Fix Inequality, Boost Growth?

John Cassidy highlights a study challenging the notion that addressing inequality slows growth:

[T]hanks to three researchers at the International Monetary Fund, we’ve got some striking new findings that answer the second question, whether tackling inequality reduces growth, with a firm no. Countries that take redistributive measures in order to attenuate inequitable market outcomes do not, on average, tend to grow less rapidly than other countries. Indeed, the contrary is true. They tend to grow a bit more rapidly.

The research paper, “Redistribution, Inequality, and Growth,” has been posted on the I.M.F.’s Web site and authorized for distribution by Olivier Blanchard, the I.M.F.’s chief economist. … Its authors—Jonathan D. Ostry, Andrew Berg, and Charalambos G. Tsanarides—begin by pointing to previous empirical findings that sustained economic growth seems, on average, to be associated with more equal income distribution. But this might not, in itself, make the case for using distribution to attain that equality, they explain: “In particular, inequality may impede growth, at least in part, because it calls forth efforts to redistribute that themselves undercut growth. In such a situation…taxes and transfers may be precisely the wrong remedy.”

Drum plays up another finding – that higher inequality correlates with shorter boom periods:

In particular, the authors find that a 1-point increase in a country’s GINI score (a measure of inequality) is associated with a decrease of about 7 percent in the length of its growth spells. In other words, countries with high inequality simply can’t maintain economic booms as long as countries with lower inequality. This is consistent with the idea that growth in these countries is driven partly by the rich loaning money to the middle class, which is obviously less sustainable than growth driven by an increase in middle-class wages. In high-inequality countries, growth is too dependent on financialization and leverage. When the merry-go-round stops, as it inevitably must, the boom times are over.

Let’s drop these ideas into a current real-world example: Stephanie Rudat explains how Venezuela’s foreign exchange regulator fed corruption and added to the country’s economic woes:

Under the pretext of creating a more equal society for the underprivileged, not only has the government nationalized key industries, but has also instituted Comisión de Administración de Divisas (CADIVI), a government institution whose purpose is to regulate foreign currency exchange. Despite the fact Venezuelans could once exchange Bolívares for US Dollars at a local bank through a simple transaction, CADIVI has imposed strict regulations in the currency exchange market. As a consequence of this, a large parallel US Dollar black market has formed in which US Dollars sell for over ten times the official exchange rate, a ratio that increases on a daily basis. The combination of nationalization of the private sector and currency exchange market regulation has driven Venezuela into an economic downward spiral that has led to uncontrollable and ever-increasing inflation rates, and dangerous levels of food and goods shortages at local supermarkets.

But Juan Cristobal Nagel, quoting a friend, suggests that Maduro’s recent attempt to reform CADIVI might have been what set off the protests:

“I think,” she said, “this all has to do with the end of Cadivi. Up until December, things were really bad, but you could still count on your cupo, your folder, and your raspaíto to make a quick buck. Take a subsidized trip abroad, buy a bunch of stuff to bring back home, or charge the credit card for cash, bring the cash home, and you earned a fortune. Now, Cadivi is a lost dream. It’s dead. The drama with the airlines means ticket prices have skyrocketed. There is an increased sense that the days of free Cadivi cash are gone forever. The end of this bubble … is really difficult for many middle-class Venezuelans to accept.”

This makes a lot of sense to me. Cadivi played such a huge role in the life of middle-class Venezuelans, its death should not be underestimated. For years, it was many people’s main source of income. Now, that’s gone, and we’re coming crashing down to Earth. It’s effect on people’s pocketbooks is enough to trigger a protest movement.