Inequality and Economic Growth: Europe vs the US

I think that’s true. Lowering taxes seems to lead to economic growth when taxes are high; but when taxes are not high, there seems to be a law of diminishing returns in effect. Further, a more relevant variable to economic growth might be the ease of obtaining investment capital.

Yes I think the issue is far more nuanced than about low or high tax. As I’ve said if you fund lower taxes through borrowing, you are causing a net boost in demand, which naturally should lead to a temporary economic growth.

But I think over longer time, even if you cut from high to low taxes, there will be no long term gain from tax cuts. If this was the case one should have seen e.g. the US consistently have higher growth than high taxed Nordics. The data I’ve seen suggests there are not statistically significant differences there.

Also I think it is highly relevant in any analysis exactly how public funds are used. If I raise taxes a lot to import military gear and build palaces, that will likely hurt growth. However if you raise taxes to invest in infrastructure and education, it will likely boost growth. Especially if infrastructure is inadequate for the economy.

And sometimes economic growth can be highly deceptive. Nazi Germany had strong growth, but they did that by borrowing and building a lot of military gear domestically. That got rid of unemployment but it also made German consumers poorer since production got allocated away from consumer goods to military hardware.

Hmmmm. Europe traditionally has less inequality but lower growth than the US.

Not sure that is true for Europe in general and if it is, I would be cautious to generalize across all of Europe since there are such huge differences between European countries.

American states operate under basically the same economic system and a fully integrated market. Europe is fragmented with widely different systems. It is hard to generalize across say Norway and Greece.

There are also numerous differences in how European countries operate and how the US operates which gives a different GDP potential for each one. Here are a number of important factors.

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GDP generated per unit of energy used. Show efficiency of an economy in utilizing energy resources.
  1. Europe has always been far more resource constrained than the US. This has led to entirely different approaches to economic growth. Back in the 1800s, an American farm would grow the same amount of food as a European farm using twice the amount of land, but half the amount of man hours. In other words the US could afford to waste resources to save man hours. This is reflected in the economies even today. If you look at resource inputs to produce a dollar of GDP, the US spends more resources. CO2 emissions, and energy usage per GDP dollar is higher in the US.
  2. American population grows faster than the European one. Bigger families and more immigrants for a long time. GDP growth tends to not take into account population growth. Hence you can have GDP growth while the country grows poorer, because population growth is faster. This is why Japanese GDP growth has looked so bad for years. Their population is shrinking. However Japanese GDP growth per capita is entirely normal.
  3. The last decades Americans have increased their work hours, while Europeans have reduced them. A lot of American GDP growth is simply from Americans working longer days, not because of higher output per hour.

The last point is worth looking into detail. I’ve compiled a list of some random countries.

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Relative GDP, is GDP per capita at PPP for a country relative to the GDP of the US. So 0.90 means the country has a GDP which is 90% of the US. Relative work hours is how many hours people work relative to the US. So e.g. Germany has 0.73, which means Germans only work 73% of the hours Americans work.

It shows that GDP per hour worked is not particularly different in the US and the European countries I’ve picked here. The primary difference for higher American GDP is that Americans work more.

That comes down to different politics, culture and values. Americans prefer consumption, Europeans prefer leisure.

There are a lot of factors other than inequality affecting growth which one has to account for. I assume the OECD report has done that.

For instance if you look at this graph, you can see that EU and US growth rates have been quite similar over the years. In the wake of the 2008 financial crisis, the US recovered better though. However that has little to do with equality, and more to do with the Greek crisis and European austerity policy.

The US employed Keynsians economics to get out of the crisis: Meaning they spent their way out of it using borrowed money. Europe tightened the belt, driving the economies down. I think that was a terrible choice.

Greece was the kind of economic mess, that the US cannot as easily suffer with any of its states. The EU suffered from having a common currency but not a fully integrated system for dealing with financial crisis. Since the US is a country with one culture and language, people in a failing state can simply move to other states with better opportunities. This is harder to achive in Europe with language and cultural barriers.

Do you have the link to the OECD paper? It’s a bit counterintuitive, if that’s in fact their finding.

OECD study is here, but I have not read it in detail.

I don’t actually think it is counterintutitive at all. Even in the Wealth of Nations written in 1776 by Adam Smith, he remarked that higher levels of equality was likely and explanation for why industrialization and rapid economic growth took off in Great Britain rather than in China.

Here is the basic argument he used: The key to economic growth is division of labour. By making large quantities of of a few things you gain economics of scale. But to be able to do mass production and thus gain efficiencies, you need a large enough market. How do you do that? Smith pointed to canals making bulk transport of goods much cheaper as well as a lot of coastline. That expanded the size of the effective market. The second factor was equality. There is a bigger market for say cotton shirts than specialized luxury items for the rich. You cannot mass produce luxury items. But you can mass produce cotton shirts. In a more unequal society the purchasing power is shifted towards consumption which cannot easily be mass produced. In a more equal society, consumption is shifted more towards products which can potentially be mass produced.

Then there are modern studies, showing that being poor makes you do bad decisions. Dutch historian Rutger Bregman also talks about this in a TED talk. He remarks that being poor knocks off a lot of your IQ, making you do stupid stuff. If we extrapolate from this to inequality, I’ll propose an argument: Inequality causes more poverty, which causes more stupid economic decisions to be made, which causes a further hampering of economic growth.

Finally there are the laws of diminishing returns. Investing $100 in a middle class child is not going to gives as big advances as investing $100 in a poor child. If we look at IQ for middle class people e.g. heritability dominates. However for the working class, environment dominates. Hence splurig more resources on the rich or middle class is a bit of a waste. You get much more back from investing in the poor.

Well, they’ve dropped. We hit a peak in real hourly wage back in 1974.

Yeah… I just didn’t want to get into a major dispute, as people seem to calculate some of this differently. Without question there has been stagnation though.

Uh, are you seriously inferring that the events of 1929 were caused by wealth inequality? Or am I reading you wrong?

No, there are numerous people claiming this. Better to google, because I cannot find the articles where I found the most compelling arguments.

The idea is something like this: As inequality rises, the lesser off tries to keep up. This is embedded in human nature. We are conformist. We don’t want to stick out. We don’t want to feel like loosers. The lesser off then start living beyond their means, by borrowing.

This borrowing can keep going for a while, because often there is an asset bubble buiding up. It looks like the sky is the limit, but then suddenly the bubble burst and it all comes crashing down.

You can think about it this way: The rich take a bigger slice of the pie, but then they lend that extra piece to the poor, so they can keep consuming. So the rich build more factories, profits increase and then they hand a lot of those profits over to the poor in the form of loans.

If equality had been better one would not have gotten into the same kind of mess. Increased output from factories of the rich could more easily be consumed by poor people using wage increases, rather than borrowed money.

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Geek dad, living in Oslo, Norway with passion for UX, Julia programming, science, teaching, reading and writing.

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