October 29th, 2014 4 Minute Read Report by Scott Winship

Inequality Does Not Reduce Prosperity: A Compilation of the Evidence Across Countries

Since the Great Recession, inequality has loomed large in policy debates in the United States and around the world. Losses from the recession and the slow pace of recovery since have fueled concerns that inequality is not simply unfair but harmful. It is now commonplace to see claims that high and rising inequality levels have held back or worsened living standards among the poor and the middle class, a theme of Thomas Piketty’s best-selling Capital in the Twenty-First Century.

Such concerns may nevertheless be misplaced. The prospect of vast economic returns might, for instance, incentivize more innovation and investment, producing stronger economic growth and higher incomes even among those who do not amass fortunes. By rewarding work and human capital investment, inequality between the upper middle class and the poor could also promote stronger earnings growth for everyone over time.

Georgia Levenson Keohane, a fellow at the Roosevelt Institute, conveys well the shortsightedness of equating low inequality with broad-based prosperity, writing of Americans: “We are living, some argue, in a North American banana republic: our income inequality is worse than that of Guyana, Nicaragua, and Venezuela. When it comes to shared prosperity, we keep company with Iran and Yemen.”[1]

Similarly, Nobel laureate Joseph Stiglitz writes that the United States is nearing “the level of inequality that marks dysfunctional societies—it is a club that we would distinctly not want to join, including Iran, Jamaica, Uganda, and the Philippines.”[2]

That inequality levels convey limited information about living standards below the top is easily seen by considering the incomes of the middle class and the poor among Keohane’s and Stiglitz’s inequality laggards. Middle-class Americans enjoy incomes more than three times higher than their counterparts in Venezuela and Iran, more than ten times higher than those in the Philippines, Jamaica, Guyana, Yemen, and Nicaragua, and more than 40 times higher than middle-class Ugandans. Americans in the bottom fifth have incomes 4.5 to 34 times larger than their counterparts in these countries.[3]

Is it the case more generally that having higher inequality lowers living standards below the top? This paper examines the relationship between income inequality and living standards among the middle class and the poor worldwide. Part 1 focuses on income inequality below the top 1 percent, over a wide range of countries. Part 2 focuses on income concentration within the top 1 percent, over a more narrow range of nations. Part 3 weighs the merits of various interpretations of the findings discussed in Parts 1 and 2. Key findings include:

  1. Across the developed world, countries with more inequality tend to have, if anything, higher living standards. The exception is that countries with higher income concentration tend to have poorer low-income populations.

  2. However, when changes in income concentration and living standards are considered across countries—a more rigorous approach to assessing causality—larger increases in inequality correspond with sharper rises in living standards for the middle class and the poor alike.

  3. In developed nations, greater inequality tends to accompany stronger economic growth. This stronger growth may explain how it is that when the top gets a bigger share of the economic pie, the amount of pie received by the middle class and the poor is nevertheless greater than it otherwise would have been. Greater inequality can increase the size of the pie.

  4. Below the top 1 percent of households—and prior to government redistribution—developed nations display levels of inequality squarely in the middle ranks of nations globally. American income inequality below the top 1 percent is of the same magnitude as that of our rich-country peers in continental Europe and the Anglosphere.

  5. In the English-speaking world, income concentration at the top is higher than in most of continental Europe; in the U.S., income concentration is higher than in the rest of the Anglosphere.

  6. Yet—with the exception of small countries that are oil-rich, international financial centers, or vacation destinations for the affluent—America’s middle class enjoys living standards as high as, or higher than, any other nation.

  7. America’s poor have higher living standards than their counterparts across much of Europe and the Anglosphere, while faring worse than poor residents of Scandinavia, Germany, Austria, Switzerland, the Low Countries, and Canada.

These findings cast doubt on claims that rising inequality is responsible for slowed income growth in America—and they suggest that attempts to reduce income inequality, in the U.S. and elsewhere, may not produce higher living standards among the poor and the middle class.



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