This paper examines the relationship between inequality, redistribution and growth. Earlier work on the inequality-growth relationship has generally confounded the effects of redistribution and inequality. The focus of this study is on the medium and long term, both growth over five-year periods and the duration of growth spells.
This paper is the first to make use of a recently compiled cross-country dataset that distinguishes market (before taxes and transfers) inequality from net (after taxes and transfers) inequality, allowing the calculation of redistributive transfers for a large number of country-year observations. While there are inherent limitations of the dataset and of cross-country regression analysis more generally, it should not be assumed that there is a big trade-off between redistribution and growth, because the data do not support that conclusion.
- More unequal societies tend to redistribute more. It is thus important in understanding the growth-inequality relationship to distinguish between market and net inequality.
- Lower net inequality is robustly correlated with faster and more durable growth, for a given level of redistribution.
- Redistribution appears generally benign in terms of its impact on growth; only in extreme cases is there some evidence that it may have direct negative effects on growth. Thus the combined direct and indirect effects of redistribution—including the growth effects of the resulting lower inequality—are on average pro-growth.
- Inequality continues to be a robust and powerful determinant both of the pace of medium-term growth and of the duration of growth spells, even controlling for the size of redistributive transfers. It would be a mistake to focus on growth and let inequality take care of itself, not only because inequality may be ethically undesirable but also because the resulting growth may be low and unsustainable.
- There is surprisingly little evidence for the growth-destroying effects of fiscal redistribution at a macroeconomic level. There is some mixed evidence that very large redistributions may have direct negative effects on growth duration, such that the overall effect—including the positive effect on growth through lower inequality—may be roughly growth-neutral. But for non-extreme redistributions, there is no evidence of any adverse direct effect. The average redistribution, and the associated reduction in inequality, is thus associated with higher and more durable growth.