## _sdn1513

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---

### Executive overview
- Two objectives:
  - Show why policymakers need to focus on the poor and the middle class: the income distribution itself matters for growth.
  - Investigate drivers of divergent inequality trends across advanced economies and emerging markets and developing countries (EMDCs), with particular attention to the poor and the middle class.

### Key empirical findings on growth and distribution
- Data and methods:
  - Sample: 159 advanced, emerging, and developing economies for the period 1980–2012.
  - Estimation method: simple growth model with time and country fixed effects estimated using system GMM.
- Main quantitative results on distribution and subsequent GDP growth (five-year horizon):
  - A higher net Gini coefficient is associated with lower output growth over the medium term.
  - If the income share of the top 20 percent increases by 1 percentage point, GDP growth is 0.08 percentage point lower in the following five years.
  - If the income share of the bottom 20 percent increases by 1 percentage point, GDP growth is 0.38 percentage point higher in the following five years.
  - Positive relationship between disposable income shares and higher growth continues for the second and third quintiles (the middle class).
- Selected coefficient estimates from regressions of GDP growth (standard errors in parentheses; significance levels preserved):
  - Lagged GDP Growth: 0.145*** (0.033); 0.112*** (0.030); 0.118*** (0.031); 0.113*** (0.031); 0.097*** (0.030); 0.114*** (0.031)
  - GDP Per Capita Level (in logs): -1.440*** (0.361); -2.198*** (0.302); -2.247*** (0.307); -2.223*** (0.308); -2.122*** (0.304); -2.222*** (0.307)
  - Net Gini: -0.0666* (0.034)
  - 1st Quintile: 0.381** (0.165)
  - 2nd Quintile: 0.325** (0.146)
  - 3rd Quintile: 0.266* (0.152)
  - 4th Quintile: 0.0596 (0.180)
  - 5th Quintile: -0.0837* (0.044)
  - Constant: 17.34*** (3.225); 18.82*** (2.579); 18.12*** (2.713); 17.45*** (3.058); 19.41*** (4.203); 25.32*** (3.496)
  - Country Fixed Effects: Yes (all specifications)
  - Time Dummies: Yes (all specifications)
  - #. of Observations733455455455455455
  - #. of Countries159156156156156156
  - Dependent Variable: GDP Growth

### Macroeconomic channels: why inequality matters
- Conceptual distinctions:
  - Inequality of outcomes measured by income, wealth, or expenditure.
  - Inequality of opportunities arises from circumstances beyond individual control (gender, ethnicity, location of birth, family background).
- Mechanisms by which rising inequality can hurt growth:
  - Under-investment in health and education among lower-income households reduces labor productivity.
  - Higher concentration of income reduces aggregate demand because the wealthy spend a lower fraction of income.
  - High inequality fuels economic, financial, and political instability:
    - Financial crises: rising influence of the rich and stagnant incomes for the poor and middle class have been linked to intensified leverage and credit overextension.
    - Global imbalances: higher top income shares combined with financial liberalization are associated with substantially larger external deficits.
    - Conflicts: extreme inequality damages trust and social cohesion and is associated with conflicts that discourage investment.

### Stylized facts and patterns
- Advanced economies: gap between rich and poor at highest level in decades.
- EMDCs: mixed trends—some countries have declining inequality, but pervasive inequities in access to education, health care, and finance remain.
- Social mobility: higher income inequality is associated with lower intergenerational mobility.

### Drivers of inequality and heterogeneity across country groups
- Common drivers:
  - Technological progress and the resulting rise in the skill premium.
  - Decline of some labor market institutions.
  - Globalization has played a smaller but reinforcing role.
- Heterogeneous drivers:
  - Advanced economies: rising skill premium associated with widening income disparities.
  - EMDCs: financial deepening associated with rising inequality where financial inclusion lags.

### Empirical evidence on drivers (selected results)
- Trade openness: associated with lower inequality (not always statistically significant).
- Financial openness and technological progress: associated with rising income inequality and increased top 10 percent disposable income share.
- Financial deepening (private credit to GDP):
  - Associated with higher income inequality in EMDCs where inclusion is limited.
  - Associated with less increase in market inequality and with lower net inequality in advanced economies.
- Regression highlights (selected coefficients and significance preserved):
  - Financial openness: 0.098*** (Market Gini); 0.047** (Net Gini); 0.026** (Top 10%); -0.002 (5th Income Decile); -0.008* (Bottom 10%).
  - Technology: 56.85* (Market Gini); 15.03 (Net Gini); 31.11 (Top 10%); -3.775 (5th Income Decile); -11.51*** (Bottom 10%).
  - Financial deepening: 0.050** (Market Gini); 0.026** (Net Gini); 0.022*** (Top 10%); -0.004 (5th Income Decile); -0.002 (Bottom 10%).
  - AEs * Financial deepening: -0.049** (Market Gini); -0.033** (Net Gini); -0.03*** (Top 10%); 0.007*** (5th Income Decile); 0.004* (Bottom 10%).
  - AEs * Skill Premium: 1.165** (Market Gini); 0.555 (Net Gini); 1.184*** (Top 10%); -0.131** (5th Income Decile); 0.024 (Bottom 10%).
  - Labor Market Institutions: 0.803*** (Market Gini); 0.497 (Net Gini); 0.338* (Top 10%); -0.045 (5th Income Decile); -0.140** (Bottom 10%).
  - Female Mortality: 0.021** (Market Gini); 0.015* (Net Gini); 0.026 (Top 10%); -0.005*** (5th Income Decile); 0.001 (Bottom 10%).
  - Government Spending: -0.26 (Market Gini); -0.426*** (Net Gini); -0.349*** (Top 10%); 0.046*** (5th Income Decile); 0.0332 (Bottom 10%).

