Redistribution, Inequality, and Growth

An excellent paper by Johnathon D. Ostry, Andrew Berg and Charalambos G. Tsangarides (2014) “Redistribution, Inequality, and Growth’, International Monetary Fund Staff Discussion Note, Washington, DC. <https://www.imf.org/external/pubs/ft/sdn/2014/sdn1402.pdf> argues:

First, more unequal societies tend to redistribute more. Among OECD countries, more inequality tends to be associated on average roughly one-for-one with higher redistribution, such that there is almost no overall correlation between net and market inequality. While the effect is weaker in non-OECD countries, it is nevertheless still present. It is thus important to distinguish between market and net inequality in trying to understand the growth-inequality nexus and to separately control for redistribution in growth-inequality work. 

Second, lower net inequality seems to drive faster and more durable growth for a given level of redistribution. These results are highly supportive of our earlier work, now encompassing not only duration analysis but also the panel regression approach common in earlier literature, and also controlling for the net/market distinction. 

Third, redistribution appears generally benign in its impact on growth; only in extreme cases is there some evidence that it may have direct negative effects on growth. Thus the combined direct and indirect effects of redistribution—including the growth effects of the resulting lower inequality—are, on average, pro-growth. 

Against these results, it must be borne in mind that the data are particularly scarce and unreliable for redistribution, even more so than for inequality. Indeed, one possible interpretation of our results is that the data on redistribution simply do not contain enough information to infer a negative (or for that matter a positive) direct effect. We believe our results are nonetheless informative. We have used the best available data for the analysis of large numbers of countries over time. The analysis of spells inevitably requires the use of older and perhaps less comparable data, but the results for average growth hold even when the analysis is restricted to only the most reliable and recent data.

They conclude:

We have taken advantage of a new comprehensive data set to look at the relationship between inequality, redistribution, and growth; earlier work on the inequality-growth relationship has generally confounded the effects of redistribution and inequality. Our focus has been on the medium and long term, both growth over five-year periods and the duration of growth spells. 

Several important conclusions emerge. 

First, inequality continues to be a robust and powerful determinant both of the pace of medium-term growth and of the duration of growth spells, even controlling for the size of redistributive transfers. Thus, the conclusions from Berg and Ostry (2011) would seem to be robust, even strengthened. It would still be a mistake to focus on growth and let inequality take care of itself, not only because inequality may be ethically undesirable but also because the resulting growth may be low and unsustainable. 

And second, there is surprisingly little evidence for the growth-destroying effects of fiscal redistribution at a macroeconomic level. We do find some mixed evidence that very large redistributions may have direct negative effects on growth duration, such that the overall effect—including the positive effect on growth through lower inequality—may be roughly growth-neutral. But for non-extreme redistributions, there is no evidence of any adverse direct effect. The average redistribution, and the associated reduction in inequality, is thus associated with higher and more durable growth. We need to be mindful about over-interpreting these results, especially for policy purposes. It is hard to go from these sorts of correlations to firm statements about causality. We have not accounted for the possible effects that redistribution may have on market inequality. We have emphasized the uncertainty caused by the scarcity of reliable data, particularly about redistribution. Our measure of redistribution captures only direct taxes and subsidies, for example, so we shed no direct light on the redistributive effects of in-kind government provision of health and education which a priori would seem, if anything, to be more growth friendly than the measures we account for. 

Finally, we know from history and first principles that after some point redistribution will be destructive to growth, and that beyond some point extreme equality also cannot be conducive to growth. We nonetheless see an important positive conclusion from our look at the big picture. Extreme caution about redistribution—and thus inaction—is unlikely to be appropriate in many cases. On average, across countries and over time, the things that governments have typically done to redistribute do not seem to have led to bad growth outcomes, unless they were extreme. And the resulting narrowing of inequality helped support faster and more durable growth, apart from ethical, political, or broader social considerations. This leaves a large research and policy agenda. Even given these results about average effects, it remains important to try to make redistribution as efficient as possible. And further insight into the mechanisms at play would help sharpen our understanding and policy recommendations. Our results here highlight the urgency of this agenda.