Freedom and the trade-off between inequality and growth

A relatively free market with a limited role for government will, over time, produce the greatest economic benefits for the lowest income earners. The higher income brought about by economic growth ultimately raises the incomes of low-income households more than an increase in the equality of incomes brought about by a redistribution of income, according to Gerald W. Scully, a senior fellow with the National Center for Policy Analysis.

In his study, "Economic Freedom and the Trade-off between Inequality and Growth," Scully found:

Freer economies enjoy higher rates of economic growth than less free ones.

Freer economies are more equal economies; economic freedom reduces inequality by increasing the share of market income going to the poor and lowering the share going to the rich.

Economic growth increases income inequality, but the effect is small.

Overall, the increase in inequality from economic growth is outweighed by the reduction in inequality caused by greater economic freedom – creating a net benefit to lower income groups.

Conversely, says Scully, nations in which the government more aggressively redistributes income have significantly lower rates of economic growth. In the long run, this income redistribution hurts the poor, says Scully. For example, among the countries analysed in the study:

Lowering a country's Gini coefficient – a measure of income inequality measured as market-based income, represented with a range from 0 (meaning everybody has the same income) to 1 (meaning one person has all the income) – by .01 would require reducing the income share of the rich by 0.6 per cent and redistributing it to others.

However, this would lower the economic growth rate by 1.6 percentage points (from 2.3 per cent to 0.7 per cent).

With the transfer, but a lower growth rate, average household income in the lowest group would reach only $8,050 after 25 years, instead of the $10,320 that would be achieved without the transfer.

Source: Gerald W. Scully, Economic Freedom and the Trade-off between Inequality and Growth, National Center for Policy Analysis, Policy Report No. 309, March 2008.

For text: www.ncpa.org/pub/st/st309

For more on Economic Issues: http://www.ncpa.org/sub/dpd/index.php?Article_Category=17

FMF Policy Bulletin/ 08 April 2008