Income Inequality and Growth: Problems with the Orthodox Approach

This paper discusses the main issues about increasing inequality, whether it matters and its impact on economic activity and growth. It starts by briefly considering the empirical evidence of the share of income going to the top one percent since 1945 in the advanced countries. It then considers whether this represents an increase in the productivity of the top one percent or merely an extraction of economic rent. The empirical evidence suggests the latter is generally the case and, as a consequence, there is not likely to be a trade-off between greater income equality and efficiency (the latter being reflected in a lower economic growth rate). This is reinforced by considering the mainstream explanation of the distribution of income and by a consideration of the argument as to whether labour is paid its marginal product, which is found to be problematic. Hence, some reservations about the use of the aggregate production function are raised. The paper turns next to the question of whether or not a greater degree of inequality causes a slower economic growth, both for the advanced and the developing countries. It next considers if the increasing gap between the top one percent and the rest of the income distribution has been either responsible for, or exacerbated, the Great Recession. It concludes that the degree of inequality is an important factor in determining economic activity and one that has been ignored for too long in macroeconomics.