Income inequality hurts economy, study suggests

Policies that favour the wealthy in the hope that money will trickle down through the economy do not produce greater growth while boosting incomes of the poor does expand the economy.

That was one of the conclusions of an exhaustive study prepared for the International Monetary Fund released on Tuesday that looked at historical data from 150 developed economies around the world over the past several decades.

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Although the study looked at many things, one of the key areas examined was income inequality — how a country's collective wealth is divided between different income groups.

Trickle-down economics questioned

Conventional economic theory in some quarters is that the best way to stimulate economic growth for everyone is to move capital to the top, where it gets invested in businesses that create jobs and tax revenues for all.

Known as trickle-down economics, it's thought by some to be a better way to expand the economy than directing wealth to lower income groups lower down, who, according to the theory, don't spend money in ways that filter through the entire economy.

But the discussion paper suggests the numbers don't back up that theory.

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"If the income share of the top 20 per cent [the rich] increases, then GDP growth actually declines over the medium term, suggesting that the benefits do not trickle down," the report reads.

The authors calculated that for every percentage point increase in income share by the richest quintile in any given country studied, GDP growth was 0.08 percentage points lower in the following five years than it would otherwise have been.

Conversely, if the income of the poorest quintile increases by one percentage point, the country's economy expands by a little over a third of a percentage point in the ensuing half-decade. 

The discussion paper was prepared by Era Dabla-Norris, Kalpana Kochhar, Frantisek Ricka, Nujin Suphaphiphat, and Evridiki Tsounta, with contributions from Preya Sharma and Veronique Salins. A disclaimer on the report makes clear that it is a "staff discussion note" and that the views expressed in it should be attributed to the authors and not the IMF.

"Staff discussion notes are published to elicit comments and to further debate reflects," the disclaimer says.

Growing gap

"Widening income inequality is the defining challenge of our time," the report notes, echoing recent remarks from IMF head Christine Lagarde, who is pushing world leaders to take action on the issue.

The discussion paper suggests that as the income share of the richest 20 per cent increases, so, too, does their political influence, which leads to what the group calls a "suboptimal" distribution of resources. The rich press for political policies tailored toward them — not necessarily those that would benefit everyone.

When economically disadvantaged people are denied an equal share of economic growth, that gap widens, because those on the bottom of the income scale tend to spend a disproportionately larger share of their income on basic needs like health care, education and food. Their spending tends to boost economic growth, but when they have less money, it drags down growth overall.

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Policies that favour those higher up the economic ladder "can lead to under-investment in education as poor children end up in lower-quality schools and are less able to go on to college," the report says. "As a result, labour productivity could be lower than it would have been in a more equitable world."

The report also suggests wholesale changes to the way developed economies tax their citizens, moving away from regressive income taxes and toward a more progressive system built on wealth and property taxes, and a crackdown on tax avoidance and evasion.