Growth’s Secret Weapon: The Poor and the Middle Class
IMF Blog, June 15, 2015
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- Authors: Era Dabla-Norris, Kalpana Kochhar, Evridiki Tsounta
- Published: June 15, 2015
Key findings on inequality and growth
- The gap between the rich and the poor is at its widest in decades in advanced countries, and inequality is also rising in major emerging markets (Chart 1).
- Earlier IMF work has shown that income inequality is bad for growth and its sustainability.
- New research shows that income distribution itself—not just the level of income inequality—matters for growth.
- Making the rich richer by one percentage point lowers GDP growth in a country over the next five years by 0.08 percentage points.
- Making the poor and the middle class one percentage point richer can raise GDP growth by as much as 0.38 percentage points (Chart 2).
- Boosting the incomes of the poor and the middle class can help raise growth prospects for all.
Mechanisms linking distribution to aggregate growth
- Short-run demand channel:
- The poor and the middle class tend to consume a higher fraction of their income than the rich.
- If more money flows to these segments, they will consume rather than save, raising demand and spurring aggregate growth in the short run.
- Long-run human capital channel:
- Persistent inequality reduces opportunities for the poor and the middle class to get educated, enhance skills, and pursue entrepreneurial activities.
- As a result, labor productivity and long-run growth suffer.
Regional patterns and human capital constraints
- Inequality has been falling in some bright spots in Latin America, sub-Saharan Africa, Middle East and North Africa, but significant concerns remain.
- In sub-Saharan Africa and the Arab world, around half of the poorest segments of the population have less than four years of education (Chart 3).
- In developing countries more generally, access to healthcare and finance is scarce for the poor.
Drivers of rising income inequality
- Technological change:
- Raises demand for skilled labor over low-skilled labor by eliminating jobs through automation or by upgrading skill requirements.
- Decline of labor market institutions:
- For example, lower trade union power is associated with rising inequality.
- Globalization:
- Has played a role in reinforcing inequality, albeit a smaller one compared with other factors.
- Skill premium:
- The rising wage difference between skilled and unskilled workers is associated with widening income disparity in advanced countries.
- Financial deepening:
- Expansion of bank credit and financial markets is associated with rising inequality in emerging market and developing economies, especially in the early stages when access to financial services is limited to a small segment of the population; benefits become more broadly shared as economies develop.
Source: Growth’s Secret Weapon: The Poor and the Middle Class — Era Dabla-Norris, Kalpana Kochhar, Evridiki Tsounta, June 15, 2015.
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