Why inequality harms economic growth

Yesterday the Organization for Economic Co-operation and Development, an international economic organization of developed countries, released a new study that argues rising income inequality is bad for economic growth due in part to worse educational outcomes. Federico Cingano, an economist at the OECD, compares the level of income inequality, economic growth, and education across the economies of its 34 member countries and finds that income inequality is bad for growth particularly if low-income households are being left behind.

The new paper first identifies the cost of income inequality in terms of gross domestic product, or the total goods and services produced by these economies. Cingano looks at the impact of changes in income inequality from 1985 to 2005 on economic growth from 1990 to 2010. In this time frame, inequality rose in all but three of the countries they studied (in those three countries, falling inequality is estimated to have increased growth). Figure 1 shows the results of the first part of the study.

Going further than many other studies on the subject, Cingano then identifies education as one of the key pathways by which inequality harms growth. Specifically, he finds that steep income disparities between adults on the lowest rungs of the income ladder and the rest of society lead to lower educational attainment and lower quality of education for their children. Furthermore, in part because of the educational disadvantages stemming from income inequality, Cingano’s work finds that higher economic inequality reduces the opportunities available to the poor. Thus, this study reinforces the work of University of Ottawa economist Miles Corak and others showing places with higher economic inequality tend to have lower economic mobility.

The new study follows in the wake of other research into the relationship between economic inequality and growth published this year. First, there was the extensive study by International Monetary Fund economists Jonathan Ostry, Andrew Berg, and Charalambos Tsangarides that foundeconomic growth was slower and periods of growth were shorter in developed countries with higher inequality. Then economists Roy van der Weide of the World Bank and Branko Milanovic of the City University of New York looked at the U.S. states and found that high income inequality decreases income growth for those at the bottom of the income distribution. These previous papers identified rising inequality as detrimental to growth, but they did not focus on the mechanisms through which higher inequality affected growth.

This past September, Heather Boushey, Equitable Growth’s Executive Director, and I released our survey of the literature on the relationship between inequality and growth. We found that the research, while nuanced, indicates that higher inequality is associated with lower long-term economic growth. This OECD study provides yet more evidence pointing to that conclusion and goes further by providing an idea for why this association occurs. By identifying a channel by which inequality may harm growth, this paper also provides a target for policymakers—improving our educational system for low-income people in particular.

This article is published in collaboration with the Washington Center for Equitable Growth. Publication does not imply endorsement of views by the World Economic Forum.

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Author: Carter C. Price is a Senior Mathematician focusing on quantitative analysis of U.S. economic policy.

Image: The Pierre building is seen through a stairway as customers enter the Apple retail store on Fifth Avenue in Manhattan, New York September 20, 2013. REUTERS/Adrees Latif.