### Quantified decomposition and stylized impacts
- Labor market institutions: an increase in labor market flexibilities index by 8½ percent (median to 60th percentile) associated with rising market inequality by 1.1 percent.
- Government redistributive spending: an increase in the proxy by 7.1 percent (median to 60th percentile) associated with a 0.6 percent decrease in income inequality.
- Health improvements mitigated around ½ percent of the almost 3 percentage points average increase in the Gini coefficient over the last 30 years.
- Drivers explaining rise in market income inequality over the last 30 years: less-regulated labor markets, financial deepening, and technological progress; globalization played a smaller but reinforcing role.

### Distributional patterns and sectoral notes
- Top income trends:
  - Top 1 percent account for around 10 percent of total income in advanced economies.
  - About half of the income of the top 1 percent is non-labor income compared with 30 percent for the top 10 percent as a whole.
- Middle-class squeeze:
  - Income share of the middle 20 percent has shrunk in many advanced economies.
  - Pretax incomes of middle-class households in the United States, the United Kingdom, and Japan have experienced declining or stagnant growth rates in recent years.
- Wealth inequality:
  - Almost half of the world’s wealth is owned by 1 percent, amounting to $110 trillion—65 times the total wealth of the bottom half of the world’s population.
  - Wealth Ginis are, on average, about twice as large as income Ginis.

### Inequality of opportunity: health and education
- Health:
  - Infant mortality rate roughly twice as high in the poor than in the rich within emerging market economies.
  - Large disparities in access and use of health care within developing countries; smaller disparities in advanced economies.
- Education:
  - Education Gini declined significantly in EMDCs over the last 60 years, driven by improvements in access at the lower end.
  - Education outcomes remain worse for disadvantaged groups; in sub-Sahara Africa, almost 60 percent of the poorest youth (aged 20–24 years) has fewer than 4 years of schooling compared to 15 percent in the richest quintile.
  - Rising university costs have reduced access for the poor in some advanced countries (example: college costs in the United States grew much faster than most households’ income since 2001).

### Poverty and growth interactions (Box 2 summary)
- Sample: almost 100 EMDCs for 1985–2010.
- Key regression results (selected coefficients):
  - GDP per capita growth: -0.278***; -0.323***; -0.256*** (various specifications).
  - Initial Gini * GDP Per Capita Growth: 0.005**; 0.003; 0.005**.
  - Initial Education Gini * GDP Per Capita Growth: 0.609**.
  - Employment in the Industrial Sector Growth: -4.096***.
  - Change in Financial Openness * GDP Per Capita Growth: -0.515***.
- Interpretation:
  - Higher initial inequality lowers the growth elasticity of poverty reduction.
  - Higher initial education inequality dampens the growth elasticity of poverty reduction.
  - Higher employment growth in manufacturing strongly associated with lower poverty.
  - Financial openness amplifies the growth elasticity of poverty reduction via interaction effects.

### Financial inclusion and safeguards
- Access disparities:
  - More than 80 percent of adults in advanced economies have an account at a formal financial institution—twice more than in EMDCs.
  - Within EMDCs, account and loan access skewed toward top income earners; bottom 40 percent rely more on limited personal savings.
- Government role and policy tools to foster inclusion safely:
  - Protect creditor rights, regulate business conduct, oversee consumer recourse mechanisms.
  - Improve information environment: disclosure standards, credit information-sharing systems, collateral registries.
  - Consumer education and protection.
  - Policies: exemptions from onerous documentation, requiring banks to offer basic accounts, allowing correspondent banking.
- Risks and trade-offs:
  - Promoting credit without sufficient financial-stability safeguards can result in crises (example: subprime mortgage crisis in the United States) with adverse effects on poor and middle class.
  - Deep social issues cannot be resolved purely by expanding credit.
- Policy balance: strike a balance between prudence, stability, inclusion, and innovation.

### Policy implications and recommendations
- Overarching principle: no one-size-fits-all; policies must be tailored to country-specific drivers, institutions, and capacity.
- Fiscal policy:
  - Fiscal redistribution can raise income shares of the poor and middle class while supporting growth if consistent with macroeconomic objectives.
  - Recommended instruments: greater reliance on wealth and property taxes, more progressive income taxation, remove opportunities for tax avoidance and evasion, better targeting of social benefits, reduce tax expenditures benefiting high-income groups, remove reduced taxation of capital gains, stock options, and carried interest where applicable.
  - EMDC-specific: expand access to education and health, well-targeted conditional cash transfers, more efficient safety nets, accompanied by revenue mobilization and reduced tax loopholes and evasion.
- Labor market policy:
  - Be cautious when easing labor market regulation—greater flexibility associated with higher market inequality and higher top 10 percent income shares.
  - Maintain protections (minimum wages, collective bargaining) and design reforms to avoid penalizing lower-income individuals.
- Education and skill policies:
  - Improve education quality, eliminate financial barriers to higher education, support apprenticeship programs.
  - Advanced economies: focus on upper secondary and tertiary education quality.
  - Developing countries: promote equal access to basic education via cash transfers and public spending that benefits the poor.
- Health:
  - Better and more equal access to quality health services improves productivity and lowers income disparities.
- Labor market inclusion in EMDCs:
  - Make labor markets more inclusive and create incentives to lower informality.
  - Policies to reduce tax, financial, and regulatory constraints to expand formal sector employment.
- Complementarities:
  - Reforms that raise average living standards (skills, infrastructure, innovation, technology adoption) can also promote more inclusive distributional outcomes.

