Mindyard | DIRECTIONS for questions 10-13: The passage below is accompanied by four questions. Based on the passage, choose the best answer for each question. Studies showing that income inequality plays a positive role in economic growth are largely based on three arguments. The first argument focuses on investment indivisibilities wherein large sunk costs are required when implementing new fundamental innovations. Without stock markets and financial institutions to mobilize large sums of money, a high concentration of wealth is needed for individuals to undertake new industrial activities accompanied by high sunk costs . . . [One study] shows the relation between economic growth and income inequality for 45 countries during 1966-1995. [It was found] that the increase in income inequality has a significant positive relationship with economic growth in the short and medium term. Using system GMM, [another study estimated] the relation between income inequality and economic growth for 106 countries during 1965– 2005 period. The results show that income inequality has a positive impact on economic growth in the short run, but the two are negatively correlated in the long run. The second argument is related to moral hazard and incentives . . . Because economic performance is determined by the unobservable level of effort that agents make, paying compensations without taking into account the economic performance achieved by individual agents will fail to elicit optimum effort from the agents. Thus, certain income inequalities contribute to growth by enhancing worker motivation . . . and by giving motivation to innovators and entrepreneurs . . . Finally, [another study] point[s] out that the concentration of wealth or stock ownership in relation to corporate governance contributes to growth. If stock ownership is distributed and owned by a large number of shareholders, it is not easy to make quick decisions due to the conflicting interests among shareholders, and this may also cause a free-rider problem in terms of monitoring and supervising managers and workers. . . . Various studies have examined the relationships between income inequality and economic growth, and most of these assert that a negative correlation exists between the two. . . . Analyzing 159 countries for 1980–2012, they conclude that there exists a negative relation between income inequality and economic growth; when the income share of the richest 20% of population increases by 1%, the GDP decreases by 0.08%, whereas when the income share of the poorest 20% of population increases by 1%, the GDP increases by 0.38%. Some studies find that inequality has a negative impact on growth due to poor human capital accumulation and low fertility rates . . . while [others] point out that inequality creates political instability, resulting in lower investment. . . . [Some economists] argue that widening income inequality has a negative impact on economic growth because it negatively affects social consensus or social capital formation. One important research topic is the correlation between democratization and income redistribution. [Some scholars] explain that social pressure for income redistribution rises as income inequality increases in a democratic society. In other words, when democratization extends suffrage to a wider class of people, the increased political power of low- and middle-income voters results in broader support for income redistribution and social welfare expansion. However . . . if the rich have more political influence than the poor, the democratic system actually worsens income inequality rather than improving it. According to the incentive or moral hazard argument, which one of the designs below is most consistent with the claim that some inequality can raise growth? A regime that concentrates stock ownership in relation to corporate governance., Wages are determined by tenure rather than output to ensure equity. , Rents protected by market power that enlarge top incomes without linking pay to results, Pay rewards on verifiable performance for highly productive workers.

DIRECTIONS for questions 10-13: The passage below is accompanied by four questions. Based on the passage, choose the best answer for each question.

Studies showing that income inequality plays a positive role in economic growth are largely based on three arguments. The first argument focuses on investment indivisibilities wherein large sunk costs are required when implementing new fundamental innovations. Without stock markets and financial institutions to mobilize large sums of money, a high concentration of wealth is needed for individuals to undertake new industrial activities accompanied by high sunk costs . . . [One study] shows the relation between economic growth and income inequality for 45 countries during 1966-1995. [It was found] that the increase in income inequality has a significant positive relationship with economic growth in the short and medium term.

Using system GMM, [another study estimated] the relation between income inequality and economic growth for 106 countries during 1965– 2005 period. The results show that income inequality has a positive impact on economic growth in the short run, but the two are negatively correlated in the long run. The second argument is related to moral hazard and incentives . . . Because economic performance is determined by the unobservable level of effort that agents make, paying compensations without taking into account the economic performance achieved by individual agents will fail to elicit optimum effort from the agents. Thus, certain income inequalities contribute to growth by enhancing worker motivation . . . and by giving motivation to innovators and entrepreneurs . . . Finally, [another study] point[s] out that the concentration of wealth or stock ownership in relation to corporate governance contributes to growth. If stock ownership is distributed and owned by a large number of shareholders, it is not easy to make quick decisions due to the conflicting interests among shareholders, and this may also cause a free-rider problem in terms of monitoring and supervising managers and workers. . . .

Various studies have examined the relationships between income inequality and economic growth, and most of these assert that a negative correlation exists between the two. . . . Analyzing 159 countries for 1980–2012, they conclude that there exists a negative relation between income inequality and economic growth; when the income share of the richest 20% of population increases by 1%, the GDP decreases by 0.08%, whereas when the income share of the poorest 20% of population increases by 1%, the GDP increases by 0.38%. Some studies find that inequality has a negative impact on growth due to poor human capital accumulation and low fertility rates . . . while [others] point out that inequality creates political instability, resulting in lower investment. . . .

[Some economists] argue that widening income inequality has a negative impact on economic growth because it negatively affects social consensus or social capital formation. One important research topic is the correlation between democratization and income redistribution. [Some scholars] explain that social pressure for income redistribution rises as income inequality increases in a democratic society. In other words, when democratization extends suffrage to a wider class of people, the increased political power of low- and middle-income voters results in broader support for income redistribution and social welfare expansion. However . . . if the rich have more political influence than the poor, the democratic system actually worsens income inequality rather than improving it.

According to the incentive or moral hazard argument, which one of the designs below is most consistent with the claim that some inequality can raise growth?

Options

A regime that concentrates stock ownership in relation to corporate governance.

Wages are determined by tenure rather than output to ensure equity.

Rents protected by market power that enlarge top incomes without linking pay to results

Pay rewards on verifiable performance for highly productive workers.

Correct Answer :

Option D

Pay rewards on verifiable performance for highly productive workers.

Solution :

The correct option is Pay rewards on verifiable performance for highly productive workers.

To answer this question, we must look specifically at the "incentive or moral hazard argument" presented in the second paragraph of the passage.

The passage states: "The second argument is related to moral hazard and incentives . . . Because economic performance is determined by the unobservable level of effort that agents make, paying compensations without taking into account the economic performance achieved by individual agents will fail to elicit optimum effort from the agents."

This argument implies that to maximize economic performance and growth, compensation must be directly linked to the individual's performance and output. Let's evaluate the given options based on this principle:

Pay rewards on verifiable performance for highly productive workers: This design perfectly aligns with the moral hazard argument. By linking rewards to verifiable performance, it ensures that highly productive workers are motivated to exert optimum effort. This leads to "certain income inequalities" but ultimately contributes to growth by "enhancing worker motivation," as stated in the passage.

A regime that concentrates stock ownership in relation to corporate governance: While this is mentioned in the passage as a way inequality contributes to growth, it is explicitly cited as the third argument (corporate governance), not the moral hazard and incentives argument.

Wages are determined by tenure rather than output to ensure equity: This directly contradicts the moral hazard argument. The passage explicitly warns that failing to consider economic performance when paying compensations will "fail to elicit optimum effort."

Rents protected by market power that enlarge top incomes without linking pay to results: Similarly, this option explicitly states that pay is not linked to results, which goes against the core idea of the incentive argument.

Therefore, paying rewards based on performance is the design most consistent with this specific claim.

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