Pursuing inclusive growth

João Tovar Jalles, Luiz de Mello 22 October 2020

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The specific channels through which growth and income distribution are related are complex and often difficult to disentangle empirically. Of particular interest is the experience of countries that manage to sustain spells of uninterrupted output growth without a concomitant deterioration in the interpersonal distribution of income. 

In fact, data from the World Bank World Development Indicators show that inclusive growth is not a rare event: between 1980 and 2013, there are 268 episodes of increases in GDP per capita without an associated deterioration in the distribution of household disposable income in the sample of up to 78 countries for which information is available. These episodes include, for instance, France between 1985 and 1989, Germany between 1995 and 1997, Brazil between 2004 and 2006, and India between 1998 and 2000. 

When the distribution of income is considered worldwide rather than within countries, global output growth has been accompanied by a gradual reduction in global income inequality (Milanovic 2020).

Inclusive growth can also be sustained over time. The average duration of episodes in our chronology is 2.5 years. Most episodes last one year (Figure 1), but longer ones, spanning five years or more, are not infrequent. 

Figure 1 Frequency of inclusive growth episodes: Number of episodes by duration (in years)

Source: Authors’ calculations.

In an average episode, real GDP per capita grows at about 3.3% per year, and the Gini coefficient of household disposable income falls by about 0.8 over the same period. While duration does not seem to have much influence on the magnitude of changes in real GDP per capita during inclusive growth episodes, the reduction in the Gini coefficient tends to be more pronounced in episodes that last four years or less (Figure 2).

Figure 2 Magnitude of inclusive growth episodes: Average change in real GDP per capita (top panel) and the Gini coefficient (bottom panel) by duration (in years)

   

Source: Authors’ calculations.

What makes an inclusive growth episode more likely to occur?

Based on this chronology, we looked at the country and time variation in the data to identify the main determinants of the likelihood that an inclusive growth episode occurs (Jalles and de Mello 2019). Empirical evidence in the same vein includes Anand et al. (2013), who estimate panel regressions using a broad sample of countries during 1970–2010 and highlight the importance of education, investment, and trade openness as determinants of inclusive growth. Atkinson and Brandolini (2010) and Dollar et al. (2015) rely on a social-welfare approach to relate changes in inequality and growth using large sets of cross-country aggregate data. Hermansen et al. (2016) and Causa et al. (2016) focus on the joint estimation of the distributional effects of a variety of stylised structural (supply-side) reforms in OECD countries. They find that the benefits of growth do trickle down, albeit differently, to different social groups.

We find that inclusive growth episodes are more likely to occur where the population is better educated, tax-benefit systems are more redistributive, labour force participation and multifactor productivity growth are higher, and economies are more open to trade. 

The duration of inclusive growth episodes matters: the longer a country can sustain inclusive growth, the higher the probability that an episode occurs. Economic development also matters, with increases in the share of the population working in industry (but not in agriculture) improving the likelihood that an inclusive growth episode takes place. 

Conversely, inclusive growth episodes are less likely where inflation is high, output growth is more volatile, and unemployment is more widespread. All these findings are intuitive and point to the importance of policy as a driver of growth inclusiveness.

There is some heterogeneity in the drivers of growth inclusiveness across countries that poses challenges in designing development policies. Less-developed countries have a lower probability that an inclusive growth episode occurs, even though the efficiency-equity trade-off is likely to be stronger the closer a country is to the technological frontier (Acemoglu et al. 2012, Andersen and Maibom 2016).

Cross-country heterogeneity is related in part to institutions (a structural factor). Inclusive growth episodes are more likely in countries with durable political systems, regular parliamentary elections, and electoral regimes based on proportional representation. Interestingly, while policy continuity is important – many pro-growth and distribution-friendly policies take time to bear fruit – it is not the durability of governments per se but of political regimes that seems to matter. 

Likewise, electoral systems seem to affect the likelihood of growth inclusiveness, possibly related to the size of government, which tends to be larger under proportional representation than majority systems, therefore allowing for higher redistributive social spending. Some degree of fiscal decentralisation also helps, possibly because policymakers are better equipped to extract information about local preferences and needs and to reflect them in policy design when making decisions in a more decentralised, rather than centralised, setting.

Other structural factors play a role. Financial deepening, as reflected in an increase in different measures of the stock of credit in the economy, reduces the probability of an inclusive growth episode. This is probably because of its association with a higher probability of banking and financial crises occurring, which are in turn detrimental to growth and improvements in the distribution of income.

Implications for policy

The empirical findings are in line with mainstream thinking. They underscore the importance of redistribution through tax-benefit systems, human capital accumulation, and a sound macroeconomic framework. Where positive effects have been found, specific policy levers can be considered ‘super pro-poor’ to the extent that they can generate inclusive growth by delivering stronger growth with improvements in income distribution. 

In a context where the COVID-19 pandemic is at the centre of everyone’s concerns, government policies would be effective in increasing economic resilience and mitigating distributional consequences since, as recent research has shown, major epidemics in this century have raised income inequality (Furceri et al. 2020). 

The main benefit of further empirical analysis in this area is to provide a better understanding of corrective measures when equity-efficiency trade-offs are identified.

References

Acemoglu, D, J A Robinson and T Verdier (2012), “Why can’t we all be more like Scandinavians? Asymmetric growth and institutions in an interdependent world”, NBER Working Paper 1841.

Anand, R, S Mishra and S J Peiris (2013), “Inclusive growth revisited: Measurement and determinants”, Economic Premise, No. 122, Washington DC: World Bank.

Andersen, T M, and J Maibom (2016), “The big trade‐off between efficiency and equity: Is it there?”, CEPR Discussion Paper 11189.

Atkinson, A B, and A Brandolini (2010), “On analyzing the world distribution of income”, World Bank Economic Review 24(1): 1–37.

Causa, O, M Hermansen and N Ruiz (2016), “The distributional impact of pro‐growth reforms”, OECD Economics Department Working Papers 1342.

Dollar, D, T Kleineberg and A Kraay (2015), “Growth, inequality and social welfare: Cross-country evidence”, Economic Policy 30: 335–77.

Furceri, D, P Loungani, J D Ostry and P Pizzuto (2020), “Will Covid-19 affect inequality? Evidence from past pandemics”, Covid Economics 12: 138–57.

Hermansen, M, N Ruiz and O Causa (2016), “The distribution of the growth dividend”, OECD Economics Department Working Papers 1343.

Jalles, J T, and L de Mello (2019), “Cross-country evidence on the determinants of inclusive growth episodes”, Review of Development Economics 23: 1818–39.

Milanovic, B (2020), “Elephant who lost its trunk: Continued growth in Asia, but the slowdown in top 1% growth after the financial crisis”, VoxEU.org, 6 October.

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Topics:  Poverty and income inequality

Tags:  GDP, growth, inclusion, inclusive growth, Income distribution, Inequality

Assistant Professor of Economics, University of Lisbon

Director, OECD Economics Department

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