### Caveats and robustness
- Cross-country regression analysis has limitations: measurement issues and potential two-way causality between growth and inequality complicate causal inference.
- Results robust to checks for omitted variables, endogeneity, alternative measures; lower marginal tax rates associated with higher market and net inequality and higher income share of the top 10 percent in complementary analyses.
- Policy effects likely heterogeneous; in-depth country-specific analyses are important.

*Source: EXECUTIVE SUMMARY and chapter extracts from "INEQUALITY: CAUSES AND CONSEQUENCES" (sdn1513) — IMF staff note.*

### EXECUTIVE SUMMARY _________________________________________________________________________________ 4

### EXECUTIVE SUMMARY

### Executive overview
- Widening income inequality is described as the defining challenge of our time. The paper has two objectives:
  - Show why policymakers need to focus on the poor and the middle class: the income distribution itself matters for growth.
  - Investigate drivers of divergent inequality trends across advanced economies and emerging markets and developing countries (EMDCs), with particular attention to the poor and the middle class.

### Key empirical findings on growth and distribution
- Data and methods:
  - Sample: 159 advanced, emerging, and developing economies for the period 1980–2012.
  - Estimation method: simple growth model with time and country fixed effects estimated using system GMM.
- Main quantitative results:
  - A higher net Gini coefficient is associated with lower output growth over the medium term.
  - If the income share of the top 20 percent increases by 1 percentage point, GDP growth is 0.08 percentage point lower in the following five years.
  - If the income share of the bottom 20 percent increases by 1 percentage point, GDP growth is 0.38 percentage point higher in the following five years.
  - The positive relationship between disposable income shares and higher growth continues for the second and third quintiles (the middle class).
- Table 1 (selected coefficient estimates from regressions of GDP growth; standard errors in parentheses; significance levels preserved):
  - Lagged GDP Growth: 0.145*** (0.033); 0.112*** (0.030); 0.118*** (0.031); 0.113*** (0.031); 0.097*** (0.030); 0.114*** (0.031)
  - GDP Per Capita Level (in logs): -1.440*** (0.361); -2.198*** (0.302); -2.247*** (0.307); -2.223*** (0.308); -2.122*** (0.304); -2.222*** (0.307)
  - Net Gini: -0.0666* (0.034)
  - 1st Quintile: 0.381** (0.165)
  - 2nd Quintile: 0.325** (0.146)
  - 3rd Quintile: 0.266* (0.152)
  - 4th Quintile: 0.0596 (0.180)
  - 5th Quintile: -0.0837* (0.044)
  - Constant: 17.34*** (3.225); 18.82*** (2.579); 18.12*** (2.713); 17.45*** (3.058); 19.41*** (4.203); 25.32*** (3.496)
  - Country Fixed Effects: Yes (all specifications)
  - Time Dummies: Yes (all specifications)
  - #. of Observations733455455455455455
  - #. of Countries159156156156156156
  - Dependent Variable: GDP Growth

### Macroeconomic channels: why inequality matters
- Inequality of outcomes vs. inequality of opportunities:
  - Inequality of outcomes is measured by income, wealth, or expenditure; inequality of opportunities arises from circumstances beyond individual control (gender, ethnicity, location of birth, family background).
- Why rising inequality can hurt growth:
  - Under-investment in health and education among lower-income households can reduce labor productivity.
  - Higher concentration of income can reduce aggregate demand because the wealthy spend a lower fraction of income.
  - High inequality can fuel economic, financial, and political instability:
    - Financial crises: rising influence of the rich and stagnant incomes for the poor and middle class have been linked to crises, e.g., by intensifying leverage and credit overextension.
    - Global imbalances: higher top income shares combined with financial liberalization are associated with substantially larger external deficits.
    - Conflicts: extreme inequality can damage trust and social cohesion and is associated with conflicts that discourage investment.

### Stylized facts and patterns (summary from broader text)
- Advanced economies: gap between rich and poor at highest level in decades.
- EMDCs: mixed trends—some countries have declining inequality, but pervasive inequities in access to education, health care, and finance remain.
- Social mobility: higher income inequality is associated with lower intergenerational mobility (parents’ earnings more important for children’s earnings).

### Drivers of inequality and heterogeneity across country groups
- Common drivers across advanced economies and EMDCs:
  - Technological progress and the resulting rise in the skill premium.
  - Decline of some labor market institutions.
  - Globalization has played a smaller but reinforcing role.
- Heterogeneous drivers:
  - In advanced countries, rising skill premium is associated with widening income disparities.
  - In EMDCs, financial deepening is associated with rising inequality, highlighting scope for policies that promote financial inclusion.

### Policy implications and recommendations
- No one-size-fits-all solution: appropriate policy depends on underlying drivers and country-specific policy and institutional settings.
- Policy priorities:
  - Policies that focus on the poor and the middle class can mitigate inequality.
  - Across all development levels: better access to education and health care, well-targeted social policies, and ensuring labor market institutions do not excessively penalize the poor help raise income shares for the poor and middle class.
  - Advanced economies: reforms to increase human capital and skills, coupled with making tax systems more progressive.
  - EMDCs: ensure financial deepening is accompanied by greater financial inclusion and create incentives for lowering informality.
- Synergies:
  - Complementarities between growth and income equality objectives mean policies aimed at raising average living standards can also influence income distribution and ensure more inclusive prosperity.

