The Impact of Inequality on Economic Development

Social and economic inequality affects the economic development of both the Southern Hemisphere and the most affluent countries. How does this impact materialize itself? Through what mechanisms does income and asset ownership inequality generate economic imbalances that are capable of causing crises of systemic nature? This analysis of the impact of inequality is part of a trilogy of articles: the other two will focus on the reactions in respect of inequality and the mechanisms and resources to bring it down.Inequality –it is worth making it clear– is one of several critical factors impacting on the progress of a development process. Other factors also have a bearing, such as: (i) educational and sanitary level of the population; (ii) scientific and technological development; (iii) competitiveness of the economic system, its value chains, its production networks, and the economic units of which they are a part; (iv) care for the environment; (v) prevailing degree of social cohesion; (vi) efficacy and transparency in the management of public affairs. The impact of all these factors on development is felt in all countries and places, yet with the singularities of each set of national and local circumstances. Thus, it should be acknowledged that the actions intended to bring down inequality cannot be deemed a sufficient condition to ensure sustainable development and avoid systemic crisis, but they do constitute a necessary, indispensable condition.

The critical factors are, however, intertwined in one way or another; they influence and condition one another. It is not always clear which is cause or effect, as relationships mutate according to the circumstances and, hence, so does the specific weight that each factor acquire in the evolution of a society.

Effects on Demand and Consumption

One first and evident impact that inequality causes on an economic system is the segmentation of aggregate demand: in one same territory there coexist affluent sectors practicing exacerbated consumerism with middle-class sectors that, in spite of their lower income, tend to emulate superfluous consumption patterns and, what is more serious, this type and level of consumption takes place next to an extended universe of poor and marginalized individuals with drastically lower standards of living, who cannot afford what is deemed to constitute a basic consumer basket.

In the Southern Hemisphere countries, inequality translates into widespread poverty; yet, in affluent countries, inequality also occurs even when society as a whole has improved its standard of living overall.

The irritating consumerism of a few and the shortages of many undermine social cohesion, multiply conflicts, increase insecurity, and affect democratic governance; they further trigger a cascade of other economic and environmental effects on, for instance, the structure of the production system, saving generation and channeling, orientation of scientific and technological development, expanded reproduction of economic concentration, and irresponsible environmental destruction, particularly, of non-renewable natural resources.

Effects on Supply and the Production System

The conspicuous consumption of the affluent sectors combined with the incapacity of low-income sectors to express their needs as effective demand, generate a level of demand that is unable to absorb the totality of the goods and services that the production system, in search of permanent expansion, would be in a position to supply. The point is that there occurs a gap, a mismatch between the mass of goods and services the production system can produce and what the demand is able to absorb. These gaps are addressed by the markets themselves as well as by economic policy interventions intended to offset them. Yet, if they remained unsolved, they block growth and may even gain systemic dimension.

Segmented demand drags a significant portion of the production system into the direction of producing goods and services that are capable of satisfying the consumerist zeal, hence enshrining an ever more defective social allocation of available resources and generating a stratum of business concerns that, in defense of their own interests, support the concentration process. On the other hand, the vast majorities’ (the poor, the needy and the low middle-income earners) lower effective demand strongly limits the development of the bottom of the production system (small and micro producers), which sell its products to low and middle-income families much more than to the affluent sectors.

Hence, capital formation – a strategic variable in a process of economic growth – occurs more vigorously in the production units serving the more dynamic market segments. This supply pattern reinforces the concentration-lag-exclusion vicious circle as, while certain business concerns become capitalized, a good portion of the enormous production potential existing at the bottom of the social pyramid is sterilized. This sector of small and micro concerns is low and middle skill labor-intensive so, when it expands, it can absorb significant segments of unemployed and underemployed workers. Conversely, when it lags behind, its capacity to improve employment levels and income distribution becomes restricted, affecting social stability, the sustenance of citizen safety and democratic governance.

Effects on Saving and Investment

Likewise, income and asset ownership inequality (reinforced cycle after cycle of economic activity) produces an enormous concentration of savings in the hands of the affluent who, by recycling those resources, trigger two perverse simultaneous effects: the first effect is that a significant portion of such resources deviate from real economy financing and are channeled through financial middlemen into speculative activities offering greater yields. The second effect, related to the first one, is that the concentration of savings and their allocation to high-yield speculative activities, enables a higher accumulation rate in the affluent sectors in relation to the remaining economic players, which reproduces – at a much more accelerated pace – the process of economic concentration and growing consumerism.

