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Income inequality leads to slower growth — IMF economists

Feb 27,2014 - Last updated at Feb 27,2014

WASHINGTON — Income inequality can lead to slower or less sustainable economic growth, while redistribution of income, when measured, does not hurt and can even help an economy, according to a research study by International Monetary Fund (IMF) staff.

Although the study by IMF economists does not reflect the fund’s official position, it is another sign of a shift in its thinking about income disparity.

“It would still be a mistake to focus on growth and let inequality take care of itself, not only because inequality may be ethically undesirable but also because the resulting growth may be low and unsustainable,” the study said.

The IMF analyses the economies of each of its 188 member countries and offers advice on government budget and monetary policies. It is also a lender of last resort, tasked with supporting global financial stability.

It has traditionally advised countries to promote growth and reduce debt, but has not explicitly focused on income inequalities. In the past year, IMF Managing Director Christine Lagarde has said that creating economic stability is impossible without also addressing inequality.

Oxfam, the international development group, has long argued that organisations like the IMF need to address rising gaps between the rich and poor, and stop encouraging low public spending.

“In the bad old days, the IMF asked governments to cut public spending and taxes,” said Nicolas Mombrial, the head of Oxfam’s Washington office. “We hope this research and Christine Lagarde’s recent statements are a sign that they are changing their tune.”

Economists are still divided about the relationship between growth and income inequality, which has spiked around the world as economies struggle in the wake of the 2007-2009 financial crisis.

Some have also blamed rising income inequality for contributing to the crisis in the first place, by encouraging more borrowing by people who wanted to maintain their standards of living. 

Jonathan Ostry and Andrew Berg, two of the authors of the IMF paper, also researched the link between income inequality and growth in 2011.

At the time, Ostry said the response was that income redistribution rather than inequality was responsible for hurting growth: some argued that inequality prompted governments to transfer money to the poor, which reduced incentives to work.

Their follow-up paper on Wednesday showed redistribution was not to blame.

“We find that inequality is bad for growth... in and of itself,” Ostry told reporters on Wednesday. “And we can say that redistribution by itself doesn’t seem to be bad for growth, unless it’s very large.”

They said there was evidence that extremely high taxes or transfers to the poor, such as which occurs in some European countries, could hurt growth. But they found that redistribution also helped growth by reducing inequality.

The researchers cited the benefits of taxes on activities of the wealthy that could hurt an economy, like excessive financial speculation, and payments to the poor to support their children going to school.

Much of the thinking has been that, even if a large wealth gap is bad, that the cures of taxes and wealth transfers to correct the problem usually hamper growth.

“Many argue that redistribution undermines growth, and even that efforts to redistribute to address high inequality are the source of the correlation between inequality and low growth,” they said. “If this is right, then taxes and transfers may be precisely the wrong remedy: A cure that may be worse than the disease itself.”

But the authors said experience across a number of countries has provided “remarkably little evidence” for that conclusion.

Indeed, they said, “faster and more durable growth seems to have followed the associated reduction in inequality”.

“The average redistribution, and the associated reduction in inequality, seem to be robustly associated with higher and more durable growth,” the economists added.

The authors are cautious to avoid saying the effects of redistribution are positive in every case or situation, and note that extreme efforts can have a bad outcome.

But overall, they argue that redistribution programmes should not be excluded from policy out of fear they would hold back an economy.

“It would still be a mistake to focus on growth and let inequality take care of itself, if only because the resulting growth may be low and unsustainable. “Inequality and unsustainable growth may be two sides of the same coin.”

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