Effects of inequality
Social cohesion
Income inequality and the social capital index in 50 U.S. states. Equality is correlated with higher levels of social capital
In a 2002 paper, Eric Uslaner and Mitchell Brown showed that there is a high correlation between the amount of trust in society and the amount of income equality. They did this by comparing results from the question "would others take advantage of you if they got the chance?" in U.S General Social Survey and others with statistics on income inequality.
Similarly, a 2008 article by Andersen and Fetner finds a strong relationship between economic inequality within and across countries and tolerance for 35 democracies.
Robert Putnam, professor of political science at Harvard, established links between social capital and economic inequality. His most important studies (Putnam, Leonardi, and Nanetti 1993, Putnam 2000) established these links in both the United States and in Italy. On the relationship of inequality and involvement in community he says:
Community and equality are mutually reinforcing… Social capital and economic inequality moved in tandem through most of the twentieth century. In terms of the distribution of wealth and income, America in the 1950s and 1960s was more egalitarian than it had been in more than a century… [T]hose same decades were also the high point of social connectedness and civic engagement. Record highs in equality and social capital coincided. Conversely, the last third of the twentieth century was a time of growing inequality and eroding social capital… The timing of the two trends is striking: somewhere around 1965-70 America reversed course and started becoming both less just economically and less well connected socially and politically. (Putnam 2000 pp 359)
In addition to affecting levels of trust and civic engagement, inequality in society has also shown to be highly correlated with crime rates. Most studies looking into the relationship between crime and inequality have concentrated on homicides - since homicides are almost identically defined across all nations and jurisdictions. There have been over fifty studies showing tendencies for violence to be more common in societies where income differences are larger. Research has been conducted comparing developed countries with undeveloped countries, as well as studying areas within countries. Daly et al. 2001. found that among U.S States and Canadian Provinces there is a tenfold difference in homicide rates related to inequality. They estimated that about half of all variation in homicide rates can be accounted for by differences in the amount of inequality in each province or state. Fajnzylber et al. (2002) found a similar relationship worldwide. Among comments in academic literature on the relationship between homicides and inequality are:
The most consistent finding in cross-national research on homicides has been that of a positive association between income inequality and homicides. (Neapolitan 1999 pp 260)
Economic inequality is positively and significantly related to rates of homicide despite an extensive list of conceptually relevant controls. The fact that this relationship is found with the most recent data and using a different measure of economic inequality from previous research, suggests that the finding is very robust. (Lee and Bankston 1999 pp 50)
Research by Richard G. Wilkinson and Kate Pickett has also presented evidence that both social cohesion and health problems are greater in countries or states where economic inequality is highest. For instance, crime rates, mental health problems and teen-age pregnancies are lower in countries like Japan and Finland compared to countries with greater inequality such as the US and UK.
Population health
Income inequality and mortality in 282 metropolitan areas of the United States. Mortality is strongly associated with higher income inequality, but, within levels of income inequality, not with per capita income.
There is debate regarding the cause of the SES Gradient. A number of researchers (A. Leigh, C. Jencks, A. Clarkwest - see also Russell Sage working papers) see a definite link between economic status and mortality due to the greater economic resources of the wealthy, but they find little correlation due to social status differences.
Other researchers such as Richard G. Wilkinson, J. Lynch, and G.A. Kaplan have found that socioeconomic status strongly affects health even when controlling for economic resources and access to health care. Most famous for linking social status with health are the Whitehall studies - a series of studies conducted on civil servants in London. The studies found that although all civil servants in England have the same access to health care, there was a strong correlation between social status and health. The studies found that this relationship remained strong even when controlling for health-affecting habits such as exercise, smoking and drinking. Furthermore, it has been noted that no amount of medical attention will help decrease the likelihood of someone getting type 2 diabetes or rheumatoid arthritis - yet both are more common among populations with lower socioeconomic status. Lastly, it has been found that amongst the wealthiest quarter of countries on earth (a set stretching from Luxembourg to Slovakia) there is no relation between a country's wealth and general population health - suggesting that past a certain level, absolute levels of wealth have little impact on population health, but relative levels within a country do.
The concept of psychosocial stress attempts to explain how psychosocial phenomena such as status and social stratification can lead to the many diseases associated with the SES Gradient. Higher levels of economic inequality tend to intensify social hierarchies and generally degrade the quality of social relations - leading to greater levels of stress and stress-related diseases. Richard Wilkinson found this to be true not only for the poorest members of society, but also for the wealthiest. Economic inequality is bad for everyone's health.
The effects of inequality on health are not limited to human populations. David H. Abbott at the Wisconsin National Primate Research Center found that among many primate species, less egalitarian social structures correlated with higher levels of stress hormones among socially subordinate individuals.
