Wednesday, December 2, 2009

Do rising top incomes mean higher growth?

Does more inequality increase growth? Theoretically, the relationship is ambiguous. Let us take to effects to illustrate this by focussing on the incomes of the richest. If these increase, the aggregate savings rate gets higher as the richest have typically a below average marginal propensity to consume. The higher savings rate leads to more capital accumulation, and thus higher wages for everyone and higher GDP. However, the same rise in top incomes puts more pressure on increasing redistribution, and we know that more taxation leads to more inefficiencies, say through diversion of resources into tax avoidance and through lower incentives to work. Which effects dominates, and there are others, is an empirical matter.

The literature is largely inconclusive on this. Cross-country regressions are particularly ill-suited for this, because the level of inequality in an economy can have many reasons that maybe correlated is some way with growth. Time-series studies are also problematic because of the possibility of a Kuzents curve: As an economy develops, on can expect inequality to rise and then fall. And in both cases, the measurement of inequality is always problematic.

Dan Andrews, Christopher Jencks and Andrew Leigh claim to do this better by focussing on just the top incomes (easier to measure than, say, a Gini coefficient) and by exploiting the pannel feature of their data. They conclude that a rise in top incomes, at least after 1960, has a positive impact on the growth rates in 12 OECD countries. Specifically, a 1% increase in the top income share leads to a 0.12% increase in the growth rate. If this income change is permanent, the growth rate change is permanent as well. On theoretical grounds, I find this hard to believe and that may be a result of the rather short period they are looking at (40 years in 5 year intervals). Imagine what this means in the context of a Solow growth model: The permanent shock means that the aggregate savings rate is higher. That leads to a higher capital level, but not a higher steady state growth rate. It looks like there is still a lot of work left in this literature.


Anonymous said...

Ok first of all I am not an economist but ...ummm NO! definitely no! Just US data for the last 30 years should be enough to convince anyone that rising incomes at the top mean nothing to the vast majority of people.
I see the last thirty years as the top small percent of 15 getting much more in the area of incomes and lesser tax responsibility and those same people acting pretty much as people act, working the rules (through the legal bribing of politicians) to reinforce their gains.
even if this meant more measurable growth to the body of people as a whole, people don't react to that. They compare their well being to others. No one feels better if their boss is driving a Bentley instead of a Cadillac. They just know that driving a Nova sucks in comparison.

Anonymous said...

Your pay generally depends on your productivity. Higher productivity means more growth.

In the reverse causation, a slow-growth economy means government is reducing productivity,thus limiting the productivity and thus pay of top income earners.

Kansan said...

To the first poster: Economists try to look deeper than first appearances. Causations are different from correlations.

Rich people are typically more industrious, and thus rewarding them better is beneficial to an economy. How much is then question this paper asks.

Whether it is good for welfare is a different question. Issues about fairness and equity come to mind.