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Just believing you are trapped by a lack of opportunity can impact economic growth

New research suggests that it is not just the stark reality of income equality but a lack of people being able to progress that can threaten growth

Olesya Dmitracova
Monday 11 November 2019 13:02 GMT
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The closeness of the income of fathers and sons is one possible indicator of inequality
The closeness of the income of fathers and sons is one possible indicator of inequality

In capitalist economies, some degree of inequality is unavoidable. “How much is too much?” has been the central question in political debate over the last decade. But what also matters is the root cause of the disparity, however large, in incomes.

Recent research by economists at the International Monetary Fund (IMF) shows that wide gaps between the rich and the poor that are caused mainly by differences of opportunity are damaging to economic growth. Based on available data, the authors define inequality of opportunity as a close correlation between fathers’ and sons’ incomes. The closer the correlation, the higher the inequality. If children from well-off families or, more importantly, children from poorer families are unlikely to become better off than their parents – if, in other words, fathers’ incomes determine their sons’ future earnings – chances are there is less equality of opportunity in that society. Or, in economic jargon, intergenerational mobility is lower.

The researchers, Shekhar Aiyar and Christian Ebeke, find that an increase in income inequality significantly reduces economic growth in countries with low equality of opportunity. Such inequality becomes entrenched, limiting the potential of low-income workers and that negatively affects long-term economic growth. Such countries include the US, UK, Japan and most nations in the eurozone, as well as major emerging economies such as China, India and Brazil.

Aiyar and Ebeke explain that this entrenchment occurs across generations. By contrast, in economies where people on low incomes have access to the same opportunities as others, an increase in inequality is easily reversed.

Take an example particularly relevant to Britain. If access to high-quality education is unequal – say, because it requires a certain level of wealth – many talented people will miss out on educational opportunities and end up being less productive workers than they would otherwise be. And a slower growth in overall productivity translates into slower GDP growth.

Perceptions of how fair a society is matter too. If lower-income families believe their children will not be able to get good jobs because they lack the right connections or even the right accent, they may not invest as much in their education.

The task of ensuring everyone can, with enough effort, get a job that makes the most of their aptitudes starts early in future workers’ lives. Studies have shown that the stimulation children receive up to the age of five has a particularly strong impact on their brain development. Therefore, investing in high-quality early years education is crucial.

If, as Aiyar and Ebeke argue, low intergenerational mobility is a good proxy for inequality of opportunity, then its steep decline in Britain has alarming implications for the economy. According to researchers at the University of Surrey and the London School of Economics, in 2005, 62 per cent of people aged between 28 and 32 earned as much or more than their fathers did at the same age. But by 2018, that share had fallen to 36 per cent.

If the majority of people aren’t getting richer, there is another reason economic growth will suffer, as pointed out in last week’s Stephanomics podcast presented by Stephanie Flanders: they are not increasing their spending, which drags on growth in countries as heavily reliant on consumer spending as the UK and the US.

Stagnation in living standards for all but the richest threatens to hurt those very winners as well. Speaking on Stephanomics, here is how one millionaire explains it:

“I made a lot of money because people pay their mortgage bills on time, and their cell phone bills, and their iTunes bills,” says Morris Pearl, the chairman of the Patriotic Millionaires, a group of wealthy Americans, investors and business people campaigning against growing inequality in the US.

“Money has trickled up from all of these people paying all those little bills every month to those of us who’ve invested in the companies like Amazon and Google and Verizon, and the banks who make money from those monthly bills coming in. And without people who can make their payments every month investors can’t make money either.”

As the existence of the Patriotic Millionaires shows, even the rich – not usually shy about using their political power to maximise their own wealth – are increasingly aware of the dangers of inequality. While some oppose it for moral reasons, the majority of those worried about their disproportionate share of the economic pie are probably better described as pragmatic capitalists. If high inequality poses a threat to their ability to make money and to broader growth, then surely the rich have a vested interest in levelling the playing field.

And once the biggest winners from the current economic order are on board, we stand a much better chance of changing it from within.

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