Inequality Represents a Wasted Opportunity for Poverty Reduction

By Paul Segal, Senior Lecturer in Economics, Department of International Development, King’s College London. Originally published at

Economists who dismiss inequality as a problem secondary to poverty miss the point: Inequality is part of what drives poverty

This is the most frequent response I get when I tell other economists that I work on inequality. The economist Deidre McCloskey put the view bluntly in an article titled  But this view shows a remarkable disregard for one of the most fundamental principles of economics: that of optimization. Economists go to great lengths to optimize GDP growth and efficiency. But when it comes to poverty, any positive change is taken as good enough. If poverty is falling by any amount, or the poor are growing richer by any amount, then apparently we (and more to the point, the poor) should stop worrying.

If we really care about poverty, this won’t do. The question isn’t just to ensure that poverty is falling: the goal should be eliminate it as quickly as possible. Economic policy should aim to maximize the growth rates of incomes of the poor, not just ensure they are above zero. There can hardly be a more urgent goal for those interested in human well-being.

This is where inequality matters: inequality represents a wasted opportunity for poverty reduction. In the vast majority of cases, whatever current policy may be, we could improve the rate of poverty reduction through inequality-reducing progressive redistribution. The fact that we fail to redistribute more means that we are allowing poverty to be higher than it needs to be.[1]

Discussions of inequality and poverty often proceed as if the two were largely independent. But both are just statistics of the same income distribution. Poverty measures tell us about the bottom end, while inequality measures tell us about the whole distribution. This means that they are not just empirically related but also logically. Policies that take from the rich to give to the poor reduce both poverty and inequality at the same time.

The standard argument against redistribution is that it is distortionary for the economy and can lower growth and living standards for all. There are neat-sounding theoretical reasons to consider this possibility. But in reality it’s just wrong. Consider the fact that the Scandinavian countries have among the greatest levels of redistribution in the world, are the most equal in the world, and are also among the richest countries in the world. Indeed, richer countries tend to be substantially more equal than poorer countries, in large part because they redistribute more. This is enough to show that progressive redistribution need not hurt growth. But if it weren’t, there is a huge academic literature on inequality and growth that fails to show that inequality-reducing policies lower income levels or growth.

Economists often claim that “what matters” is growth rather than inequality, as if we have to choose one or the other. But this is nonsense. The fact that redistribution doesn’t lower growth means that redistribution is close to a zero-sum game: taking from the rich to give to the poor makes the rich poorer and the poor richer—end of story. It shouldn’t be surprising that the relatively rich (who include most economists) don’t like the sound of progressive redistribution. But this is because it works, not because it doesn’t work.

According to the World Bank,[2] 13% of the population of the U.S. live in households with per capita incomes below $20 per day (about $30,000 for a family of four). Compare this with four European counties: in Denmark the figure is five percent, and in France, Germany and Sweden it is seven to eight percent.

Looked at from another angle, the bottom 40 percent in these four European countries are 10 to 20 percent richer on average than the bottom 40 percent in the U.S.—despite the fact that average incomes in these countries are nearly 20 percent lower than in the US (see figure).

Source: Author’s calculations based on Povcalnet,

The reason is inequality. The Gini coefficient is 41 in the U.S., compared with 28.5 to 32.5 in the other countries. And these figures just refer to disposable income—if we included the value of public services received then the more egalitarian countries would do better still in the comparison. Of course, the rich in the U.S. are richer than their European counterparts. That’s why it’s a question of inequality.

Turning to fast-growing poorer countries, China, India and Indonesia all have levels of poverty than today’s rich countries had when they were at the same levels of per capita GDP – because they are more unequal. Certainly, China has an extraordinary record of poverty reduction. But it fastest when policies focused on raising incomes of the poor in rural areas, and it shows no correlation over time between growth rates and changes in inequality. Even China could have done better had it been more focused on stemming the rise in inequality. In contrast, in Brazil over 2001-2014 the incomes of the poorest 40% grew 107% through a combination of growth and inequality reduction, as the Gini coefficient fell from 58 to 51; without the inequality reduction they would have grown only 53%.[3]

Naturally, it is possible to name policies that would reduce inequality but would also hurt the poor. Anti-egalitarians often do so. But such arguments are irrelevant, since the policies that egalitarians advocate are designed to make the poor better off. These include policies that support labor bargaining power and unions, high minimum wages, and direct redistribution through taxes and benefits. Such policies exist in strong forms in rich low-inequality countries, where people at the lower end of the distribution are better off than their counterparts in more unequal rich countries.

