How People Misunderstand Growth and Inequality - and the Effects of Correcting Their Beliefs

Abstract

Income and wealth grow over time, and this leads to changes in the level of inequality in a society. Yet, a large literature in cognitive psychology suggests that individuals often struggle to understand the effect of exponential growth. Misunderstanding how growth influences inequality may lead to biased preferences for policies with long-term effects, from taxation to investments in education. In an incentivised experiment, I examine (i) whether individuals are able to predict how exponential economic growth influences inequality, and (ii) whether informing individuals about the actual development in inequality influences their preferences for redistribution. I find that most people underestimate how much inequality increases in the presence of growth. However, informing individuals about the actual development in inequality does not affect their preferences for redistribution. Rather, what matters is whether people know if redistribution will come at a personal cost to themselves.