Income distribution, growth and social-welfare: towards an economic solution to the growth-equality trade-off problem

Abstract

This thesis assesses the social-welfare implications of modifications to the post transfer distribution of income, in the context of welfare maximising policy design. Both the inequality-distributional efficiency and inequality-growth relationship are assessed. An Atkinson social welfare function is employed in a novel fashion to model the inequality distributional efficiency relationship, including direct effects that result from the concavity of the personal utility function, and external losses operating via positional income effects. This analysis produces estimates of the social welfare losses from inequality across a data set of 137 countries, where the unweighted average of total losses is found to be equivalent to be 47% of GNI. The equality-growth relationship is analysed from the standpoint of both endogenous growth theory and post-Keynesian theories of demand and investment. The relationships between the functional and personal distribution of income and key macroeconomic variables including the rate of savings, and physical and human capital accumulation are assessed. Crucially, these relationships are found to be highly modifiable by economic policy and structural reform, and in theory, no growth–equality trade off need exist. On the contrary, equality may be growth promoting at moderate to high inequality levels. Combined with the large static welfare losses from inequality uncovered in this analysis, the welfare optimum level of inequality is likely to be close to the level associated with distributional efficiency maximisation. This is likely to be a very low level of inequality in comparison to existing levels in most countries and regions, and large welfare losses result from levels of inequality significantly above this level. Honours Thesis: Submitted as partial requirement for the degree of Bachelor of Arts (Honours), Political Economy, University of Sydney, 2011. 2 This work contains no material which has been accepted for the award of any other degree or diploma in any university, and to the best of my knowledge and belief, this thesis contains no material previously published or written by another person except where due references is made in the text of the thesis.