Inequality is not just an economic matter

Inequality has become one of the burning issues of our age. Even those who have no interest in it from a moral perspective are often concerned about it for practical reasons. They fear that widening inequality could cause unrest that could in term damage economic prospects and financial markets.

It is presumably for such reasons that the International Monetary Fund (IMF) has devoted a chapter to globalisation and inequality in its latest twice-yearly World Economic Outlook. The chapter is partly a riposte to the critics who contend that globalisation tends to widen inequalities. But, coming from the IMF, the response has to be grounded in economic data and econometric models.

The first conclusion of the report is that most people, including the poor, have improved their living standards over the past two decades: “average real incomes of the poorest segments of the population have increased across all regions and income groups”. But while absolute living standards have risen, so have inequalities in most countries and regions.

From a moral perspective, this presents a picture that is open to debate. Is it more important that living standards have generally improved overall? Or is the persistence and widening of inequality a more pressing problem? The report also goes further to identify the sources of inequality. Contrary to many critics, it argues that trade liberalisation is associated with lower income inequality. However, financial openness, and particularly foreign direct investment, tends to be linked with wider inequalities.

But technology is seen as having the greatest impact on widening inequalities. The reasoning is that more advanced technology favours those with higher skills and therefore exacerbates a skills gap.

But such breakdowns of the causes of inequality should be treated with caution. Building mathematical models to simulate economic variables is relatively easy. However, this is not the same as pinning down the causes of inequality. Even the IMF itself is cautious about the conclusions drawn from its model.

There is also a key broader point missing from the contemporary discussion. Whether or not inequality leads to unrest is not a given. It also depends on the prevailing political climate.

In some circumstances, people will remain quiescent, even if there is widening inequality. In others, the same widening inequality could lead to substantial unrest. Economics is an important part of the picture, but it does not provide the whole story.