Labor Can Stop Beating The Inequality Drum

The Labor Party’s new Inclusive Prosperity Commission is driven by the principle that “equality itself is a driving force for economic growth”, in the words of Wayne Swan.

It is a lovely idea. Inequality is a bad thing. Growth is a good thing. Wouldn’t it be great if by reducing inequality we would also be boosting economic growth? A true win-win. For Labor, it would be a win-win-win, given that it would align with their philosophical interest in redistributive tax and welfare policies anyway.

Unfortunately for Labor, this is voodoo economics – ideological wish-fulfilment dressed up as analysis. The proposition that equality and growth are intrinsically linked is weak.

Two extremely high-profile documents published last year made the economic case for action against inequality. The first, “Redistribution, Inequality, and Growth” was published by the International Monetary Fund (IMF) in February 2014. The other, “Trends in Income Inequality and its Impact on Economic Growth”, was published by the Organisation for Economic Co-operation and Development (OECD), in December.

(There was of course another other major inequality document of 2014: Thomas Piketty’s Capital in the Twenty-First Century. I looked Piketty’s book on The Drum when it was published.)

Now, there are lots of reports published every year by these and other bodies. The IMF and OECD have been talking a lot about inequality recently. But it was these two papers that most clearly spelled out a causal relationship between reducing inequality and boosting growth. It helped that they came from the IMF and OECD – two apparently neoliberal, conservative organisations. It wasn’t so long ago that the IMF was protested as a bastion of anti-poor plutocracy.

Hence the prolonged press coverage. This Guardian story on Labor’s new Commission cites the IMF paper. A piece breathlessly citing the OECD report was published in The Age this week.

Yet there were less to these reports than the media coverage suggested.

The IMF report is actually a staff discussion note with the usual “does not necessarily represent IMF views” caveat. It found a correlation between less inequality and growth. That’s not new. Remember that correlation does not equal causation. The real question is: what is the economic impact of policy designed to reduce inequality? The IMF paper concluded that income and wealth redistribution does not harm growth. This was the finding that made global headlines.

But there’s an important qualification in the paper. The IMF authors were only willing to say that redistribution is “generally benign”. In “extreme cases” they found that redistribution does harm growth. So what is an extreme case? As the economics journalist Tim Worstall points out, what the IMF paper calls extreme redistribution is the exactly sort of redistribution many first world countries indulge in.

You can see the key chart in figure 7 on page 23. According to the IMF paper’s findings, the United States could afford to do a little more redistribution without harming growth. Countries like France and Germany do too much – that is, if they’re worried about growth.

Australia is dead on the line between extreme and benign. If this is right, any more redistribution would hurt our economy. Is this really the story that Wayne Swan and Labor want to tell right now?

So much for the IMF report. It shows exactly the opposite of what is claimed in the Australian press.

The story contained in the OECD report is a little more complicated. Again, it’s not a report – it’s a working paper with the standard caveat (“should not be reported as representing the official views of the OECD” etc.). This paper says that increasing inequality has a causal effect on growth, and “it follows” that reducing inequality is necessary to sustain long term growth. That’s all well and good, as far as it goes.

But the paper also has some strange findings. For instance, its modelling finds that investment in human capital – that is education – has no positive effect on economic growth. (They write: “the results … do not point to a positive effect of human capital on growth. Those findings are in fact hard to reconcile with the large amount of evidence on the positive consequences of education on individual productivity … and on the significant contribution of human capital to aggregate growth”.)

Huge, if true. All the money we put into skills and education as individuals and as society as a whole does little to grow the economy. If that’s not strange enough, the economist Eric Crampton observed that the OECD paper nonetheless calls for greater spending on education. Huh? If the authors don’t believe the own findings of their own model, why should we?

Yet despite these issues, the OECD and the IMF papers are Exhibits A and B for political action on inequality.

Let’s be fair. Comparisons between countries are fraught. Untangling the relationship between inequality and economic growth is complicated. The mechanisms by which one affects the other are controversial and unclear. Thomas Piketty’s book was one attempt, and a very idiosyncratic one at that.

Still, politics rarely waits for scholarship to come to a conclusion. What one New Yorker writer recently said about the British election could stand in for the entire inequality debate:

While [John Maynard] Keynes was being unceremoniously booted out the front door of Labour’s headquarters, Thomas Piketty was being ushered in through the side entrance.
It’s obvious that the Australian Labor Party needs a new agenda – particularly after the grubby politics of the Rudd and Gillard years. And they probably think focusing on inequality is a nice counterweight to the Coalition with its rich mates and its unfair budget.

But it’s not obvious that tackling inequality will grow the economy. If Labor is looking for an agenda, it would be wise to look elsewhere.