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Income Distribution and Economic Growth Dynamics

Beyond a certain national income level, a greater increase in social satisfaction can be achieved through distributing it more evenly than through its quantitative increase. This is a major hint for economic policy. Well, actually not only for policy, also for the education system. The better people understand it, the easier it will be to follow that direction. At the same time, there’s a risk involved, as policy based on such a thesis may turn out to be populist rather than pragmatic. This is all the more difficult because output growth is quite easy to measure. When it comes to human satisfaction, on the other hand, such estimates can be easily manipulated.

We can perceptibly increase this satisfaction, by reducing the Gini index by a certain fraction of a point, instead of pushing the traditionally measured GDP up by several percent. Economic policy of the future will have to, more and more often, resort to such a course of action. This will be all the easier because, on the one hand, the absolute output and consumption level is growing, and, on the other hand, the present scale of income inequality is higher than before. In other words, when it comes to inequality, there’s ample room for reduction. In poor countries, the traditionally defined economic growth, or an increase in the volume of output, is what will count most for many years to come. Conversely, in most rich countries, except for social market economies which are characterized by low inequality level, the most important method will be a properly oriented change in income proportion.

We should take resolute measures against unjustified inequalities, especially those resulting from pathologies of distribution. They weaken mutual trust between people, which affects social capital, a very desirable component of development processes. If various professional and community groups place no trust in one another, if the society doesn’t trust the authorities, and the feeling is mutual, if entrepreneurs are mistrustful of one another, the social capital, instead of growing, is eroding. In the economy, like in a family: even if there’s enough money, but trust is in short supply, things are not going well.

What about capital accumulation? After all, it’s necessary for the economy to run properly, mostly to invest in modernizing the existing production capacities and to create new ones. Isn’t a shorter ladder of income going to weaken the propensity to save, and thus to create capital and invest in a better future? No at all. If that was to happen, we shouldn’t reduce the income differentials. However, apart from exceptional situations, it is not the case. There is no empirical or theoretical evidence to prove that in economies with a more flat income structure people save and invest less. It’s enough to examine the course of relevant capital formation processes in Austria, France, Nordic countries and other countries with similar characteristics in this respect, to learn that more egalitarian societies were able to save no less than countries with a more elitist distribution.

This is also corroborated by conclusions that are easy to draw when comparing the so called “big government” economies with those where the government is “small”. Well, in several decades (1960-95), in countries with a small, around 30 per cent government involvement in national income redistribution (and, consequently, with higher inequality of distribution) the rate of investment or the percentage share of investment in the GDP was 20.7 per cent on average. At the same time, in countries with a high scale of budget redistribution, with around 50 per cent government involvement in the GDP (and, consequently, relatively lower inequalities in the income distribution), the investment rate was 20.5 per cent on average. No difference at all. You can have the same capacity for capital formation, which determines economic growth in the future, with a no less balanced income distribution, which co-determines satisfaction with the present state of economy. And that’s an important guideline for the New Pragmatism economic policy. That’s what things should be like in the future.

The continuous growth of human needs, with the attendant irresistible desire to satisfy them is a double-edged sword. It overcomes many barriers and, by permanently stimulating the economy, is an indispensable link in the extended reproduction process, or economic growth. At the same time, it’s a devastating force as it can dull the minds, spoil preferences, favor reprehensible qualities and, as a result, contribute irrational elements to resource allocation.

The perennial growth of consumption aspirations is a great problem. The huge crisis of the turn of the first and second decade of the 21st century only slightly toned it down and deferred it a bit. It’s also a product of a specific system of values. Ever since, a couple of centuries ago, humanity broke the chains of simple reproduction, when the same volume and production and consumption conditions would be reproduced from one period to another, and moved to extended reproduction, where it produces more and more from one period to another, appetites are hard to quench. In the old time, one needed just enough to ensure similar living standards to those one had a day, a year, a generation before; now, it’s the more, the better. Is it really better though? No matter how much we produce, how much we consume, we want more. They say that appetite comes with eating, so economic gluttony is rampant, and with it, economic obesity and many resulting social pathologies. Economy needs a healthy diet, just like one is necessary for a well-functioning body. The economy of the future needs moderation.

Even though the degree to which needs are satisfied is growing, needs themselves are growing even faster. As a result, even though economic growth continues, the gap between needs and satisfying them is widening. Even though one has more, things are worse. This is, in essence, a psychological problem but one having significant economic consequences. And political ones, too. I once referred to this syndrome as a paradox of a lower level of satisfaction of needs at a higher consumption level. How to solve this problem? Well, it should be clear that we need to solve it or else there will be no end to the chase for producing more goods, while getting no satisfaction from consuming more. This is environmentally-devastating and causes social disturbance so what’s the point in that?

Professor Kolodko, currently Director of TIGER, Transformation, Integration, and Globalization Economic Research, former deputy prime minister and minister of finance of Poland, is the author of international bestseller “Truth, Errors, and Lies: Economics and Politics in a Volatile World” published by Columbia University Press (http://cup.columbia.edu/book/978-0-231-15068-2/). He writes a blog at www.volatileworld.net.

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