*Source: EXECUTIVE SUMMARY (sdn1513) — IMF staff note (selected excerpts).*

### 11. Inequality can lead to policies that hurt growth. In addition to affecting growth drivers,

### 11. Inequality can lead to policies that hurt growth. In addition to affecting growth drivers,

### Inequality and public policy / growth
- Inequality can result in poor public policy choices, including a backlash against growth-enhancing economic liberalization and increased protectionist pressures against globalization and market-oriented reforms (Claessens and Perotti 2007).
- Enhanced power by the elite can lead to a more limited provision of public goods that boost productivity and growth, and which disproportionately benefit the poor (Putnam 2000; Bourguignon and Dessus 2009).

### Inequality and poverty reduction
- Income inequality affects the pace at which growth enables poverty reduction (Ravallion 2004).
- Growth is less efficient in lowering poverty in countries with high initial levels of inequality or where the distributional pattern of growth favors the non-poor.
- Higher inequality increases vulnerability to poverty when economies are subject to shocks.

### Measuring inequality: concepts and data
- Income inequality is typically measured by market (gross) and net (after tax and transfers) Gini coefficients and by changes in income shares by decile/quintile.
- Wealth measures (assets held by the wealthiest) offer a complementary perspective.
- Inequality of opportunities is measured by tracking health, education, and human development outcomes by income group, and by examining access to basic services.

### Global inequality: levels and trends
- Global inequality ranges from 0.55 to 0.70 depending on the measure used.
- Per capita income disparities across countries account for around three quarters of global inequality (Milanovic 2013).
- Some global measures declined in recent decades due to rising incomes in China and India; other measures adjusted for top incomes appear broadly stable since the early 1990s.

### Distributional changes: winners and losers globally
- Between 1998 and 2008, the largest gains in real incomes accrued to the global median (50th percentile) and to the top 1 percent (Lakner and Milanovic 2013).
- Income gains decline after the 50th percentile, become stagnant around the 80th–90th percentiles, then increase sharply for the global top 1 percent (Krugman 2014).

### Within-country income inequality: patterns and regional differences
- Gini coefficients of gross and net incomes have increased substantially since 1990 in most of the developed world.
- Inequality has remained, on average, stable in EMDCs but at higher levels than advanced economies; large disparities exist across EMDCs:
  - Asia and Eastern Europe experienced marked increases in inequality.
  - Latin America exhibited notable declines, though it remains the most unequal region.
- Redistribution (difference between market and net inequality) cushioned market income inequality in advanced economies: during 1990–2012 market income inequality increased by an average of 5¼ Gini points compared to a 3 Gini point increase in the net Gini.

### Income-decile drivers of inequality
- Rising income inequality in most advanced and many emerging market economies has been driven primarily by the growing income share of the top 10 percent.
- The top 10 percent now has an income close to nine times that of the bottom 10 percent.
- In EMDCs, rising inequality often reflects shifts from the upper middle class to the upper class (examples: China, South Africa).
- In EMDCs with falling inequality (e.g., Peru, Brazil), the main beneficiaries were those at both the bottom and the middle of the distribution.

### Top 1 percent trends
- The top 1 percent account for around 10 percent of total income in advanced economies.
- The growing share of the top 1 percent in advanced economies reflects higher inequality in labor incomes and capital gains; about half of the income of the top 1 percent is non-labor income compared with 30 percent for the top 10 percent as a whole.
- Corporate profits have been translated into high executive salaries and bonuses, exacerbating income inequality (Brightman 2014).

### Middle-class squeeze
- The income share of the middle 20 percent has shrunk in many advanced economies (Australia, Canada, and Sweden are exceptions) and some large emerging market economies.
- Pretax incomes of middle-class households in the United States, the United Kingdom, and Japan have experienced declining or stagnant growth rates in recent years.
- Average wages have risen more slowly than productivity amid large economic rents (high profitability and large increase in executive compensation).

### Drivers of middle-class pressures
- Advanced economies: decline in middle-skilled occupations relative to low- and high-skilled occupations (Autor, Kerr, and Kugler 2007; Goos, Manning, and Salomons 2009).
- EMDCs: income polarization, widespread informality, and large geographical differences in economic performance (examples: China—one-third of wealth concentrated in the top 1 percent; India—class and caste-based inequality).

### Poverty trends
- In many EMDCs, poverty (population below a defined poverty line) has declined despite rising income inequality in some countries.
- Poverty rose in advanced countries since the 1990s (OECD 2011).
- The ratio of earnings of the 90th percentile to the 10th percentile grew in most advanced economies between 1980 and 2011, particularly in the United States and the United Kingdom.

### Wealth inequality
- Estimates suggest almost half of the world’s wealth is owned by just 1 percent of the population, amounting to $110 trillion—65 times the total wealth of the bottom half of the world’s population (Fuentes Nieva and Galasso 2014).
- In the United States, a third of total wealth is held by 1 percent of the population.
- In most countries with data, the share held by the top 1 percent is rising at the expense of the bottom 90 percent.
- Wealth Ginis are, on average, about twice as large as income Ginis in both advanced economies and EMDCs.
- Explanations include stagnant wage growth, low saving ability among middle- and lower-income workers, and lower propensity to consume by the rich.

### Inequality of opportunity: health
- Health outcome disparities are large in EMDCs; infant mortality rate is roughly twice as high in the poor than in the rich within emerging market economies.
- Female mortality rates are disproportionately higher for lower-income groups in EMDCs.
- Access and use of health care (e.g., births attended by skilled health personnel) show large disparities across income levels within developing countries; disparities are smaller in advanced economies.
- Even in advanced economies, income inequality increasingly correlates with lower life expectancy (notably in the United States).

