Low-income, upscale neighborhoods abut in Sao Paulo, Brazil: excessive income inequality drags down economic growth rate (photo: Danny Lehman/Corbis)
INEQUALITY AND GROWTH
She told a Brussels conference that growing and excessive inequality has become a problem for economic growth and development.
“You do not have to be an altruist to support policies that lift the incomes of the poor and the middle class. Everybody will benefit from these policies, because they are essential to generate higher, more inclusive, and more sustainable growth,” Lagarde declared.
“In other words, if you want to see more durable growth, you need to generate more equitable growth.”
Trickling up, not down
New IMF research shows that if you lift the income share of the poor and middle class by1 percentage point, then GDP growth increases by as much as 0.38 percentage points in a country over five years. By contrast, if you lift the income share of the rich by 1 percentage point, then GDP growth decreases by 0.08 percentage points.
“Our findings suggest that—contrary to conventional wisdom—the benefits of higher income are trickling up, not down,” Lagarde said, adding that one possible explanation is that the rich spend a lower fraction of their incomes, which could reduce aggregate demand and undermine growth.
Earlier IMF research shows that excessive income inequality actually drags down the economic growth rate and makes growth less sustainable over time.
Causes, consequences of excessive inequality
Lagarde highlighted the divergence between a steady, decades-long fall in inequality between countries—driven by rapidly rising average incomes in emerging market economies—and growing income inequality within countries.
The two main factors driving the widening earnings gap between higher- and lower-skilled individuals, especially in advanced economies, are technological progress and financial globalization, Lagarde noted. Other factors include overreliance on credit finance; low social mobility; and inequality of access to education, health care, and financial services, especially in developing economies.
Recipes for growth
“With these kinds of disadvantages—with this kind of inequality of opportunity—millions of people have little or no chance of earning higher incomes and building up wealth,” Lagarde said. But, she added, there are recipes for stronger, more inclusive, and more sustainable growth in all countries.
• Macroeconomic stability—“Sound macroeconomic policies are the poor’s best friend”—supported by good governance, since corruption can be a strong indicator of profound social and economic inequality;
• Adopting prudent policies that strike a balance between promoting greater equality and preserving strong incentives to compete, innovate, and invest;
• Adjusting fiscal policy by clamping down on tax evasion, removing unfair tax relief, reducing high labor taxes, relying more on conditional cash transfers, and freeing up resources by reducing energy subsidies;
• Enacting smart reforms in education, health care, labor markets, infrastructure, and financial inclusion, to lift potential economic growth and boost income and living standards over the medium term.
Lagarde said later this year policymakers have a once-in-a-generation opportunity for development at which good intentions can be translated into bold and lasting actions: the United Nations Sustainable Development Goals summit in September, and a summit in December to seek a deal to cut carbon emissions.
Important IMF role
The IMF has an important role in all these issues, Lagarde said. The IMF’s key mandate is to promote global economic and financial stability, and the institution has been deeply involved in development by helping its 188 member countries to design and implement policies and by lending to countries in times of distress, so they can get back on their feet.
In sub-Saharan Africa, for example, many countries have applied sound macroeconomic policies over the past decade, and they are now reaping the benefits in the form of stronger growth and higher living standards. The IMF has supported these efforts through new instruments such as zero-interest loans, as well as increased financing and capacity building.
The IMF is also stepping up its research on inequality, gender, and climate-related issues and looking into increasing access to its loans for developing countries to help them buffer external shocks. In particular, the IMF aims to increase its focus on helping the poorest and most fragile countries, Lagarde said.
