between inequality and uprisings but that it is intermediated with other factors such as expectations and a sense of dignity.
Arjan de Haan, Program Leader, for ‘Inclusive Growth’ at the International Development Research Centre.Stephan Klasen, Professor of Development Economics at the University of Göttingen, Germany.Shobha Raghuram, independent researcher who has specialised in development studies and philosophy.David Sogge, independent researcher based in Amsterdam, the Netherlands, where he is board secretary of the Transnational Institute, a worldwide fellowship of scholar activists.
- World Bank, World Development Report 2006: Equity and development.
- Berg, A.G. and Ostry, J.D. (2011), Equality and Efficiency, in: Finance & Development 48 (3). Idem (2011), Inequality and Unsustainable Growth: Two Sides of the Same Coin?
- Wade, R.H. (2011) “Income Inequality: Should we worry about global trends?” The European Journal of Development Research, Special debate section: The politics of poverty and inequality, 23(4).
- Ravallion, M. (2012) “Why Don’t We See Poverty Convergence?”American Economic Review.
- Milanović, M. (2006), Global income inequality: what it is and why it matters?, World Bank Policy Research Working Paper 3865.
- There are three requirements for global redistribution. 1. Funds should flow from a (mean-income) rich to a (mean-income) poor country. 2. The tax-payer ought to be richer than the beneficiary of the transfer. 3. Transfers be such that inequality decreases in both countries, donor and recipient. (see Milanović, note 3, p 27)
- Getting a government that pursues such policies is not that easy as inequality tends to lower the political engagement of citizens. Oxford professor Frances Stewart found that to overcome this inequality a democratic system with universal suffrage is a first requirement, but is by far not enough. Mass participation of the poor is necessary and to obtain this, they probably need to have more characteristics in common than being poor (for example having shared class characteristics). Next to that, the type of democracy matters. “Majoritarian winner-takes-all democracy can disempower minority groups completely. This is one reason why an election is so often the occasion for violence and cheating in multi-ethnic societies.” Stewart considers proportional representation therefore desirable. See Stewart, F., “Inequality in Political Power: A Fundamental (and Overlooked) Dimension of Inequality”, in: European Journal of Development Research, Vol. 23, 4, 541-545, p542. See also the final section of this article in which the political consequences of inequality are discussed.
- Treeck, T. van and Sturn, S. (2012) Income inequality as a cause of the Great Recession? A survey of current debates.
- “Brazil household credit”.
- See Wilkinson, R. and Pickett, K, (2009) The Spirit Level.London: Allen Lane. Wilkinson and Pickett focus their research on industrialized countries and mobilize a huge quantity of statistics. They do not generalize their conclusions to other countries.
- UNODC (2011), Global Study on homicide.
- UNODC, 2011, p79-81.
- Kelly, M. (2000), “Inequality and crime”, The review of economics and statistics, 82(4), Pages 530-539.
- Thorat, S. and Newman, K.S. (2007),”Caste and Economic Discrimination: Causes, Consequences and Remedies”, in: Economic and Political Weekly October 13, 2007, p 4122.
- Jacob, K.S., “Caste and inequalities in health”, in: The Hindu, August 22, 2009.
- Neckerman, K. and Torche, F. (2007)”Inequality: Causes and Consequences”, Annual Review of Sociology 33:335–57, p350.
- Oishi, S., Kesebir, S., and Diener, E. (2011), Income Inequality and Happiness,Psychological Science 22(9) 1095–1100.
- Helliwell, J., Layard, R. and Sachs, J. (eds.) (2012), World Happiness Report, p4-5.
- Edsall, T.B. (2012), “Separate and unequal”, New York Times.
- Stiglitz, J. (2012), The price of inequality, London: Penguin Books Ltd.
- Jacobs, L. and Skocpol, T. (2005), Inequality and American Democracy: What We Know and What We Need to Learn. New York: Russell Sage Foundation.
- Gilens, M. (2009), `Preference Gaps and Inequality in Representation’. PS: Political Science & Politics 42(2):335-241.
- Solt,F. (2006), Economic Inequality and Democratic Political Engagement, March 28, 2006.
- Chong, A. and Gradstein, M. (2007), “Inequality and institutions”, The Review of Economics and Statistics, 89(3): 454–465.
- India appears to be an exception to this rule. Although the country is very unequal and highly corrupt, it is still considered a democratic country. Political scientist Robert Dahl gives three main reasons for this. First, every Indian is a member of a cultural minority that is too small to govern the country alone. Second, these groups do not live together in the same places, but are spread throughout the country. Third, Indians do not see an alternative for democracy – it is their national ideology, even among the military and police forces. Clearly, other factors than inequality can be more important for the establishment or survival of democracy. See Dahl, R. (2000), On democracy, New Haven & London: Yale University Press, p160-163.
- Lipset, S.M. (1963), Political Man: The Social Bases of Politics, Garden City, New York: Doubleday, Anchor Books.
- See Özbudun, E. (2005) The Role of the Middle Class in the Emergence and Consolidation of a Democratic Civil Society. Ankara Law Review 2(2) 95-107, p 101.
- UNRISD (2012), Research and policy brief, October 2012
- Davies, J, (1962) Toward a Theory of Revolution, American Sociological Review, Vol. 27, No. 1, pp. 5-19.
- Zavaleta Reyles, D. (2007), `The Ability to go about Without Shame: A Proposal for Internationally Comparable Indicators of Shame and Humiliation’. Oxford Development Studies 35(4):405-430.