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Income Inequality Hurts Economic Growth, But Fixing It Doesn’t

By Alan Pyke on February 27, 2014 at 2:38 pm

"Income Inequality Hurts Economic Growth, But Fixing It Doesn’t"

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Economists at the International Monetary Fund (IMF) say that ignoring income inequality will hurt economic growth.

“Lower net inequality is robustly correlated with faster and more durable growth,” IMF economists Jonathan Ostry, Andrew Berg, and Charalambos Tsangarides write in a newly released research paper that is the first income distribution study to make use of a new set of international data on inequality. The economists further find that the conservative policy notion that a rising economic tide will lift even the poorest people’s boats is not supported by the data. It is “a mistake to focus on growth and let inequality take care of itself,” they write, in part because inequality impairs the growth poor people need to make gains.

They also find that modest redistributive policies that address poverty do not hurt economic growth. In a blog post accompanying the more technical research paper, the authors explain how their findings conflict with a common argument against government efforts to combat inequality by shuffling money around from the haves to the have-nots. While “many argue that redistribution undermines growth,” meaning that “taxes and transfers may be precisely the wrong remedy” for the harm inequality does to economic growth, the IMF researchers find “remarkably little evidence” that those people are correct. In the paper, they write that governments enjoy “a win-win situation” where redistribution boosts growth. Extreme redistributive policies can do more harm than good, but very few countries they examined are engaged in a sharp enough redistribution of wealth to have a harmful effect.

Meanwhile, the gap between the richest and the rest continues to yawn in America. Over the decades prior to the Great Recession, the top 1 percent of earners saw their after-tax income jump by 278 percent, compared to just a 40 percent bump for the middle class. Since the recession officially ended, the richest one percent have captured 95 percent of all income gains the country has made as a whole.

The new paper doesn’t represent official IMF policy or mean the organization’s recommendations to the 188 countries that participate in it will change overnight. But it is another example of an influential international body reassessing longstanding commitments to relatively conservative economic policy beliefs. Over the summer, the group admitted that it had badly underestimated the pain Greece would experience from a sweeping austerity package. In the fall, an economist from the European Commission, a key IMF partner in pushing austerity policies and other supply-side economic theories on struggling governments, published research that showed austerity is more harmful than the IMF says it is.

Groups like these influence the window of economic policy ideas that legislators and other political elites in the U.S. and elsewhere treat as serious and credible. The harder they look at the theories behind cutting public services, resisting higher taxes on the wealthy, and other conservative policy positions, the more evidence they seem to find that investing in the fight against inequality is essential to future prosperity.

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