The historian R H Tawney wrote in 1913 that “what thoughtful rich people call the problem of poverty, thoughtful poor people call with equal justice the problem of riches.” The problem of poverty is not simply that there is not enough to go around. It is also that the well-off consume too large a share of it. If we believe that poverty reduction is a moral imperative, then we need to tackle inequality.

Footnotes

[1] The realization that inequality implies a wasted opportunity for poverty reduction is just a special case of and argument that inequality implies an inefficient use of resources from the perspective of social welfare.

[2] Povcalnet, 2013 figures for per capita household disposable income using 2011 PPP$, downloaded 26/09/18.

[3] Author’s calculations based on Povcalnet, World Bank, http://iresearch.worldbank.org/PovcalNet/.

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13 comments

  1. Denis Drew

    Re: Inequality Represents a Wasted Opportunity for Poverty Reduction

    Poverty in the US is caused by labor not squeezing as much out of the consumer as the consumer is actually willing to pay — full stop. Root cause: virtual disappearance of collective bargaining.

    BTW, Human beings everywhere and at all times judge their condition — and thereby are made happy or unhappy — by taking stock of their condition relative to that of their fellows.

    [cut-and-paste]
    Quick reset of the American labor market:

    FIRST, recognize that old fashioned union organizing as we knew it may safely be declared dead (forever!) in this country. Even if we now make union busting a fed felony and hire (tens of?) thousands of fed investigators, what’s to keep millions of business owners and managers from laughing it off, asking: “What are you going to do, lock up all the business know how of the country?”

    SECOND, observe Repub: H.R.2723 (115th Congress) — Employee Rights Act
    “(2) require union recertification after a turnover in the workforce exceeding 50% of the bargaining unit”

    THIRD, think blue wave Dem modification: H.R.2723 (1/2)116th Congress — All Employees Rights Act
    (1) Require union cert/recert/decert elections at all private workplaces — option for one, three or five year cycles, local plurality rules.”

  2. Daniel A Lynch

    Once a subsistence level is attained, poverty is not a problem — as long as everyone is equally poor. There’s nothing wrong with living in a hut with no indoor plumbing as long as everyone else lives in a hut with no indoor plumbing. The problem is when you live in a hut with no indoor plumbing while your neighbor lives in a mansion. That breeds insecurity and resentment.

    We’re not any happier today, with our flat screen tv’s and fancy cars and cell phones, than people were 200 years ago. In fact, our suicide rate suggests that we may be less happy today than 200 years ago.

    Poor people produce fewer greenhouse emissions than affluent people, so it would be better if we were all poor.

  3. Denis Drew

    Remember; all those blue collar, swing states that have swung supposedly irretrievably into the Republican column voted for Obama — not just over Wall Street Romney in 2012 — but over Viet war hero, half-sensible Republican John McCain in 2008. Looking for someone thought might finally hear out their complaints (no joy)

    Promise their own econ and pol power back any time they want to vote to cert and they can easily be persuaded to return to the party of their long belonging.

  4. Sound of the Suburbs

    Why we should worry about inequality.

    Mariner Eccles, FED chair 1934 – 48, passes comment the last time they used neoclassical economics in the US in the 1920s.

    “a giant suction pump had by 1929 to 1930 drawn into a few hands an increasing proportion of currently produced wealth. This served then as capital accumulations. But by taking purchasing power out of the hands of mass consumers, the savers denied themselves the kind of effective demand for their products which would justify reinvestment of the capital accumulation in new plants. In consequence as in a poker game where the chips were concentrated in fewer and fewer hands, the other fellows could stay in the game only by borrowing. When the credit ran out, the game stopped”

    The wealth accumulates in fewer and fewer hands like this.

    US wealth distribution:

    shot 2015-06-15 at 11.28.56 am.png

    The exponential curve keeps going within the 1% and at the top, a very few have an awful lot

    The system is kept running on debt until it collapses
    .
    When the credit runs out, the game stops, like the 1920s.

    The neoclassical economists won’t see it because they don’t consider debt, like the 1920s.

    1. Sound of the Suburbs

      They don’t see it, because the neoclassical economists don’t consider private debt.

      1929 – Inflating the US stock market with debt (margin lending)
      2008 – Inflating the US real estate market with debt (mortgage lending)

  5. Jeremy Grimm

    We are a wealthy country. We can afford to extinguish poverty and for many reasons we cannot afford not to. But this post fails to concern itself with issues of inequality beyond levels of consumption or privation. For our wealthy money is power. Money owns legislatures, governors, Congress, Courts, and Presidents. Our levels of inequality are anathema to democracy. Our levels of inequality are anathema to free enterprise, any semblance of entrepreneurship, and to our most sacred of entities the ‘free’ market — which bears absolutely no relation to the Neoliberal Market.

