IMF: Redistribution, Inequality and Growth

In a staff paper published in February, the IMF examines the links between rising inequality and the fragility of economic growth. They note that conventional wisdom would suggest that redistribution would in itself be bad for growth but, conceivably, by engendering greater equality, might help growth.


Disentangling the effects of inequality and redistribution on growth
In earlier work, the authors documented a robust medium-run relationship between equality and the sustainability of growth, but did not indicate whether the relationship justified efforts to redistribute.

They note that 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. If this is right, then taxes and transfers may be precisely the wrong remedy: a cure that may be worse than the disease itself.

The authors note that the literature on this issue remains controversial.  A number of papers point out that some policies that are redistributive—e.g., public investments in infrastructure, spending on health and education, and social insurance provision—may be both pro-growth and pro-equality. Others are more supportive of a fundamental tradeoff between redistribution and growth, as argued by Okun (1975) when he referred to the efficiency “leaks” that come with efforts to reduce inequality.

In their latest work, the authors ask what is the evidence about the macroeconomic effects of redistributive policies, both directly on growth, and indirectly as they reduce inequality, which in turn affects growth?

To disentangle the channels, the authors make use of a new cross-country data set that carefully distinguishes net (post-tax and transfers) inequality from market (pre-tax and transfers) inequality and allows them to calculate redistributive transfers for a large number of countries over time—covering both advanced and developing countries. They analyze the behavior of average growth during five-year periods as well as the sustainability and duration of growth.

The links between redistribution, inequality and growth
First, the authors continue to find that inequality is a robust and powerful determinant both of the pace of medium-term growth and of the duration of growth spells, even controlling for the size of redistributive transfers. Thus, 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.

And second, there is remarkably little evidence in the historical data used in our paper of adverse effects of fiscal redistribution on growth. The average redistribution, and the associated reduction in inequality, seem to be robustly associated with higher and more durable growth. The authors find some mixed signs that very large redistributions may have direct negative effects on growth duration, such that the overall effect—including the positive effect on growth through lower inequality—is roughly growth-neutral.

The conclusion that emerges from the historical macroeconomic data used in the paper is that, on average across countries and over time, the things that governments have typically done to redistribute do not seem to have led to bad growth outcomes. And quite apart from ethical, political, or broader social considerations, the resulting equality seems to have helped support faster and more durable growth.

In summary, the authors find little evidence of a “big tradeoff” between redistribution and growth. Inaction in the face of high inequality thus seems unlikely to be warranted in many cases.

Jonathan D. Ostry, Andrew Berg, and Charalambos G. Tsangarides, Redistribution, Inequality, and Growth, IMF Staff Discussion Note 14/02, February 2014.

Andrew Berg and Jonathan D. Ostry, Inequality and Unsustainable Growth: Two Sides of the Same Coin?, IMF Staff Discussion Note 11/08, 8 April 2011.