The IMF's Work on Inequality: Bridging Research and Reality
IMF Blog, February 22, 2017
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Bibliographic details
- Authors: Prakash Loungani, Jonathan D Ostry
- Published: February 22, 2017
Overview
- Authors: Prakash Loungani, Jonathan D. Ostry
- Date: February 22, 2017
- Available versions in عربي (Arabic), 中文 (Chinese), Français (French), and Español (Spanish)
- Key premise: Over the past three decades, income inequality has gone up in most advanced economies and in many developing ones as well. IMF research shows that the design of government policies matters and can help limit increases in inequality.
Understanding inequality (country case studies and diagnostics)
- Bolivia
- Historical context: Bolivia had one of the highest levels of income inequality in Latin America at the turn of the century.
- Commodity boom effect: A boom in commodity-export prices early in this century coincided with a big reduction in inequality that placed Bolivia in the middle of the regional pack.
- Mechanisms identified: Wealth from commodity exports was shared through increased public investment, social transfers, and a higher minimum wage.
- IMF engagement: Inequality featured prominently in IMF annual consultations in 2015 and 2016, drawing on detailed household income data and a model of the Bolivian economy to simulate inequality dynamics and policy effects.
- Policy simulation results: Maintaining infrastructure investment and making it more efficient, and better targeting cash transfers, were identified as the best policy levers to preserve gains.
- Additional finding: Expanding access to financial services can play a key role in lowering inequality.
- Ethiopia
- IMF review measured distributional impacts of growth-enhancing policies.
- IMF recommendations: make income-tax thresholds more progressive; promote financial instruments for rural savers; revamp indirect subsidies to better serve low-income households.
- Broader country coverage (selected IMF country reports for 2015–16):
- Africa: Ethiopia, Republic of Congo, Zambia
- Asia: Kyrgyz Republic, Myanmar, Singapore
- Europe: Denmark, Hungary, Lithuania
- Middle East: Israel, Saudi Arabia
- Latin America: Brazil, Guatemala, Honduras
Causes: fiscal policy, labor markets, and capital mobility
- IMF economists focus on three policy areas where reforms can have distributional side effects:
- Reducing budget deficits through tax increases or spending cuts
- Liberalizing labor markets
- Removing barriers to the movement of capital across borders
- Empirical findings:
- Studies of Honduras, Guatemala, Republic of Congo, and Uganda confirm that fiscal policies have a strong impact on inequality.
- The size of fiscal impacts depends on how taxes are collected and revenue spent.
- Effects on inequality are larger when there is less recourse to direct income taxes and greater reliance on indirect taxes.
- Spending on infrastructure reduces inequality.
- Case studies of Ethiopia and Myanmar show financial sector reforms can exacerbate inequality if access to financial services remains limited and labor mobility is constrained.
Consequences: inequality and growth
- Core finding: Rising inequality poses risks to durable economic growth, placing inequality squarely within the IMF’s mandate to help countries improve economic performance.
- Channels and evidence:
- Developing economies: Higher inequality has sometimes led to social or political crises, which can derail growth.
- Advanced economies: Greater income inequality may lead to excessive borrowing by low- and middle-income households, which eventually triggers a crisis; this sequence characterized the run-ups to both the Great Depression and the Great Recession.
- US review finding: income polarization since 2000 has “had a negative impact on the economy, hampering the main engine of US growth: consumption.”
- Implication: High inequality imposes a direct economic cost in terms of reduced durability of growth, in addition to non-economic costs such as elite capture of the political process and a decline in social cohesion.
Cures for excessive inequality: redistribution and predistribution
- Policy framing:
- Predistribution: Improve equality of opportunity to prevent extreme inequality (examples: public spending on health and education).
- Redistribution: Actions taken after the fact to make disposable incomes more equal than market incomes (examples: progressive taxation, cash transfers to low-income families, welfare benefits).
- Key empirical finding relevant for policy design:
- Redistribution, unless extreme, does not have an adverse impact on growth.
- IMF policy guidance highlights:
- Design fiscal policies with distributional consequences in mind.
- Combine maintaining or improving public investment (including infrastructure) with targeted cash transfers and progressive tax measures.
- Expand access to financial services and ensure reforms do not leave vulnerable groups behind.
Conclusion — synthesis of IMF contributions
- On causes: Economic policies are an important determinant of inequality, implying governments can take steps to reduce excessive inequality.
- On consequences: Inequality has a direct economic cost by reducing the durability of growth, aligning inequality with the IMF’s core mandate of fostering sustained growth.
- On cures: Policy design should explicitly take distributional outcomes into account; IMF advice increasingly incorporates such considerations.
Source: The IMF's Work on Inequality: Bridging Research and Reality (Prakash Loungani, Jonathan D. Ostry, February 22, 2017).
Content in this bundle
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