  6. diptherio

    I tried to make this argument in a slightly different way during my undergrad years and never made much headway. I reasoned thusly: obviously, taking $10 away from Bill Gates and giving it to a homeless guy on the street will result in an increase in overall well-being, as Bill Gates will not be any worse off for having $10 less in his bank account while the homeless guy will be better off — a net gain!

    And Bill, of course, could have his wealth reduced by $10 million and it wouldn’t effect his lifestyle one bit. But take that $10 million and divvy it up into $1,000 bundles and distribute it to 10,000 of our poorest citizens, and 10,000 people have been made objectively and subjectively better off at the expense of….nothing. From a marginal utility standpoint, it’s the obvious thing to do.

    I was told, in response, that interpersonal comparisons of marginal utility were not allowed in proper economics. While we were taught in econ 101 about diminishing marginal utility (the first ice cream cone is awesome, the second is ok, the third one is nauseating) we were not allowed to apply that reasoning to money (because money can “turn into” anything) or between individuals. So you couldn’t, for instance, say that John gets less marginal utility out of his 9th house than Mary gets out of her 1st. That’s economics for you…and why I didn’t pursue it past my BA.

  7. Egil Johanzen

    The basic conclusion of this article is right. Everything else is put on its Head.

    1) reducing inequality does not hurt growth, it increases growth by stimulating spending, consumption and then investments.
    2) increasing inequality is not a necessary byproduct of growth. Increasing inequality hurts growth because the rich consume a smaller share of their income and as such lowering consumption and then growth. The author states that the problem is that the rich consume to much. From an economics viewpoint this is wrong. The problem is that they consume to little and save and speculates too much. If they have consume more, that would have created more Jobs etc. Now they spend their money on real estate, share buybacks and invest in job cutting automation. This kills jobs and excacerbate wealth inequality.
    3) the reason why the rich thinks reducing inequality will hurt growth is because they think they will make less if others make more. This is also not true. To support their view, they have modeled mainstream economics to support their view. In mainstream economics savings always equals investments. There are no such thinks real estate savings, share buy backs, debt repayment and other saving objects. So in their view, when the rich gest a larger share of the pie, they save/ invest more which increases productivity and then economic growth. We all now that this is not true and only a smal proportion of the rich savings ends up in investments that increases productivity growth and that is why the mainstream economic models are fundamentalt wrong.
    4) The author suggest that reducing inquality could be a way to reduce poverty. The rich will never contemplate such an option as long as their current thinking and economic models does not support this.

    In my view the center left in politics should stop making inequality and poverty info a moral question. It should be an economic issue. We should reduce poverty and inequality in order to promote economic growth and not only to become a moral and just society. The emperor (mainstream economic models) has no clothes. We just need to make that clear to both rich and poor slike.

    1. Samuel Conner

      “In my view the center left in politics should stop making inequality and poverty info a moral question. It should be an economic issue.”

      Agreed. In the author’s terms, redistribution is actually a positive sum game. And if one throws in MMT, one can positive-sum stimulate (within the limits of the real resource constraints) without redistributing via taxation, making all better off, but the poor proportionally more so

  8. Newton Finn

    “In my view the center left in politics should stop making inequality and poverty into a moral question. It should be an economic issue.” E.F. Schumacher (and I) would disagree. He says that it may be more economical, in some situations, to run either a car or a horse into the ground and then replace it, that under certain circumstances economics would indicate the efficiency of the former as compared to maintaining the car or horse. He then asks if the horse should be subject, MORALLY, to the same economic calculus as the car. I think he made a rather telling point with that question, don’t you?

  9. TG

    Inequality does not cause poverty. Poverty causes inequality.

    To reduce inequality, reduce poverty. Or rather, reduce the competition for jobs by workers, and increase the competition for workers by employers.

    When labor is the limiting factor, even ‘unskilled’ labor has significant bargaining power, this naturally both increases wages and flattens the wage structure. I mean, if you absolutely need BOTH a truck driver AND an engineer to run your business, and both classes of workers are in short supply, the gap between their wages will, not go to zero, but certainly narrow. Ditto for CEOs vs. workers.

    To my knowledge, no society with a flooded labor market has ever reduced inequality. When there are 100 desperate people competing for every job, there will be inequality no matter how much we wring our hands. Only societies where the labor market is tight have ever shown any sort of consistent success in reducing inequality. Because supply and demand.

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