In developed countries, the levels of production and consumption are already environmentally unsustainable. Further growth in these countries can only come at enormous cost to the environment. A solution to major economic problems in these countries, such as poverty and unemployment, has to be found in the redistribution of income and wealth in favour of the poorer sections.
At the same time, the condition of most developing countries is far different from developed countries. Most people in these countries lack even the basic necessities of life and they face chronic hunger and grave deprivation. For achieving improvement in their lives, economic growth is necessary. The enormity of the problems that these people face is such that even though more equitable sharing of currently-produced output levels will improve their living conditions somewhat, but it may not take them very far.
There is a great deal of literature that deals with the relationship of economic growth with income and wealth distribution and poverty reduction. Some important questions raised in this context are: What generally is the impact of economic growth on distribution of income and wealth? Does economic growth worsen distribution (make it more uneven) or improves it (i.e., it reduces disparity)? Does the impact of economic growth on distribution depend on initial conditions? Does it depend on the nature of growth? What roles do balance of class power, nature of regime, governance factor and policy framework play in this? We explore these issues in the remaining part of this article.
Poverty and Growth
After the Second World War, i.e., from the 1950s to the 1970s, the dominant view, known as “the inverted hypothesis”, held that in the early period of economic growth, distribution tends to worsen; and only after achieving a certain economic level, one can expect improvement in distribution. This hypothesis was propounded by Simon Kuznets in his 1955 paper that contained an empirical investigation of the relationship between per capita income and inequality in a cross section of countries.
There was an earlier discernible similarity between Kuznets’ empirical results and prediction of Lewis’ 1954 labour supply model. Lewis’ model focused on structural change in a dual economy setting, in which labour was shifted from a labour surplus traditional agricultural sector to a modern industrial sector. This process of labour transfer continued until the labour supply was exhausted. The Kuznets’ hypothesis suggested trade-off between equality and growth. For a short while, in the 1970s, a trend in literature emerged that downplayed the trade-off arguments and advocated that to alleviate poverty in many developing countries, redistribution measures should be identified that do not hamper growth (Dagdeviren, et al, 2004).
The enthusiasm for “growth with justice”, however, did not last long. The focus of literature shifted with the rise of neo-liberalism and market fundamentalism in the early 1980s. In this period (lasting for about two decades) associated with globalization and the Washington Consensus, the major international financial institutions (the World Bank and the International Monetary Fund) dictated a policy formulation in a large number of countries who had to borrow money from them for various reasons through imposed structural adjustment programmes (SAP) involving liberalization and privatization. During this phase, questions related to distribution and poverty were set aside in favour of growth. It was argued that growth itself would curtail poverty through “trickle down” mechanisms. There was, however, not much discussion about the processes through which trickle-down would work.
In the 1990s the subject of relationship between growth, distribution and poverty again started attracting attention of researchers. Despite the growth over a period of many years, in many, if not most, developing countries, there was neither a decline in the incidence of poverty, nor in its severity. This led many scholars to question the basic tenets of the neo-liberal analysis including its reliance on trickle-down to solve the problem of poverty. There was an increasing emphasis in the development community on making growth pro-poor, on bringing the benefits of growth to the poor.
Misleading Studies
Although the vast literature during this period takes a pro-distribution stance, it generally lacked a consensus on most issues of importance. The studies were mostly empirical and provided no theoretical breakthroughs. As usual with economists, there are contradictory analyses and interpretations of the existing situation and recommendations are too diverse to be of any practical use.
As mentioned above, the literature exploring relationship between growth, distribution and poverty is mostly empirical in nature. The studies use existing cross-country data on income distribution which are full of problems. Estimates of poverty and inequality are based on data obtained from household surveys. Here, randomly selected samples of households are asked questions related to income and expenditure. As the methodology and coverage of the household surveys differ from country to country, the comparability of data between countries is quite suspect. And the problem exists even when data of different household surveys done at different points in the same country are compared.
A major problem with income and expenditure data is that of gross under-reporting of incomes and spending by the rich section of society, who often do not want to participate, are hard to reach, or deliberately understate their incomes or spending (Ravallion, 2004: 64). It is primarily the rich people’s intentions to evade payment of taxes that lead them to hide their incomes and spending. The conversion of nominal values into real values to take into account changes in cost of living also poses problems, as suitable consumer price indices that adequately capture changes in consumption behaviour of the poor are generally not available.
