Much of the discourse on inequality treats the distribution of income
as separate, or at least separable, from its growth, often suggesting
(implicitly or explicitly) a trade-off between the two. Growth is seen
as a matter of efficiency, distribution as a separate (and generally
secondary) issue of equity, which can be dealt with separately by add-on
measures.
This is problematic on at least two levels. At the most basic
level, growth and distribution are summary measures of the same set of
variables (individual incomes). As incomes change over time, the average
level changes; but, unless all incomes change by exactly the same
percentage (which is clearly not the case), so does distribution.
Moreover, policies designed to promote economic growth inevitably affect
the incomes of different individuals in systematically different ways.
Some gain more than the average, while others gain less, or may even
lose in absolute terms. Since gains and losses typically depend on the
nature of engagement in economic processes, which is itself closely
related to initial income levels, an effect on distribution is
inevitable. It thus makes no more sense to think that growth can be
pursued without affecting distribution than it does to assume that
distribution can be changed without affecting growth.
Second, the consideration of distribution only as a matter of
equity, and not of efficiency, is erroneous. It is clear that an extra
$100 of income has an immeasurably greater impact to a landless labourer
living on less than a dollar a day (whose life and prospects could be
permanently improved) than it is to a billionaire, to whom it would make
no difference whatsoever. Thus the value of the additional income
generated by economic growth, in terms of its effect on human
well-being, is critically dependent on whether it accrues to someone on a
high or a low income.
Thus, while distribution is certainly important to equity, it also
has a major impact on efficiency – the efficiency with which a given
level of aggregate income is translated into well-being. The scale of
such efficiency effects is difficult to assess, depending on the nature
of the relationship between income and well-being; but the sheer
magnitude of global inequality (and the still greater inequality in the
distribution of the proceeds of global growth) suggests that it is
considerable, and could well be comparable to variations in productive
efficiency.
Even setting aside equity considerations, and even to the extent
that there is a trade-off between distribution and productive efficiency
(which is itself questionable), it follows that consideration of any
economic policy designed to increase productive efficiency must also
take account of any off-setting effect on distributional efficiency –
otherwise, its net effect could well be negative. Moreover, even if the
net effect is an increase in overall efficiency, this would need to be
set against any adverse effect on equity.
If we accept that the value of each dollar of income varies
(inversely) according the total income of recipient, this clearly
undermines the usefulness of national income as an indicator of economic
performance, let alone as an objective of policy. However, its
implications are much more far-reaching than this. It requires us very
largely to rethink economics as it is generally used in policy.
For example, the standard economic response to externalities is the
use of “market-based” policies, which ultimately rely on pricing
mechanisms to change behaviour (particularly consumption patterns). The
underlying rationale is that this is economically efficient: those who
value their consumption most will continue to consume, while those who
value their consumption less will be less willing to pay the additional
cost, and will be priced out of the market. Overall consumption will
thus be reduced by eliminating that consumption which is least valuable.
However, if we take account of the differential value of money
according to who receives it, then the picture becomes very different.
Suppose, hypothetically, that we were to decide to apply a price to the
extraction of raw materials to discourage over-exploitation. Take the
example of iron ore:
Consider two individuals, one a wealthy individual planning to buy a
second Mercedes, the other a poor resident of an urban slum hoping to
buy a corrugated iron roof for her home. If the price of iron ore is
doubled, the price of the Mercedes will barely be affected, because it
is such a small proportion of the total price; and even if the price
rises a little, it is most unlikely that the purchase decision will be
affected, because the price elasticity demand for prestigious cars is
very low. (It is quite possible that it is negative, to the extent that
higher prices add to the car’s status value – but that is a separate
issue.) And even if the purchase decision is affected, the most likely
effect is a switch to a cheaper product (e.g. a BMW) which may or may
not have a lower iron content.
Our poor urban resident, on the other hand, will face a much
greater increase in the price of her new roof, because the cost of iron
ore represents a much greater proportion of its total cost. Moreover,
her very limited means make it much more likely that she will be unable
to afford it (or at least have to delay the purchase); and it is likely
that this is already the cheapest available option, limiting the
possibility of substitution.
Thus, far from pricing out the least valuable consumption, pricing mechanisms may systematically price out the consumption which would contribute the most to well-being.
In fact, this goes beyond the use of “market-based mechanisms” to
the operation of markets themselves. As the opening chapter of Global
Health Watch 3 (discussing the interplay of the financial, food, fuel,
climate and development crises) points out in the context of the major
rise in cereal prices after 2005:
“The amount of maize required to produce enough ethanol to drive
one mile in an SUV in town is approximately the amount needed to feed
someone for a day. It seems beyond question that having enough to eat
for a day rather than nothing at all provides vastly more benefit than
driving one more mile in an SUV. But the purchasing power of poor people
who depend on maize as a staple is very limited, while that of SUV
owners is much greater. Those whose need is greatest are priced out of
the market as prices are forced up by the consumption of those whose use
is most trivial”.
The assumption that each extra dollar provides the same increase in
well-being at all levels of income is fundamental to economics; and yet
this assumption appears wholly unfounded and counter-intuitive. In a
relatively equal society, this might not matter very much. But in a
world where 1.3 billion people below the $1.25-a-day line, with an
average purchasing power of around $300 per person per year, must
compete in an increasingly globalised market with 1,426 billionaires, with a combined net worth of more than $5,300,000,000,000, it matters very much indeed.
So, this assumption seems quite untenable in the contemporary
world. But if we relax it, and think of the economy’s purpose as being
to maximise overall well-being rather than simply to maximise total
production, regardless of what is produced or who consumes it, then we
are forced to rethink, not only certain economic policies and
approaches, but the whole basis of economics as a discipline.
David Woodward
Literature:
People’s Health Movement, Medact, Health Action International, Medico International and Third World Network (2011) Global Health Watch 3: an Alternative World Health Report. London: Zed Books, p. 35.
Forbes (2013) The Richest People on the Planet, 2013.
http://www.thebrokeronline.eu/Blogs/Inequality-debate/The-failure-of-economics-in-an-unequal-world
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