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.