Media Briefings

Inequality And Redistribution: The Politically Decisive Role Of Middle Class Investors

  • Published Date: October 2007

Societies in which a large proportion of output is produced in small and medium-sized
enterprises are more unequal. That is one of the findings of research by Professors
Hans Peter Grüner and Rüdiger Schils, published in the October 2007 issue of the
Economic Journal. Their study of the relationship between inequality and political
pressures for redistribution examines the politically decisive role of the middle class
investors who finance entrepreneurs’ investments.
Many democracies are characterised by an unequal distribution of wealth. In 2001, the
richest 1% of all US households owned 33% of the domestic wealth and roughly 40% of
net financial wealth. 67% of net financial wealth was concentrated in the hands of the
top 5% of the households while the bottom 60% owned about 1%. The figures are
similar for other industrialised countries.
The ownership of physical capital is particularly highly concentrated although politically
the redistribution of capital is an option available to voters. So why don't the poor take a
rich man's wealth? And why do very unequal societies such as the United States
redistribute less than the more equal European ones?
This study presents a unified explanation for both empirical observations: the limits to
wealth redistribution and the missing link between inequality and redistribution.
At the core of the authors’ reasoning lies the connection between the wealth distribution
and the economy's interest rate. When capital markets are imperfect, a firm's ability and
willingness to borrow depends on its owner's wealth. When wealth is distributed more
equally, relatively rich entrepreneurs can only produce efficiently if their interest burden
declines. Hence, equilibrium interest payments have to decrease.
This adverse interest rate effect of equality would harm the politically decisive middle
class investors who finance entrepreneurs’ investments. Consequently, they vote
against redistribution. More inequality may reduce redistribution because a larger
wealth gap between the entrepreneurial classes and the lower classes makes the
interest rate effect more pronounced. This is why inequality may be politically selfsustaining.
Grüner and Schils find that the initial distribution of the capital stock and the available
technology play a crucial role in determining whether the middle class's political
preferences are aligned with those of either the upper or lower class. Technological
change may induce dramatic changes in political outcomes.
According to their analysis, the importance of capital income for the middle class should
play a role in shaping individuals' preferences for political redistribution. Moreover,
voters should have fewer incentives to redistribute income or wealth in economies with
a larger entrepreneurial sector.
This should in particular be the case when small or medium-sized enterprises play a
major role in the economy. The authors relate OECD and European data on the
importance of small and medium-sized enterprises with a measure of income inequality.
In deed, most of the very unequal OECD societies produce more than half of their
output in small and medium-sized enterprises. The positive relationship is significant for
the European countries.
Professor Grüner concludes:
‘The message of the paper is a simple one: the middle class benefits from
wealthy entrepreneurs when this alleviates incentive problems and generates
higher returns on their investments.’
Notes for editors: ‘The Political Economy of Wealth and Interest’ by Hans Peter
Grüner and Rüdiger Schils is published in the October 2007 issue of the Economic
Hans Peter Grüner is at the University of Mannheim. Rüdiger Schils is at RWE AG,
For further information: contact Hans Peter Grüner on +49 621 181 1886 (email:; or Romesh Vaitilingam on 07768-661095 (email: