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Economic Inequality Vs Economic Growth

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Economic inequality has a wide variety of meaningsю In my essay I discuss income inequality and wealth inequality. Economic growth is a long-term expansion in the productive potential of the economy. Common economic theory predicts that high levels of inequality will cause a decline in economic growth, whilst high levels of growth will cause an increase in inequality.

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First, I will discuss inequality. Some degree of inequality is necessary for a functioning capitalist economy. It incentivizes competition, which leads to innovation, and facilitates the efficient distribution of resources to innovative people. Additionally, inequality is necessary because rich people are test buyers, this stimulates investment in new products. Some argue that economic inequality is not the issue, but instead the number of people living in absolute poverty is key. Absolute poverty is defined as people being unable to meet basic needs, it is often extremely difficult to break out of. Consequently, instead of mitigating inequality with a socialist government approach, the UK should aim to maximise growth with a free market economy, with the belief that this wealth will trickle down and help lift people out of absolute poverty. As substantiated by the number of people in the world living in absolute poverty falling by 50%, between the years 2000-2012. This was achieved through minimal government intervention.

This is a strong argument and should not be ignored. However, it does not consider all the negative externalities associated with high levels of economic inequality. For instance, high income inequality is strongly related to male-on-male homicide rates, with a correlation of 0.9. In the context of an economy, this incurs costs for the police force, jails, judicial system, and the opportunity cost of those who can no longer work. In addition, high levels of income inequality can lead to an economy where there is little social mobility, this causes two main problems:

  1. First, it allows the majority of available economic resources to be concentrated at the top. This is uncompetitive, taking productive potential away from the economy. It leaves people who have something to contribute at the bottom, with little access to economic resources.
  2. Second, this stagnation leads to a system that serves power instead of competence and work ethic. This allows corruption to become an efficient way to succeed financially.

It is for these reasons that inequality should not simply be ignored, however, this still does not mean that inequality should be prioritized over economic growth.

Arguably, the most important issue that economic growth and more equality seek to address is absolute poverty. Absolute poverty is not only a problem because of the poor standard of living it provides, it can also destabilize the economy. When there are large numbers of people without hope of progressing financially these people become dispossessed. This both acts as an incentive for crime and creates a climate where extreme political ideas become attractive. It is a climate such as this that allowed the Nazis to rise to power, with massive economic and social costs.

Consequently, when deciding whether the UK should prioritize inequality, you first have to decide whether a solution focused on growth or redistribution of wealth would be more efficient at reducing absolute poverty. Could we focus on growth until absolute poverty is eradicated?

An optimist might say yes. However, an equally justifiable argument would be to say that we cannot ignore the negative externalities associated with high levels of economic inequality. Undoubtably unchecked Capitalism will produce rampant inequality. This is largely because the wealth return rate on capital is greater than the growth rate of the economy, identified by Thomas Piketty as r > g. It means that the more capital you have, the easier it is for you to gain more wealth. The aggregate economy can only generate a finite amount of wealth each year, so, in theory, the exponential nature of capital gains means that eventually all the economic growth each year will be absorbed by whoever has the most wealth already.

Therefore, a completely free market approach is not viable. As time increases inequality increases, until it begins to undermine growth and social mobility ossifies. Evidence of this can be seen in America (which has a more free market economy than the UK) where already it is predicted that inequality is slowing real GDP growth by 2-5 percent annually. This amount will only increase without sufficient measures to ameliorate inequality.

Now, I will discuss economic growth. Economic growth is the key function of an economy, it is important for four main reasons:

  1. It increases the standards of living in a country.
  2. It raises government tax revenue and reduces the cost of spending on welfare benefits- this can help stabilize the economy by reducing government debt and providing more resources to deal with shocks to the economy.
  3. Sustained growth leads to more jobs, this can have the effect of lowering income inequality.
  4. It can allow for funding of new and important technologies, for example in the UK it could increase investment in infrastructure and renewable energy projects.

Economic growth is clearly important, it is the key macroeconomic objective. However, it can also cause a lot of problems and it is because of these problems that economic growth should be obtained sustainably.

Historically we have been shown that fast economic growth will lead to a recession. For example, fast economic growth in the 1920s was one of the key causes of the great depression. This is because during a period of fast growth people become overconfident and begin to overinvest, taking superfluous risks they likely would not take during a period of slower economic growth. Not only is this bad in the short term, some economists believe this cycle produces a hysteresis effect, where each recession has lasting impacts that can reduce the trend growth rate of the UK in the long term. In addition, fast growth in the UK is known to produce a current account deficit. This is due to the UKs import orientated economy, where the disposable income created by economic growth will be spent on imports from other countries. This can have a variety of consequences. A current account deficit will reduce the value of net exports, therefore reducing aggregate demand for a country. Current account deficits are also seen as an indication of an unbalanced, unsustainable, and uncompetitive economy, this can lead to risk of currency depreciation for that country.

Another example of unsustainable economic growth is growth that comes from one sector. This is because that growth will only benefit people who work in that sector (promoting income inequality), and because that growth is tenuous. If your economy becomes reliant on one sector for growth then when that sector fails so will your economy. An example of this in the UK would be overreliance of the financial sector. It is this overreliance which caused the UK government to bail out the big banks after 2008, making the banks bigger than they were pre-2008, resulting in the UK being more reliant on them.

Finally, unsustainable economic growth will cause environmental damage. Without sufficient government intervention, these externalities will be ignored by businesses. This is causing climate change, pollution, deforestation, and desertification. The present consensus among scientists is that the way we are living currently cannot be sustained. Our environmental damage is increasing in line with our economic growth. In order to mitigate the climate crisis heavy government intervention is necessary, and a change to sustainable economic growth must occur.

In conclusion, encouraging economic growth and reducing inequality is essential in a sustainable Capitalist economy. Whether you think the UK should prioritize growth or inequality should depend on your perception of the state of the present UK economy. Considering the current climate of the UK; the joint pressures of Brexit Coronavirus, and the disproportionately negative effect coronavirus has had on the working poor, it could be argued that inequality should be prioritized in order to mitigate the unequal suffering of these individuals. However, I believe a stronger argument would be that we should prioritize sustainable economic growth because of the UK governments expanding budget deficit and because of the new jobs high levels of economic growth will create. This is important to offset the unemployment and deflationary risk created by coronavirus.

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Despite this, it is important to note that economic growth and equality are not mutually exclusive. I do not believe that you can have long term economic growth without some form of inequality reducing policy, the result would be corruption followed by a system crash and revolution. Equally you cannot achieve optimal levels of equality without sufficient resources (generated by economic growth). Optimal equality would be a level where there is no abject poverty and enough social mobility that hard work can guarantee financial success. Yet also there is still a divide between the wealthiest and poorest in society. The rich need to exist to fill their role of creating innovative products and providing hope to the less wealthy that one day they could also be rich.

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