Redistribution a Recipe for Growth?

Last Thursday, the IMF released a new study looking at the relationship between inequality, redistribution and growth.  While the idea of such a document may not fill you with excitement, even a close look at the findings could turn everything you previously thought about the link between inequality, growth and redistribution on its head.

For quite some time, the economic consensus has been that government taxing and redistributing income through cash transfers is bad for growth. The IMF’s findings not only suggest that this is false, but that the opposite may actually be true. Not only is inequality bad for growth, government redistribution is an effective way of encouraging growth. Rather than our economic crisis and low levels of growth being caused by high levels of redistribution, this suggests that it may have been one of the few things keeping our growth up.

Via thorough analysis of international data on redistribution, inequality and growth going back to 1960, the IMF showed that redistribution has no effect on growth and when combined with the positives of a lower level of inequality it actually increases growth. It is only in the case of ‘extreme redistribution’ (the largest government redistributions internationally since 1960 are fairly massive in scale) where there is evidence of a negative effect on growth once the effect of decreased inequality has been taken into account.  However, it is within the margin of error as to whether the net effect on growth is negative.

There are plenty of killer findings in this paper, but perhaps the most important is that more equal countries have more stable growth, which is experienced over a longer period of time. Previous IMF research andothers have argued that inequality creates higher levels of debt and increases the probability of financial crises, but they’d been unsure if this was due to market inequality or net inequality (after government redistribution). This new research suggests that, most of the time, redistribution doesn’t matter as long as inequality is lower.  

Specifically, this looks at the effects of redistribution only in cash terms and doesn’t include benefits in kind (like education and health services). This is particularly interesting because previous thinking had suggested that the extent to which redistribution was beneficial for growth was dependent on how it funded productivity increasing services.  The report doesn’t look at this (understandably because the data is very difficult to compile), suggesting that either redistribution is usually used to provide these services or that direct redistribution is just as economically effective.

For the UK there is a slight note of caution to this research. Its findings indicate that our level of redistribution before the last election was high – among the top quarter in the world – but also that it was still good for growth. The largest health warning for the UK that should be taken from the IMF’s report is that our market inequality is amongst the highest in the world (including most of the developing world).  Amongst developed countries, only Germany has a higher market inequality than us, yet they also redistribute more generously. Whilst these IMF findings should restore faith in UK redistribution, they also suggest if we are to really improve growth we must look first at the root of the problem: the UK’s massive pay gap.

Tim Stacey, Policy and Campaigns Officer