### Inequality of opportunity: education
- The education Gini has declined significantly in EMDCs over the last 60 years, driven by improvements in access at the lower end of the income distribution.
- Education outcomes remain much worse for disadvantaged groups due partly to pro-rich biases in the incidence of public spending.
- In sub-Sahara Africa, almost 60 percent of the poorest youth population (aged 20–24 years) has fewer than 4 years of schooling compared to 15 percent in the richest quintile.
- Education inequality is, on average, unchanged in most advanced economies over the last decade, though rising university costs have reduced access for the poor in some countries (example: college costs in the United States grew much faster than most households’ income since 2001).

*Source: IMF staff calculations and chapter content.*

### 27. Disparities in financial services access. There are large disparities in the use of financial

### 27. Disparities in financial services access. There are large disparities in the use of financial

### Disparities in financial inclusion
- More than 80 percent of adults in advanced economies have an account at a formal financial institution—twice more than in EMDCs.
- Within EMDCs, the share of adults with an account or a loan at a formal financial institution is largely skewed toward the top income earners; the bottom 40 percent rely more on limited personal savings to invest in education or start businesses.
- Barriers for low-income households and small-scale firms in many EMDCs include lack of financial knowledge, complicated processes, onerous paperwork, and other market failures.
- Available financial products in many EMDCs tend to be more limited and relatively costly.

### Figure and data references
- Figure 14: Financial Inclusion in Advanced and Developing Countries (Percent of total, 2011) — sources: World Bank, Global Financial Inclusion Database; and IMF staff calculations.
- Note: AEs = advanced economies; DCs = developing countries; EMs = emerging market economies.

### IV. INEQUALITY DRIVERS — Overview
- Section examines global and country-specific drivers of income inequality, noting both positive effects of globalization and technology on growth and poverty reduction and the concurrent rise in inequality.

### Technological change (Paragraph 29)
- Technology reduced transportation costs, improved automation and communication, and opened new markets, lifting hundreds of millions out of poverty.
- Technological change has contributed to rising the skill premium, increasing labor income inequality.
- Evidence: technological advances contributed nearly a third of the widening gap between the 90th and the 10th percentile earners over the last 25 years in OECD countries (OECD 2011).
- Figure 15: Technological Progress and Skill Premium in OECD Countries — source: OECD; note on skill premium measurement.

### Trade globalization (Paragraph 30)
- Trade has promoted competitiveness and efficiency but can affect inequality in complex ways.
- In advanced economies, labor-saving technologies and offshoring have been cited as drivers of manufacturing decline and rising skill premium.
- Trade openness can raise the skill premium but also lower real wages via lower import prices; effects depend on relative factor abundance and whether income derives from wages or capital.
- Increased trade can lower inequality in EMDCs by raising demand and wages for lower-skilled workers; disentangling trade’s impact is challenging.

### Financial globalization (Paragraph 31)
- Financial globalization can improve capital allocation and risk sharing but has been shown to increase income inequality in both advanced and emerging market economies.
- Possible mechanisms: concentration of foreign assets and liabilities in higher skill- and technology-intensive sectors; FDI inducing skill-specific technological change and training biased toward skilled workers.
- Financial deregulation and globalization increased financial wealth and relative wages in the finance industry.

### Financial deepening (Paragraph 32)
- Financial deepening can enable households and firms to save, invest in education, and smooth shocks; inclusive financial systems can lower income inequality.
- Theory suggests early-stage financial development benefits the rich disproportionately; benefits become broader as economies develop (Greenwood and Jovanovic 1990).
- Empirical findings: financial development can boost top incomes most in early development stages (Roine, Vlachos, and Waldenström 2009); inequality can increase when access to finance is concentrated among higher-income households (Claessens and Perotti 2007).

### Changes in labor market institutions (Paragraph 33)
- More flexible labor market institutions can boost economic dynamism but pose challenges for low-skill workers and can increase inequality.
- Declines in trade union membership (union rate) can reduce labor bargaining power and exacerbate wage inequality.
- Jaumotte and Osorio-Buitron (2015) and forthcoming IMF work: reduction in the minimum wage relative to the median wage is associated with higher inequality in advanced economies; decline in unionization is strongly associated with rising top income shares.
- Wage dispersion, part-time and temporary employment shares can drive inequality in labor earnings in some advanced economies.
- In many EMDCs, rigid hiring/firing rules and weak income protection encourage informality, fueling wage inequality.
- Evidence from a large sample suggests de facto labor market regulations (minimum wages, unionization, social security contributions) on average tend to improve income distribution (Calderón and Chong 2009; OECD 2011).

### Redistributive policies (Paragraph 34)
- Advanced economies historically mitigated inequality via progressive taxes and social transfers (public retirement benefits); yet net income inequality has risen in many advanced countries.
- Top marginal tax rates fell from 59 percent in 1980 to 30 percent in 2009 in many advanced economies (Figure 18).
- Conditional cash transfers are important in EMDCs but their redistributive impact varies widely depending on size and progressivity.

### Education (Paragraph 35)
- Education shapes occupational choice, job access, and pay; human capital models link educational inequality to income inequality.
- The effect of increased educational attainment on income inequality can be positive or negative depending on rates of return to education (skill premium).
- The inequality impact of education depends on individual and public investment levels and the rate of return; access and affordability matter for equality of opportunity.

