Treating Inequality with Redistribution: Is the Cure Worse than the Disease?

IMF Blog, February 26, 2014

Source details

Canonical URL: Treating Inequality with Redistribution: Is the Cure Worse than the Disease?

Publication: February 26, 2014
Authors: Jonathan D. Ostry, Andrew G. Berg
Problem framed: rising income inequality poses social, political, and economic risks (undermining access to health and education, causing investment-reducing political and economic instability, and thwarting the social consensus required to adjust in the face of major shocks).
Core empirical question: What do historical cross-country data say about the macroeconomic effects of redistributive policies—directly on growth and indirectly via reduced inequality?
Methodological highlight: use of a new cross-country data set distinguishing net (post-tax and transfers) inequality from market (pre-tax and transfers) inequality, allowing calculation of redistributive transfers for many countries over time; analysis focuses on average growth during five-year periods and the sustainability/duration of growth.

Inequality’s role:
- Inequality is a robust and powerful determinant of both the pace of medium-term growth and the duration of growth spells, even when controlling for the size of redistributive transfers.
- Conclusion: focusing solely on growth while ignoring inequality risks producing low and unsustainable growth; “Inequality and unsustainable growth may be two sides of the same coin.”
Redistribution’s effects:
- Historical data show remarkably little evidence that typical fiscal redistribution has adverse effects on growth.
- The average redistribution, and the associated reduction in inequality, are robustly associated with higher and more durable growth.
- There are mixed signs that very large redistributions may have direct negative effects on growth duration; when these direct effects are netted with the positive indirect effects through lower inequality, the overall effect is roughly growth-neutral.
Tradeoff assessment:
- Little evidence of a “big tradeoff” between redistribution and growth in the historical macroeconomic data used.

Possible explanation: countries that have implemented redistributive policies may have designed them in a reasonably efficient way.
Important caveats emphasized by the authors:
- Efficiency matters: governments wishing to enhance fiscal redistribution should attend to efficiency considerations, especially where governance and administrative capacity are weak.
- Heterogeneity: different types of redistributive policies can have different effects across countries and over time.
- Limits of cross-country regression analysis: causality is difficult to establish with full confidence; historical and theoretical arguments imply that beyond some point redistribution can be destructive and extreme equality may also be harmful to growth.
- Planned follow-up: a forthcoming IMF paper will delve into fiscal design and implementation issues.

On average, typical government redistribution has not led to bad growth outcomes and associated equality appears to have supported faster and more durable growth.
Inaction in the face of high inequality thus seems unlikely to be warranted in many cases.
Policy design priorities:
- Prioritize efficient design of taxes and spending instruments to achieve redistribution, particularly in countries with weak governance and administrative capacity.
- Recognize that scale and composition of redistribution matter—very large redistributions may warrant careful assessment of direct growth effects.
- Account for country-specific contexts: choose redistributive instruments mindful of timing, institutional capacity, and differing country circumstances.

IMF blog post: Treating Inequality with Redistribution: Is the Cure Worse than the Disease? (February 26, 2014)

Staff Discussion Note
- Staff Discussion Note (Markdown version)
- Staff Discussion Note (PDF)
Staff Discussion Note
- Staff Discussion Note (Markdown version)
- Staff Discussion Note (PDF)