The standard neoclassical growth model hides income inequality behind a representative agent who has the average, per capita level of income. As a result, GDP per capita has become engrained in national accounting as the go-to measure of economic performance, at the expense of important other determinants of societal wellbeing, such as inequality.
In this paper the authors show that if society is averse to income inequality, a government that is concerned with societal wellbeing would choose paths of economic growth that focus not only on the size of the overall ‘pie’ but also on how the pie is shared. A small adjustment to the standard model of economic growth to include inequality and aversion to inequality shows that not just income levels but distribution is important for overall societal wellbeing. In fact, they make the case that inequality aversion goes some way to explain why countries with similar gross domestic product (GDP) per-capita growth rates, achieve growth by starkly different economic growth distributional patterns.
One important implication of the paper is that a new measure of economic performance is required. The authors argue that an inequality adjusted growth measure should be deployed alongside the usual GDP per capita growth measure. This measure could simply report the difference between mean and median growth as a check on how inequality is developing in society: if the former outweighs the latter, growth increases inequality, and vice versa. Alternatively, if agreement on the extent of societal inequality aversion could be found, in the form of the ‘Atkinson measure of inequality aversion (η)’, for instance, observed growth could be compared to that which would be seen as fair.
One consequence of this analysis is to show that economic growth and environmental quality choices are not necessarily in opposition, because optimising GDP per-capita is not always fitting with societal preferences. In another interpretation, we might identify changes in η in an economy over time as the underlying process resulting in the environmental Kuznets curve phenomenon.
Key points for decision-makers
- The authors demonstrate that GDP per-capita growth is not always the best statistic by which to judge a country’s growth progress.
- They suggest a supplementary statistic to GDP growth which reports how closely economic growth outcomes match societal preferences over the distribution of the returns to economic growth.
- Economic growth and distributional outcomes are then seen in terms of societal preferences rather than as a preference-free process.
- The paper provides estimates of η for several countries which would not be possible by existing methods.
- Incorporating the elasticity of marginal utility of consumption, η, into an economic growth model closes the conceptual gap between economic growth and environmental policy studies.