### Empirical analysis — scope and approach (Paragraphs 36–37; Box 1)
- Sample: almost 100 advanced economies and EMDCs over 1980–2012; five-year panels with year and country fixed effects.
- Outcomes examined: Gini coefficients of market and net inequality and disposable income shares of bottom 10 percent, fifth decile (middle class), and top 10 percent.
- Key explanatory variables: trade openness (exports + imports as share of GDP), financial globalization (foreign assets + liabilities as share of GDP), technology (share of ICT capital in total capital stock), credit (private credit to GDP), average years of education (proxy for skill premium), labor market flexibility (World Economic Forum measure).
- Controls: beginning-of-period education Gini, female mortality (aged 15–60), beginning-of-period Fraser Institute index measuring total government spending as share of GDP, lagged GDP growth, employment shares in agriculture and industry, time and country fixed effects.
- Robustness checks included dummies for financial crises, GDP per capita, alternative measures of skill premium, trade, financial openness, and, for some OECD countries, alternative redistributive policy measures including top marginal personal income-tax rates.

### Empirical findings (Paragraphs 37–38 and Figure 19)
- Trade openness is associated with lower inequality (not always statistically significant).
- Greater financial openness and technological progress are associated with rising income inequality; financial globalization and technological progress are associated with an increase in the top 10 percent disposable income share across all countries.
- Impact of financial deepening (private credit to GDP) varies by country group:
  - Financial deepening is associated with higher income inequality in EMDCs, likely because financial inclusion has not kept pace with deepening and credit concentrates among large firms and wealthier households.
  - Financial deepening is associated with less increase in market inequality and with lower net inequality in advanced economies, reflecting easier access to credit.
- Figure 19: Impact of Change in Financial Deepening on Inequality (Average in percentage points, 1990s–2011) — indicates higher market and net income inequality in countries with low levels of financial inclusion; sources: World Bank, Global Financial Inclusion Database; World Bank, World Development Indicators; and IMF staff calculations.

### Box 1 — Empirical specification highlights
- Model focuses on within-country variation in inequality using five-year panels (1980–2012) with country fixed effects.
- Interaction terms capture differential effects: credit × advanced-economy dummy; skill premium × advanced-economy dummy.
- Country fixed effects and time dummies control for unobserved heterogeneity and common shocks.
- Lagged GDP growth included to mitigate two-way causality concerns.
- Results are robust to checks for omitted variables, endogeneity, and alternative variable measures; lower marginal tax rates are associated with higher market and net inequality and a higher income share of the top 10 percent in complementary analyses.

*Source: IMF staff analysis in “INEQUALITY: CAUSES AND CONSEQUENCES,” chapter on disparities in financial services access and drivers of income inequality (extract provided).*

### 39. Higher skill premium is associated with widening inequality in advanced economies. In

### 39. Higher skill premium is associated with widening inequality in advanced economies. In

### Main empirical findings
- In advanced economies, increases in the skill premium exacerbate market income inequality, reflecting that education gains accrue disproportionately at the higher end of the income distribution.
- The effect of the skill premium on net income inequality is statistically insignificant; this could reflect that the net Gini underestimates increases in inequality at the top of the distribution (Kakwani 1980).
- An increase in the skill premium is associated with a significantly higher disposable income share of the top 10 percent in advanced economies; this effect is statistically insignificant in EMDCs.
- Less-regulated labor markets (easing of labor market regulations) are associated with higher market inequality and a higher income share of the top 10 percent.
- Government redistributive spending and better health outcomes are associated with lower income inequality.

### Regression evidence (selected coefficients and results from Table 2)
- Financial openness: 0.098*** (Market Gini, Column 1); 0.047** (Net Gini, Column 2); 0.026** (Top 10%, Column 3); -0.002 (5th Income Decile, Column 4); -0.008* (Bottom 10%, Column 5). (Standard errors shown in table.)
- Technology: 56.85* (Market Gini); 15.03 (Net Gini); 31.11 (Top 10%); -3.775 (5th Income Decile); -11.51*** (Bottom 10%).
- Financial deepening: 0.050** (Market Gini); 0.026** (Net Gini); 0.022*** (Top 10%); -0.004 (5th Income Decile); -0.002 (Bottom 10%).
- AEs * Financial deepening: -0.049** (Market Gini); -0.033** (Net Gini); -0.03*** (Top 10%); 0.007*** (5th Income Decile); 0.004* (Bottom 10%).
- Skill Premium: 0.413 (Market Gini); -1.351 (Net Gini); -0.475 (Top 10%); 0.063 (5th Income Decile); -0.083 (Bottom 10%).
- AEs * Skill Premium: 1.165** (Market Gini); 0.555 (Net Gini); 1.184*** (Top 10%); -0.131** (5th Income Decile); 0.024 (Bottom 10%).
- Labor Market Institutions: 0.803*** (Market Gini); 0.497 (Net Gini); 0.338* (Top 10%); -0.045 (5th Income Decile); -0.140** (Bottom 10%).
- Female Mortality: 0.021** (Market Gini); 0.015* (Net Gini); 0.026 (Top 10%); -0.005*** (5th Income Decile); 0.001 (Bottom 10%).
- Government Spending: -0.26 (Market Gini); -0.426*** (Net Gini); -0.349*** (Top 10%); 0.046*** (5th Income Decile); 0.0332 (Bottom 10%).

Additional regression table details:
- Country Fixed Effects: Yes; Time Dummies: Yes.
- #. of Observations: 361 (Columns 1–2), 220 (Columns 3–5).
- #. of countries: 97 (Column 1), 97 (Column 2), 67 (Columns 3–5).
- Adjusted R-squared: 0.386 (Market Gini), 0.246 (Net Gini), 0.491 (Top 10%), 0.412 (5th Income Decile), 0.225 (Bottom 10%).

