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F&D Spotlights Widening Gap Between Rich and Poor

Pedestrians pass by limousine in Times Square area of New York City, United States. Inequality is growing in most countries (Photo: Michel Setboun/Corbis)

INCOME INEQUALITY

F&D Spotlights Widening Gap Between Rich and Poor

By Marina Primorac
Managing Editor, Finance & Development

September 12, 2011

  • Income inequality within countries is rising, research shows
  • Global financial crisis probably narrowed inequality across countries
  • Equality is important ingredient in sustainable economic growth

The disparity between the haves and the have nots is increasing, according to an article in Finance & Development (F&D) magazine by inequality expert Branko Milanovic.

Some say that inequality doesn’t matter as long as markets are working efficiently and economies are growing so that everyone is getting more. But research is finding a number of important advantages to reducing inequality. Some of the pluses are practical—a more even distribution of income facilitates economic growth. Others are normative: many people believe there is a limit to how much of a gap is fair, and too much inequality can lead to social unrest as witnessed by the Arab Spring.

In addition to the cover theme of income inequality, the September issue of F&D magazine profiles Elinor Ostrom—the first woman to win the Nobel Prize in economics, looks at lessons learned by the euro area from its debt crisis, and describes the rise of emerging markets as systemically important trading centers.

More or less?

Economists used to think that income inequality didn’t matter as long as people were doing better overall. And when machines were the key to economic growth, that required a large proportion of rich people who could save their income and invest it in capital.

But technological advances in rich countries have increased demand for highly educated workers, so that education has now become the secret to growth. And the more equal a society, the more people have access to education, explains Milanovic.

Income inequality has been on the rise in most countries since the early 1980s, including in advanced, emerging, and transition economies, Milanovic finds. Explanations for this increase include technological progress, government policies on the use of taxes and social transfers to redistribute income, changing social norms, and globalization. Today, the poorest 20 percent of the world’s population receive only 1.27 percent of global income, while the richest 1 percent alone receive 13.08 percent.

Despite the increase in inequality within most countries, the global economic crisis may have narrowed inequality somewhat between countries, because most emerging and developing economies maintained strong growth. But global inequality is still far higher than inequality within any one country.

Some say inequality doesn’t matter as long as markets work and economies grow so that everyone gets more. But research finds advantages to reducing inequality

Efficient growth

Research by IMF economists Jonathan Ostry and Andrew Berg finds that inequality is counterproductive. More equal societies are more likely to sustain longer-term growth.

While policies to reduce inequality have to be carefully designed to avoid distorting incentives, better-targeted social subsidies, better access to education, and labor market measures that promote unemployment can offer win-win solutions. In other words, social justice and social product are not at war with each other.

Inequality equals indebted

Another disadvantage of inequality, according to research by IMF economists Michael Kumhof and Romain Ranciere, could be current account imbalances that in turn lead to financial crisis. They found that countries with persistently high deficits have in common a steep increase in income inequality in recent decades. As income shares of the top 5 percent increased in the past quarter-century, the poor and middle class borrowed from the rich and foreign lenders, fueling persistently high current account deficits.

Bigger slice of growing pie

It’s one thing to decide a more equal world is desirable. But how to achieve it? The IMF’s Sarwat Jahan and Brad McDonald start with the accepted premise that more varied and more accessible financial services – from banking to insurance to stock markets—enhance growth by allowing more savings to be efficiently channeled toward productive investments. It turns out, they find, that not only does financial development enlarge the pie, it also divides it more evenly.

Painful medicine

The debt crisis in many countries has forced governments to face the need for fiscal consolidation. Cutting deficits and/or raising revenues is clearly necessary, but policymakers need to consider the effects that such steps can have on inequality and unemployment.

Research by Laurence Ball of Johns Hopkins University along with IMF economists Prakash Loungani and Daniel Leigh found that the long-term goals of fiscal consolidation must be weighed against the short-term disadvantages. It is likely to lower incomes, hitting wage earners more than others, and raise unemployment. So fiscal measures that are approved now but kick in to reduce deficits only when the recovery is more robust would be especially helpful.

All for one

It is in countries’ interest to minimize the gap between their own rich and poor, economists find. Doing so can boost the availability of skilled workers, lower the chance of social unrest, and reduce the risk of current account deficits and perhaps financial crisis.

Decreasing global inequality—driven by high growth rates and improved living standards in populous and still relatively poor economies like China and India—reflects the newfound prosperity of millions of people, Milanovic concludes. And in the end, that might matter more than the rising inequality within nations.

■ Also in the September 2011 issue of Finance & Development, we look at how the United States and Canada handled their public debts, why unconventional policies by central banks helped during the recession but are not advisable in normal times, and the difference between macro- and microeconomics.