Economic system to improve income distribution

Readers Question 1) Can an economy that factors in the need for government funded public services and to offer people a living wage, and other more distributive economic strategies such as taxing the rich more, etc. Can it work in purely economic terms?

Essentially the question is

  • Can we have economic growth and greater income redistribution to ensure everyone benefits from the proceeds of growth?


Economic growth (rising real GDP) makes it easier for the government to spend money on public services and welfare payments. With economic growth, tax revenues rise, as the government will collect more VAT and income tax. This can help reduce absolute poverty. If you compare UK society – 50 or 100 years ago, there have been great strides made in reducing the worst forms of poverty.

However, to reduce relative poverty and inequality may require different policies, such as a more progressive tax system and more generous means tested benefits.

Welfare payments can help economic growth

Unemployment benefit enables people to survive economic turbulence. It helps support them in finding a new job suited to their qualifications. Removing benefits would reduce income and could cause serious social problems as people feel totally excluded from society.

Government funded public services like education and health care play a major role in improving a nations productive capacity and helping long-term economic growth.

A living wage / minimum wage can help prevent monopsonistic exploitation. By increasing workers wages also creates more demand in society for goods.

Factors other than government policy

Also, fairness in society doesn’t just depend on government policy. It depends on the attitudes of firms, workers and society. If people in society value an element of redistribution it is more likely to happen. For example, do firms make workers shareholders in the company or is society dominated by powerful monopolists who want to maximise profits?

In the Nineteenth Century, the Dickensian idea of firms was that they were happy to pay as low wages as they could. The proceeds of economic growth did little to ‘trickle down’ to the poorest workers.

Post Second World War, economic growth was more consistent with reduced inequality; this was partly due to government welfare policies – e.g. unemployment benefit, but also firms were perhaps more likely to see it in their ‘enlightened self-interest’ to pay workers well and look after their welfare. Success in society became a little less judged by monetary gain, but also how you treated other people.

Arguably, some of these gains were lost in the past three decades with a renewed widening of inequality since the early 1980s. The proceeds of growth have become less well distributed. This partly reflects government policy, but also perhaps reflects a trend within society.

To give one particular example of a factor which may have increase inequality. From the mid 1980s, building societies which didn’t make profit became quite aggressive profit maximising banks – leading to a growth in bonuses for high paying executives. If we had kept a more conservative financial system where building societies were non-profit making organisations, there would have perhaps been less inequality.

The point about building societies is just one particular small example. In practice there are a huge range of social and cultural factors which determine how economic growth will affect different people in society in different ways.

Limits of redistribution policy

  • Unemployment benefit can play a role in helping the economy to function more efficiently and fairly. However, if benefits become too generous it creates a disincentive to work. If benefits are nearly as high as income from work, then people will prefer to be unproductive and live on benefits. This will damage economic productivity.
  • Inequality provides incentives. In society, many entrepreneurs take risks to set up business because of the prospect of making money. If tax is too progressive, if marginal tax rates are too high, then there is a major disincentive for people to create new business and work hard.
  • A minimum wage / living wage can increase living standards of the low paid, but if the minimum wage is increased too much, firms may not be able to afford to pay workers. This could lead to unemployment and a worsening of inequality.



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