A New Twist in the Link Between Inequality and Economic Development

By Francesco Grigoli

May 11, 2017

Version in  عربي (Arabic),  Español (Spanish)

Much has been written about the relationship between inequality and economic development, but theory remains inconclusive. When income is more concentrated in the hands of a few individuals, this can lead to less demand by the general population and lower investment in education and health, impairing long-term growth. At the same time, a certain level of inequality endows the rich with the means to start businesses, and creates incentives to increase productivity and investment, promoting economic activity. But the initial inequality levels also matter to explain why an increase in inequality varies in its impact on economic development across countries.

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Fiscal Consolidation: Striking the Right Balance

The debate on austerity vs. growth has gained in intensity, as countries in Europe and elsewhere struggle with low growth, high debt, and rising unemployment. In essence, policymakers are being asked to tackle a continuation of the worst crisis since the Great Depression. This would be no easy task under any circumstances. But it is made considerably harder by the fact that a number of countries need to engage in fiscal consolidation simultaneously. Complicating the picture further is the fact that monetary policy in most advanced economies is approaching the limits of what it technically can do to stimulate activity, while global growth remains weak.

Mediocre Growth, High Risks, and The Long Road Ahead

Geopolitical tension affecting the oil market is surely a risk. The main risk remains, however, that of another acute crisis in Europe. The building of the “firewalls”, when it is completed, will represent major progress. By themselves, however, firewalls cannot solve the difficult fiscal, competitiveness, and growth issues that some of these countries face. Bad news on the macroeconomic or the political front still carries the risk of triggering the type of dynamics we saw last fall.

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