Who Let the Gini Out?

AuthorDavide Furceri and Prakash Loungani

Income inequality is at historic highs. The richest 10 percent took home half of U.S. income in 2012, a division of spoils not seen in that country since the 1920s. In countries that belong to the Organisation for Economic Co-operation and Development, inequality increased more in the 3Â years up to 2010 than in the preceding 12. The recent increases come on top of growing inequality for more than two decades in many advanced economies.

What explains this rise? A number of factors are at play (Milanovic, 2011). Technological change in recent decades has conferred an advantage on those adept at working with computers and information technology. Global supply chains have moved low-skill tasks out of advanced economies. Thus the demand for highly skilled workers in advanced economies has increased, raising their incomes relative to those less skilled.

Our recent research uncovered two other contributors to increased inequality. The first is the opening up of capital markets to foreign entry and competition, referred to as capital account liberalization. The second source is policy actions by governments to lower their budget deficits. Such actions are referred to as fiscal consolidation in economists’ jargon and, by their critics, as “austerity” policies.

These results do not imply that countries should not undertake capital account liberalization or fiscal consolidation. After all, such policy actions are not taken on a whim, but reflect an assessment that they will benefit the economy. What the research suggests is that these benefits should be weighed against their distributional impact. In many cases governments may have the flexibility to design the policy actions in a way that mitigates the distributional impact. IMF Managing Director Christine Lagarde (2012) urges a “fiscal policy that focuses not only on efficiency, but also on equity, particularly on fairness in sharing the burden of adjustment, and on protecting the weak and vulnerable.”

Open to inequity

The past three decades have been associated with a steady decline in the number of restrictions that countries impose on cross-border financial transactions, as reported in the IMFâs Annual Report on Exchange Arrangements and Exchange Restrictions. An index of capital account openness constructed from these reports shows a solid increase—that is, restrictions on cross-border transactions have been steadily lifted. At the same time, there has been an increase in income...

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