Income Inequality Hurts Growth; Redistribution Doesn’t

A new report from researchers from the International Monetary Fund (IMF) finds that not only is rising inequality a drag on economic growth, but that policies designed to lessen inequality through a moderate level of redistribution do not slow growth. While the report is clear in stating it isn’t the official opinion or policy of the IMF, researchers Jonathan D. Ostry, Andrew Berg and Charalambos G. Tsangarides make a compelling case that austerity policies are bad for economic growth and that it isn’t just morally sound to reduce income inequality, it’s the economically wise choice, too. While countries have pursued policies focused heavily on deficit reduction and lower government spending, the new report suggests those legislative priorities may be the wrong approach to economic growth, joining a growing chorus of evidence from economic analysts that is pushing for a move away from austerity.

More specifically, the researchers found that societies with higher levels of inequality have slower economic growth that is more fragile. They suggest that inequality doesn’t “take care of itself” as austerity proponents suggest, and that more equal societies actually produce higher levels of growth, regardless of how much redistribution the country has, unless the system has a very high level of redistribution. The overwhelming majority of countries in their sample showed no negative effects on growth from redistribution.

In an editorial in the Financial Times (registration required), Ostry sums up the research:

Put these two observations together and you come to an important conclusion for policy. Making the tax system modestly more redistributive seems to have little direct effect on growth. Over time, however, it will result in a more equal distribution of income—and that, in turn, seems to lead to higher growth. Taking into account the direct effect of redistribution, and the indirect effect that operates through reduced inequality, we find that average levels of redistribution are associated with higher and more durable growth. Even large redistributions—undertaken presumably with the goal of improving equality—do not seem to carry a clear growth cost….

But we do see an important lesson. If there were a big trade-off between redistribution and growth, as has long been assumed, one would expect to see evidence of it in a study like ours. Our conclusion is rather that the measures that governments have typically taken to reduce inequality do not seem to have stunted growth.

Read the full report


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