3.16 - Impacts of Income & Wealth Inequality
How inequality affects economic growth
Inequality in income and wealth can slow down the overall expansion of an economy. Studies from organisations like the Organisation for Economic Co-operation and Development (OECD) and the International Monetary Fund (IMF) estimate that the rise in inequality across OECD nations over the past two decades has cut gross domestic product (GDP) by around 8.5%. This happens because inequality limits opportunities for many people, which in turn affects productivity and investment levels.
Ways inequality reduces economic growth
- Limited access to essential services - People with lower incomes often cannot afford proper healthcare or education, which prevents the development of skills and knowledge needed for a strong workforce.
- Lower productivity from poor education - Children from disadvantaged backgrounds may go to under-resourced schools and have less chance of higher education, resulting in a less skilled labour force and slower increases in output.
- Decreased savings and investment - Inequality squeezes the middle class, who usually save the most, while richer groups might spend on imported luxuries or send money overseas, leading to less money available for domestic investments that could improve resources and technology.
- Rent-seeking activities - This involves efforts by wealthy individuals to secure a bigger portion of existing resources through influencing rules, rather than creating new value, which diverts effort away from activities that could expand the economy.
- Restricted access to finance - High inequality means fewer people can get loans or credit, stopping them from investing in education for their children or launching new enterprises.
- Fragile and non-inclusive expansion - When benefits are concentrated among the rich, growth is less stable and more vulnerable to setbacks, as it does not involve the whole population.
- Instability that discourages investment - Divisions caused by inequality can create political and social unrest, making businesses hesitant to invest, and governments struggle to agree on solutions during economic difficulties.
Effects on living standards and social stability
High levels of inequality create broader problems that make life harder for everyone in society. It leads to higher social costs and can make communities less safe and cohesive, affecting overall well-being.
Social and stability issues caused by inequality
- Higher crime levels - Disadvantaged groups are more likely to be involved in or affected by criminal activities, increasing insecurity for all.
- Erosion of trust and cohesion - Inequality damages faith in organisations and weakens the bonds that hold society together.
- Resistance to positive changes - Powerful groups with wealth often block reforms that would benefit everyone, as they protect their own interests.
- Support for extreme policies - People facing hardship might back radical or harmful political ideas in response to their situation.
- Concentration of influence - Wealthy individuals gain more control over decisions, often shaping outcomes to favour themselves rather than the wider public.
- Risk of major disruptions - Extreme differences can spark conflicts or uprisings, leading to loss of life and setbacks in development.
Key pathways to economic and social issues
Inequality influences economies and societies through several connected routes. These pathways show how gaps in income and wealth create ongoing cycles of disadvantage and instability.
Pathways from inequality to slower growth
Each of these routes begins with something inequality does to households or firms, which then feeds through to productivity or investment, and finally to the rate of growth.
| Starting point | What it leads to | Effect on growth |
|---|---|---|
| Low levels of human capital | Low labour productivity | Slower growth |
| Lower savings | Lower investment | Slower growth |
| Rent-seeking behaviour | Resources diverted away from productive purposes | Slower growth |
| Lack of access to credit | Lower investment | Slower growth |
| Instability created by inequality | Investment discouraged | Growth limited |
| High inequality | Non-inclusive growth, with the gains held by the wealthiest | Fragile growth |
Pathways from inequality to social problems
| Effect on society | How inequality produces it |
|---|---|
| Higher criminality | Disadvantaged people are more likely both to commit crimes and to be victims of them |
| Damaged trust and social cohesion | Citizens lose confidence in institutions |
| Reforms resisted | The powerful few expect to be worse off after a socially efficient reform, so they have both the incentive and the means to block it |
| Growing support for populist policies | Households on low incomes back radical policies that can prove damaging |
| Increasing power of the rich | Wealth strengthens political and bargaining power, which is then used to secure outcomes favouring the rich |
| Conflicts and upheavals | Extreme inequality can spark civil conflict, costing lives and setting back development |
TermDefinition
Rent-seekingEfforts by individuals or firms to increase their own wealth by influencing rules and policies, without creating any new wealth or value for society.
Human capitalThe skills, knowledge, education and health acquired by workers, which determine their productivity.
ProductivityThe amount of output produced per unit of input, typically measured as output per worker per hour.
Social cohesionThe strength of relationships, trust and solidarity among members of a society.
Gross domestic product (GDP)The total monetary value of all final goods and services produced within an economy in a given period.