Revisiting the debate on inequality and economic

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Revisiting the debate on inequality and development

François Bourguignon ——————————————————————————————————————————————— 637
REP 125 (5) septembre-octobre 2015
Document téléchargé depuis - Biblio SHS - - - 26/04/2016 h. © Dalloz

A standard representation of the way income redistribution through taxes and benefits depends on the initial level of income inequality is through majority voting on the rate of taxation in a democratic society (see Romer
[1975] and Meltzer and Richard [1981]). Low-income voters are in favor of a progressive redistribution of income, even though they take into account that taxation will reduce the growth of their future income. In contrast,
high-income voters are opposed to redistribution. The pivotal voter is the voter with the median market income. Her decision logically depends on how far below the mean income she is and, therefore, how much inequality there is in society. This model maybe generalized to non-majority voting, as long as the pivotal voter’s income is below the mean.
It may also be generalized to nondemocratic societies by assuming the ruling elite redistributes income so as to minimize the probability of social disorder that would threaten its political control over the population.
The possibility of some social movement caused by too high a degree of inequality provides another, more direct way through which inequality may affect economic growth. Political instability, social tensions, or social conflicts are direct impediments to investment and entrepreneurship and, therefore, to growth. This argument can also be extended to crime, if it were proven that, as suggested by some authors, the extent of criminality is a consequence of the degree of inequality.
Again, note that the aforementioned channels for the impact of inequality upon growth may refer to types of inequality other than income inequality.
For example, social conflict or political instability may arise from inequality among ethnic groups. Likewise, the lack of social mobility maybe more relevant to social tensions and even criminal behavior than the degree of income inequality in a country. Imperfect credit markets and wealth inequality
A strong argument in favor of inequality generating inefficiency and slowing down economic growth relies on the imperfection of the credit market and the inequality of the wealth distribution. The argument is simple. People without enough wealth cannot undertake potentially profitable investment projects because they lack collateral to offer to lenders, who are imperfectly informed about their project and their determination to make it successful.
In contrast, richer people can undertake projects with less private and social profitability because they have the collateral, or simply because they do not need to borrow. Clearly, it would be better for society if the most profitable projects in the former group were undertaken rather than the least profitable. This endogenous redistribution model of the relationship was originally developed by
Persson and Tabellini [1993], Alesina and Rodrik [1994]. The generalization to the case where the pivotal voter is not the median voter is discussed in Benabou [2000].
6. For evidence on the relationship between inequality and political instability see Alesina and Perrotti [1996]; about inequality and crime see Fajnzylber et al. [2002].
638 ——— Revisiting the Debate on Inequality and Economic Development
REP 125 (5) septembre-octobre 2015
Document téléchargé depuis - Biblio SHS - - - 26/04/2016 h. © Dalloz

in the latter group. Yet, it is the latter that are actually implemented. It follows that redistributing wealth from the top of the distribution to those in need of collateral at the bottom would improve the efficiency of the economy and accelerate growth by encouraging investment and making the economy more productive, on average.
This argument is illustrated in figure 1, where a wealth transfer, x, is made between individual R and individual P, whose wealth is just below the borrowing threshold, X. Thus, X is the collateral required by a lender to lend enough to P to cover the cost (greater than X) of a specific investment project. The size of the transfer is such that it allows P’s wealth to jump above X, so that P can undertake a project with a net annualized return, b. In the case of R, transferring x is equivalent to an annualized loss of income equal to a
rx, where r is the rate of interest. The project undertaken by P is supposed to have a rate of return above r, so that b
a. Thus, the wealth transfer raises the aggregate income of the economy by b



. Equalizing the wealth distribution via a transfer from a rich person, R, to a
“poor” person, P, just below the borrowing threshold, X, raises the aggregate income of the economy when P’s project comes to fruition and, thus,
fosters growth.
This line of argument was initially proposed by Banerjee and Newman and Galor and Zeira [1993], the latter in connection with education.
The argument is very persuasive, in particular because of clear microeco- nomic evidence of inefficient rationing in the credit market in many economies, especially in developing countries. Not surprisingly, it was successful in convincing both the profession and some policymakers that there was indeed a relationship between inequality and economic efficiency or economic growth. However, the problem is that the implications of the argument were not always fully understood. In particular, the interpretation in terms of inequality, whatever its definition, being responsible for slower growth was certainly not justified. Here too, the nature of the inequality in this argument matters.
First, the imperfect capital market argument refers to the distribution of wealth. Thus, extending it to the distribution of income, as often occurs in. Other important contributors to this line of reasoning include Aghion and Bolton [1997],
Benabou [1996], or Piketty [1997].

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