### Quantified impacts and decomposition of changes in market (gross) income inequality
- A decline in organized labor institutions measured by an increase in labor market flexibilities index by 8½ percent—from the median to 60th percentile—is associated with rising market inequality by 1.1 percent.
- An increase in the proxy for government redistributive spending relative to total spending by 7.1 percent (shift from median to 60th percentile) is associated with a 0.6 percent decrease in income inequality.
- Improvements in health outcomes mitigated around ½ percent of the almost 3 percentage points average increase in the Gini coefficient over the last 30 years.
- Based on the estimated models, less-regulated labor markets, financial deepening, and technological progress largely explain the rise in market income inequality in the full sample over the last 30 years; globalization (financial openness) played a smaller but reinforcing role.

### Drivers of income shares for the poor and the middle class
- Rising income shares of the poor (bottom 10 percent) and the middle class have been much slower than the top 10 percent, contributing to rising inequality.
- Factors that raise income shares of the poor and middle class:
  - Better access to education (declining educational inequality).
  - Improved health outcomes.
  - Redistributive social policies.
- Factors that dampen the income share of the poor and middle class:
  - Easing of labor market regulations (labor market flexibility).
  - Technological progress.
- Cross-region differences:
  - Financial deepening raised income shares of the poor and middle class in advanced economies but not in EMDCs.
  - Reducing gaps in access to education has been a key driver of higher income shares for the bottom 10 percent and the middle class in EMDCs.
  - Financial globalization and a higher skill premium contributed more to widening gaps between the top 10 percent and the poor/middle class in advanced economies than in developing countries.

### Box 2 — Drivers of poverty (population living below $2 a day)
- Sample: almost 100 EMDCs for 1985–2010.
- Key regression results (Table 3):
  - GDP per capita growth: -0.278*** (Column 1); -0.323*** (Column 2); -0.256*** (Column 3).
  - Initial Gini * GDP Per Capita Growth: 0.005** (Column 1); 0.003 (Column 2); 0.005** (Column 3).
  - Initial Education Gini * GDP Per Capita Growth: 0.609** (Column 2).
  - Employment in the Industrial Sector Growth: -4.096*** (Column 2).
  - Change in Trade Openness: 1.009 (Column 3).
  - Change in Trade Openness * GDP Per Capita Growth: -0.151 (Column 3).
  - Change in Financial Openness: 0.509 (Column 3).
  - Change in Financial Openness * GDP Per Capita Growth: -0.515*** (Column 3).
- Interpretation:
  - Higher initial inequality lowers the growth elasticity of poverty reduction.
  - Higher initial education inequality dampens the growth elasticity of poverty.
  - Higher employment growth in manufacturing is associated with lower poverty.
  - Financial openness amplifies the growth elasticity of poverty reduction in a significant way (interaction term).

### Policy implications and recommendations
- No one-size-fits-all: policy choices need to be tailored to country-specific conditions, institutional settings, and capacity constraints.
- Fiscal policy:
  - Fiscal redistribution can raise income shares of the poor and middle class while supporting growth if implemented consistent with macroeconomic objectives.
  - Recommendations include greater reliance on wealth and property taxes, more progressive income taxation, removing opportunities for tax avoidance and evasion, better targeting of social benefits, reducing tax expenditures that benefit high-income groups, and removing tax reliefs such as reduced taxation of capital gains, stock options, and carried interest where applicable.
  - In EMDCs, better access to education and health services, well-targeted conditional cash transfers, and more efficient safety nets can boost disposable incomes of the poor; such spending may need to be accompanied by rising revenue mobilization and reduced tax loopholes and evasion.
- Labor market policy:
  - Policymakers should be cautious when easing labor market regulation, as greater labor market flexibility is associated with higher market inequality and higher top 10 percent income shares.
  - Ensure labor market reforms do not excessively penalize lower-income individuals; maintain protections (for example, minimum wages, collective bargaining) that support lower-income workers.
- Education and skill policies:
  - Improving education quality, eliminating financial barriers to higher education, and supporting apprenticeship programs are key to boosting skill levels and reducing earnings dispersion.
  - In advanced economies, focus on improving the quality of upper secondary and tertiary education.
  - In developing countries, promote equal access to basic education through measures such as cash transfers to encourage school attendance and public education spending that benefits the poor.
- Health:
  - Better and more equal access to quality health services can improve productivity and lower income disparities.
- Caveats:
  - Cross-country regression analysis has limitations; measurement issues and potential two-way causality between growth and inequality complicate causal inference.
  - Policy effects are likely heterogeneous across countries and time; in-depth country-specific analyses are important.

*Source: IMF staff calculations and analysis presented in the chapter "INEQUALITY: CAUSES AND CONSEQUENCES" (text and tables provided).*

### 49. Fostering financial inclusion safely. Financial deepening in EMDCs needs to be

### 49. Fostering financial inclusion safely. Financial deepening in EMDCs needs to be

### Financial inclusion: role of government and safeguards
- Governments have a central role in alleviating impediments to financial inclusion by creating the associated legal and regulatory framework:
  - protecting creditor rights,
  - regulating business conduct,
  - overseeing recourse mechanisms to protect consumers.
- Governments should support the information environment:
  - setting standards for disclosure and transparency,
  - promoting credit information-sharing systems and collateral registries.
- Governments should educate and protect consumers.
- Country experiences suggest useful policies to foster inclusion:
  - granting exemptions from onerous documentation requirements,
  - requiring banks to offer basic accounts,
  - allowing correspondent banking.
- Risks and trade-offs:
  - The promotion of credit without sufficient regard for financial stability can result in crises (example cited: the subprime mortgage crisis in the United States), with disproportionately adverse effects on the poor and the middle class.
  - Deep social issues cannot be resolved purely with an infusion of credit.
- Policy balance:
  - Policies need to strike a balance between fostering prudence, stability, and inclusion, while encouraging innovation and creativity.

