Sustainable Economic Growth: is Income Equality the Answer?

IMF economists Andrew G. Berg and Jonathan D. Ostry noted that igniting high economic growth is the easy part for poor countries.  Indeed, many have managed to do that.

The hard part, however, is sustaining the high rate of economic growth. 

Sustained growth is what separates a South Korea (which saw GDP per capital rise from $155 to $20,757 in 50 years) from a Cameroon (which saw a 17 percent real GDP growth rate in 1981 fizzle to contractions from 1987 to 1994).

(chart from IMF)

(chart from Google Public Data Explorer)

Berg and Ostry studied several factors that drive sustainable economic growth. They found that the most important one is the equality of income distribution, followed by trade openness, strength of political institution, foreign direct investment, exchange rate competitiveness and external debt.

A 10 percentile increase in income equality resulted in a 50 percent increase in the length of a growth spell (defined by the economists as “the interval starting with a growth upbreak and ending with a downbreak”), according to their findings.

(chart from IMF)

(chart from IMF)

Berg and Ostry listed the following factors that may explain why income equality leads to sustained economic growth:

- the ability of the masses to afford human capital investments (e.g. education)

- political stability, which encourages physical capital investment (i.e. equipment and buildings)

- societal stability, which increases the likelihood of public buy-in for needed policy adjustments in response to unfavorable economic shocks (e.g. oil shocks or sovereign debt crises)

Some economists also argue that income inequality, especially in big countries like China and the U.S., reduces sustainable private consumption and causes massive distortion.

Rising income inequality in the U.S. in the last few decades, for example, meant middle and lower income Americans had to borrow money to increase their consumption.

The heavy debt load they accumulated as a result of doing so was then blamed for exacerbating the Great Recession.