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What’s Wrong With Inequality?

Is inequality really bad for economic growth?

March 21, 2001

Is inequality really bad for economic growth?

Look at the distribution of world income and population. Not surprisingly, high-income countries have the overwhelming share of world income, nearly 60%, but they have barely 15% of world population. In contrast, the poorest countries in the world have 35% of world population but less than 10% of world income.

And these averages disguise the even more striking differences between the upper-income groups in rich countries and the poorest in poor countries, a contrast that is as sharp as day and night. When you look at income distribution around the globe, clearly there is nothing remotely resembling equality, nor is there a trend in that direction.

Within countries, comparisons of poor and rich tell a more favorable story, at least in the past 30 years. Of course, the poor still have a far smaller income share than the rich, but the discrepancy has declined almost everywhere.

In Latin America, where the poor used to have only 5% of the income of the rich, they are now up to nearly 8%. In far more equality-minded Asia, the poor have moved from 16% to 22% of the incomes accruing to the rich.

And then there is a third dimension of inequality that is worth considering: How do the top and bottom 10% of the labor force compare in earnings? Across industrial countries, we see dramatic differences. As expected, the United States has the largest difference, almost twice that of Germany. Not surprisingly, German workers resist the U.S. model because they essentially are pessimists. They believe that somehow they will wind up at the bottom — even though not everybody can be at the bottom.

In open and competitive markets, wages in any year (or for any person) may have a large luck component. But surely on average they reflect energy and talent, motivation and investment in human skills. Any society that limits rewards to accomplishment will achieve equality, but it will come at the price of arriving at a low common denominator. In my view, rewards for excellence, or inequality if one wants to call it that, are the great driving force of progress.

As a consequence, public policy makers should therefore be concerned with giving broad access to strong education. That is by far still the best tool for helping women, men and children to get ahead. Conversely, I will counsel to pay less attention to the outcomes of the economic race. As hard as it sounds at first, I would say three cheers for inequality. It is good for growth — and growth, believe it or not, is the best way of rooting out poverty.

After all, the real issue is not inequality itself. The real issue is whether or not individuals are able to improve their own economic situation. When unequal incomes prevent people from developing their abilities, then inequality is dangerous. But this problem cannot, in any event, be solved simply by placing a limit on the inequality of wages.

The only way to ensure that inequality does not freeze people out of fulfilling their potential is to make a commitment to providing society with access to education. The growth of the Internet economy over the past few years — regardless of its busts and booms — has well demonstrated the importance of knowledge to the economy.

And this will become ever more apparent in the years ahead. What will freeze people out of the potential for raising their standard of living will not be the lack of physical wealth — but the lack of opportunities for education.

Attempting to correct income inequality is not the best policy to encourage a strong and innovative economy. But providing the resources necessary to open up education opportunities to the most people will strengthen an economy — and help to bring true equality, the equality that occurs when every citizen is given the full chance to reach his or her potential.

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