## A New Twist in the Link Between Inequality and Economic Development

_IMF Blog, May 11, 2017_

## Source details

**Canonical URL:** [A New Twist in the Link Between Inequality and Economic Development](https://www.imf.org/en/blogs/articles/2017/05/11/a-new-twist-in-the-link-between-inequality-and-economic-development)

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## Bibliographic details
- Authors: Francesco Grigoli
- Published: May 11, 2017

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### Research scope and methods
- Sample: 77 countries at different stages of development and representing all geographical regions, with at least 20 years of data.
- Focus: income inequality only (owing to data limitations, wealth inequality is not analyzed).
- Approach: techniques that address some shortcomings in the literature and allow heterogeneity in the inequality–growth relationship across countries.

### Main empirical findings
- The effect of income inequality on economic growth can be either positive or negative; it is not uniform across countries.
- There is a hump-shaped relationship between inequality and economic development, termed an “inequality overhang.”
- Turning point: the direction of the relationship changes at a Gini of about 27 percent (net Gini, measured after taxes and transfers).
  - For net Gini values below 27 percent, the impact of income inequality on economic development is positive.
  - For net Gini values above 27 percent, the impact becomes negative, and as countries become more unequal the negative impact on economic development becomes larger.
- Country heterogeneity:
  - Median impact of inequality growth on per capita GDP growth is negative and significant, lasting about 2 years.
  - Some countries show large negative effects (examples: Ecuador, Jordan, Nigeria, and Panama).
  - Some countries show positive effects (example at the 25th percentile: Finland).
- Implication: average effects commonly estimated in the literature can be misleading because of large dispersion across countries.

### Mechanisms and interpretation
- Positive channel at low inequality: increased inequality can endow the rich with means to start businesses and create incentives to increase productivity and investment.
- Negative channels at high inequality:
  - Reduced aggregate demand by the general population and lower investment in education and health, impairing long-term growth.
  - Increased rent-seeking behavior with the top appropriating a larger share of national income.
  - Greater risk of reduced social consensus and social unrest, hindering the implementation of pro-growth reforms.

### Policy analysis: trade-offs and win-win options
- Financial inclusion and female labor participation are examined as tools to mitigate harmful effects of rising inequality.
- Financial access:
  - Generally desirable, but can exacerbate the negative impact of income inequality on economic development.
  - Mechanism: banks may curtail credit to customers at the lower end of the income distribution because of inability to repay, potentially deepening adverse effects.
  - Policy implication: consider mechanisms to ensure those who lose access to credit when income becomes more concentrated can continue consuming even when their income falls.
- Female labor participation:
  - Considered a win-win: enlarges the pool of talent available to work and reduces (or even reverses) the negative impact of inequality on growth.
- Caution: policies that expand access to credit or labor supply could also have adverse effects (e.g., over-leveraging poorer households or generating an oversupply of labor) and should be designed to manage these trade-offs.

*Source: A New Twist in the Link Between Inequality and Economic Development (May 11, 2017), Francesco Grigoli*

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## References

- [عربي](https://blog-montada.imf.org/?p=5372)
- [inequality](https://blogs.imf.org/2017/02/22/the-imfs-work-on-inequality-bridging-research-and-reality/)
- [Inequality Overhang](https://www.imf.org/en/Publications/WP/Issues/2017/03/28/Inequality-Overhang-44774)
- [Inequality and Growth: A Heterogeneous Approach](http://www.imf.org/en/Publications/WP/Issues/2016/12/31/Inequality-and-Growth-A-Heterogeneous-Approach-44464)
- [https://www.imf.org/wp-content/uploads/2017/05/ENG_May_9_Inequality_1-1.jpg](https://www.imf.org/wp-content/uploads/2017/05/ENG_May_9_Inequality_1-1.jpg)
- [https://www.imf.org/wp-content/uploads/2017/05/ENG_May_9_Inequality_2-3.jpg](https://www.imf.org/wp-content/uploads/2017/05/ENG_May_9_Inequality_2-3.jpg)
- [https://www.imf.org/wp-content/uploads/2017/05/ENG_May_9_Inequality_3.jpg](https://www.imf.org/wp-content/uploads/2017/05/ENG_May_9_Inequality_3.jpg)
- [https://www.imf.org/wp-content/uploads/2017/05/ENG_May_9_Inequality_4.jpg](https://www.imf.org/wp-content/uploads/2017/05/ENG_May_9_Inequality_4.jpg)

_Source: https://www.imf.org/en/blogs/articles/2017/05/11/a-new-twist-in-the-link-between-inequality-and-economic-development_