Inequality, Economic Growth, and Technological Change

For many decades, it has been proclaimed that economic development and technological progress should be on top of the political agenda. However, there also have been worries that fast growth would lead to socially unacceptable levels of income/wealth inequality and even to increased poverty (i.e. to a decline not only of the relative position of a bottom share of the population but also of its absolute position). The European welfare states which are in place today may be regarded as a recognition of these concerns. However, large-scale redistribution measures have increasingly come under attack. One argument to cut welfare expenditure is that redistribution of income and wealth towards the poor distorts savings and investment decisions (since, for instance, a tax on human or physical capital income reduces the return to capital). It has also been suggested that an unequal society serves to provide individual incentives to work hard, to accumulate skills and to undertake risky projects, since the marginal benefit per unit of effort in these activities is high when the income ladder to climb is steep.¹ Moreover, under certain conditions, if the marginal propensity to save is rising in income, a more unequal distribution of income boosts savings and thus possibly investment and growth.² Because of these arguments, it has been concluded that redistribution has a negative impact on growth.

In this chapter, the literature on the link between income/wealth distribution, economic growth and technological progress is reviewed, emphasizing open questions and unexplored issues which are analyzed in the subsequent chapters.

This chapter explores the relationship between status concerns and growth. Social status is a good which is always in fixed supply, even in a growing economy. Thus, on the one hand, it is interesting to examine how competition among individuals over this scarce good affects people’s wellbeing in the developed world (i.e. in economies where the ‘basic needs’ are satisfied) as the economy grows. On the other hand, one would like to know how the growth rate of the economy is affected by status-seeking.

As has been extensively discussed in the preceding chapters, growth models linking the income distribution and the size of the government are based on majority voting. According to these models, inequality is positively related to the size of the government (due to the demand for redistribution policies) and taxation depresses growth. Whether or not taxation empirically has a negative and significant effect on growth is controversial. Whereas Easterly and Rebelo (1993), Perotti (1996) and Figini (1999) find ambiguous results, Kneller, Bleaney and Gemmell (1999) suggest that when `productive’ public expenditure like infrastructure or education expenditure is controlled for, the ratio of the total tax revenue to GDP negatively affects growth. (See chapter 1, section 1.4 for further evidence and discussion). However, the notion that a negative relationship between income inequality and growth works through the politico-economic channel is not at all confirmed by the data [e.g. Perotti (1996), Figini (1999)].¹ Also without considering growth, the empirical evidence for the hypothesis that a more unequal income distribution leads to higher redistributive government spending [see e.g. Meltzer and Richard (1981) for a theoretical model] is, at best, mixed.²

As we have seen in chapter 1 (section 1.5), despite a rising relative supply of high-skilled labor, wage inequality across skill groups has surged in the U.S. and Great Britain, and, at least, it has not declined in most other countries.¹ In addition, both absolute and relative unemployment rates of low-skilled labor have substantially increased in almost all OECD countries.² These facts strongly indicate that relative labor demand has shifted towards high-skilled labor, thus deteriorating (at least relative) earning opportunities of low-skilled workers. According to a standard view, this shift has been due to “a change in the production function that raises the marginal product of the skilled relative to the unskilled” [Krugman (1994, p. 37)], a hypothesis which is commonly referred to as `skill-biased technological change’ (SBTC).³

This book has examined the relationship between inequality, growth and technological change along two lines: first, the impact of wealth/income inequality on an economy’s growth rate (of output, capital, consumption and productivity), and, second, the impact of both technological change and capital accumulation on the income distribution. Concerning the latter line, the book has followed the recent literature in focusing primarily on the impact of technological change on earnings inequality.