Utility, economic welfare, and distributive efficiency
Economic inequality is thought to reduce distributive efficiency within society. That is to say, inequality reduces the sum total of personal utility because of the decreasing marginal utility of wealth. For example, a house may provide less utility to a single millionaire as a summer home than it would to a homeless family of five. The marginal utility of wealth is lowest among the richest. In other words, an additional dollar spent by a poor person will go to things providing a great deal of utility to that person, such as basic necessities like food, water, and healthcare; meanwhile, an additional dollar spent by a much richer person will most likely go to things providing relatively less utility to that person, such as luxury items. From this standpoint, for any given amount of wealth in society, a society with more equality will have higher aggregate utility. Some studies (Layard 2003;Blanchard and Oswald 2000, 2003) have found evidence for this theory, noting that in societies where inequality is lower, population-wide satisfaction and happiness tend to be higher.
Economist Arthur Cecil Pigou discussed the impact of inequality in The Economics of Welfare. He wrote:
Nevertheless, it is evident that any transference of income from a relatively rich man to a relatively poor man of similar temperament, since it enables more intense wants, to be satisfied at the expense of less intense wants, must increase the aggregate sum of satisfaction. The old "law of diminishing utility" thus leads securely to the proposition: Any cause which increases the absolute share of real income in the hands of the poor, provided that it does not lead to a contraction in the size of the national dividend from any point of view, will, in general, increase economic welfare.
In addition to the argument based on diminishing marginal utility, Pigou makes a second argument that income generally benefits the rich by making them wealthier than other people, whereas the poor benefit in absolute terms.
Pigou writes: Now the part played by comparative, as distinguished from absolute, income is likely to be small for incomes that only suffice to provide the necessaries and primary comforts of life, but to be large with large incomes. In other words, a larger proportion of the satisfaction yielded by the incomes of rich people comes from their relative, rather than from their absolute, amount. This part of it will not be destroyed if the incomes of all rich people are diminished together. The loss of economic welfare suffered by the rich when command over resources is transferred from them to the poor will, therefore, be substantially smaller relatively to the gain of economic welfare to the poor than a consideration of the law of diminishing utility taken by itself suggests. --Arthur Cecil Pigou in The Economics of Welfare
Schmidtz (2006) argues that maximizing the sum of individual utilities does not necessarily imply that the maximum social utility is achieved. For example:
A society that takes Joe Rich’s second unit [of corn] is taking that unit away from someone who . . . has nothing better to do than plant it and giving it to someone who . . . does have something better to do with it. That sounds good, but in the process, the society takes seed corn out of production and diverts it to food, thereby cannibalizing itself
Aspirational consumption and household risks
Firstly, certain costs are difficult to avoid and are shared by everyone, such as the costs of housing, pensions, education and health care. If the state does not provide these services, then for those on lower incomes, the costs must be borrowed and often those on lower incomes are those who are worse equipped to manage their finances. Secondly, aspirational consumption describes the process of middle income earners aspiring to achieve the standards of living enjoyed by their wealthier counterparts and one method of achieving this aspiration is by taking on debt. The result leads to even greater inequality and potential economic instability.
Economic incentives
Many people accept inequality as a given, and argue that an increased gap between rich and poor increases the incentives for competition and innovation within an economy.
Some modern economic theories, such as the neoclassical school, have suggested that a functioning economy entails a certain level of unemployment. These theories argue that unemployment benefits must be below the wage level to provide an incentive to work, thereby mandating inequality and that additionally, it is impossible to lower unemployment down to zero. Hypotheses such as socialism, dispute this positive role of unemployment.
Many economists believe that one of the main reasons that inequality might induce economic incentive is because material well-being and conspicuous consumption are related to status. In this view, high stratification of income (high inequality) creates high amounts of social stratification, leading to greater competition for status. One of the first writers to note this relationship was Adam Smith who recognized "regard" as one of the major driving forces behind economic activity. From The Theory of Moral Sentiments in 1759:
[W]hat is the end of avarice and ambition, of the pursuit of wealth, of power, and pre-eminence? Is it to supply the necessities of nature? The wages of the meanest labourer can supply them... [W]hy should those who have been educated in the higher ranks of life, regard it as worse than death, to be reduced to live, even without labour, upon the same simple fare with him, to dwell under the same lowly roof, and to be clothed in the same humble attire? From whence, then, arises that emulation which runs through all the different ranks of men, and what are the advantages which we propose by that great purpose of human life which we call bettering our condition? To be observed, to be attended to, to be taken notice of with sympathy, complacency, and approbation, are all the advantages which we can propose to derive from it. It is the vanity, not the ease, or the pleasure, which interests us (Theory of Moral Sentiments, Part I, Section III, Chapter II).
Modern sociologists and economists such as Juliet Schor and Robert H. Frank have studied the extent to which economic activity is fueled by the ability of consumption to represent social status. Schor, in The Overspent American, argues that the increasing inequality during the 1980s and 1990s strongly accounts for increasing aspirations of income, increased consumption, decreased savings, and increased debt. In Luxury Fever Robert H. Frank argues that people's satisfaction with their income is much more strongly affected by how it compares with others than its absolute level.
