The Link Between Income Inequality and Economic Growth
- Param Vastani
- Dec 22, 2024
- 3 min read
By Param Vastani
The past few decades have seen tremendous economic development in the world, with countries like China and India completely transforming in the 80s and 90s. This economic growth has improved living conditions for a large proportion of the population; however, the benefits haven’t been equal. The top percent of the rich have grown at exponentially greater rates than the average person. Is this income inequality good for growth? The first answer that comes to mind is a clear no, but this issue is more complicated than it appears.
Impact of Inequality on Growth:
Income Inequality can have both a positive and a negative impact on the growth of a country depending upon its circumstances. On one hand, extreme inequality limits basic services like healthcare and education from a significant part of the population. But on the other hand, the existence of inequality makes people want to work harder, innovate and invent to reach the top. Thus, there is some incentive for its existence, but ensuring fairness is a difficult task.
There’s a moral question. Should everyone be earning equally? If that was the case, it would lead to an economically depressed society with no person having any incentive to innovate. If the right people have access to more resources, they can achieve great things, improve the quality of life of everyone through their ideas and create jobs. They can invest in various new projects and can afford to take risks, and if they strike gold, there’s more growth. This leads to a cascading effect, however, as the rich get richer and the poor stay where they were and eventually become poorer without access to basic things.
So we see that inequality is an incentive for people which leads to economic growth, but when it reaches an extreme, economic growth is hurt. Demand falls as many have nothing to survive, while the few people with money continue to enjoy as the remaining population is suffering.
Impact of Growth on Inequality:
This relation can be explained with a Kuznets Curve. Named after the Nobel Prize Winner Simon Kuznets, a Kuznets Curve shows how income inequality first increases later decreases with economic growth. This can be explained with an example of a shift from agriculture to industry. As a shift from agriculture to industry takes place, inequality rises as the industrialists grow faster than the workers. The urban sector improves more than the rural sector. The economy as a whole grows as employment also increases. This eventually slows down and the government has to step in and provide the poorest with the basic means of living.
This can be clearly seen in India’s example. As it opened its economy in 1991, there was significant growth as the country industrialised further and foreign entities entered its market. This growth was unequal, though. The Urban sector grew more than the rural, manufacturing and service sector grew more than agriculture. This is magnified by the fact that most of India’s population lives in rural areas and is engaged in agriculture.
In the past decade, the government has focused significantly on rural development and living conditions of these parts of the population have improved very much.
Thus, we have seen how income inequality affects economic growth and vice versa. Policymakers must try to achieve equitable growth for everyone and reduce inequality so that having a low income doesn’t mean suffering. While a few basic services should be insured, the market should not be strictly controlled or it will lead to a negative effect.
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