In the middle of the 20th century, it came to be believed that “a rising tide lifts all boats”: economic growth would bring increasing wealth and higher living standards to all sections of society. At the time, there was some evidence behind that claim. In the ensuing economic and political debate, this “rising-tide hypothesis” evolved into a much more specific idea, according to which regressive economic policies—policies that favor the richer classes—would end up benefiting everyone. Resources given to the rich would inevitably “trickle down” to the rest.
Today, the trend to greater equality of incomes which characterized the postwar period has been reversed. Inequality is now rising rapidly. Contrary to the rising-tide hypothesis, the rising tide has only lifted the large yachts, and many of the smaller boats have been left dashed on the rocks. This is partly because the extraordinary growth in top incomes has coincided with an economic slowdown.
This chapter, “Inequality and Economic Growth“, looks critically at both claims. It argues in favor of alternative explanations of inequality, with particular reference to the theory of rent-seeking and to the influence of institutional and political factors, which have shaped labour markets and patterns of remuneration. And it shows that, far from being either necessary or good for economic growth, excessive inequality tends to lead to weaker economic performance. In light of this, it argues for a range of policies that would increase both equity and economic well-being.