It is not only the problems with the data sets used in studies explaining the relationship between growth, distribution and poverty that are serious. The empirical techniques used to study these relationships are also prone to give misleading, if not meaningless, results and are thus, useless from the point of view of providing policy guidelines. Dollar and Kraay (2004: 32) warn readers against misinterpretation of results of their own study:
…existing cross-country data on income distributions that we use contains substantial measurement error. We, therefore, cannot rule out the possibility that our failure to uncover systematic effects of average incomes and policy on income share of the poorest quintile is simply a consequence of this measurement error. We also cannot rule out the possibility that there are complex interactions between inequality and growth, not captured by our simple empirical models, that net out to small changes in the former that are uncorrelated with the latter.
Ravallion points out that lack of correlation found between changes in inequality and indicators of policy reforms, as in Dollar and Kraay, does not mean that the growth effects are the only factors on which the outcomes of such reforms for the poor depend upon. According to Ravallion (2004: 74):
(One) reason why the low correlations found between policy reform and changes in overall inequality can be deceptive is that starting conditions vary a lot between reforming countries. Averaging across this diversity in initial conditions can readily hide systematic effects.
He further elaborates (ibid: 75):
Suppose that reforming developing countries fall into two categories: Those in which pre-reform controls on the economy were used to benefit the rich, keeping inequality artificially high, and those in which the controls had the opposite effects, keeping inequality low. The reforms may well entail sizeable redistribution between the poor and the rich, but in opposite directions in the two groups of countries. Then one should not be surprised to find that there is zero correlation between growth and changes in inequality, or that the average impact of policy reform on inequality is not significantly different from zero. Yet, there could well be non-random distributional change going on under the surface of this average impact calculation. This can arise when policy reforms shift the distribution of income in different directions in different countries. And it is not implausible that they would do so, given the diversity in initial conditions across developing countries at the time reforms begin.
Two Opposing Strands
There are broadly two opposing strands found in the literature on these subjects. At one end of the spectrum are those who argue that a free market-based system and liberal economic policies raise incomes of all, the rich and the poor, proportionately. Dollar and Kraay (2004) argue that growth-enhancing policies and institutions tend to benefit the poor — and everyone else in society — equiproportionately. According to them (ibid: 30);
We cannot reject the null hypothesis that the income share of the first quantile vary systematically with average incomes. In other words, we cannot reject the null hypothesis that incomes of the poor rise equiproportionately with average incomes… There is no systematic relationship between average incomes and the share of income accruing to the poorest fifth of the income distribution.
This “growth is distribution-neutral” stance of these studies translates into a stance that “growth is good for the poor”. It is stated that as incomes of poor also rise with the incomes of the rest in society, there is a reduction in poverty as measured by some fixed income levels. This way the focus remains on growth, away from explorations of alternative policy packages and debates on their consequences for redistribution and poverty. Growth is good for the poor is the usual policy prescription given to developing countries by the international finance institutions and western governments.
At the other end of the spectrum is the argument that economic growth, especially during the last two or three decades, has been associated with an increase in inequality. This has prevented benefits of economic growth reaching the poor. To support this view, evidence is cited that shows during the 1980s and 1990s, inequality and poverty have risen in many countries, including some developed countries. This leads to the conclusion that poverty reduction cannot be achieved just by faster economic growth: redistribution measures need to be a necessary component of any strategy aimed at poverty reduction (Dagdeviren, et al, 2004).
Focus on the USA
During the last 30 years, income inequality has risen considerably in all western economies and more so in the USA. In our analysis, we will focus on USA because this issue has been very extensively researched in the USA and huge quantity of very authentic data has been produced in this area by economists in recent years. The earlier studies deliberating on this issue have been inconclusive about the direction of effect of growth on distribution, largely because they have used data of 30–40 years after the Second World War during which the growth in Europe and the USA was relatively quite inclusive. As Stiglitz (2012: 4) in his recent book, The Price of Inequality puts it:
For 30 years after WW II, America grew together — with growth in income in every segment, but with those at the bottom growing faster than that at the top…But for the past 30 years, we have become increasingly a nation divided; not only has the top been growing the fastest, but the bottom has actually been declining. (It hasn’t been a relentless pattern — in the 1990s, for a while, those at the bottom and the middle did better. But then…beginning around 2000, inequality grew at even more rapid pace).
