Media Briefings

GROWTH BENEFITS OF REDISTRIBUTION AND LOWER INEQUALITY: Cross-country evidence

  • Published Date: March 2015

Lower inequality is strongly correlated with faster and more durable growth, according to research by Charalambos Tsangarides and colleagues, to be presented at the Royal Economic Society’s 2015 annual conference. What’s more, the study finds, there is little evidence of a ‘big trade-off’ between redistribution and growth: indeed, on average, redistribution has a positive impact on growth.

To disentangle the effects of inequality and redistribution on growth, the researchers analyse a recently compiled dataset that distinguishes net inequality from market inequality and allows the calculation of redistributive transfers for a large number of advanced and developing countries. They ask what is the effect of policy, and in particular, fiscal redistribution directly on growth, and indirectly as it reduces inequality, which in turn affects growth. They find that:

• Lower inequality is strongly and robustly correlated with faster and more durable growth, controlling for the effect of redistribution.

• Redistribution appears generally benign in terms of its impact on growth. Only in extreme cases is there some evidence that it may have direct negative effects on growth.

• The combined direct and indirect effects of redistribution – including the growth effects of the resulting lower inequality – are on average pro-growth.

The authors conclude:

‘While we should be cautious about drawing definitive policy implications from cross-country regression analysis alone, our results suggest that inaction in the face of high inequality seems unlikely to be warranted in many cases.’

More…

Economists are increasingly focusing on understanding the links between rising inequality and economic growth. Recent narratives include how inequality intensified the leverage and financial cycle, sowing the seeds of crisis; or how political economy factors, especially the influence of the rich, allowed financial excess to balloon ahead of the crisis. Rising income inequality also looms high on the global policy agenda, reflecting not only fears of its pernicious social and political effects, but also the economic implications.

Formal analysis of the link between inequality and growth seems to have converged toward a tentative consensus that inequality is generally harmful for economic growth over the medium run. The main argument is that while positive incentives are surely needed to reward work and innovation, too much inequality undermines access to health and education, and causes investment-reducing political and economic instability.

Inequality may also impede growth at least in part because it calls forth efforts to redistribute through the fiscal system that themselves may undermine growth. While the research literature on this score remains controversial, the notion of a trade-off between redistribution and growth seems well embedded in policy-makers’ consciousness.

What is the evidence about the role of redistribution to bring about greater equality? Some policies that are redistributive – for example, public investments in infrastructure, spending on health and education, and social insurance provision – may be both pro-growth and pro-equality.

Others are more supportive of a fundamental trade-off between redistribution and growth, as argued by Okun (1975) when he referred to the efficiency ‘leaks’ that come with efforts to reduce inequality. Looking at past experience, faster and more durable growth seems to have followed the associated reduction in inequality, while there is scant evidence that typical efforts to redistribute have on average had an adverse effect on growth.

The policy implications are far from clear. The issue is complex, as there may be multiple interrelated connections between inequality, redistribution and growth. To disentangle the effects of inequality and redistribution on growth, this study investigates the relationships using a recently compiled dataset that distinguishes net from market inequality and allows the calculation of redistributive transfers for a large number of advanced and developing countries. The researchers ask what is the effect of policy, and in particular, fiscal redistribution directly on growth, and indirectly as it reduces inequality, which in turn affects growth.

The investigation suggests that lower inequality is strongly and robustly correlated with faster and more durable growth, controlling for the effect of redistribution. This result highlights that the inequality-growth relationship is not due to the impact of inequality on redistribution.

In addition, it appears that redistribution appears generally benign in terms of its impact on growth; only in extreme cases (the top quartile, and here only for spells) is there some evidence that it may have direct negative effects on growth – that is, there is little evidence of a ‘big trade-off’ between redistribution and growth. Thus, the combined direct and indirect effects of redistribution – including the growth effects of the resulting lower inequality – are on average pro-growth.

The authors conclude that while we should be cautious about drawing definitive policy implications from cross-country regression analysis alone, their results suggest that inaction in the face of high inequality seems unlikely to be warranted in many cases.

ENDS


‘Redistribution, inequality, and growth: new evidence’ by Andrew Berg, Jonathan D. Ostry, Charalambos G. Tsangarides and Yorbol Yakhshilikov