Measuring the Trade-offs Between Economic Growth and Unequal Distribution of the Benefits

London School of Economics professor Danny Quah recently delivered an address on “Life in Unequal Growing Economies”, as part of the Singapore Management University School of Economics Distinguished Lecture Series. He presented an empirical model to measure the trade-offs between economic growth and income inequality, and to assess the implications of such trade-offs for an individual’s welfare. Knowledge@SMU spoke to Quah about the wider implications of his research in developing economies.

Knowledge@SMU: How would you describe your research findings and their implications for ordinary people in developing countries?

Quah: We live in a world where there is great inequality across different parts of the world, where prosperity has been brought to significant chunks of it but, at the same time, a huge fraction of the world’s population remains very, very poor. In the views of some, high growth rates are accompanied by high and rising levels of inequality. The question that I tried to address is: how much of the improvement in the human condition can we trace back to changes in economic growth, and how much of the deterioration in human welfare is due to fact that there is inequality in society? It is a question of measuring the state of the human condition globally and, simultaneously, from the perspective of economic growth and inequality.

What my research tries to do is use a mathematical model to calibrate or estimate the relative importance of these different, large global forces. What it concludes is that, if you are really concerned about alleviating poverty, economic growth is unambiguously a good thing. It is a powerful locomotive for bringing poor people out of poverty. The effect of inequality is very much secondary. One bottom line, therefore, is that economic growth is good — almost regardless of how much rising inequality accompanies it — given how, historically, inequality and growth have evolved. Now there might be extreme circumstances that the world has not yet experienced and that might overturn this conclusion, but based on the last 25 to 50 years of recorded world history, we have to conclude that growth is the single most powerful force for lifting hundreds of millions of people out of poverty.

Knowledge@SMU: Do you follow the conventional definition that equates welfare with economic efficiency and equitable income distribution?

Quah: That definition presupposes some answers and it takes certain things as given. I don’t calculate human welfare that way. Instead, I approach it from the perspective of an individual in society who enjoys different kinds of patterns in consumption. Somebody living in a fast-growing society can reasonably expect that his or her consumption will rise over time. I proceed from a level of individual welfare and then ask the question, given the patterns of growth and inequality that we see out there, how important are these different factors for how well off someone is? I don’t tackle the much more difficult question of social welfare that you defined as economic efficiency and some variant of income inequality.

Knowledge@SMU: Everyone would like to live in an egalitarian society. Aren’t the effects of changes in income distribution on welfare too obvious to be measured?

Quah: We could debate that. I think that some very reasonable people hold the view that income inequality in society does affect the individual. All else equal, someone living in a highly unequal society feels worse off than someone living in an egalitarian society.That is not unreasonable as an a priori possibility. But it is very, very difficult to put reasonable numbers on that. You and I can sit here and debate if it is 20 times the weight of growth, or 2000, but there is no evidence we can bring to bear on that either way.

So I take the opposite extreme position, but which we might again debate as being just as bad. In my own mind, I say that, while that possibility might be there, I am not going to consider it. So in effect I put zero weight on it. In this regard, I follow what is conventional practice among certain groups of economists. We don’t look at altruistic concerns. We look at individualistic concerns.

Knowledge@SMU: You have said that this isa consequence-based paper and not a causality-based one. But do you think there may be different implications or consequences for welfare depending whether inequality causes growth or vice-versa?

Quah: Yes, there is a possibility that if the causality were of an extreme form then it might overturn my conclusions. But, paradoxically, I take comfort in how so much research has gone into trying to disentangle the causality between growth and inequality, and yet found nothing strongly systematic. If there were such an extreme possibility with regard to causality, then it would surely have been discovered by now.

Knowledge@SMU: What about envy arising from inequality? Do you think it may have negative implications for welfare?

Quah: Envy raises interesting sociological issues. Arguably, in medieval times inequality was much higher than it is now. Royalty owned 90% of all the wealth.  The poor worked themselves to death and were taxed. When countries went to war, it was royalty attacking other royalty using the brawn, muscle, and lives of ordinary workers. People’s mindsets were such that they tolerated this in those days, but they would not stand for such behavior today.

So what is it that people envy? Sometimes, perhaps for light relief, I fall back onto figures from the cinema for explanations. Take, for instance, what we might call the Hannibal Lecter theory of envy. In “Silence of the Lambs”, while talking to Clarice about the serial killer she is investigating, Lecter explains, “You envy what you see everyday. You can only be envious of things you think are within your grasp. How do we begin to covet? Do we seek out things to covet? We begin by coveting the things we see everyday.”  When royalty was the cause of inequality, most of human society thought such wealth was beyond reach. But now we see ordinary people becoming spectacularly rich. This generates two sets of forces. On the one hand, we have aspiration and mobility which creates growth and allows societies to live with high levels of inequality because everyone feels that, at some point, he or she will get a piece of the action. On the other hand, there is the increasing level of envy in society and the media has a role to play here. The world’s rich are on display, and every schoolboy thinks that it could happen to him. The world of inequality, envy, and social cohesion is changing in ways that economics is obviously not yet coming to grips with.

Knowledge@SMU: As there is no single aggregate to measure how inequality affects welfare, is this one of the reasons why growth matters more than inequality?

Quah: Yes, that’s right. Part of the reason is also that growth is like the tide that comes into a harbour. When it comes in powerfully, that tide lifts all the boats. Some boats are lifted a bit higher than others but the force of the tide lifts them all. It is the sheer magnitude of this force that makes growth much more important than inequality.

Knowledge@SMU: An important basis of your research is the trade-off between growth and inequality. Empirically, high growth rates are accompanied by high rates of income inequality. What is the future of countries like China?

Quah: I suppose, implicit in my own thinking, is that such rapid increases in inequality will not continue. It will never be the case that two or three people end up owning everything in society, and everybody else is destitute. I’d imagine some natural bound operates on how unequal societies can get. On the other hand, I see no natural bound on how much societies can grow.

Knowledge@SMU: In your discussion, you also talk about one of the least progressive regions – sub-Saharan Africa. Would it even be appropriate to talk about inequality and its implications in these countries?

Quah: I agree that the much more pressing problem in sub-Saharan Africa is that of absolute poverty. Talking about relative poverty or income inequality just misses the point. Literacy is low. Epidemic HIV-AIDS is rampant. Even basic needs like access to clean water are not yet met. Such chronic poverty is the first-order problem that needs to be addressed there before we even talk about inequality. The tide of growth needs to lift them to a higher basic level before anything else becomes meaningful.

Knowledge@SMU: Would your theory also apply to the education industry with its tremendous growth and correspondingly high levels of inequality?

Quah: That is a very interesting insight, I hadn’t thought of it that way. Certainly for education, it is useful to think about how these ideas might apply to the streaming of students into different channels of study at a very young age in schools in Malaysia and Singapore. Such a policy increases the measured inequality and it raises performance or efficiency. But then we are back in the discussion of what the trade-off is between inequality and growth.

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