Although most economic theory suggests that markets should distribute both income and wealth fairly within a society,
Most economic theory doesn’t say that at all. It says they will be distributed efficiently. And also that often enough efficiency and equity will be in conflict.
There are good economic reasons why this is the case. With regard to income it is because the spending patterns of those with different levels of income vary considerably. For example, those on very low incomes tend to spend all of any additional income that they might earn precisely because they have unmet needs and wants. They also, very commonly, spend that additional income on consumption. This means that if they earn additional income it circulates back into the economy very quickly. They have what is called a high marginal propensity to consume.
In contrast, if the wealthiest in a society receive additional income they very often save it because they have few or no additional consumer spending that they need to undertake. They have a low marginal propensity to consume. Alternatively, if they do spend, they might buy items with either a long-term benefit, such as property, or items that reflect their social status e.g. artwork, antiques and other such items, which very often add very little overall value to the level of current economic activity in a country.
Which is to forget that a low marginal propensity to consume means a high one to save. Savings becoming the capital with which society builds the productive assets to increase future growth.
Jeez, doing economics without capital, eh?
The consequence is that countries with relatively low levels of income diversity tend to see overall higher levels of growth when compared to those with higher levels of income inequality.
And you know what? I’d really love to see that proven. No, not waved at as being obvious, but shown. Because I don’t believe it for a moment.
China, for example, is quite amazingly unequal but the growth rate is something to envy, no?
This is also true of countries with relatively low levels of wealth inequality. In this case this is because those with high levels of wealth tend to be very risk averse and overall do not invest in new risk-based or entrepreneurial activity: they do, instead, tends to invest in existing businesses, land and buildings or other stores of value which may suit their purpose of preserving existing wealth but which do not stimulate new economic activity in the economy as a whole.
Again, I’d love to see this shown. The US has fairly high levels of wealth inequality. The investment world over there is quite risk loving, isn’t it?
In contrast, those with lower levels of wealth tend to have greater risk appetites, and so are inclined to invest in new business activities that are more likely to encourage economic growth, new employment opportunities, and higher wages. Economies with lower levels of wealth diversity do, then, tend to have higher appetites for risk taking. As a result they also tend to have higher rates of growth.
It’s amazing how we can get more investment creating more wealth from the wealth distribution, but not more growth from greater savings from the income distribution, isn’t it? Seriously, he’s telling us that marginal propensity to spend – more of it – leads to growth, then talks about how investment – the savings that don’t happen – improve growth.
If a government does, then, wish to stimulate economic growth within its jurisdiction it is likely that it will wish to limit the diversity of incomes and wealth within that country to help stimulate this outcome, and by far the best way to do this is to use progressive taxation systems. A progressive tax is one that overall charges higher rates of tax on a person as their income or wealth rises.
A stunning answer, eh? The way to encourage people to risk and invest to make a fortune is to tax fortunes more heavily. Wouldn’t have thought of that answer myself you know.
And I’d really, really, love to know where that proof comes from.