EC1111 - International Economic Policy RHUL - Autumn Vinay P. Nundlall Seminar 8 Solutions Read the following articles from Moodle: 1. B. Milanovic (2011) - More or Less (First article in the Finance and Development Special Issue on Inequality) 2. F. Ferreira and M. Walton (2005) - The Inequality Trap 3. Persson and Tabellini (1994) - Is Inequality harmful for Growth? For the Persson and Tabellini paper, read the introduction and conclusions to get an idea of what issues the authors are trying to raise. Answer the following questions: 1. Define equity and relate it to income inequality. Equity is equality of opportunity, and fairness. It means that a person's achievements in life should not depend upon his/her place of origin, gender, race and family origins. Income inequality is a manifestation of inequity in many circumstances. However, income inequality can be the result of innate abilities (skills) and labour market forces. 2. Outline the consequences of income inequality. In the past, there was a belief that inequality helps growth because the rich who have accumulated wealth can invest in the economy. However, we now know that inequality can be a big price to pay for such growth! Inequality can persist over time. This persistence of inequality has repercussions on the economy: inequality, combined with market imperfections, will stultify investment, thus hindering economic development. This can work either via the lack of credit by financial institutions to the poorest, lack of property rights resulting from unequal land distribution, or even lack of self-confidence due to prejudice that affects productivity and achievement. EXTRA NOTE: Further, in the presence of inequality, political institutions are not developed to help the poor but only to perpetuate an elite system that appropriates itself of the country's wealth - Latin America and some parts of Africa are examples. Such a system has its origins from the times of colonization, when European countries went to extract natural resources using cheap labour (such as slaves from
Africa and natives in the Americas). Over time, the elite built a type of governance where they kept power and wealth, while leaving the subordinate providers of cheap labour in a static condition of poverty. In more recent times we have seen that inequality can cause severe disruptions in society. Income inequality and lack of opportunities for certain groups in the midst of rising food prices were the main causes of revolutions in North Africa and the Middle East a few years ago. In London and in NYC, the perceived disparity in income between financiers and other sections of society during times of economic hardship were behind the causes of protests in London (by St Paul Cathedral) and Wall Street. Why care about inequality? - There are economic reasons: for example, aggregate utility of society would be higher if there were less inequality (assuming a diminishing marginal utility of wealth, the rich lose less utility than what the poor gain for a transfer of £1 from the rich to the poor.) There are