### Well-designed labor market policies and institutions
- Well-designed labor market policies and institutions can reduce inequality and, at the same time, not be a drag on efficiency.
- Policies that reduce labor market imperfections and institutional failures that affect job creation can support poor and middle-income workers:
  - appropriately set minimum wages,
  - spending on well-designed active labor market policies aimed at supporting job search and skill matching,
  - better use of in-work benefits for social benefit recipients.
- Policies that reduce labor market dualism can reduce inequality while fostering greater market flexibility:
  - addressing gaps in employment protection between permanent and temporary workers—especially young workers and immigrants.
- Caution on extremes:
  - Labor market rules that are very weak or programs that are nonexistent can leave problems of poor information, unequal power, and inadequate risk management untreated, penalizing the poor and the middle class (World Bank 2012).
  - Excessively stringent regulations can compound market imperfections with institutional failures, and weigh on job creation and efficiency.

### Challenges and policies in EMDCs (Emerging Market and Developing Countries)
- Making labor markets more inclusive and creating incentives for lowering informality is a key challenge:
  - Workers often lack equal access to productive job opportunities and do not benefit evenly from economic growth.
  - Many low-skill individuals remain trapped in precarious jobs, often in the informal and unregulated economy.
  - In such jobs, even full-time employment tends to be insufficient to lift households out of poverty.
- Policy priorities:
  - Creating accessible, productive, and rewarding jobs is key to escaping poverty and reducing inequality.
  - Informal workers need legal, financial, and educational means to access formal sector employment.
  - Higher formal sector employment requires better incentives for firms to become formal.
  - Policies to reduce tax, financial, and regulatory constraints can expand formal sector employment by:
    - increasing the benefits of participating in the formal sector,
    - reducing the costs of doing so (Dabla-Norris and Inchauste 2008).

### Complementarities between growth and income equality objectives
- Reforms raising average living standards can influence income distribution; tackling inequality goes beyond labor, social welfare, financial inclusion, and tax policies.
- Advanced economies:
  - The key to minimizing the downside of globalization and technological change is a policy agenda of a race to the top, not a race to the bottom. This agenda includes:
    - policies to encourage innovation,
    - reduce burdensome product market regulations that stifle competition and technology diffusion,
    - move goods produced upwards in the value chain,
    - ensure that this rise benefits everyone.
- Developing countries:
  - Raising agricultural productivity, rapid accumulation of capital, and technology diffusion in labor-intensive sectors can substantially lift growth and ensure broader sharing of prosperity (Dabla-Norris and others 2013).
- Sustaining growth in emerging market economies requires:
  - more intensive patterns of growth,
  - greater flexibility to shift resources within and across sectors,
  - capacity to apply more knowledge- and skill-intensive production techniques.
- Essential policies to drive growth and inclusive prosperity:
  - improve skills for all,
  - ensure infrastructure meets national needs,
  - encourage innovation and technology adoption.

### Annex I: Definitions and sources of variables (selected indicators and periods from Table A1)
- Market Gini — Gini index of distribution of income before taxes and transfers — Standardized World Income Inequality database — 1980-2011
- Net Gini — Gini index of distribution of income after taxes and transfers — Standardized World Income Inequality database — 1980-2011
- Gini growth — Growth of the Gini index of inequality in equalized household market income — Standardized World Income Inequality database — 1980-2011
- Shares of income (deciles/quintiles) — Share of net income accruing to each decile / quintile of the income distribution — UNU-WIDER database — 1980-2012
- Poverty Headcount ratio growth — Growth of the share of the population living with $2 per day or less — World Bank’s Povcal database — 1980-2012
- GDP growth — Annual growth of real GDP — World Bank’s World Development Indicators database — 1980-2013
- GDP per capita — Real GDP per capita based on constant local currency — World Economic Outlook — 1980-2012
- GDP per capita growth — Annual percentage growth rate of GDP per capita based on constant local currency — World Bank’s World Development Indicators database — 1980-2011
- Trade Openness — Exports plus imports (goods and services), in percent of GDP — WEO Database — 1980-2013
- Financial Openness — External assets plus liabilities, in percent of GDP — External Wealth of Nations Database, WEO Database — 1980-2013
- Credit — Domestic credit to the private sector in percent of GDP — World Bank’s World Development Indicators database — 1980-2012
- Industrial employment growth — Growth of the employment in industry as a percentage of total employment — World Bank’s World Development Indicators database — 1980-2012
- Government spending — Simple average of the three relevant sub-indexes (transfers and subsidies, public consumption and public investment) of the size-of-the-government index — Fraser Institute — 1980-2010
- Technology — Share of information and communication technology capital in the total capital stock — Jorgenson, Dale and Khuong Vu (2011) — 1980-2010
- Labor market institutions — Simple average of firing and hiring and collective bargaining indexes — World Economic Forum — 1980-2010
- Education gini — Gini index of distribution of educational attainment — World Bank’s Education Statistics — 1980-2010
- Skill Premium — Average number of total years of schooling — Barro-Lee education attainment dataset — 1980-2013
- Female mortality — Probability of dying between the ages of 15 and 60 for women — World Bank’s World Development Indicators database — 1980-2010

*Source: IMF Staff Discussion in "INEQUALITY: CAUSES AND CONSEQUENCES" (section 49–52 and Annex I).*

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