Outgoing US President Barack Obama has named the reduction of economic inequality as the “defining challenge of our time”. This is true not only for the United States – the richest country and, at the same time, the one with the highest wealth inequality – but also for a large number of countries around the world, independent of their level of economic development. So, for instance, the average Gini coefficient of disposable household income across OECD countries reached its highest level since the mid-1980s, from 0.315 in 2010 to 0.318 in 2014 (OECD, 2016).
Extreme economic inequality is undesirable for many reasons. First and foremost, extreme income and wealth inequality is likely to jeopardize moral equality (“all people are created equal”), undermining the very basis of democratic societies. When a large share of wealth is in the hands of a few privileged people, equal access to nominally public goods such as education or an independent judicial system may not be guaranteed. As economic inequality may exacerbate inequality of opportunity, it is likely to solidify the social stratification and divisions in a country, making its society more prone to extremist political movements, as the recent US elections and other global political developments have shown. And second, pronounced economic inequality may contribute to the instability of the global macroeconomic system through the buildup of large imbalances either through excessively credit-financed consumption, as in the US, or through deficient domestic aggregate demand and oversized net exports, as in China and Germany.
For a long period, however, and partly due to the emergence of a large affluent middle class in the US and most industrialized countries, economic inequality was a second order issue in them. The emergence of the neoliberal era with Ronald Reagan and Margaret Thatcher, however, not only eroded many social institutions such as trade unions demanding a more equal distribution of income in those countries but significantly influenced the IMF’s perspective of the IMF from then on.
The poor performance of the IMF’s Washington Consensus policy prescriptions during that era is nowadays widely acknowledged. These were too much of a “one-size-fits-all’’ format, often ignoring important country-specific features. But an equally and maybe – from the current perspective – more important drawback of IMF economic policy prescriptions was the implicit assumption that the question of how the benefits of growth would be distributed was of second-order importance, with the poorer benefiting from higher growth through the trickle-down effect in the worst case.
During the 2000s the IMF’s view of its own past performance began to change, with the appointment of Olivier Blanchard as Chief Economist in September 2008 leading to a new era, especially in terms of research focus and output. During his tenure new research was undertaken which challenged orthodox policy prescriptions, often supported and propagated by the IMF previously, concerning for instance the asymmetric importance of countercyclical fiscal policy especially during recessions, as government spending multipliers are larger in contractions than in economic expansions, see e.g. Baum et al. (2012).
In this light, and because of the widening gaps in income and wealth distribution around the world, recent research by IMF officials has made a strong argument for the link between income inequality, private sector indebtedness and financial and macroeconomic instability (see e.g. Kumhof et al. 2015 and Ostry et al. 2016). Accordingly, substantial income inequality may not only jeopardize progress in education and health, leading even to political unrest, but act as an important drag on long-term economic growth owing to a lower accumulation of human capital and increased financial instability resulting from higher leverage across the economy, as the 2007-08 crisis illustrated only too clearly.
The aftermath of the subsequent Great Recession has also had important distributional effects. Apart from disastrous first-round labor markets, especially among low-skilled workers, that exacerbated the already sizeable income gaps in many economies, austerity measures meant to reduce higher government indebtedness also affected mainly those at the lower end of the income scale (see e.g. Ball et al. 2013). In this context, a new focus of the IMF on the reduction of income inequality would thus imply a change in its position in future debt renegotiations, looking more at the social and distributive consequences of its stipulations, and less at the creditor’s interests, than in the past. That the IMF management has been insisting on debt relief for Greece since the summer of 2015 may be a sign of a real paradigm shift.
Given the current Zeitgeist and the strong media presence of grass-roots movements such as Spain’s indignados (from which PODEMOS emerged), as well as the rise of extremist right-wing parties in many countries, ignoring the current excessive economic inequality comparable to that during the Gilded Age would be more than short-sighted: it could even lead to a further political polarization. Much speaks for the paradigm intellectual shift taking place at the IMF, towards a more inclusive and equitable economic policy orientation. How much of this progressive thinking is translated into consistent policy prescriptions in the years ahead will be defining for the IMF’s role in this new geopolitical landscape.
Christian R. Proaño was born in 1980 in Quito, Ecuador. He studied Economics at the Catholic University Ecuador (PUCE) and at Bielefeld University, subsequent promotion in 2008. From 2008 until 2010 he was research economist at the Macroeconomic Policy Institute (IMK) in the Hans-Böckler Foundation in Düsseldorf. From 2010 until 2015 Assistant Professor of Economics at the New School for Social Research in New York, NY. Since May 2015 holder of the Professorship for Economics, especially Empirical Economics at the Otto-Friedrich-University Bamberg in Germany. He is co-author of more than 30 articles in peer-reviewed academic journals such as Journal of Economic Dynamics and Control, Journal of Economic Behavior and Organization, Journal of International Money and Finance, Journal of Applied Econometrics, among others, various books on macroeconomic theory and numerous additional publications.