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THE economist Robert Lucas, winner of the Nobel Prize for Economics in 1995 and regarded by many as the most influential macro economist of the last quarter of the previous century, once remarked that when it comes to economic growth “the consequences for human welfare involved in questions like these are simply staggering: once one starts to think about them, it is hard to think about anything else”.
Later he stated that “of the tendencies that are harmful to sound economics, the most seductive, and in my opinion the most poisonous, is to focus on questions of distribution”.
Lucas would therefore probably object strongly to any discussion on the link between inequality in income distribution and economic growth. Furthermore, arguing that the redistribution of income could promote economic growth by bringing about greater equality would surely go against his grain!
And yet this is precisely the question that is being debated with great passion in the wake of the global financial crisis, for the very reason that the financialisation of the economy over the past 30 years is often regarded by less orthodox economists as the root cause of the increase in inequality and the slowdown in growth.
A recent book that has elicited much discussion although it focuses more on the distribution of wealth than on economic growth, is Capital in the Twenty-First Century by French economist Thomas Piketty.
None other than Paul Krugman, winner of the Nobel Prize for Economics in 2008, describes it as a “magnificent, sweeping meditation on inequality” and says “this book will change both the way we think about society and the way we do economics”.
It is impossible to do justice to such a celebrated book in this article. A good starting point is Brad DeLong’s list of worthwhile reviews on the webpage of the Washington Center for Equitable Growth.
Readers are also advised to consult the reviews in the most recent issues of The Economist and Foreign Affairs and then decide for themselves whether they have the stamina to confront Piketty’s almost 700 page magnum opus (see below for references).
In brief, Piketty argues that inequality in the distribution of wealth will continue to expand indefinitely because in his opinion the return on capital (physical as well as financial) is likely to exceed the growth rate of the economy in the long run.
This means that the wealth accumulated in especially the past 30 years by those who find themselves in the top 1% in terms of the distribution of income and wealth will be inherited by their descendants, which will result in the formation of a new rentier class, similar to the elite of the nineteenth century. Hence the obvious reference to Karl Marx in the choice of the title of the book!
In fact, Piketty argues that not only are we returning to the level of inequality that existed in the nineteenth century, but we are also on the way back to a system of “patrimonial capitalism” in which the “commanding heights” of the economy are not controlled by talented individuals but by family dynasties as a result of the inheritance of wealth.
Piketty’s solution is a more progressive tax system on a global level, particularly with regard to wealth taxes such as estate duty. However, he admits that his proposal is not implementable in practice!
Opinions about Piketty’s book are divided. In his review, Tyler Cowen describes it as “brilliant but fundamentally flawed”. The brilliance of the book lies in in the light it sheds on the history of inequality in the developed world by exploiting new data sources.
The flaws are to be found in the author’s inclination to present opinions as if they are indisputable laws and in the book’s ill-considered policy proposals.
It is in any case debatable to what extent Piketty’s argument applies to South Africa. Although part of the Davis tax commission’s terms of reference is to investigate the progressiveness of the South African tax system, as well as to look at estate duty, the South African context differs radically from those in Europe and the USA.
Another contribution to the debate that is also attracting a lot of attention, also in South Africa, is a discussion paper by Jonathan Ostry and two of his IMF colleagues. The title is self-explanatory: Redistribution, Inequality, and Growth. Their argument is probably more relevant to the South African situation than that of Piketty.
Ostry and his co-authors came to the following conclusions:
- The greater the inequality in a community, the more they turn to the redistribution of income.
- The lower the level of inequality, the faster the growth in the economy and the more sustainable that growth.
- Redistribution is generally beneficial for economic growth, except in extreme cases.
On the face of it their findings have direct implications for South Africa, given our high level of inequality and low economic growth. In fact, proponents of the idea of “growth through redistribution” will regard these findings as confirmation of their point of view.
With regard to the third finding above, Ostry and colleagues came to the conclusion that redistribution (by means of taxes and fiscal transfers), which reduces inequality as measured by the Gini coefficient by up to 13 points, is beneficial for growth.
At present, redistribution in South Africa via the fiscus accounts for approximately half thereof, which gives the impression that doubling redistribution measures would be to the benefit of economic growth.
The paper does not explain the mechanism through which redistribution will allegedly result in higher growth. However, proponents of the “growth through redistribution” point of view often point out that the spending patterns of the rich and the poor differ – the poor spend less on imported goods than the rich, and because they spend more on basic goods this could support the local manufacturing sector.
Another motivation often put forward is that redistribution from people with a relatively high propensity for saving to those with a relatively higher propensity for spending would stimulate overall demand in the economy. However, at best this can only offer a temporary, short-term stimulus.
Ostry and his co-authors do qualify their findings to such an extent that one should be careful not to get overenthusiastic about them. According to them the nature and quality of redistribution are crucial and that whether redistribution in practice would be to the benefit or detriment of growth is an empirical question.
They also point out the shortcomings inherent in the data (panel data for different countries and years) and the statistical methods (cross-country regression analysis) they used.
