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Warning! Inequality May Be Hazardous to Your Growth

There is little question that growing income inequality is dangerous for democracy. Money as a form of "Freedom of Speech" is now firmly a part of  American law and its impact on swaying elections and passing bills is increasingly clear. However, it seems that the gap could also be bad for a country's economy. The more money that gets sucked out of the economy and into the accounts of the wealthiest classes, the smaller are the resources the country has with which to sustain growth times and bounce back in recessions.

In a recent note on the IMF Blog, shares research they did on the relationship between income and economic stability and found that countries that have a declining income gap (like Brazil) have longer booms and shorter busts. And countries with a widening income gap (like the US) are just the opposite: longer busts and shorter booms. Our experience in the recent sluggish recovery from the 2001 recession and non-recovery from the 2008 recession seem to support their research.

Here is an excerpt from the article, "Warning! Inequality May Be Hazardous to Your Growth," (Note that bold faced print was in the original.)
Some time ago, we became interested in long periods of high growth (“growth spells”) and what keeps them going. The initial thought was that sometimes crises happen when a “growth spell” comes to an end, as perhaps occurred with Japan in the 1990s. 
We approached the problem as a medical researcher might think of life expectancy, looking at age, weight, gender, smoking habits, etc. We do something similar, looking for what might bring long “growth spells” to an end by focusing on factors like political institutions, health and education, macroeconomic instability, debt, trade openness, and so on. 
Somewhat to our surprise, income inequality stood out in our analysis as a key driver of the duration of “growth spells”. 
We found that high “growth spells” were much more likely to end in countries with less equal income distributions. The effect is large. 
For example, we estimate that closing, say, half the inequality gap between Latin America and emerging Asia would more than double the expected duration of a “growth spell”. Inequality seemed to make a big difference almost no matter what other variables were in the model or exactly how we defined a “growth spell”.
Inequality is of course not the only thing that matters but, from our analysis, it clearly belongs in the “pantheon” of well-established growth factors such as the quality of political institutions or trade openness. 
While income distribution within a given country is pretty stable most of the time, it sometimes moves a lot. In addition to the United States in recent decades, we’ve also seen changes in China and many other countries. Brazil reduced inequality significantly from the early 1990s through a focused set of transfer programs that have become a model for many around the world. 
A reduction of the magnitude achieved by Brazil could—albeit with uncertainty about the precise effect—increase the expected length of a typical “growth spell” by about 50 percent. 
The upshot? It is a big mistake to separate analyses of growth and income distribution. A rising tide is still critical to lifting all boats. The implication of our analysis is that helping to raise the lowest boats may actually help to keep the tide rising!

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