Inequality Is Untenable

• Author: Rodney Ramcharan
• Position: a Senior Economist in the IMF's African Department.

SHOULD policymakers care about rising inequality? Or should they focus on fostering growth in output—gross domestic product (GDP)—in the belief that a rising tide lifts all boats? Economic theory and a growing body of empirical evidence suggest that inequality should be an important policy concern.

A case in point is the United States: After emerging from recession in 1982, the United States enjoyed one of the longest periods of economic growth in the post–World War II era—marred by only two brief downturns in the early 1990s and 2001. But it was not a shared prosperity. Even as economic activity accelerated during the Internet boom of the 1990s, there were winners and losers. In fact, during the 25 years of boom between 1982 and the onset of the global economic crisis in 2007, inequality rose sharply in the United States. From 1980 to 2004, the aggregate share of after-tax income held by the top 10 percent of earners increased from 7.5 percent to 14 percent (CBO, 2006). But more specific data over a longer time span suggest a starker rise in inequality. In 1976, the top 1 percent of households accounted for just 9 percent of income in the United States; by 2007, that share rose to about 24 percent. Similarly, the Gini index—a common measure of inequality that is 0 if everyone has identical incomes and 1 if a single person has all the income—rose by about 25 percent during the same period.

Inequality is far worse in many countries than it is in the United States. South Africa also enjoyed robust growth from 2000 to 2005, but inequality worsened dramatically. During those five years, South Africa’s Gini index increased by about 12 percent to 0.58, making it one of the most unequal countries in the world.

The toll of risks

High inequality within a society can have significant economic and social costs both for individuals and, more broadly, for the society. Life is risky, and income inequality can determine how individuals manage risk. Business ventures can fail, and poor health can make it difficult to work. In a world with well developed capital markets—easily accessible banking systems and available insurance opportunities—individuals can insure themselves against misfortune, either through their own savings or by purchasing insurance contracts. But, as the recent debate over health care in the United States underscored, access to credit and insurance is imperfect in advanced economies. It is even more limited in less developed economies...