If the gap between rich and poor people in countries like the UK and the United States
continues to widen, future economic recessions will be more severe and future booms
more pronounced. That is the central conclusion of new research by Professors Murat
Iyigun and Ann Owen, published in the April Economic Journal.
The widening gap between rich and poor in several industrialised economies has
generated concern among politicians, economists and the general public among… who is
concerned? Politicians? Economists? because they associate lower equality it with a less
fair economic system. less fairness in the
economic system. However, rThis research suggests that increased income inequality
should be troubling for other reasons too.
Using data from 27 countries over 25 years, the researchers show that increases in
income inequality in developed countries are associated with more severe business
cycles. In developing countries, however, they find the opposite: greater inequality is
associated with less severe fluctuations in consumption and GDP growth.
The results of this research indicate that the effect of greater inequality would be
noticeable. For example, increases in income inequality in the United States over the past
decade would (do you mean would or have? Hasn’t the real per capita GDP growth
changed? I am a little confused) increase the volatility of real per capita GDP growth in
the next several years by about 15%.
The reasoning behind this finding is that in more developed economies, an increase in
inequality means that there are more poor households. Because poor households do not
have the same ability to borrow as the rich, when they fall on hard times, they must
reduce their spending. Rich households, however, are able to borrow and do not have to
reduce their consumption when their income is temporarily low.
As a result, when there are more poor people in an economy, consumer spending will be
more variable. Because consumption accounts for such a large portion of GDP (or
national income), (it might help to offer a basic definition of GDP here)
more variable consumption leads to greater GDP volatility as well.
Applying this same reasoning to developing countries leads to the opposite conclusion
because in these countries, a large fraction of the population is poor and does not have
access to credit. Although many people equate poverty and inequality, in developing
countries where many people are poor by Western standards, equality is generally
achieved when most households are poor.
Therefore, greater inequality in developing countries actually translates into fewer poor
households. As a result, in
developing countries and increases in inequality in these countries means that fewer
households are poor and are vulnerable to negative income shocks. (I don’t understand
why, because a larger fraction of the population is poor, they would be less affected by
inequality and why there would be fewer poor households – I am missing a piece of the
logic – it might just be me)
Iyigun and Owen find corroborating evidence for their theory that consumption volatility
and income inequality are related through access to credit by showing that countries with
more developed financial markets also experience less severe swings in consumption
and output growth.macroeconomic (you might give a simpler definition or offer examples
of what this represents – examples of what changes when there is macroeconomic
volatility) volatility.
In other words, the income distribution and level of financial development determine the
percentage of the population vulnerable to negative shocks. When a larger percentage of
households is vulnerable, aggregate consumption will be more volatile.
These results suggest that the traditional dichotomy between equity and efficiency may
not exist. Policy-makers in developed economies should be concerned about growing
income inequality not just for its own sake, but also because greater inequality causes the
economy to be less efficient and exhibit more volatility.
In other words, if inequality in developed economies continues to increase, future
recessions will be more severe and future economic expansions will also be more
pronounced. In developing countries, the opposite effects will be felt.How does this
impact the man on the street? If inequality continues to grow, what will happen in rich and
poor countries alike that the general public would care about and therefore journalists
would care about. If you can put your results in more concrete terms, that would be
helpful. If this can wait, I would be glad to meet with you on Tuesday to talk through this .
ENDS
Notes for Editors: ‘Income Inequality, Financial Development and Macroeconomic
Fluctuations’ by Murat Iyigun and Ann Owen is published in the April 2004 issue of the
Economic Journal.
Murat Iyigun is Assistant Professor of Economics at the University of Colorado, Boulder;
Ann Owen is Associate Professor of Economics at Hamilton College in Clinton, New York.
For Further Information: contact Murat Iyigun on +1-303-492-6653 (email:
murat.iyigun@colorado.edu); Ann Owen on+1-315-859-4419 (email:
aowen@hamilton.edu); or RES Media Consultant Romesh Vaitilingam on 0117-983-9770
or 07768-661095 (email: romesh@compuserve.com).