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Why Reduce Income Inequality

Andrew Berg and Jonathan Ostry from the IMF have found an interesting link between income inequality and sustainable economic growth. The authors found that a ten percent decrease in income inequality increases the expected length of growth periods by 50%! That is, a country is expected to have a longer period of economic growth with lower levels of income inequality. This finding refutes older claims that economic inequality is an incentive and prerequisite necessary for economic development. Rather than the neoclassical approach that market forces will lower inequality overtime (see Simon Kuznets), Berg and Ostry suggest that an active policy aimed to lower inequality will improve growth sustainability.  However, the authors state, that it would be taking the results too far to determine that ensuring economic equality is the best policy for economic growth. They suggest, “growth and inequality-reducing policies are likely to reinforce one another and help to establish the foundations for a sustainable expansion”.

Why would reducing income inequality aid in growth sustainability? One reason that Berg and Ostry highlight is credit market imperfections. Those on the lower end of the income distribution have little to no access to credit. Without access to credit it becomes harder to go to school. Higher levels of income inequality lead to higher levels of education inequality. (Anyone who has taken the Economics of Social Issues will know that this is a positive feedback loop: increases in education inequality contribute to increased income inequality.) Therefore a reduction in income inequality would lead to a more educated future workforce yielding a higher productivity. This is one of many reasons outlined in the report that explains why economic growth favors more equitable distributions.




  1. Margaret Womble Margaret Womble

    The issue of income inequality has been highly present and rather controversial in the past few years, particularly with the presence of the Occupy Wall Street movement. The blog post and article above, however, highlights that this issue has not all of the sudden surfaced in the past few years. Rather, income inequality is a long-term problem that cannot be solved with a quick-fix. The focus on education inequality is particularly important. With costs of higher education increasing by the year, it is more likely that education inequality will grow in the US, furthering the issue of income inequality. Thus, in order to fully address the issue of income inequality in the US, one cannot simply instill a policy to redistribute the wealth throughout the population. Rather, long term solutions must also be put into place– such as making moves to make higher education substantially more affordable, leading to a more skilled, educated, and productive workforce in the future.

    • duncan duncan

      This is especially true as the economy has transformed over the last hundred years. At the beginning of the twentieth century the cumulative effects of physical capital accumulation were a large contributor to economic inequality with human capital having less influence. Following decades of rapid technological advancement, human capital has become a far more important input. Today, the cumulative effects of human capital accumulation are contributing to income inequality. Higher levels of human capital yield higher returns on physical capital.

      • duncan duncan

        To read more see:
        Galor, O., & Moav, O. (2004). From physical to human capital accumulation: Inequality and the process of development. The Review of Economic Studies, 71(249), 1001-1001. doi:

  2. Lower income inequality above is approached solely as a supply-side story. But it also enhances the demand-side, for things such as housing and consumer durables, which improves the profitability of investment, feeding into productivity, growth and higher incomes.
    Now why the higher inequality in the US? Surely lots of factors contribute, but the share of income going to financial services did rise over the past couple decades, without evidence that it improved the allocation of capital (no increase in investment in productive assets, no productivity increase), indeed with lots of evidence that capital was misallocated. “Occupy” is not just anger and noise, though their rhetoric focuses on a symptom which may or may not be directly amenable to policy.
    Finally, Kuznets viewed inequality as representing an outcome of the pickup of growth, not desirable but secondary issue as long as everyone was being pulled along. For example, for per capita farm incomes to rise requires changes in how farming is done, including that fewer people farm more land. Migration off the farm and consolidation of land takes time. So that sector will often lag, and as long as it does — a disequilibrium story — income inequality will rise, or at least not improve. Can policy speed the transition out of agriculture? Maybe, maybe not. But as long as it doesn’t try to impede change, farm incomes will nevertheless grow a lot. Hence that it grows less isn’t worrisome, addressing inequality isn’t central.
    That story however doesn’t apply to the US.

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