Inequality and economic growth
The classical theory
Initial theories stated that inequality had a positive effect on economic development. The marginal propensity to save increases with wealth and inequality increases savings, capital accumulation, and economic growth.
The neoclassical theory
The neoclassical theory ignores the relevance of income distribution for macroeconomic analysis[citation needed]. It interprets the observed relationship between inequality and economic growth as a reflection of the growth process on the distribution of income.
The modern theory
The modern theory suggests that income distribution plays an important role in the determination of aggregate economic activity and economic growth.
The credit market imperfection approach, developed by Galor and Zeira (1993), demonstrates that inequality in the presence of credit market imperfections has a long lasting detrimental effect on human capital formation and economic development.[54]
The political economy approach, developed by Alesian and Rodrik 1994) and Persson and Tabellini (1994), argues that inequality is harmful for economic development because inequality generates a pressure to adopt redistributive policies that have an adverse effect on investment and economic growth.
Evidence
Perotti (1996) examines of the channels through which inequality may affect economic growth. He shows that in accordance with the credit market imperfection approach, inequality is associated with lower level of human capital formation and higher level of fertility, while lower level of human capital is associated with lower growth and lower levels of economic growth. In contrast, his examination of the political economy channel refutes the political economy mechanism. He demonstrates that inequality is associated with lower levels of taxation, while lower levels of taxation, contrary to the theories, are associated with lower level of economic growth
In their study for the World Institute for Development Economics Research, Giovanni Andrea Cornia and Julius Court (2001) reach policy conclusions as to the optimal distribution of income. They conclude that too much equality (below a Gini coefficient of .25) negatively impacts growth due to "incentive traps, free-riding, labour shirking, [and] high supervision costs". They also claim that high levels of inequality (above a Gini coefficient of .40) negatively impacts growth, due to "incentive traps, erosion of social cohesion, social conflicts, [and] uncertain property rights". They advocate for policies which put equality at the low end of this "efficient" range.
Later studies restricted their analysis to the reduced form relationship between inequality and growth. Forbes (2000) and Barro (2000) examined the effect of inequality on economic growth in a panel of countries.[58] They find a positive and zero effect, respectively, of an increase in inequality on economic growth. These findings appear to have no bearing on the validity of the theories and are not very informative about the overall effect of inequality. First, these studies examine the effect of inequality beyond its effects through education, fertility, and investment. For instance, Barro (2000) has found that, once controls for education, fertility, and investment are introduced, there is no relationship between inequality and economic growth in the entire sample. His findings, therefore, suggest that inequality does not have a direct effect on growth beyond its effects through education, fertility and investment. In particular, if the control for fertility is dropped in Barro (2000), the effect of inequality on growth is significantly negative, as predicted by the theory. Moreover, these studies examine the effect of inequality in the short run (i.e., the effect of inequality on the average growth rate in the subsequent 5–10 years), while as suggested by the theories, inequality is likely to have a long-run effect (e.g., via the human capital formation).
The United Nations Research Institute for Social Development (UNRISD)’s 2010 report comes to multiple conclusions, some of which concur with and others that challenge the findings of previous research. The report claims that inequality has risen partly due to neoliberal economic policies that have made it difficult to have high rates of economic growth without increasing inequality.The report acknowledges that there has been a decrease of inequality in the Middle East, North Africa, and sub-Saharan Africa, but the level is still high in these regions overall (above a Gini coefficient of .40). It also notes that in a study done by the International Labour Organization (ILO), over two-thirds of the 85 countries surveyed experienced a rise in income inequality between 1990 and 2000.
The report looks to the functional distribution of income of a country as an indicator of inequality as well as the Gini coefficient. The functional distribution of income looks at how income is distributed between wage earners and profit earners: the larger the share of GDP wage earners share, the more equal the situation. The report notes that a high growth rate contributes to income inequality when a small portion of the population - profit earners – earns the majority of the money. This is common in situations in which a rise economic growth is caused by a specific sector, such as the technological sector. This picture becomes more muddled in developing countries when one takes into account large informal sectors; these workers earn profits rather than wages, so it’s difficult to say if an increase in the share of profit income is helping or harming income inequality.
The UNRISD report also states, in contradiction to Pagano’s research, that growth and equity can be “mutually reinforcing” when supported by “well-thought-out economic and social policies”.[59] It explains that reducing poverty through growth is difficult when inequality is rampant; wealth and land tends to concentrate in small groups, which in turn excludes the poor from economic participation. The poor have less disposal income to spend and as a result effective aggregate demand lowers, limiting the size of the domestic market. This in turn makes it harder for a country to industrialize, thereby hindering its development.
A 2011 note for the International Monetary Fund by Andrew G. Berg and Jonathan D. Ostry found a strong association between lower levels of inequality in developing countries and sustained periods of economic growth. Developing countries with high inequality have "succeeded in initiating growth at high rates for a few years .... longer growth spells are robustly associated with more equality in the income distribution."
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