This article first appeared on the Business Insider website at this link: https://www.businessinsider.com.au/inequality-economic-growth-australia-2018-7
Tackling inequality has the potential to drive the kind of economic growth Australia has been looking for
In the decade or so since the global banking and financial crisis plunged the world into the Great Recession, policy makers around the world have been adopting a range of policies that were previously considered ‘unconventional’ as they has sought to promote economic growth, lower unemployment and reflate economic conditions.
Think about some of those policies.
Negative interest rates – fancy being paid to borrow money!
Quantitative easing or QE, which has been colloquially referred to as central banks printing money and dropping it into the streets out of a helicopter. Government debt levels exploded to levels only seen when the world was at war as revenue collapsed and in some instances, fiscal stimulus measures were implemented. To this day, governments are struggling to get their budgets anywhere near balance, let alone in a position to reduce debt.
It is clear, or at least it should be, that these policies cannot be in place forever. At some point, interest rates will normalise, central banks will have to mop up the excess cash from the economy and budgets will need to be repaired. This begs the vital questions of how to pull off these tricky maneuvers without disrupting financial markets and the economy?
I think I have an answer.
It will not appeal to everyone and is politically challenging.
It is to do with making society less unequal or, if you wish to avoid two negatives, making society more equal. The economic debate on inequality of income and wealth shows, unambiguously, that as inequality increases, the rate of economic growth slows or at least is slower than it would otherwise be.
In simple terms, the link between more equality and stronger economic growth is based on the observation that if, for example, a low income earner gets an extra $20 a week in their pocket, they are more inclined to spend most if not all of it, whereas a $20 a week extra to a very high income earner – think a billionaire – will have little influence on their spending patterns. If the tax system is structured in a way that sees low income earners taking home more pay while high income earners take home a little less, the economy will be boosted by the extra spending of the low income earner.
This extra spending will deliver a higher rate of economic growth which will, in turn, boost demand for labour and this will lower the unemployment rate. Such a policy initiative can be revenue neutral to the budget. This requires the very well off to pay more tax or get less tax deductions and those proceeds are redirected to low income earners.
This is where the political problem can emerge. As we can see in the current debate about income and company tax cuts, issues of fairness and equity are important aspects of the case for and against lower company tax rates and the introduction of a flat tax rate for both low and high income earners (those on $40,000 and $200,000 will pay the same marginal tax rate).
Polls show that many people are against the company tax cuts, largely because of fairness issues. There are other areas where inequality can hamper economic growth, including access to education and health care.
People on high incomes usually have little trouble accessing the best quality of health care and education. Poorer people often struggle on these fronts. Think access to health services in the public health system versus the private sector.
Wealth, health, and education This matters for economic growth because good health and high levels of skills and educational attainment are positively correlated with economic growth.
Countries with an educated workforce are generally rich. This is why most people want to have a good education for themselves and their children. It pays off not only for the individual, but for society.
Health care is also important. People who are sick do not go to work as often as those who are healthy. This extends to people taking time off work to care for sick relatives who have less access to health professionals. To the extent that access to high quality health care allows the population to be fit enough to turn up to work, there is a clear productivity boost from wide access to good health care.
All of which goes to the point that economic growth can be nurtured by more than just interest rates, printing money, tax and government spending.
Policies that reducing income equality and improve access of low income people to education and health care is good for GDP.
Maybe policies aimed at reducing inequality will be the new wave of thinking when it come to generating stronger economic growth. It will take bold political leadership but when other policies have had limited success, it seems a matter of time before this path is taken.