According to them “we should of course be cautious about drawing definitive policy implications from cross-country regression analysis. We know that different sorts of policies are likely to have different effects in different countries at different times, and causality is difficult to establish with full confidence”.
Furthermore, “We need to be mindful about over-interpreting these results, especially for policy purposes. It is hard to go from these sorts of correlations to firm statements about causality.”
Consequently their final findings are rather ambiguous and of questionable value. On the one hand they are saying that one should be cautious about assuming a negative link between redistribution and growth. Yet on the other hand they are saying that “equality that seems to drive higher and more sustainable growth does not in itself support efforts to redistribute”.
It will therefore be opportunistic to use this paper as part of an argument in favour of greater redistribution in South Africa.
In short, South Africa’s growth dilemma cannot be solved simply through increased redistribution. However, in a low growth environment such as we currently find ourselves in and which looks set to continue for some time still, one must expect the debate on distributional issues to heat up.
Piketty acknowledges that peoples’ views regarding inequality is ideological by nature and therefore subjective, depending on their perceptions of social justice.
For example, in his response to Pope Francis’s statements on inequality under the heading “Why Is Pope Francis Promoting Sin?”, Lant Pritchett, development economist at Harvard University, refers to the Pope’s “errors of fact and reasoning”.
He then advises the Pope to leave the matter to the professionals and to rather stick to preaching the tenth commandment!
- Fin24
*Jac Laubscher is Group Economist of Sanlam. Opinions expressed are his own.
Follow Fin24 on Twitter, Facebook, Google+ and Pinterest.
References
Cowen, Tyler: Capital Punishment, Foreign Affairs, May/June 2014.
DeLong, Brad: Eleven (so Far) Worthwhile Reviews of and Reflections on Thomas Piketty’s “Capital in the Twenty-First Century”. Washington Center for Equitable Growth. 25 March 2014.
Krugman, Paul: Why We’re in a New Gilded Age. The New York Review of Books. 8 May 2014.
Lucas, Robert E Jr: On the Mechanics of Economic Development. Journal of Monetary Economics. 22 July 1988.
Lucas, Robert E Jr: Lectures on Economic Growth. Harvard University Press. September 2004.
Ostry, Jonathan D; Berg, Andrew; Tsangarides, Charalambos G: Redistribution, Inequality, and Growth. IMF Staff Discussion Note SDN14/02. February 2014.
Piketty, Thomas: Capital in the Twenty-First Century. Harvard University Press. 2014.
Piketty Fever: Bigger than Marx. The Economist, 3 May 2014.
Pritchett, Lant: Why Is Pope Francis Promoting Sin? Bloomberg, 15 December 2013.
Later he stated that “of the tendencies that are harmful to sound economics, the most seductive, and in my opinion the most poisonous, is to focus on questions of distribution”.
Lucas would therefore probably object strongly to any discussion on the link between inequality in income distribution and economic growth. Furthermore, arguing that the redistribution of income could promote economic growth by bringing about greater equality would surely go against his grain!
And yet this is precisely the question that is being debated with great passion in the wake of the global financial crisis, for the very reason that the financialisation of the economy over the past 30 years is often regarded by less orthodox economists as the root cause of the increase in inequality and the slowdown in growth.
A recent book that has elicited much discussion although it focuses more on the distribution of wealth than on economic growth, is Capital in the Twenty-First Century by French economist Thomas Piketty.
None other than Paul Krugman, winner of the Nobel Prize for Economics in 2008, describes it as a “magnificent, sweeping meditation on inequality” and says “this book will change both the way we think about society and the way we do economics”.
It is impossible to do justice to such a celebrated book in this article. A good starting point is Brad DeLong’s list of worthwhile reviews on the webpage of the Washington Center for Equitable Growth.
Readers are also advised to consult the reviews in the most recent issues of The Economist and Foreign Affairs and then decide for themselves whether they have the stamina to confront Piketty’s almost 700 page magnum opus (see below for references).
In brief, Piketty argues that inequality in the distribution of wealth will continue to expand indefinitely because in his opinion the return on capital (physical as well as financial) is likely to exceed the growth rate of the economy in the long run.
This means that the wealth accumulated in especially the past 30 years by those who find themselves in the top 1% in terms of the distribution of income and wealth will be inherited by their descendants, which will result in the formation of a new rentier class, similar to the elite of the nineteenth century. Hence the obvious reference to Karl Marx in the choice of the title of the book!
In fact, Piketty argues that not only are we returning to the level of inequality that existed in the nineteenth century, but we are also on the way back to a system of “patrimonial capitalism” in which the “commanding heights” of the economy are not controlled by talented individuals but by family dynasties as a result of the inheritance of wealth.
Piketty’s solution is a more progressive tax system on a global level, particularly with regard to wealth taxes such as estate duty. However, he admits that his proposal is not implementable in practice!
Opinions about Piketty’s book are divided. In his review, Tyler Cowen describes it as “brilliant but fundamentally flawed”. The brilliance of the book lies in in the light it sheds on the history of inequality in the developed world by exploiting new data sources.
