How Inequality Damages Economies

Research Proves That a More Equal World Would Be More Stable

Source: http://g-mond.parisschoolofeconomics.eu/topincomes

Looking back at Irving Kristol's 1980 essay "Some Personal Reflections on Economic Well-Being and Income Distribution," as Foreign Affairs recently did, provides a useful intellectual lens from the past to focus the economic conversation today. Kristol argued that economic inequality was "but one manifestation of how nineteenth-century ideologies -- and most especially the socialist ideologies -- have so decisively shaped modern social science." Moreover, he wrote, income distribution does not really change over time so it is, as a subject for study, inconsequential.

Fortunately, economists failed to take his advice; recent studies of inequality reveal the limitation of Kristol's historical perspective. Kristol narrowly focused on one long spell of stable and relatively even distribution. But a careful look at the varying levels of inequality in different countries demonstrates just how much societal divides in wealth really matter. Countries with high inequality are far more likely to fall into financial crisis and far less likely to sustain economic growth.

It is a coincidence that just as Kristol was writing, the United States was set to undergo a dramatic economic transformation. In the 30 years that followed (see chart above), income inequality grew significantly, rising gradually in the early 1980s, and then later more sharply. So, at least in some sense, Kristol's argument can be forgiven as a victim of circumstance. 

Still, economic inequality was a significant phenomenon long before 1980. Kristol chides the National Bureau of Economic Research for its excessive concern with income distribution in the 1920s. But as an influential study by the economists Thomas Piketty and Emmanuel Saez shows, income inequality in the United States reached unprecedented heights in the 1920s.

Indeed, a growing body of economic literature suggests that inequality can lead to system-wide financial crises. For example, in his book Fault Lines, the economist Raghuram Rajan points at the political and economic pressures that in recent decades led high-income individuals in the United States to save and low-income individuals to borrow and spend. Financial

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