Economists have long argued about the economic effects of inequality. One school says big income differences spur poorer people to work harder. Another says inequality is bad for economies because it reduces economic spending from people of lower and middle incomes.
Now the International Monetary Fund is saying where it stands on the issue. A new report from its economists finds a definite relationship between inequality and reduced performance, and, what’s more, it gives numbers for the strength of that link.
“If the income share of the top 20% (the rich) increases, then GDP growth actually declines over the medium term, suggesting that the benefits do not trickle down. In contrast, an increase in the income share of the bottom 20% (the poor) is associated with higher GDP growth,” the report says.
The paper looks at 159 advanced and developing economies between 1980 and 2012, investigating how income is distributed in each society and its level of national growth. It finds that when the income share of the top 20% increases 1%, economic growth is then down 0.08% in the following five years. At the same time, a 1% increase for the bottom 20% leads to increased GDP of 0.38% in the following years.
The IMF is known for sometimes forcing countries into “pro-market reforms” in return for its loans. In Greece, left wing parties (who are in charge) say these requirements aggravate inequality as they reduce workplace protections, make hiring and firing easier, and undercut the safety net. However, in its more academic pronouncements, the IMF has been more sympathetic to the poor. Another paper on inequality last year reported a “benign” impact to redistributive policies, like raising taxes on the rich and making transfers to the poor.
The economists lays out reasons why inequality has been increasing in most countries. In advanced economies, it says it’s mainly due to a declining number of “middle-skilled occupations relative to low- and high-skilled occupations,” technological advances and the weakness of the trade union movement. They talk of a “middle class squeeze,” where the mid-20% have falling incomes relative to both high- and low-income groups. In emerging markets and developing countries, the IMF blames “financial deepening,” or the way in which some members of society have access to financial services while other groups don’t.
Because it thinks the lower income percentiles are key to a dynamic economy, the IMF recommends that “policymakers need to focus on the poor and the middle class.” In advanced countries, that includes more education opportunities for poorer people and a more progressive tax system, and, in emerging ones, more financial inclusion policies and efforts to reduce the size of the “informal economy.”
“Policies that focus on the poor and the middle class can mitigate inequality,” the paper says. “Irrespective of the level of economic development, better access to education and health care and well-targeted social policies, while ensuring that labor market institutions do not excessively penalize the poor, can help raise the income share for the poor and the middle class.”
All advice that economists and government leaders–especially at the IMF itself–would be wise to listen to.