Relationship Between Slow Economic Growth and Income Inequality is Tenuous

A commentary published by the Federal Reserve Bank of Cleveland found that slower economic growth has had little effect on income and wealth inequality in the United States.

Daniel Carroll, an economist with the Cleveland Fed, and Eric Young, a professor at the University of Virginia, contend in their commentary titled "Zero Growth and Long Run Inequality" that "to the extent that different rates of trend growth are associated with changes in wealth inequality, lower growth tends to yield less inequality rather than more."

Carroll and Young addressed research by Thomas Piketty which concluded that income inequality and wealth inequality increases as economic growth slows. Whereas Piketty's research made certain assumptions about the evolution of wealth distribution and the output of the economy, Carroll and Young based their commentary on a more sophisticated treatment of income and wealth distributions, such as those found in world contexts, according to the Cleveland Fed. Using this model, Carroll and Young determined that not only is inequality weakly related to long-run economic growth, but that income and wealth inequality tend to be lower when economic input remains the same over time and the long-run growth rate stays at zero.

"On the other hand, when capital and labor are less interchangeable or when they work together, as the empirical literature strongly suggests, long-run inequality is lower under zero growth."

The direction the relationship between economic growth and income inequality takes is dependent on the interchangeability of capital and labor in production, according to the Cleveland Fed.

"When they are strong substitutes for each other, inequality can become very extreme, exactly as Piketty describes," Carroll and Young wrote. "On the other hand, when capital and labor are less interchangeable or when they work together, as the empirical literature strongly suggests, long-run inequality is lower under zero growth."

When contemplating a world with extreme capital accumulation, Carroll and Young state in their commentary that this idea is of particular importance.

"In such an environment, capital would be very abundant relative to labor," Carroll and Young wrote. "Unless the two factors are very substitutable, the relative scarcity of labor would drive up wages relative to the rental rate (of capital). All else being equal, this relative rise in the wage would increase labor income relative to capital income and thus reduce income inequality."

Click here to see the entire commentary by Carroll and Young.