The deviation of funds toward speculative activities occurs because, as demand becomes segmented, there is a widening of the gap, in terms of opportunities and yields, between financial investment and real economy investment, which is more vulnerable to situations where effective demand is contained or repressed. The pace of expansion of investment opportunities in the real economy is unable to absorb the rate of accumulation of monetary surpluses concentrated in a few hands which seek to recycle maximizing returns. Savings concentration and the relative lag of real economy investment opportunities combine to deviate a significant portion of the national savings into ever more speculative financial products.

This results in an explosive combination of factors: a concentrated structure of assets, income and savings; mismatch between the production potential of the economic system and the demand originating from genuine income; a relative narrowing of opportunities in the real economy associated with the above-mentioned demand segmentation; seeking of greater financial yields and shorter maturities in speculative activities; portfolio management by financial middlemen who ignore, fail to properly weigh or fully inform their clients of their growing systemic exposure; the action of regulators who are negligent, venal or not sufficiently qualified to control non-sustainable courses; all of which – as we will discuss in the next article of this series – tends to produce speculative bubbles which, as they burst, generate the conditions for the occurrence of recurrent crises.
Effects on the Orientation of Scientific and Technological Development

Scientific and technological development represents one of the most powerful leverages of contemporary growth. Indeed, its discoveries, the innovations it produces and the applications it enables, permanently expand the field and scope of market opportunities. The science and technology “industry”, which finances a good portion of basic science and applied knowledge development, orients its interest in the direction of the knowledge and technology areas earning them greater economic yields. In this sense, it follows the markets in the pursuit of returns. Hence, the concentration of income and assets, and its effects on the segmentation of effective demand as well as the composition of the production system, further condition the course and nature of scientific and technological development, many times watching from a distance, or ignoring, the most significant social and environmental needs.

This, indeed, cannot be generalized, because there is a host of scientists and researchers who carry out their activities driven by motivations other than the maximization of income and returns. Yet, they tend to work in much less comfortable conditions than those who are engaged by the science and technology “industry”, as a result of which, in one way or another, the type of scientific and technological results end up being conditioned and oriented by the requirements of concentrated markets.

Effects on Social Cohesion, Insecurity and Governance

Inequality implies that efforts, burdens and results are not distributed on equal footing within a given society. There are groups or sectors who do not take their share of responsibility dumping onto others the costs they should bear, in spite of the fact that they concentrate a high portion of the results of the economic activity. This is not done openly but through subtle mechanisms that are more difficult to be perceived by ordinary citizens, for instance via altering relative prices in their favor due to the dominant position exerted by certain market players or because their products “float” better than others’ with inflation; via regressive public spending allocation; via easier access to institutional credit; via regressive tax systems; via enjoying differential access to better health care and education; via discretional awarding of public work contracts; via access to insider information that enables them to take advantage of opportunities because they are close or belong to influential social networks and the contacts they generate.

This situation of social inequality brings about privileges and neglect, diametrically different standards of living within one same society, and ensuing resentments and misgivings. When attempts are made to reduce such differences, struggles among groups and individuals worsen, affecting social cohesion and, hence, making it harder to reach cooperation agreements among the different sectors. What happens is that no effort-sharing calls can be made without ensuring that the results will be fairly distributed. As inequality prevails, insecurity and social instability situations occur, even in affluent countries and places. As a matter of fact, not only poverty and indigence cause indignation: so do the outrageous differences in terms of standards of living and access to goods and services prevalent in contemporary societies.

Effects on Socioeconomic Dynamics and Sustainable Development

An economic dynamics reproducing asset and income concentration enshrines and augments inequality. Within this context, the segmented demand expressing in the market is unable to accompany production supply; the majority sectors lack genuine resources to absorb what the production system is able to produce. Attempts are then made at bridging the demand gap through financing, which would be very wise if loan borrowers were able to bring their situation back to health with time, improving their genuine income (i.e., that which does not stem from loans). When this is not possible because the rate of expansion of financed demand is significantly higher than the pace of borrowers’ recovery – one of the effects resulting from the concentration process – an over-borrowing phase ensues, paving the way for the feared financial bubbles. In other words, if no genuine income were generated for vast sectors of the population, and demand were artificially maintained with successive borrowing entailing ever-greater risk, the conditions would be in the making for, unless corrected, serious social and economic disruptions.

This particular concentration and inequality pattern disrupts organic economic growth; wastes an enormous segment of the national production potential; sterilizes talent and energy, particularly of small and micro producers; fosters irresponsible consumerism that ends up marking the course and progress of the economic system and the scientific and technological development; destroys the environment mercilessly and relentlessly; all of which causes market operational bottlenecks, periodic economic implosions, spiraling social instability and antagonist confrontations that, as it can be seen today in almost all affluent countries, may slide into crises of systemic nature.

Leave a comment

Your email address will not be published. Required fields are marked *