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Institute for Workplace Studies----------------- Professor Samuel B. Bacharach

School of Industrial & Labor Relations-------- Director, Institute for Workplace Studies

Cornell University

16 East 34th Street, 4th floor---------------------- Stuart Basefsky

New York, NY 10016 -------------------------------Director, IWS News Bureau

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International Monetary Fund (IMF)

IMF Staff Discussion Note April 8, 2011 SDN/11/08

Inequality and Unsustainable Growth: Two Sides of the Same Coin?

by Andrew G. Berg and Jonathan D. Ostry

http://www.imf.org/external/pubs/ft/sdn/2011/sdn1108.pdf

[full-text, 21 pages]

[excerpt]

This note focuses on the duration of growth spells―defined as the interval starting with a growth upbreak and ending with a downbreak―and on the links between duration and various policies and country characteristics, including income distribution. It turns out that many of even the poorest countries have succeeded in initiating growth at high rates for a few years. What is rarer―and what separates growth miracles from laggards―is the ability to sustain growth. The question then becomes: what determines the length of growth spells, and what is the role of income inequality in duration?

We find that longer growth spells are robustly associated with more equality in the income distribution. For example, closing, say, half the inequality gap between Latin America and emerging Asia would, according to our central estimates, more than double the expected duration of a growth spell. Inequality typically changes only slowly, but a number of countries in our sample have experienced improvements in income distribution of this magnitude in the course of a growth spell. Inequality still matters, moreover, even when other determinants of growth duration―external shocks, initial income, institutional quality, openness to trade, and macroeconomic stability―are taken into account.

A key implication of these results is that it is difficult to separate analyses of growth and income distribution. The immediate role for policy, however, is less clear. Increased inequality may shorten growth duration, but poorly designed efforts to lower inequality could grossly distort incentives and thereby undermine growth, hurting even the poor. There nevertheless may be some �win-win‖ policies, such as better-targeted subsidies, improvements in economic opportunities for the poor, and active labor market policies that promote employment. When there are trade-offs between potential short-run effects of policies on growth and income distribution, the evidence presented in this note is not decisive. But the analysis below does perhaps tilt the balance towards the notion that attention to inequality can bring significant longer-run benefits for growth. Over longer horizons, reduced inequality and sustained growth may thus be two sides of the same coin.

Contents

Executive Summary ...................................................................................................................3

I. Introduction ............................................................................................................................4

II. The Hills and Valleys of Growth ..........................................................................................5

III. Income Distribution and Growth Sustainability ..................................................................8

IV. Some Tentative Policy Implications ..................................................................................16

References ................................................................................................................................19

Tables

1. Growth Breaks by Region and Decade ...............................................................................7

2. Characteristics of Growth Spells .........................................................................................8

3. The Ends of Six Spells ......................................................................................................11

Figures

1a. The Hills of Growth .............................................................................................................5

1b. The Hills, Valleys, and Plateaus of Growth .........................................................................6

2. Duration of Growth Spells and Inequality ...........................................................................9

3. Effect of Increase of Different Factors on Growth Spell Duration ....................................12

Box

1. Is It Really Income Distribution? A Closer Look at Country Cases..................................14

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