December 9, 2013
WHEN IS INEQUALITY HARMFUL? When It’s Caused By Cronyism.
In other words, is it a bad thing for a country to have some really rich people? Again, it depends on how they got rich.
Sutirtha Bagchi of the University of Michigan’s business school and Jan Svejnar of Columbia’s School of International and Public Affairs studied how inequality correlates with economic growth. In general, more inequality meant slower growth, and less inequality meant faster growth.
But in many countries, over various time periods, growing inequality had no effect on economic growth. The new study suggests that an increase in inequality hurt the economy when the rich were getting rich through political connections.
That is, inequality hurts the economy when “a large share of the national wealth is held by a small number of politically connected families,” as the authors put it. . . . When a country’s wealthiest people got their wealth as Pangestu and Fridman did, inequality places a drag on the economy. When a country’s wealthiest got wealthy through market means, the resulting inequality has no negative effect on economic growth.
This jibes with what we know about free markets. If people can get rich by providing valuable things at good prices, then society will get more valuable things at good prices—and people across the income spectrum benefit. But if people get rich by pocketing subsidies and using the state to crush competitors, then they gained their wealth at the expense of everyone else.