Inequality can be economically harmful, not just ethically distasteful

In the concluding part of the series, the author explores the variety of reasons why inequality can have serious inefficiency consequences

The link between inequality and crime has often been pointed out both in scholarly and popular discussion. There is empirical confirmation of the association between inequality of visible or conspicuous expenditure and violent crime, as there is also evidence from several countries of a positive relation between income inequality and property crimes and violent crimes like robbery, homicide and murder. A visit to cities like Nairobi, Johannesburg and Rio de Janeiro, to take the cities in three highly unequal countries, often makes it plain even for the most casual observer. 

Similarly, the link between inequality and social and political conflicts (and hence, economic disorder and instability) is also often suggested. Here the evidence is more mixed. There are several reasons for this. Firstly, one is not always clear about the nature of conflict one wants to study — conflicts can range from industrial strikes and agitations all the way to violent civil wars. Secondly, for most of these conflicts grievance arising out of economic disparity is not enough; one needs resources, organisation, agency, initiative and leadership to mobilise action that takes the form of conflict, and, more importantly, to sustain it, as the long history of failed rebellions and suppressed popular resentment would testify. Thirdly, when group conflict arises out of inter-group disparity, the measure of disparity that may be more relevant than that of usual inequality is what some scholars measure as polarisation, which takes into account the depth of cleavage or distance between the groups, as well as their size. Fourthly, conflict may originate in the tension that may grow more from the change in the relative income status of two even similar groups rather than the overall level of inequality. Then there is what is called the Tocqueville paradox -— in his words: “The hatred that men bear to privilege increases in proportion as privileges become fewer and less considerable, so that democratic passions would seem to burn most fiercely just when they have least fuel”. 

Just as the evidence on the relation between inequality and conflict is mixed, that between inequality and the obverse of conflict, that is, cooperation (whether in team production efforts, or in resolving disputes in collective action, or in the management of the local commons like forestry, fishery or irrigation water) is also not straightforward. I have a co-edited book, Inequality, Cooperation, and Environmental Sustainability (Princeton University Press, 2007) on this subject. 

A review of the empirical literature on, for example, the relation between inequality and cooperation in management of water resources for irrigation in developing countries shows the complexity of the relation. There are sometimes important initial set-up costs in an irrigation management regime, which the rich and powerful people in the village often provide or take the leadership in mobilising and sustaining. On the other hand, there is quite a bit of evidence that relative equality helps in the formation and maintenance of water user associations, in the following of water allocation rules and in the broad-based resolution of water disputes. There is also similar evidence in the community management of forests, fisheries and grazing lands. 

illustration: Ajaya Kumar Mohanty

 

The empirical evidence is, however, often deficient in providing sufficiently refined data to discern among varied theoretical hypotheses about norms, bargaining power and perceptions of fairness under situations of inequality. Experimental evidence suggests that people whose fallback positions are very different are less likely to come to agreements than are more equally-situated ones. Also, under inequality, bargaining failures may occur because inequality heightens informational asymmetries among the bargaining partners, or because very unequal offers based on disparities in initial wealth or bargaining power are likely to be perceived as unfair and rejected (as one usually finds in experimental play of what are called "ultimatum games"). 

It is quite common to observe in the labour market (which is qualitatively different from markets in say, vegetables, as it more directly involves social institutions and norms) that perceived inequality may disrupt norms of individual dignity and autonomy of the worker, and thus affect labour discipline, loyalty, turnover, and ultimately productivity. Looking particularly to the future patterns of work, as the nature of human work is likely to involve more personalised or customised (including care giving) services and more of production and dissemination of knowledge, the role of intrinsic motivation (i.e. when you do something largely for your own satisfaction/esteem not just for external rewards) and of shared norms inherent in these lines of work will be increasingly important — perceived inequality palpably affects these motivations and norms. 

It has been widely observed and commented upon that economic inequality enables the rich and the corporate sector to pour resources in the political influence machine to get the system to work in their favour, particularly through lobbying (not just in improving access, but in the US the lobbyists now actually develop and draft the legislation in some cases, and even are put in charge of its implementation) and election finance. This often results in laws and regulations in favour of wealth concentration and perpetuation of plutocratic power and away from efficient outcomes, apart from undermining democracy. Corporate power in lobbying, bribing, election-funding and media-shaping is rampant in many developing countries as well. 

Another political mechanism through which inequality can affect efficiency in the delivery of public services is what is called "secession of the rich": Rising inequality is usually associated with the rich opting out of public services and turning to private providers (private schools, nursing homes, gated communities for safety, etc.); this "exit" results in a lowering of the general quality of public services as they lose influential political support ("voice"). 

Social inequalities also have adverse economic efficiency effects. In countries of acute gender inequality women’s education, health and work participation suffer, and this has negative consequences not merely for the women themselves, but also for the children that these women bring up. Thus society pays the price of gender inequality across generations. 

Similarly, if there are serious inequalities across neighborhoods and localities, a child born in a backward area will have inferior schools, roads and other facilities, and less exposure to good networks, peer groups, and role models in the neighbourhood and other forms of social capital. This has obvious effects on fut­ure economic performance of the child. 

We have thus considered several reasons why inequality can have serious inefficiency consequences even from the narrow point of view of economists, belying their traditional dogma of equality-efficiency trade-off. Inequality is thus not just ethically distasteful, it can be economically harmful, even ignoring problems of absolute poverty.   

(Series concluded)

Part 1: Does inequality matter when poverty is falling?

Part 2: How inequality can lead to inefficient economic outcomes

The writer is professor of Graduate School at University of California, Berkeley. His most recent two books are Awakening Giants, Feet of Clay: Assessing the Economic Rise of China and India, and Globalisation, Democracy and Corruption: An Indian Perspective; the article was first published in the international blog 3 Quarks Daily