He further states,
What America has been experiencing in recent years is the opposite of trickle-down economics: the riches accruing to the top have come at the expense of those down below (ibid: 6).
In a major work on distribution of income in the USA, spanning several decades, Emmanuel Saez and Thomas Piketty using income tax data show that the income share of the richest 1 per cent of individuals in 2007 (the year before the onset of the great recession) stood at 23.5 per cent. It was 10.02 per cent in 1980. From 1980 to 2007, the US economy experienced a long phase of economic growth, albeit interrupted a few times by minor downturns. The gains of growth, however, accrued mostly to the rich. The top 1 per cent seized about 60 per cent of the gains in national income between 1979 and 2007. In contrast, the bottom 90 per cent earners’ share in gains was a fourth of what the top 0.1 per cent got (see Emmanuel Saez’s web-site: http://emlab.berkeley.edu/~saez/ with tables and figures updated to 2010) .
It is not only during the growth phase that the wealthiest captured most of the gains in national income, they continue to seize the lion’s share of gains even of the feeble recovery during this continuing great recession.
Even what has been happening in this recession is unusual. Typically, when the economy weakens, wages and employment adjust slowly, so as sales fall, profits fall more than proportionately. But in this recession, the share of wages has actually fallen and many firms are making good profits (Stiglitz 2012: 29).
As revealed by Piketty and Saez, the top 1 per cent of Americans gained 93 per cent of the additional income generated in 2010. The Gini-coefficient in the US was 0.469 in 2010, registering a huge rise from 0.403 in 1980. In comparison to income inequality, wealth inequality in capitalist societies is generally even more severe. According to Sylvia Allegretto (2011), in 2000 the wealthiest 1 per cent Americans owned 35.6 per cent of the nation’s net wealth.
In Conclusion
From the foregoing analysis, it is clearly evident that in the current phase of advanced capitalism in the 21st century, when the full effects of neoliberalization (accompanied with globalization and financialization) resulting from the historical shift in the balance of class power in favour of capital around 1980 have been fully worked out, changes in income and wealth distribution are completely independent of different phases of growth cycle. Inequality has been on the rise in the period of growth as well as in the period of stagnation or recession.
Stiglitz argues that “inequality is the result of political forces as much as of economic ones” (Stiglitz 2012: 30). Schtuz (2011: 136) is in broad agreement with many analysts in economics and other social sciences who have “forcefully contended that power and class are at the very heart of the problem of rising inequality”.
In his “Introduction to the 2006 Verso Edition” of his book Limits to Capital originally written in 1982, David Harvey writes that “Marx’s critical apparatus is far more applicable to neoliberalism than it was to the ‘embedded liberalism’ and Keynesianism that dominated in the advanced capitalist world up until the mid-1970s” (Upadhyay 2011). Referring to Marx, Harvey (2006: xi) writes:
In Volume 1 of Capital, Marx shows that the closer a society conforms to a deregulated, free-market economy, the more the asymmetry of power between those who own and those excluded from ownership of the means of production will produce an ‘accumulation of wealth at one pole’ and an ‘accumulation of misery, agony of toil, slavery, ignorance, brutality, mental degradation, at the opposite pole’.
Stating that “(t)hree decades of neoliberalization have produced precisely such an unequal outcome”, he opines that “this was what neoliberalizing agenda of leading factions of the capitalist class was about from the very outset”.
About the Author:
Dr. V. Upadhyay is a world renowned Economist and Prof. Upadhay has taught at the most prestigious institutes in India and Canada. He was the Head of Department of Humanities and Social Sciences of IIT Delhi, and had previously worked with IIT Kanpur, New Brunswick University, Canada, Prince Edward Island University, Canada and Rajasthan University, Jaipur. His area of interest is development Economics and has written around 100 research papers. He is also a member of Indian Political Economy Association.