The flaws are to be found in the author’s inclination to present opinions as if they are indisputable laws and in the book’s ill-considered policy proposals.
It is in any case debatable to what extent Piketty’s argument applies to South Africa. Although part of the Davis tax commission’s terms of reference is to investigate the progressiveness of the South African tax system, as well as to look at estate duty, the South African context differs radically from those in Europe and the USA.
Another contribution to the debate that is also attracting a lot of attention, also in South Africa, is a discussion paper by Jonathan Ostry and two of his IMF colleagues. The title is self-explanatory: Redistribution, Inequality, and Growth. Their argument is probably more relevant to the South African situation than that of Piketty.
Ostry and his co-authors came to the following conclusions:
- The greater the inequality in a community, the more they turn to the redistribution of income.
- The lower the level of inequality, the faster the growth in the economy and the more sustainable that growth.
- Redistribution is generally beneficial for economic growth, except in extreme cases.
On the face of it their findings have direct implications for South Africa, given our high level of inequality and low economic growth. In fact, proponents of the idea of “growth through redistribution” will regard these findings as confirmation of their point of view.
With regard to the third finding above, Ostry and colleagues came to the conclusion that redistribution (by means of taxes and fiscal transfers), which reduces inequality as measured by the Gini coefficient by up to 13 points, is beneficial for growth.
At present, redistribution in South Africa via the fiscus accounts for approximately half thereof, which gives the impression that doubling redistribution measures would be to the benefit of economic growth.
The paper does not explain the mechanism through which redistribution will allegedly result in higher growth. However, proponents of the “growth through redistribution” point of view often point out that the spending patterns of the rich and the poor differ – the poor spend less on imported goods than the rich, and because they spend more on basic goods this could support the local manufacturing sector.
Another motivation often put forward is that redistribution from people with a relatively high propensity for saving to those with a relatively higher propensity for spending would stimulate overall demand in the economy. However, at best this can only offer a temporary, short-term stimulus.
Ostry and his co-authors do qualify their findings to such an extent that one should be careful not to get overenthusiastic about them. According to them the nature and quality of redistribution are crucial and that whether redistribution in practice would be to the benefit or detriment of growth is an empirical question.
They also point out the shortcomings inherent in the data (panel data for different countries and years) and the statistical methods (cross-country regression analysis) they used.
According to them “we should of course be cautious about drawing definitive policy implications from cross-country regression analysis. We know that different sorts of policies are likely to have different effects in different countries at different times, and causality is difficult to establish with full confidence”.
Furthermore, “We need to be mindful about over-interpreting these results, especially for policy purposes. It is hard to go from these sorts of correlations to firm statements about causality.”
Consequently their final findings are rather ambiguous and of questionable value. On the one hand they are saying that one should be cautious about assuming a negative link between redistribution and growth. Yet on the other hand they are saying that “equality that seems to drive higher and more sustainable growth does not in itself support efforts to redistribute”.
It will therefore be opportunistic to use this paper as part of an argument in favour of greater redistribution in South Africa.
In short, South Africa’s growth dilemma cannot be solved simply through increased redistribution. However, in a low growth environment such as we currently find ourselves in and which looks set to continue for some time still, one must expect the debate on distributional issues to heat up.
Piketty acknowledges that peoples’ views regarding inequality is ideological by nature and therefore subjective, depending on their perceptions of social justice.
For example, in his response to Pope Francis’s statements on inequality under the heading “Why Is Pope Francis Promoting Sin?”, Lant Pritchett, development economist at Harvard University, refers to the Pope’s “errors of fact and reasoning”.
He then advises the Pope to leave the matter to the professionals and to rather stick to preaching the tenth commandment!
- Fin24
*Jac Laubscher is Group Economist of Sanlam. Opinions expressed are his own.
Follow Fin24 on Twitter, Facebook, Google+ and Pinterest.
References
Cowen, Tyler: Capital Punishment, Foreign Affairs, May/June 2014.
DeLong, Brad: Eleven (so Far) Worthwhile Reviews of and Reflections on Thomas Piketty’s “Capital in the Twenty-First Century”. Washington Center for Equitable Growth. 25 March 2014.
Krugman, Paul: Why We’re in a New Gilded Age. The New York Review of Books. 8 May 2014.
Lucas, Robert E Jr: On the Mechanics of Economic Development. Journal of Monetary Economics. 22 July 1988.
Lucas, Robert E Jr: Lectures on Economic Growth. Harvard University Press. September 2004.
Ostry, Jonathan D; Berg, Andrew; Tsangarides, Charalambos G: Redistribution, Inequality, and Growth. IMF Staff Discussion Note SDN14/02. February 2014.
Piketty, Thomas: Capital in the Twenty-First Century. Harvard University Press. 2014.
Piketty Fever: Bigger than Marx. The Economist, 3 May 2014.
Pritchett, Lant: Why Is Pope Francis Promoting Sin? Bloomberg, 15 December 2013.
