Growth, Inequality, and Social Welfare: A Reassessment

Our analysis aims at assessing the effects of income inequality on social welfare, based on the contribution of Dollar, Kraay and Kleineberg (2014). We calculate the respective contributions of the growth in average income and income inequality to the growth in social welfare. From a methodological point of view, our work differs from Dollar et al. (2014) in three ways. First, Dollar et al. (2014) choose weights on individuals. Focusing on individuals rather than income results in assigning more weight on incomes at the top of the distribution and in lowering the effects of income inequality on social welfare. For our part, we choose to assign weights on income which does not lower implicitly the impact of income inequality on social welfare. Secondly, we emphasize on income inequality resulting from the increasing share hold by top incomes. The increase in income inequality during the last decades seems to be very closely associated with the increase in top incomes (Atkinson, Piketty, and Saez, 2011). Finally, we run empirically threshold regressions that give a nuanced picture of the conclusions led by Dollar et al. (2014). Whereas the main result shown by Dollar et al. (2014) is unambiguously that the contribution of inequality to the growth in social welfare is small relatively to the growth in average income, we obtain more nuanced results. In particular, we show on a sample of 22 advanced OECD countries over the 1980-2010 period that distinguishing two distinct configurations is needed. When inequality is low, i.e. lower than an endogenous threshold determined by our threshold model, the contribution of the growth in average income to the growth in social welfare is higher than the one of inequality, as shown by Dollar et al. By contrast, when the level of inequality is higher than this threshold, the contribution, in terms of absolute value, of inequality to the growth in social welfare is higher than the one of the growth in average income. We thus use this threshold of inequality to establish a topology of the economies and periods in which inequality has strongly/weakly impacted social welfare.