A Positive Theory of Optimal Personal Income Distribution and Growth

By Sell, Friedrich L.; Blumle, Gerold | Atlantic Economic Journal, December 1998 | Go to article overview

A Positive Theory of Optimal Personal Income Distribution and Growth


Sell, Friedrich L., Blumle, Gerold, Atlantic Economic Journal


Introduction

All over Europe, national governments are actually pursuing restrictive fiscal policies in order to meet the criteria set by the Maastricht Treaty. This austerity program primarily consists of cutting public expenditures on social security, thus narrowing the gap between the consumer and the producer wage rate. Hence, a secondary effect that politicians aim for is to gain (or regain) additional competitiveness and to foster the preconditions for economic per capita growth in the framework of the globalization of markets.

However, one side effect of these measures is a considerable shift in the distribution of functional and personal income in favor of earnings not stemming from labor. It is not clear how such changes in personal income distribution will affect the economy's per capita growth rate. It can be argued that each economy or society strives at different degrees of consciousness for an individual, somewhat stable combination between the per capita growth rate to be achieved and the prevailing income distribution. If there are economic reasons to find a concave relationship between the per capita growth rate and the distribution of personal income,(1) then the optimization puzzle requires a social preference function where social utility increases by a higher per capita growth rate or by a more equal income distribution. This paper's social optimization model can help to understand "how income distribution and economic growth are jointly determined in political equilibrium" [Persson and Tabellini 1994, p. 618].

Recent contributions on the links from income distribution(2) to growth are mainly characterized by three approaches (see Alesina and Perotti [1994] for a survey):

1) those stressing purely economic links from income distribution to growth (incentives for the accumulation of physical or human capital and the like);

2) those pointing at political channels (rent seeking, fiscal policy, and political instability aspects) that link income inequality and growth; and

3) Benabou's admirable approach to integrate political economy or sociopolitical theories and imperfect capital markets or property rights theories.

This paper's approach is eclectic,(3) drawing on all of the directions of research mentioned and, hence, giving a survey on many of these as well. However, at the same time, it is clearly biased toward the first option as explanations will rely much more on purely economic arguments than on political economy considerations and integrating theories which stress the advantages of redistribution.

This paper is organized as follows. In the next section, the basic reasoning of this model is presented. In the third section, the explanation power of the model will be tested when trying to analyze the glory and the crisis of the welfare state. The fourth section serves to find empirical support for the theoretical findings and the last section contains the conclusion.

The Model

Personal Income Distribution as a Determinant of Economic Growth

First, it should be discussed how inequality in personal income distribution gives (dis)incentives to income generation. Thereafter, light may be shed on the impact of income (in)equality on the pattern of income use of different income groups where an aggregate consideration of personal income distribution can ensue in general. Finally, this paper discusses the reciprocal relationship between personal income distribution and economic growth within the broader framework of the social climate of a society.

When analyzing the relationship between income distribution and per capita economic growth, the impact of income distribution on the national savings rate is mostly under discussion [Yun, 1992]. In the majority of cases (following macroeconomic models of economic growth), it is argued with the aggregates of the functional income distribution.(4) As opposed to this, this paper concentrates on the issue of personal income distribution.

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