The Unassuming Economist

Below is the executive summary of a new IMF report:

“Despite strong growth over the past two decades, income inequality remains high in many low-income developing countries (LIDCs). As shown by earlier work, including by the IMF, high levels of inequality can impair both the future pace and the sustainability of growth and macroeconomic stability, thereby also limiting countries’ ability to reach the Sustainable Development Goals.

This note explores how policies and reforms aimed at boosting growth affect the extent of income inequality in LIDCs and how complementary policy measures can be used to offset adverse distributional effects of such reforms. It examines: (i) the distributional consequences of selective economic reforms and macro-structural policies that are generally considered to be growth-enhancing; (ii) the channels and mechanisms through which inequality is likely to be affected, given structural characteristics common to most LIDCs; and (iii) the scope for complementary policies to ensure that a reform package can boost growth without widening inequality. The study complements recent work on the inequality-growth trade-offs (including Ostry, Berg, and Tsangarides, 2014; and Organization for Economic Cooperation and Development (OECD), 2015), and by using a more granular model-based analysis to identify the mechanisms through which specific reforms affect growth and inequality.

The note identifies macro-distributional challenges that can be expected to confront LIDCs, given structural characteristics common to these economies. Specifically, the note examines how features such as high levels of informality, limited geographic or inter-sectoral labor mobility, large inter-sectoral productivity differences, lack of access to finance, and low levels of infrastructure can make growth-inequality trade-offs particularly challenging for these economies. The main focus is on identifying the key channels through which growth-oriented reforms can influence income distribution, rather than identifying the universe of reforms that could have adverse distributional effects. For illustrative purposes, the note zooms in on a set of macro-structural reforms that have been regarded as growth-promoting in LIDCs (see IMF, 2015a)—specifically, selected fiscal reforms (tax policy measures, higher public infrastructure investment); financial sector reforms; and reforms to the agricultural sector.

The findings confirm that these macro-structural policies can have important distributional consequences in LIDCs, with the impact dependent both on the design of reforms and on country-specific economic characteristics. Results from cross-country statistical analysis and detailed country-case studies suggest that: (i) the distributional impact of tax policies depends not only on the specific tax instruments chosen (with indirect taxes usually seen as being regressive and direct income taxation usually seen as progressive), but also on how the additional budgetary resources are deployed; (ii) better and more infrastructure investment can both boost growth and lower inequality levels; (iii) financial sector reforms can exacerbate inequality if financial access is limited to a small share of the population and labor mobility is constrained; and (iv) reforms that boost agricultural output can worsen income inequality in situations where the agricultural sector is large and productivity gains benefit mostly the rural better-off.

Accompanying measures can make reforms supportive of growth while limiting adverse distributional effects. Some reforms may boost growth and welfare for all with distributional consequences that may not be undesirable from an economic and/or social point of view. Other reforms can bring economic gains only to a few with distributional consequences that may be considered unwelcome by societies. While there is no one-size-fits-all recipe, the note explores how targeted policy interventions, implemented in conjunction with pro-growth reforms, can be deployed to contain any adverse distributional effects of the reform measures—recognizing that societal views on what constitutes an undesirable distributional outcome will differ from country to country. The analysis focuses on the macroeconomic mechanisms through which such interventions can contain or offset any adverse distributional impact of pro-growth reforms; the note does not examine how these interventions can best be implemented in the presence of weak domestic administrative capacity or political economy constraints. Some policy interventions cited, such as conditional cash transfers, can be challenging to administer in countries with weak capacity, while measures to enhance labor mobility, such as strengthening land ownership rights, can take time and be politically very difficult to implement.”