By now, you've already heard of the debate surrounding inequality. progressives want to reduce it whereas cosnervatives say that it's nothing to worry about and that to some extent, it's a good thing.
But which one is right?
There is actually one economic theory known as the Galor-Zeira model. This model seeks to explain the effects of inequality on economic growth. Basically, the model says that inequality is good for growth in low income countries whilst being detrimental in high income ones. Brückner and Lederman tested this model and found that countries within the bottom quarter experienced growth that was directly correlated with inequality while those in the top fifth experienced growth that was inversely correlated.
The relationship between aggregate output and income inequality is central in macroeconomics. This column argues that greater income inequality raises the economic growth of poor countries and decreases the growth of high- and middle-income countries. Human capital accumulation is an important...
voxeu.org
Now why might that be?
The lowest income countries are dominated by agriculture. In order for their economies to grow, they must develop a manufacturing industry. Because it will obviously produce inferior goods when compared to upper income countries, the selling point becomes cheap labor. Obviously, having cheap labor means keeping wages low, resulting in high inequality. Examples include Bangladesh and Cambodia whose economies center around light industry. Both countries have high GDP growth rates at 6–10% a year.
The advantage of inequality disappears when a country hits the middle income trap. You see, unless the government actively suppresses wages, wages will grow with the economy. Eventually, it reaches the point where it’s no longer profitable to make goods in country A to be shipped to country B. At that point, the economy will shift towards services. This is the point where education becomes increasingly necessary. Some jobs pay well but those require education while others don’t require much education but pay very little. Thailand is an example of a country whose economy grew fast for the past few decades but has recently hit the middle income trap.
The US is at a point where the emerging industries promote those with college education. In this instance, high inequality means that many people can’t afford to go to college to obtain the necessary skills, thus slowing down economic growth.